UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997 Commission file number 0-21835
SUN HYDRAULICS CORPORATION
--------------------------
(Exact Name of Registration as Specified in its Charter)
FLORIDA 59-2754337
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1500 WEST UNIVERSITY PARKWAY 34243
SARASOTA, FLORIDA -----
----------------- (Zip Code)
(Address of Principal Executive Offices)
941/362-1200
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(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $.001 per share
---------------------------------------------------
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant on March 25, 1998, was $43,727,683 based upon the reported closing
sale price of such shares on the Nasdaq Stock Market's National Market for that
date. As of March 25, 1998, there were 6,325,922 shares outstanding.
1
PART I
ITEM 1. BUSINESS
Certain statements contained in this "Item 1. Business" that are not historical
facts are "forward-looking statements" within the meaning of Section 21E of the
Securities Exchange Act of 1934. See "Item 7. Forward-Looking Information."
OVERVIEW
The Company is a leading designer and manufacturer of high-performance,
screw-in hydraulic cartridge valves and manifolds which control force, speed and
motion as integral components in fluid power systems. The innovative floating
construction of the Company's screw-in cartridge valves provides demonstrable
performance and reliability advantages compared to other available screw-in
cartridge valves. Screw-in cartridge valves are an increasingly accepted
alternative to conventional forms of hydraulic valving, offering significant
design flexibility, as well as substantial size, weight and efficiency benefits
afforded to designers of fluid power systems. Since the introduction of screw-in
hydraulic cartridge valves in the late 1950s, management believes manufacturers
of these and similar products have captured approximately $550 - 600 million of
the worldwide market for all non-aerospace hydraulic valves and manifolds, which
management believes to be in excess of $3 billion. The Company has generated a
profit each year since 1972. The Company believes that its success is primarily
a result of its innovative product design, consistent high quality and superior
product performance.
Fluid power involves the transfer and control of power through fluids
under pressure. Fluid power systems are integral to a wide variety of
manufacturing, material handling, agricultural and construction equipment. Due
to its mechanical advantage, fluid power is widely employed to move and position
materials, control machines, vehicles and equipment, and improve industrial
efficiency and productivity. Fluid power systems typically are comprised of
valves and manifolds that control the flow of fluids, a pump that generates
pressure and actuators such as cylinders and motors that translate pressure into
mechanical energy.
The Company designs and manufactures one of the most comprehensive lines
of screw-in hydraulic cartridge valves in the world. These valves control
direction, pressure, flow and loads, are available in up to five size ranges,
and are suitable for flows from 5 to 400 gallons per minute and continuous
operating pressures up to 5,000 pounds per square inch. The floating
construction pioneered by the Company provides demonstrable performance and
reliability advantages compared to competitors' product offerings due to its
self-alignment characteristic that accommodates potential manufacturing
deviations common in the thread-making operations of screw-in cartridge valves
and manifolds. This floating construction significantly differentiates the
Company from most of its competitors, who design and manufacture rigid screw-in
cartridge valves that fit an industry common cavity. The Company believes that
competitors'
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products typically do not offer the inherent reliability of the Company's
products and cannot provide equivalent operating performance because of the
design constraints imposed by the industry common cavity.
The Company also designs and manufactures the most comprehensive line of
standard manifolds in the world. A manifold is a solid block of metal, usually
aluminum, steel or ductile iron, which is machined to create threaded cavities
and channels into which screw-in cartridge valves are installed and through
which the hydraulic fluids flow. Fluid power engineers can package standard or
customized manifolds with screw-in cartridge valves to create
application-specific, multiple-function hydraulic control systems that are safe,
reliable and provide greater control. In 1997, screw-in cartridge valves
accounted for approximately 75% of the Company's net sales while standard and
custom manifolds accounted for approximately 25% of net sales.
The Company sells its products primarily through a global network of
independent fluid power distributors to a diverse universe of end users, for use
in various "mobile" applications, such as construction, agricultural and utility
equipment (approximately 68% of net sales), and a broad array of "industrial"
applications, such as machine tools and material handling equipment
(approximately 32% of net sales). Sales to the Company's largest distributor
represented approximately 6% of net sales in 1997, and the Company believes that
aggregate sales by its distributors to the largest end user represented less
than 3% of net sales in 1997.
The Company believes that screw-in cartridge valves will continue to
achieve significant growth at the expense of conventional hydraulic valves as
design engineers recognize the inherent advantages of screw-in cartridge valves.
The Company believes that additional growth potential for screw-in cartridge
valve applications exists as a result of a trend toward miniaturization as end
users require smaller, lighter-weight and more efficient components. Custom
manifolds that utilize screw-in cartridge valves allow customers to design an
optimal solution for control of their fluid power systems that significantly
reduces assembly time and expense. The United States and Western Europe are the
largest developed markets for screw-in cartridge valves, and the Company
believes the long-term future growth prospects are particularly attractive in
the Pacific Rim, Eastern Europe and India where the adoption of screw-in
cartridge valves is in the early stage. In 1997, approximately 35% of the
Company's net sales were outside the United States.
Management believes that the Company's success during its 28-year history
is due in large part to its emphasis on innovative product designs and
vertically integrated, state of the art manufacturing processes. Management
attributes the Company's ability to continuously implement process improvements
to its horizontal management structure that encourages employee contribution at
all levels. The Company does not have a formal organizational chart and employee
responsibilities are not derived from titles or narrow job descriptions. This
management philosophy is utilized throughout the Company's operations.
3
The Company was organized as a Florida corporation in 1986 to take over
the operations of the business of the Company's predecessor, Suninco, Inc.
(f/k/a Sun Hydraulics Corporation) which was founded in 1970 by Robert E. Koski
for the specific purpose of developing and promoting screw-in cartridge valve
technology. The address of the Company's executive offices is 1500 West
University Parkway, Sarasota, Florida 34243 and its telephone number is (941)
362-1200.
On June 28, 1996, Suninco, Inc. was merged into the Company. Prior to the
merger, the Company and Suninco were controlled by the same group of
stockholders and were operated as a common enterprise, with Suninco as the owner
and lessor of the Company's Sarasota, Florida, manufacturing plant and certain
equipment utilized by the Company at that location. See "Item 13. Certain
Relationships and Related Transactions - Suninco Merger." Immediately prior to
the Company's initial public offering of Common Stock in January 1997, the
Company acquired all of the outstanding shares of capital stock of Sun Hydraulik
Holdings Limited, a private limited company organized under the Laws of England
and Wales ("SHHL"), pursuant to an exchange offer made by the Company to all of
the stockholders of SHHL. See "Item 13. Certain Relationships and Related
Transactions Reorganization with Sun Hydraulik Holdings Limited."
INDUSTRY BACKGROUND
Fluid power is one of three basic technologies, along with electrical and
mechanical, utilized to achieve power transmission and motion control. Due to
its mechanical advantage, fluid power is widely employed to move and position
materials, control machines, vehicles and equipment, and improve industrial
efficiency and productivity. Fluid power can perform work on very light loads
with a high degree of accuracy or develop enormous forces to move and position
materials and equipment that weigh many tons. As a result, fluid power systems
are integral to a wide variety of manufacturing, material handling, agricultural
and construction equipment. Fluid power systems typically are comprised of
valves and manifolds that control the flow of fluids, a pump to generate fluid
pressure, and actuators, such as cylinders and rotary motors, to translate
pressure into mechanical energy.
Screw-in hydraulic cartridge valves first appeared in the late 1950s as an
alternative to conventional forms of hydraulic valving. Conventional hydraulic
valves are generally larger in size, typically manufactured from cumbersome iron
castings, relatively inflexible in their ability to interface with machinery and
equipment, and are usually simple devices designed to control a single task.
Screw-in cartridge valves represent a miniaturization of hydraulic valves,
providing the same functional characteristics as conventional valves, but in a
smaller package size. In addition to being lighter-weight and more compact,
screw-in cartridge valves frequently offer significant advantages in interface
flexibility and cost over conventional hydraulic valves.
Screw-in cartridge valves have achieved greater marketplace acceptance in
recent years as hydraulic system design engineers increasingly use them to
develop
4
multiple-function control systems. A number of screw-in cartridge valves can be
grouped together in a manifold, creating a hydraulic control system that is
functionally analogous to an electronic integrated circuit. The Company's
breadth of products offers many custom "packaging" opportunities that allow
design engineers to create custom, application-specific solutions using the
Company's cataloged "off-the-shelf" screw-in cartridge valves and related
components. End users can utilize screw-in valves and custom manifolds to design
an optimal solution for control of their fluid power systems that significantly
reduces assembly time and expense.
The Company estimates the global market for non-aerospace hydraulic valves
to be in excess of $3 billion, and believes that manufacturers of screw-in
hydraulic cartridge valves and manifolds and similar products have captured
approximately $550 - $600 million of the total market. The United States and
Western Europe are the largest developed markets for screw-in cartridge valves,
and the Company believes that the long-term future growth prospects are
particularly attractive in the Pacific Rim, Eastern Europe and India, where the
adoption of screw-in cartridge technology is in the early stage.
STRATEGY
The Company's objective is to enhance its position as one of the world's
leading designers and manufacturers of screw-in hydraulic cartridge valves by
(i) broadening the market for screw-in cartridge valve applications, (ii)
continuing the geographic expansion of its markets, and (iii) selectively
expanding its product lines. Key elements of the Company's strategy include the
following:
Deliver Value Through High-Quality, High-Performance Products. The
Company's products are designed with operating and performance characteristics
that typically exceed those of functionally similar products. Overall, the
Company's products provide high value because they generally operate at higher
flow rates and pressures than competitive offerings of the same size. The
Company tests 100% of its screw-in cartridge valves to ensure the highest level
of performance on a consistent basis.
Offer a Wide Variety of "Off-the-Shelf" Products. The Company currently
offers one of the most comprehensive lines of screw-in cartridge valves in the
world. The Company is committed to producing functionally superior, cataloged
products that contain a high degree of common content to minimize work in
process and maximize manufacturing efficiency. Products are designed for use by
a broad base of industries to minimize the risk of dependence on any single
market segment or customer. The Company, in the future, will seek to expand its
business through development of products that are complementary to its existing
products.
Capitalize on Custom Manifold Opportunities. Because fluid power system
design engineers are increasingly incorporating screw-in cartridge valves into
custom control systems, the Company will concentrate its efforts in the custom
manifold market in two ways, (i) by designing and manufacturing manifolds which
incorporate the
5
Company's screw-in cartridge valves for sale to original equipment manufacturers
("OEMs"), and (ii) by encouraging competitive manifold manufacturers to utilize
the Company's screw-in cartridge valves in their manifold designs. The Company's
internally developed, proprietary expert system software allows the Company to
efficiently design and manufacture smaller, more efficient manifolds in low
quantities. The Company provides free software to aid manifold designers in
designing the Company's unique cavity into their manifolds and sells tooling at
cost for machining its cavities, allowing independent manifold manufacturers
easily to incorporate the Company's screw-in cartridge valves into their
designs. In March 1997, the Company commenced operations in a new 60,000 square
foot factory in Sarasota, Florida, that houses all of the United States standard
and custom manifold manufacturing operations.
Expand Global Presence. The Company intends to continue to increase its
global presence through expansion of its distribution network and its
international manufacturing capabilities. Key areas for expansion where the
Company has minimal presence include Central and South America, China and
Eastern Europe. In addition to operating units in Germany and England, the
Company has strong distributor representation in most developed and developing
markets, including Western Europe, Taiwan, Korea, Singapore, Australia, India
and Japan. In 1997, the Company generated approximately 35% of its net sales
outside the United States. The Company believes that further expansion of its
international manufacturing facilities could enhance its competitive position in
certain foreign markets. In addition, custom manifolds provide an opportunity
for distributors to offer significant local-added content through the local
production of manifolds that incorporate the Company's screw-in cartridge
valves. This strategy helps minimize potential tariffs and duties that could
inflate the price of the Company's products in foreign markets.
Maintain a Horizontal Organization with Entrepreneurial Spirit. The
Company believes that maintaining its horizontal management structure is
critical to retaining key personnel and an important factor in attracting top
talent from within the hydraulic valve and manifold industry. The Company will
strive to maintain its horizontal management structure that encourages
communication, creativity, an entrepreneurial spirit and individual
responsibility among employees. Employee initiatives have led to continuous
process improvement, resulting in considerable operating efficiencies and
quality control, as well as the maintenance of a safe and comfortable working
environment. The Company believes that a lack of job titles and direct formal
reporting responsibilities eliminates perceived barriers to advancement and
reduces the potential for adversarial relationships to arise within the
organization. A workplace without walls in the Company's offices as well as on
the shop floor encourages informal employee consultation and provides the
opportunity for all personnel to interface across functional areas.
Leverage Manufacturing Capability and Know-how as Competitive Advantages.
The Company believes one of its competitive advantages is its ability to
manufacture products to demanding specifications. The Company's strong process
capability allows
6
it to machine parts to exacting dimensional tolerances, resulting in the high
performance characteristics of its screw-in cartridge valves. The Company has
the ability to control manufacturing processes to replicate products
consistently and can, if it desires, manufacture all components of its products
with the exception of springs and elastomer seals. Additionally, the Company has
in-house heat treatment capability to provide consistent and reliable control of
this critical operation.
Sell Through Distributors, Market to End Users. Due to the variety of
potential customers and the Company's desire to avoid unnecessary bureaucracy,
the sales function has been performed primarily by independent distributors. The
Company currently has approximately 63 distributors, 40 of which are located
outside the United States and a majority of which have strong technical
backgrounds or capabilities which enable them to develop practical, efficient
and cost-effective fluid power systems for their customers. The Company provides
a high level of technical support to its distributors through open access to the
Company's engineering staff, catalogs, technical documents and technical
training programs. In addition, the Company maintains close relationships with
many OEMs and end users of its products to understand and predict future needs
for fluid power control devices and to test and refine new product offerings.
PRODUCTS
The Company's products are integral components in fluid power systems for
both "mobile" applications, such as construction, agricultural and utility
equipment (approximately 68% of net sales) and a broad array of "industrial"
applications, such as machine tools and material handling equipment
(approximately 32% of net sales). In 1997, screw-in cartridge valves accounted
for approximately 75% of the Company's net sales while standard and custom
manifolds accounted for approximately 25% of net sales.
Screw-in Cartridge Valves
The Company designs and manufactures high-performance, screw-in hydraulic
cartridge valves in up to five size ranges, suitable for flows from 5 to 400
gallons per minute and continuous operating pressures up to 5,000 pounds per
square inch. The floating construction pioneered by the Company provides
demonstrable performance and reliability advantages compared to competitors'
product offerings due to its self-alignment characteristic that accommodates
potential manufacturing deviations common in the thread-making operations of
screw-in cartridge valves and manifolds. This floating construction
significantly differentiates the Company from most of its competitors, who
design and manufacture rigid screw-in cartridge valves that fit an industry
common cavity. The floating construction of the Company's screw-in cartridge
valves eliminates the tendency of working parts inside rigid cartridge valves to
bind when screwed into the manifold, which leads to unnecessary stress and often
premature failure.
7
The Company has developed new market opportunities by scaling its screw-in
cartridge valves to accommodate application requirements with various flow
ranges. Management believes that the series zero valve introduced in 1996 will
allow the Company to gain entry to new market applications which it previously
had not been able to serve, including fork lift trucks and food processing
equipment, factory automation and robotics. The Company believes that scaling
involves minimal risk, as many manufacturing processes are already proven.
Future upward scaling of the product line is currently under review.
The Company manufactures screw-in cartridge valves for load control,
pressure control, flow control and logic and directional control, with a broad
range of other unique functional offerings. Many variants of the same basic
functional products can be interchanged with each other to attain an optimum
level of performance in a customer's fluid power system. The Company's screw-in
cartridge valves are described below:
Load Control Valves. The Company considers itself to be the world's
recognized leader in the design and manufacture of load control valves and
believes that it holds a dominant market share position in multiple end
use applications. Load control valves are pressure devices that are used
to control the motion and locking of linear and rotary hydraulic actuators
(cylinders and motors) and often are used as safety devices in many
critical system areas. Typical applications for these products include
cranes, manlifts and aerial platforms. The uncompromising requirement for
smooth and reliable operation in these applications has helped build the
Company's reputation as a high quality, screw-in cartridge valve
manufacturer. Load control valves represent the Company's largest selling
product family.
Pressure Control Valves. The Company manufactures screw-in cartridge
valves for limiting or regulating fluid pressure. Types of pressure
controls include relief valves, reducing valves, reducing/relieving valves
and sequence valves, each available in many variants and configurations.
Most hydraulic systems incorporate at least one pressure relief valve for
over-pressure protection.
Flow Control Valves. The Company manufactures a variety of two-,
three- and four-port valves to control the rate of flow of fluids in fluid
power systems. These valves typically are used to control speed and are an
integral component in most fluid power systems. Variety and high flow
capacity relative to physical size help differentiate the Company in this
product area.
Logic and Directional Control Valves. The Company manufactures a
variety of screw-in cartridge valves that can be used as directional
control devices. These valves are used to start, direct and stop the flow
of fluid in a fluid power system and can be actuated electrically,
manually or with hydraulic pressure. The Company's logic control valves,
some of which are patented, can be used in combination with one another to
provide complex directional control functions. The Company also
manufactures high-pressure spool-type solenoid
8
valves and other pilot devices that can be used to actuate other screw-in
cartridge valves that the Company manufactures.
Other Products. The Company designs and manufactures a broad array
of screw-in cartridge valves that can be used in combination with other
Company products to offer useful and unique functionality. For example,
the Company's Air-Bleed and Start-Up cartridge valves help protect a fluid
power system from potential damage by releasing air trapped in the system
when a machine is shut down for maintenance. Many of these functional
products are not manufactured by any other competitors, providing the
Company with additional sales opportunities. While these products are not
generally demanded in high volumes, their usefulness across industries
helps strengthen the Company's brand name and market penetration.
Manifolds
A manifold is a solid block of metal, usually aluminum or ductile iron,
which is machined to create threaded cavities and channels into which screw-in
cartridge valves can be installed and through which the hydraulic fluid flows.
The manifolds manufactured by the Company are described below:
Standard Manifolds. The variety of standard, cataloged manifolds offered
by the Company is unmatched by any screw-in cartridge valve competitor.
These products allow customers easily to interface the Company's screw-in
cartridge valves into their systems in many different ways. Once designed,
standard manifolds require minimal, if any, maintenance engineering over
the life of the product. The following are the types of standard manifolds
manufactured by the Company:
- Line Mounted Manifolds can be placed anywhere in a hydraulic system
and are easily connected to various standard couplings. These
specific products are suitable for both mobile and industrial
applications.
- Subplates and Sandwich Manifolds are offered in five different sizes
and industry standard interface patterns and generally are used in
industrial applications. The Company believes that the breadth of
different functional screw-in cartridge valves it manufactures
allows it to offer more functionally unique standard sandwich
manifolds than any other cartridge valve or conventional valve
manufacturer.
- Motor Mount Manifolds fit a variety of the most common commercially
available hydraulic motor interface patterns. These products allow
users of hydraulic motors to buy standard control elements to
interface simply and easily with their motors.
9
- Pre-packaged Valve Assemblies are pre-configured packages designed
to control common hydraulic circuits such as hydrostatic drives,
accumulator unloading and cylinder regeneration. These products
typically contain at least two dissimilar cartridges and allow
designers to conveniently purchase a valve package for common
hydraulic circuit requirements.
Custom Manifolds. Custom manifolds are designed for a customer-specific
application and typically combine many different screw-in cartridge valves
in a single package. The Company's internally developed, proprietary
expert system software design allows the Company to design and manufacture
manifolds efficiently in low volumes. The innovative design of the
Company's screw-in cartridge valves allows manifolds to be physically
smaller than similar functional manifolds that contain competitors
screw-in cartridges, given that flow capacities are equal. Custom
manifolds provide many benefits, including reduced leakage points, neater
packaging, potentially fewer hose and fitting connections, and more
control functions in a single location.
ENGINEERING
The Company believes that it is critical for engineers to play an
important role in all aspects of the Company's business, including design,
manufacturing, sales and marketing and technical support. When designing
products, engineers work within a disciplined set of design parameters that
often results in repeated incorporation of existing screw-in cartridge valve
components in new functional products. The Company's focus on engineering has
served as the foundation of its ability to offer the expansive range of screw-in
cartridge valves that it brings to market.
Before designing functionally new screw-in cartridge valves, the Company's
engineers and sales and marketing personnel first establish performance and
operating requirements for the products. An iterative design process is
undertaken to meet the expected performance requirements in a screw-in cartridge
valve that fits the Company's cavity. Prototypes are typically hand built and
subject to extensive testing until the desired performance levels are achieved.
Before a new product is released for sale, the Company's engineers will work
with beta site customers to test the product under actual field conditions.
During product development, engineers work closely with manufacturing
personnel to define the processes required to manufacture the product reliably
and consistently. The close link between engineering and manufacturing helps to
smooth transition from design to market. Design changes to facilitate
manufacturing processes are rarely considered if performance levels would be
compromised. The Company practices a continuous improvement process, and at
various times the Company may incorporate design changes in a product to improve
its performance or life expectancy. All of the Company's engineers provide
application support to customers and distributors.
10
MANUFACTURING
The Company is a process intensive manufacturing operation that
extensively utilizes state of the art computer numerically controlled ("CNC")
machinery to manufacture its products. Where commercial machinery is not
available for specific manufacturing or assembly operations, the Company often
designs and builds its own machinery to perform these tasks. The Company makes
extensive use of automated handling and assembly technology (robotics) where
possible to perform repetitive tasks, thus promoting manufacturing efficiencies
and workplace safety. The Company has its own electric heat treatment furnace to
provide consistent and reliable control of this important operation.
The Company's manufacturing operations include turning, grinding, honing
and lapping operations for its screw-in cartridge valves and milling and
drilling operations for its manifolds. Most machinery employed by the Company is
computer numerically controlled, including CNC lathes and machining centers. The
Company also employs robots, including programmable and traditional pick and
place units, and a variety of vision systems for inspection and decision making
tasks. In its manifold manufacturing operations in Florida and England, the
Company utilizes internally developed, proprietary personal computer based
software to program machines off-line and to minimize setup times. This expert
system also helps the Company to utilize compound angle holes in its manifold
designs, a technique that allows manifolds to be made smaller in size with fewer
potential leak points.
At its Sarasota, Florida, cartridge valve plant, the Company has extensive
testing facilities that allow its design engineers to test fully all cartridge
valve products at their maximum rated pressure and flow rates. A metallurgist
and complete metallurgical laboratory support the Company's design engineers and
in-house heat treatment facility. Test equipment also is utilized by the
resident engineers at the Company's plants in England and Germany.
The Company employs a build-to-order philosophy and relies on its
distributors to purchase and maintain sufficient inventory to meet their
customers' demands. On the front end, most raw materials are delivered on a
just-in-time basis, with a one-day supply of aluminum and a five-day supply of
steel held in plant. These and other raw materials are commercially available
from multiple sources.
The Company's ability to machine components to exacting tolerances makes
it difficult for competitors to offer products of equal performance. The Company
controls most critical finishing processes in-house but does rely on a small
network of outside manufacturers to machine cartridge components to varying
degrees of completeness. Many high volume machining operations are performed
exclusively at outside vendors. The Company is very selective in establishing
its vendor base and develops long-term relationships with vendors. The Company
is capable of machining all parts of its cartridge valves and manifolds in
house, except elastomer seals and springs.
11
Manufacturing processes at the existing facilities in the United States and
England have been certified to ISO 9002 since 1993.
The Company's operations involve the handling and use of substances that
are subject to federal, state and local environmental laws and regulations that
impose limitations on the discharge of pollutants into the soil, air and water
and establish standards for their storage and disposal. The Company believes
that it is in material compliance with all of such laws. Compliance with such
laws and regulations has not had, and is not expected to have, any material
adverse effect on the Company's earnings or competitive position. The Company
has not been required to make any material capital expenditures, nor does it
expect to have to make any material capital expenditures in connection with its
compliance with such laws and regulations.
SALES AND MARKETING
The Company's products are sold globally primarily through independent
fluid power distributors. Distributors are supported with product education
programs conducted by the Company at its facilities. Technical support is
provided by each of the Company's manufacturing operations (Florida, England and
Germany), with two additional regional support offices in the United States.
Included in the Company's sales and marketing staff are hydraulic engineers that
have significant experience in the fluid power industry. Discount pricing
structures encourage distributors to buy in moderate to high volumes to ensure
there is a local inventory of products in the marketplace. Domestic distributors
are rewarded with additional pricing discounts if payments are received within
10 days of invoicing, helping to establish lower accounts receivable cycle
times. The Company does not grant extended payment terms to distributors. The
Company has an exchange policy which encourages distributors to return standard
screw-in cartridge valves and standard manifolds for which they do not have a
current need. All inventory exchanges must be approved by the Company, and a
distributor's quarterly total list price value of inventory exchanges generally
is not permitted to exceed 2% of the distributor's prior year's annual
shipments, up to a maximum of $50,000.
The Company currently has approximately 63 distributors, 40 of which are
located outside the United States and a majority of which have strong technical
backgrounds or capabilities which enable them to develop practical, efficient
and cost-effective fluid power systems for their customers. Sales to the
Company's largest distributor represented approximately 6% of net sales in 1997
and approximately 34% of the Company's net sales were outside of the United
States in 1997.
In addition to distributors, the Company sells directly to other companies
within the hydraulic industry under a pricing program that does not undermine
the primary distributors' efforts. Companies that participate in this program
must utilize the Company's products in a value-added application, integrating
the Company's screw-in cartridge valves into other fluid power products of their
manufacture. Management believes this strategy strengthens the Company by
encouraging other manufacturers to
12
buy from the Company instead of competing with it. The "goodwill" relationships
that result from this strategy also help to keep the Company abreast of
technological advances within the fluid power industry, aiding in new product
development. In 1997, direct sales to other fluid power component manufacturers
accounted for approximately 3.5% of net sales.
While the Company generally does not sell directly to end users, it
markets directly to end users with catalogs that typically include suggested
list prices along with suggested customer discounts. This program is intended to
provide design engineers with all the necessary information that is required to
specify and obtain the Company's products. Since the average price for a single
screw-in cartridge valve is about $20 and the typical order from an end user is
for a relatively small quantity, the Company recognizes that its products are
often "bought" and not "sold." Publishing and distributing technically
comprehensive catalogs makes the Company's products easy to purchase. The
Company believes that publishing prices helps to maintain the Company's pricing
strategy.
CUSTOMERS
The Company typically mails its catalogs to more than 15,000 potential end
users in the United States and Canada. Overseas marketing and catalog
distribution is executed primarily through distributors. The Company believes
that its single largest end use customer represented less than 3% of net sales
in 1997, minimizing risks of dependence on major customers. The loss of any one
customer would not have a material adverse effect on the Company's business. End
users are classified by whether their primary applications for the Company's
products are "mobile" or "industrial."
Mobile applications involve equipment that generally is not fixed in
place, such as construction, agricultural and utility equipment. Mobile
customers were the original users of screw-in cartridge valves due to the
premium that these industries place on considerations of space, weight and cost.
Mobile customers currently account for approximately 68% of the Company's net
sales.
Industrial applications involve equipment that generally is fixed in place
in factories or processing plants. Examples include presses, injection molding
equipment and machine tools. The requirements of the industrial marketplace are
more demanding than most mobile applications since industrial equipment
typically operates at significantly higher cycles. The Company's products are
designed to withstand these operating imperatives, and industrial applications
currently account for approximately 32% of the Company's net sales. Many
conventional valve designs still are used in industrial applications and
represent substitution opportunities for the Company's products.
The Company's distributors are not authorized to approve the use of its
products in any of the following applications, (i) any product that comes under
the Federal
13
Highway Safety Act, such as steering or braking systems for passenger-carrying
vehicles or on-highway trucks, (ii) aircraft or space vehicles, (iii) ordnance
equipment, (iv) life support equipment, and (v) any product that, when sold,
would be subject to the rules and regulations of the United States Nuclear
Regulatory Commission. These "application limitations" have alleviated the need
for the Company to maintain the internal bureaucracy necessary to conduct
business in these market segments.
COMPETITION
The hydraulic valve industry is highly fragmented and intensely
competitive. The Company has a large number of competitors, some of which are
full-line producers and others that are niche suppliers like the Company. Most
competitors market globally. Full-line producers have the ability to provide
total hydraulic systems to customers, including components functionally similar
to those manufactured by the Company. There has been some consolidation activity
in recent years, with large, full-line producers filling out their product lines
by acquiring, or entering into relationship with, smaller, privately held
screw-in cartridge valve producers. The Company believes that it competes based
upon quality, reliability, price, value, speed of delivery and technological
characteristics.
Most of the Company's screw-in cartridge valve competitors produce
screw-in cartridge valves that fit an industry common cavity that allows their
products to be interchangeable. The industry common cavity is not supported by
any national or global standards organizations. The International Standards
Organization (ISO) recently developed a standard screw-in cartridge cavity that
is different from the industry common cavity. The Company does not manufacture a
product that fits either the industry common or the ISO standard cavity.
Currently, the Company is not aware that any major competitor produces a line of
standard products that conform to the ISO standard.
The manifold business is also highly fragmented and intensely competitive.
All of the major screw-in cartridge valve manufacturers either manufacture
manifolds or have sources that they use on a regular basis. In addition, there
are a number of independent manifold suppliers that produce manifolds
incorporating various manufacturers' screw-in cartridge valves, including those
made by the Company. Finally, there are many small, independent machine shops
that produce manifolds at very competitive prices. Competition in the manifold
business is based upon quality, price, relationships based on proximity to the
customer, and speed of delivery.
14
EMPLOYEES
As of December 31, 1997, the Company had approximately 504 full-time
employees in the United States, approximately 82 in England and 12 in Germany.
Over 80% of its employees are in manufacturing functions, over 10% are in
engineering and marketing functions, and the remainder are in other support
functions. None of the employees in any operating unit are represented by a
union, and the Company believes that relations with its employees are good.
Employees are paid either hourly or with an annual salary at rates that
are competitive with other companies in the industry and geographic area.
Management believes that the combination of competitive salary, above average
health and retirement plans, and a safe and pleasant working environment
discourages employee turnover and encourages efficient, high-quality production.
The Company recognizes the need for continuing employee education to allow
the workforce to remain effective in today's rapidly changing technological
environment. Significant time is dedicated to education programs that assist
employees in understanding technology and the change it brings to their jobs.
The Company also offers tuition reimbursement programs that encourage employees
to continue the education process outside the workplace.
PATENTS AND TRADEMARKS
The Company believes that the growth of its business will be dependent
upon the quality and functional performance of its products and its relationship
with the marketplace, rather than the extent of its patents and trademarks. The
Company's principal trademark is registered globally in the following countries:
Australia, Canada, France, Germany, Italy, Japan, Korea, Mexico, Spain, Sweden,
Switzerland, the United Kingdom and the United States. While the Company
believes that its patents have significant value, the loss of any single patent
would not have a material adverse effect on the Company.
ITEM 2. PROPERTIES
The Company owns four manufacturing facilities, two in Sarasota, Florida,
one in Coventry, England, and one in Erkelenz, Germany. The Sarasota cartridge
valve facility has approximately 66,000 square feet, with additional acreage at
the site that can accommodate future expansion. The Sarasota manifold facility,
which commenced operations in March 1997, has approximately 60,000 square feet.
The Coventry plant is comprised of approximately 25,000 square feet, with
additional acreage at the site that can accommodate future expansion. The
Company's facility in Erkelenz, Germany, which was completed in March 1997, has
approximately 42,000 square feet that is used as a distribution center and will
be used for future manufacturing needs.
15
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings other than
routine litigation incidental to its business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS
There were no matters submitted to a vote of the security holders of the
Company through the solicitation of proxies or otherwise during the fourth
quarter of the fiscal year ended December 31, 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK
AND RELATED STOCKHOLDER MATTERS
Market Information
The Common Stock of the Company has been trading publicly under the symbol
SNHY on the Nasdaq National Market since the Company's initial public offering
on January 9, 1997. The following table sets forth the high and low closing sale
prices of the Company's Common Stock as reported in the Nasdaq National Market
for the periods indicated:
High Low
1997
----
First quarter
(beginning January 9, 1997) $ 12.375 $ 10.250
Second quarter 11.875 10.375
Third quarter 12.500 11.250
Fourth quarter 12.500 11.000
Holders
There were 106 shareholders of record of Common Stock on March 25, 1998.
The number of record holders was determined from the records of the Company's
transfer agent and does not include beneficial owners of Common Stock whose
shares are held in the names of securities brokers, dealers, and registered
clearing agencies. The Company believes that there are approximately 2,000
beneficial owners of Common Stock.
Dividends
The Company declared quarterly cash dividends of $.035 per share to
shareholders of record on March 31, July 3, October 1 and December 31, 1997.
These
16
dividends were paid on April 15, July 15, October 15, 1997 and January 15, 1998,
respectively.
The Company increased its quarterly dividend and declared a cash dividend
of $.04 per share on March 4, 1998, to shareholders of record on March 31, 1998,
payable on April 15, 1998. The Board of Directors currently intends to continue
to pay a quarterly dividend of $.04 per share during 1998. However, the
declaration and payment of future dividends is subject to the sole discretion of
the Board of Directors of the Company, and any determination as to the payment
of future dividends will depend upon the Company's profitability, financial
condition, capital needs, future prospects and other factors deemed pertinent by
the Board of Directors.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following summary should be read in conjunction with the consolidated
financial statements and related notes and Exhibit 11.1 contained herein. See
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations" and "Item 1. Business."
YEAR ENDED DECEMBER 31,
1993 1994 1995 1996 1997
(IN THOUSANDS EXCEPT PER SHARE DATA)
STATEMENT OF INCOME DATA:
Net sales $ 32,431 $ 42,853 $ 55,388 $ 54,572 $ 64,198
Cost of sales 21,971 27,512 34,581 37,185 44,621
-------- -------- -------- -------- --------
Gross profit 10,460 15,341 20,807 17,387 19,577
Selling, engineering and
administrative expenses 7,346 8,605 10,578 12,097(1) 11,275
-------- -------- -------- -------- --------
Operating income 3,114 6,736 10,229 5,290 8,302
Interest expense 931 859 814 823 905
Miscellaneous (income) expense 249 66 (79) 267 133
-------- -------- -------- -------- --------
Income before income taxes 1,934 5,811 9,494 4,200 7,264
Deferred tax provision (2) -- -- -- 2,425 --
Income tax provision (benefit) (3) (148) 408 633 704 2,554
-------- -------- -------- -------- --------
Net income $ 2,082 $ 5,403 $ 8,861 $ 1,071 $ 4,710
======== ======== ======== ======== ========
Basic net income
per common share $ .56 $ 1.41 $ 2.29 $ 0.27 $ 0.75
Weighted average
shares outstanding 3,740 3,825 3,878 3,978 6,308
Diluted net income
per common share $ .50 $ 1.30 $ 2.15 $ 0.26 $ 0.73
Weighted average
shares outstanding 4,150 4,156 4,123 4,178 6,499
17
YEAR ENDED DECEMBER 31,
1995 1996 1997
(IN THOUSANDS EXCEPT PER SHARE DATA)
PRO FORMA STATEMENT OF INCOME (UNAUDITED) (4):
Income before income taxes 9,494 4,200 7,264
Income tax provision 3,611 1,583 2,554
-------- -------- --------
Net income $ 5,883 $ 2,617 $ 4,710
======== ======== ========
Basic net income
per common share $ .95 $ 0.42 $ 0.75
Weighted average
shares outstanding 6,224 6,300 6,308
Diluted net income
per common share $ .92 $ 0.40 $ 0.73
Weighted average
shares outstanding 6,433 6,519 6,499
YEAR ENDED DECEMBER 31,
1993 1994 1995 1996 1997
(IN THOUSANDS EXCEPT PER SHARE DATA)
OTHER FINANCIAL DATA:
Depreciation $ 2,112 $ 2,197 $ 2,556 $ 2,857 $ 3,706
Capital expenditures 3,005 5,130 7,657 16,963 6,490
BALANCE SHEET DATA:
Cash and cash equivalents $ 1,883 $ 2,371 $ 2,434 $ 1,038 $ 1,249
Working capital 4,557 5,085 4,326 958 6,100
Total assets 22,674 27,868 33,864 48,416 53,389
Total debt 8,184 8,025 6,186 17,218 9,564
Shareholders' equity 12,051 15,624 21,529 22,397 35,000
(1) Includes a non-recurring, non-cash compensation expense of $1.4 million
related to the termination of employee phantom stock compensation
agreements and the issuance of options to Directors. See Note 13 of the
Notes to Financial Statements. Excluding such expense, pro forma net
income for the twelve months ended December 31, 1996 would have been
approximately $3.8 million.
(2) Resulting from the termination of the Company's S Corporation status as of
December 31, 1996.
(3) The Company previously operated as an S Corporation. Therefore, the
historical income tax provision for the years ended December 31, 1993 to
December 31, 1996 represents primarily foreign taxes.
18
(4) The 1997 information reflects actual data. The pro forma 1995 and 1996
net income is based on historical income as adjusted to reflect a
provision for income taxes calculated using the statutory rates in effect
during the applicable periods, as if the Company had been a C Corporation
since inception. See Notes 2, 3, and 13 of the Notes to the Consolidated
Financial Statements. The pro forma net income per share is based on
estimated weighted average number of shares outstanding during the period,
after giving effect to the reorganization and the initial public offering.
ITEM. 7 MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Sun Hydraulics Corporation is a leading designer and manufacturer of
high-performance, screw-in hydraulic cartridge valves and manifolds which
control force, speed and motion as integral components in fluid power systems.
The Company's innovative product design, consistent high quality and superior
product performance have allowed it to generate a profit in every year since
1972. In recent years, the Company's sales have been comprised of approximately
75% screw-in cartridge valves and approximately 25% manifolds, and the Company
expects that relationship to remain relatively constant. The Company sells its
products globally through independent distributors. In 1997, the Company
generated approximately 35% of its net sales outside the United States, and the
Company's single largest end user customer represented less than 3% of net
sales.
Demand for the Company's products is dependent upon demand for the capital
goods into which the Company's products are incorporated. The capital goods
industry in general, and the fluid power industry in particular, is subject to
economic cycles. In 1997, the United States fluid power industry experienced
favorable growth. However, the Company is unable to predict the length or
amplitude of the current upturn.
Product demand was strong in all of the Company's major markets during
1997, and net sales increased 17.6% over 1996 sales. Production output, however,
failed to keep pace with demand during the first half of the year and customer
delivery lead times increased. In 1996 and 1995 the United States production
facility operated at near 100% capacity and the Company embarked on a capacity
expansion program in 1996. The capacity expansion of the United States
manufacturing operation was completed during the first half of 1997. Manifold
production was relocated to a new facility and the existing manufacturing
facility was reconfigured to take advantage of the increased floor space.
Cellular production was implemented for certain high volume models. Concurrent
with the United States expansion, a new manufacturing facility was completed in
Germany for future production requirements. Following the completion of the
United States capacity expansion, production increased significantly in the
third and fourth quarters. For the last half of the year, shipping levels kept
pace with strong incoming order levels.
19
North American distributor inventories increased approximately 33%, from
June 1997 to December 1997. Through the first half of 1997, distributors
depleted inventories at a faster rate than normal to assist the Company in
meeting its customer commitments. Management believes that in the second half of
the year, the increase in production replenished distributor inventories.
Profit margins in 1997 were adversely affected by incremental
manufacturing costs associated with expediting to meet increased customer demand
and start-up costs related to capacity expansion programs. Expediting costs
included direct labor overtime premiums and increased material costs associated
with outsourcing. Management believes that the costs associated with expediting
were necessary to improve customer satisfaction in light of the Company's
extended lead times. In the second half of 1997 production rates kept pace with
incoming order rates, however, the Company expects that the product mix
requirement of the marketplace will require continued expediting into 1998.
In November 1997, the Company produced approximately 39,000 cartridges
that were subsequently found to have spring retainers that had not been heat
treated. Of this total, 21,000 had been shipped. In December 1997, the Company
recommended to its distributors and customers that all cartridges be returned
and the spring retainer replaced. Substantially all of the cartridges were
repaired and returned to customers by December 31, 1997. No significant costs
remain to be incurred in 1998 concerning this event.
Results of Operations
The following table sets forth, for the periods indicated, certain items
in the Company's statements of income as a percentage of net sales.
YEARS ENDED DECEMBER 31,
1995 1996 1997
---- ---- ----
Net sales 100.0% 100.0% 100.0%
Cost of sales 62.4 68.1 69.5
----- ----- -----
Gross profit 37.6 31.9 30.5
Selling, engineering and
administrative expenses 19.1 22.2 17.6
----- ----- -----
Operating income 18.5 9.7 12.9
Interest expense 1.5 1.5 1.4
Miscellaneous (income) expense (0.1) 0.5 0.2
----- ----- -----
Income before income taxes 17.1% 7.7% 11.3%
===== ===== =====
20
Comparison of Years Ended December 31, 1997 and 1996
Net Sales
Net sales increased 17.6%, or $9.6 million, to $64.2 million in 1997,
compared to $54.6 million in 1996. Domestic net sales increased 16.7%, or $6.0
million, to a total of $42.0 million in 1997, compared to $35.9 million in 1996.
International net sales increased 19.4 %, or $3.6 million, to $22.2 million in
1997, compared to $18.6 million in 1996. Demand was strong in all major markets
with an increase in orders of approximately 26% in 1997 compared to 1996. Sales
in the first half of the year were restricted by capacity constraints and the
disruptions of completing the capacity expansion in the United States. With the
additional space gained through bringing the new plant in the United States on
line in March 1997, worldwide shipments in the last six months of 1997 increased
27.4% over the same period in 1996 and increased 14.7% over the first six months
of 1997.
Gross Profit
Gross profit increased 12.6%, or $2.2 million, to $19.6 million in 1997,
compared to $17.4 million in 1996. Gross profit as a percentage of net sales
decreased to 30.5% in 1997 from 31.9% in 1996. The decrease in gross profit as a
percent of sales was due to a higher fixed cost base associated with the new
plants in the United States and Germany. In addition, there were production
start-up costs in the United States and incremental production costs associated
with expediting product shipments to meet the significant increase in customer
demand.
Selling, Engineering and Administrative Expenses
Selling, engineering and administrative expenses decreased 6.8%, or $0.8
million, to $11.3 million in 1997, compared to $12.1 million in 1996. For the
year ended December 31, 1996, these expenses included a non-cash, non-recurring
compensation expense of $1.4 million related to the termination of phantom stock
compensation agreements and the issuance of options to directors. Excluding this
expense selling, engineering and administrative expenses increased 5.2%, or $0.6
to $11.3 million compared to $10.7 million in 1996. This increase was due to
application software expenses in the United States and the United Kingdom and
increased fixed administrative expenses in the new manifold plant in the United
States. Expenses as a percentage of net sales excluding the non-recurring charge
in 1996 decreased to 17.6% in 1997 from 19.6% in 1996. The decrease in these
expenses as a percentage of net sales resulted from allocating these higher
expenses over greater net sales.
Interest Expense
Interest expense increased $0.1 million or 10% to $0.9 million in 1997
compared to $0.8 million in 1996. This was due to the use of the unsecured
credit line in the
21
United States throughout 1997 which required higher working capital related to
increased sales volumes.
Miscellaneous (Income) Expense
Miscellaneous (income) expense decreased $0.1 million to $0.1 million in
1997 due to interest income related to the temporary investment of cash received
from the Company's initial public offering, offset by currency exchange losses,
primarily in the German operation.
Income Taxes
The provision for income taxes for the year ended December 31, 1997 was
35.2% of pretax income. The 1996 provision for income taxes included a $2.4
million deferred charge resulting from the termination of the Company's S
Corporation status as of December 31, 1996. Excluding this charge, the pro forma
1996 provision for income taxes was 37.7% of income before taxes. The decrease
in the effective tax rate from 1996 to 1997 was primarily due to the mix of
pretax income between the United States, the United Kingdom and Germany.
Prior to January 1, 1997, the Company was an S Corporation for federal and
state income tax purposes. As a result, the Company was not subject to federal
and state income taxes, but was subject to foreign taxes. The Company terminated
its S Corporation status as of December 31, 1996, and since that date has been
subject to federal and state income taxes. Upon termination of its S Corporation
status, the Company recognized approximately $2.4 million of deferred income
taxes in the year ended December 31, 1996.
Comparison of Years Ended December 31, 1996 and 1995
Net Sales
Net sales decreased 1.5%, or $0.8 million, to $54.6 million in the year
ended December 31, 1996, compared to $55.4 million in the year ended December
31, 1995. Domestic net sales decreased 1.9%, or $0.7 million to $35.9 million in
the year ended December 31, 1996. The decline primarily was due to a general
decrease in fluid power industry shipments for the first three quarters of the
year, United States distributor inventory corrections in the first half of the
year and capacity constraints throughout the year. International net sales
decreased 1.5%, or $0.3 million, to $18.5 million in the year ended December 31,
1996. United Kingdom, Pacific Rim and other foreign net sales increased 8.1%
offset by net sales decreases in Germany and Canada of 11.2% and 26.2%,
respectively.
22
Gross Profit
Gross profit decreased 16.4%, or $3.4 million, to $17.4 million in the
year ended December 31, 1996, compared to $20.8 million in the year ended
December 31, 1995. Gross profit as a percentage of net sales decreased to 31.9%
for the year ended December 31, 1996, from 37.6% for the year ended December 31,
1995. The decrease in gross profit was primarily due to increased costs in the
United States plant as new machinery for future growth was installed in severely
restricted space, creating excess down time and start-up costs. In addition,
material cost increases also were experienced due to an increase in outsourcing
necessitated because the United States plant was operating near capacity.
Selling, Engineering and Administrative Expenses
Selling, engineering and administrative expenses increased 14.4% or $1.5
million, to $12.1 million in the year ended December 31, 1996, compared to $10.6
million in the year ended December 31, 1995. These expenses as a percentage of
net sales increased to 22.2% for the year ended December 31, 1996, from 19.1%
for the year ended December 31, 1995. The increase in selling, engineering and
administrative expenses primarily was due to a non-recurring, non-cash
compensation expense of $1.4 million related to the issuance of stock options
and the cancellation of phantom stock compensation agreements. Excluding the
$1.4 million compensation expense, selling, engineering and administrative
expenses as a percentage of sales would have been 19.4% for the year ended
December 31, 1996, compared to 19.1% for the year ended December 31, 1995.
QUARTERLY RESULTS OF OPERATIONS
The following table set forth certain quarterly financial information for
each of the Company's last eight quarters. The Company believes that this
information includes all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of such quarterly information
when read in conjunction with the Financial Statements and the Notes thereto
included elsewhere herein. The income tax provision and net income for the 1996
quarters are pro forma results and are presented as if the Company were a C
Corporation in the periods presented.
23
Quarter Ended
March 31 June 30 Sept. 30 Dec. 31 March 31 June 30 Sept. 30 Dec. 31
1996 1996 1996 1996 1997 1997 1997 1997
------- ------- ------- ------- ------- ------- ------- -------
(in thousands)
Net sales $13,806 $13,831 $13,596 $13,339 $14,599 $15,276 $17,301 $17,022
Cost of sales 9,491 9,125 9,287 9,282 10,202 10,444 11,842 12,133
------- ------- ------- ------- ------- ------- ------- -------
Gross profit 4,315 4,706 4,309 4,057 4,397 4,832 5,459 4,889
Selling, engineering
and administrative
expenses(1) 2,665 2,929 3,694 2,809 2,717 2,849 3,018 2,691
------- ------- ------- ------- ------- ------- ------- -------
Operating income 1,650 1,777 615 1,248 1,680 1,983 2,441 2,198
Interest expense 205 218 255 145 152 216 285 252
Miscellaneous (income)
expense 53 (63) 117 160 (58) 72 27 92
------- ------- ------- ------- ------- ------- ------- -------
Income before income
taxes 1,392 1,622 243 943 1,586 1,695 2,129 1,854
Tax
provision(2) 554 646 55 328 568 616 777 593
------- ------- ------- ------- ------- ------- ------- -------
Net income $ 838 $ 976 $ 188 $ 615 $ 1,018 $ 1,079 $ 1,352 $ 1,261
======= ======= ======= ======= ======= ======= ======= =======
(1) September 30, 1996 includes non-recurring compensation expense of $1.4
million.
(2) Pro forma income tax provision as if the Company was a C Corporation for
all quarters in 1996.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company's primary source of capital has been cash
generated from operations, although short-term fluctuations in working capital
requirements have been met through borrowings under revolving lines of credit as
needed. The Company's principal uses of cash have been to pay operating
expenses, make capital expenditures, pay dividends to shareholders and service
debt.
At December 31, 1997, the Company had working capital of $6.1 million.
Cash flow from operations in 1997 was $6.5 million, compared to $7.0 million in
1996 and $12.7 million in 1995. The decrease in the Company's cash flow from
operations in 1997 compared to 1996 was due primarily to increased inventory
levels in the plants in the United States and increased accounts receivable
related to increased sales volume, offset partially by increases in net income
and depreciation.
Capital expenditures in 1997 were $6.5 million, compared to $17.0 million
in 1996 and $7.7 million in 1995. In 1997, approximately $1.1 million was spent
to complete the new manufacturing plants in the United States and Germany, both
of which commenced operations in March 1997. In 1996, the Company was awarded a
24
grant of $0.4 million by the German government, which helped to offset the cost
of the German facility. This grant requires that the German operation employ 26
people by June 30, 1998. The Company anticipates that this headcount requirement
will not be met until the first half of 1999. The Company believes that an
extension may be available from the German authorities. If the Company fails to
obtain an extension of time to meet the terms of the grant, then the $0.4
million will have to be repaid. This amount has been recorded as a deferred
grant. The repayment of the $0.4 million would only affect cash and would have
no effect on net income. The balance of 1997 capital expenditures included $5.4
million for machinery and equipment. Capital expenditures in 1996 included $12.6
million for buildings and land improvements for the United States and German
facilities and $4.4 million for machinery and equipment.
The Company has three revolving lines of credit: one in the United States,
one in England, and one in Germany. None of these arrangements contain
pre-payment penalties.
The United States had a $1.7 million revolving credit agreement, secured
by all inventory and accounts receivable, bearing interest at the lender's prime
rate with a maturity date of March 1, 1997. In February 1997, the Company
negotiated a one-year, unsecured revolving credit facility to replace the $1.7
million revolving credit agreement. The new credit facility provides for a
maximum availability of $10.0 million, payable on demand at the lender's prime
rate of interest. There are no debt covenants related to this facility. At
December 31, 1997, $0.7 million was outstanding under this credit facility. In
February 1998, the Company renegotiated this unsecured credit facility with a
term of one year and an interest rate equal to the bank lender's prime rate less
1%, or LIBOR plus 1.9% for predetermined periods of time at the Company's
option.
In England, the Company has a $1.2 million line of credit, denominated in
British pounds, which bears interest at a floating rate equal to 2.25% over the
bank's base rate and is a demand note. At December 31, 1997, there was no
balance outstanding on this credit facility.
The German line of credit is denominated in German Marks, and is a demand
note with interest payable at the lender's prime rate.
A 10-year mortgage note of $6.1 million was obtained in May 1996, at a
fixed interest rate of 8.25% for construction of the manifold facility. Terms on
the new mortgage note were interest-only on the balance drawn down through the
completion of construction and then conversion to a 10-year note with a 15-year
amortization schedule. In March 1998, this mortgage note was renegotiated to an
interest rate of 7.875%. New terms are monthly principal and interest payments
for 8.25 years with remaining principal due July 1, 2006.
In May 1996, the Company obtained a mortgage loan of approximately $2.4
million, denominated in German marks, for the new facility in Erkelenz, Germany.
The loan has a term of 12 years and bears interest at 6.47%.
25
In addition, the Company has $1.9 million in notes payable to former
stockholders, which bear interest at a weighted rate of 15%, and which have
terms ranging from three to five years. These notes were issued by the Company
in connection with the repurchase of shares of Common Stock from the former
shareholders, and do not allow for prepayment by the Company.
In January 1997, the Company received $20.3 million of proceeds from its
initial public offering of 2,300,00 shares of common stock. Net proceeds after
expenses were approximately $19.3 million of which $10.5 million was distributed
to shareholders of record as of December 31, 1996; $2.9 million was used to
repay the equipment note; $2.4 million was used to repay the mortgage on the
Florida cartridge facility; $1.0 million was paid on the mortgage on the Florida
manifold facility; $1.4 million was paid on the United States revolving line of
credit; and the remaining $1.1 million was used for working capital.
The Company has submitted a business interruption insurance claim of $2.3
million to its insurance carrier. The claim is related to a fire in the manifold
plant in the United States which occurred while the plant was under
construction. The Company believes that this fire delayed the opening of the new
plant which, in turn, delayed the rearrangement of the cartridge operation and
the creation of the cellular production for high volume models. The validity and
amount of the claim currently are under evaluation by the Company's insurance
carrier.
The Company believes that cash generated from operations and borrowing
availability under the $10 million bank line of credit will be sufficient to
satisfy the Company's operating expenses and capital expenditures for the
foreseeable future.
Year 2000
Management believes that the computer systems in three of the Company's
four locations are currently capable of processing data related to the year
2000. The systems in the United States cartridge plant are not capable of
properly processing year 2000 data. The Company plans to replace the current
system in time to meet year 2000 requirements. The new system cost is not
expected to significantly impact the results of operations. As with any new
system implementation, there can be no assurance that the conversion will not
significantly impact operations. Also, there can be no assurance that the
systems of other companies on which the Company relies will be timely converted
or that any such failure to convert by another company would not have an adverse
effect on the Company's operations.
26
SEASONALITY
The Company generally has experienced reduced activity during the fourth
quarter of the year, largely as a result of fewer working days due to holiday
shutdowns. As a result, the Company's fourth quarter net sales, income from
operations and net income typically have been the lowest of any quarter during
the year. This was not true in 1997 because of the ramp-up in production related
to the increased capacity in the United States operations.
INFLATION
The impact of inflation on the Company's operating results has been
moderate in recent years, reflecting generally lower rates of inflation in the
economy and relative stability in the Company's cost of sales. While inflation
has not had, and the Company does not expect that it will have, a material
impact upon operating results, there is no assurance that the Company's business
will not be affected by inflation in the future.
FORWARD-LOOKING INFORMATION
Certain oral statements made by management from time to time and certain
statements contained herein that are not historical facts are "forward-looking
statements" within the meaning of Section 21E of the Securities Exchange Act of
1934 and because such statements involve risks and uncertainties, actual results
may differ materially from those expressed or implied by such forward-looking
statements. Forward-looking statements, including those in "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations" and in
"Item 1. Business," are statements regarding the intent, belief or current
expectations, estimates or projections of the Company, its Directors or its
Officers about the Company and the industry in which it operates, and
assumptions made by management, and include among other items, (i) the Company's
strategies regarding growth, including its intention to develop new products,
(ii) the Company's financing plans; (iii) trends affecting the Company's
financial condition or results of operations; (iv) the Company's ability to
continue to control costs and to meet its liquidity and other financing needs;
(v) the declaration and payment of dividends; and (vi) the Company's ability to
respond to changes in customer demand domestically and internationally,
including as a result of standardization. Although the Company believes that its
expectations are based on reasonable assumptions, it can give no assurance that
the anticipated results will occur.
Important factors that could cause the actual results to differ materially
from those in the forward-looking statements include, among other items, (i) the
economic cyclicality of the capital goods industry in general and the hydraulic
valve and manifold industry in particular; (ii) conditions in the capital
markets, including the interest rate environment and the availability of
capital; (iii) changes in the competitive marketplace that could affect the
Company's revenue and/or cost bases, such as increased competition, lack of
qualified engineering, marketing, management or other personnel, and increased
labor and raw materials costs; (iv) changes in technology or customer
27
requirements, such as standardization of the cavity into which screw-in
cartridge valves must fit, which could render the Company's products or
technologies noncompetitive or obsolete; and (v) changes relating to the
Company's international sales, including changes in regulatory requirements or
tariffs, trade or currency restrictions, fluctuations in exchange rates, and tax
and collection issues.
28
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to financial statements:
Report of Independent Certified Public Accountants 30
Consolidated Balance Sheets as of December 31, 1996 and 1997 31
Consolidated Statements of Income for the years ended
December 31, 1995, 1996, and 1997 32
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 1995, 1996, and 1997 33
Consolidated Statements of Cash Flows for the years ended
December 31, 1995, 1996, and 1997 34
Notes to Consolidated Financial Statements 35
29
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders
of Sun Hydraulics Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, changes in shareholders' equity and of cash
flows present fairly, in all material respects, the financial position of Sun
Hydraulics Corporation and its subsidiaries (the "Company") at December 31, 1997
and 1996, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
Price Waterhouse LLP
Tampa, Florida
February 27, 1998
30
SUN HYDRAULICS CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
DECEMBER 31, DECEMBER 31,
1996 1997
ASSETS
Current assets:
Cash and cash equivalents $ 1,038 $ 1,249
Accounts receivable, net of allowance for
doubtful accounts of $62 and $47 3,535 4,558
Inventories 4,451 6,775
Other current assets 1,132 932
------- -------
Total current assets 10,156 13,514
Property, plant and equipment, net 37,212 39,789
Other assets 1,048 86
------- -------
Total assets $48,416 $53,389
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,273 $ 2,847
Accrued expenses and other liabilities 1,961 2,174
Long-term debt due within one year 2,340 1,035
Notes payable to related parties due within one year 655 757
Dividends payable 508 221
Income taxes payable 461 380
------- -------
Total current liabilities 9,198 7,414
Long-term debt due after one year 12,314 6,620
Notes payable to related parties due after one year 1,909 1,152
Deferred income taxes 2,578 3,203
Other liabilities 20 --
------- -------
Total liabilities 26,019 18,389
------- -------
Commitments and contingencies (Note 17)
Shareholders' equity:
Preferred stock -- --
Common stock (Note 2) 2,179 6
Capital in excess of par value 2,719 24,163
Retained earnings 17,450 10,732
Equity adjustment for foreign currency translation 49 99
------- -------
Total shareholders' equity 22,397 35,000
------- -------
Total liabilities and shareholders' equity $48,416 $53,389
======= =======
The accompanying Notes to the Consolidated Financial Statements are an integral
part of these financial statements.
31
SUN HYDRAULICS CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
1995 1996 1997
---- ---- ----
NET SALES $ 55,388 $ 54,572 $ 64,198
Cost of sales 34,581 37,185 44,621
-------- -------- --------
GROSS PROFIT 20,807 17,387 19,577
Selling, engineering and
administrative expenses 10,578 12,097 11,275
-------- -------- --------
OPERATING INCOME 10,229 5,290 8,302
Interest expense 814 823 905
Miscellaneous (income) expense (79) 267 133
-------- -------- --------
INCOME BEFORE INCOME TAXES 9,494 4,200 7,264
Income tax provision 633 3,129 2,554
-------- -------- --------
NET INCOME $ 8,861 $ 1,071 $ 4,710
======== ======== ========
BASIC NET INCOME PER COMMON SHARE $ 2.29 $ 0.27 $ 0.75
WEIGHTED AVERAGE SHARES OUTSTANDING 3,878 3,978 6,308
DILUTED NET INCOME PER COMMON SHARE $ 2.15 $ 0.26 $ 0.73
WEIGHTED AVERAGE SHARES OUTSTANDING 4,123 4,178 6,499
The accompanying Notes to the Consolidated Financial Statements are an integral
part of these financial statements.
32
SUN HYDRAULICS CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS)
EQUITY
ADJUSTMENT
CAPITAL IN FOR FOREIGN
COMMON EXCESS OF RETAINED CURRENCY
SHARES STOCK PAR VALUE EARNINGS TRANSLATION TOTAL
Balance, December 31, 1994 3,858,244 $2,181 $ 848 $12,969 $(374) $ 15,624
Exercise of stock options 99,756 149 149
Net income 8,861 8,861
Distributions to shareholders (3,154) (3,154)
Adjustment for foreign
currency translation 49 49
--------- ------ -------- ------- ----- --------
Balance, December 31, 1995 3,958,000 2,181 997 18,676 (325) 21,529
Issuance of stock options 2,110 2,110
Suninco step-up for purchase accounting 185 185
Exercise of stock options 42,002 70 70
Repurchase and retirement of shares (41) (41)
Exchange of shares in merger (2) (602) 604 --
Net income 1,071 1,071
Distributions to shareholders (2,901) (2,901)
Adjustment for foreign
currency translation 374 374
--------- ------ -------- ------- ----- --------
Balance, December 31, 1996 4,000,002 2,179 2,719 17,450 49 22,397
Net proceeds from stock offering 2,300,000 2 19,250 19,252
Distributions to shareholders (10,545) (10,545)
Dividends declared (883) (883)
Net income 4,710 4,710
Merger with Sun Holdings (Note 2) (2,175) 2,123 (52)
Exercise of stock options 22,000 71 71
Adjustment for foreign
currency translation 50 50
--------- ------ -------- ------- ----- --------
Balance, December 31, 1997 6,322,002 $ 6 $ 24,163 $10,732 $ 99 $ 35,000
========= ====== ======== ======= ===== ========
The accompanying Notes to the Consolidated Financial Statements are an integral
part of these financial statements.
33
SUN HYDRAULICS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
1995 1996 1997
Cash flows from operating activities:
Net income $ 8,861 $ 1,071 $ 4,710
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation 2,556 2,857 3,706
Compensation expense of stock options -- 2,110 --
(Benefit from) provision for deferred income taxes (110) 2,494 625
(Increase) decrease in:
Accounts receivable (479) 39 (1,023)
Inventories (679) 27 (2,324)
Other current assets 307 (910) 200
Other assets (4) (1,021) 962
Increase (decrease) in:
Accounts payable 1,146 281 (426)
Accrued expenses and other liabilities 280 773 213
Income taxes payable, net 490 (29) (81)
Other liabilities 369 (732) (20)
-------- -------- --------
Net cash provided by operating activities 12,737 6,960 6,542
-------- -------- --------
Cash flows from investing activities:
Capital expenditures (7,657) (16,963) (6,490)
Proceeds from dispositions of equipment 23 23 207
-------- -------- --------
Net cash used in investing activities (7,634) (16,940) (6,283)
-------- -------- --------
Cash flows from financing activities:
Proceeds from debt 3,337 16,502 5,580
Repayment of debt (4,661) (4,896) (12,579)
Repayment of notes payable to related parties (515) (574) (655)
Purchase accounting - Suninco -- 185 --
Proceeds from exercise of stock options 149 70 71
Repurchase of shares -- (41) --
Net proceeds from stock offering -- -- 19,252
Cash paid for Sun Holdings merger (Note 2) -- -- (52)
Dividends to shareholders -- -- (663)
Distributions to shareholders (3,399) (3,036) (11,052)
-------- -------- --------
Net cash provided by (used in) financing activities (5,089) 8,210 (98)
-------- -------- --------
Adjustment for foreign currency translation 49 374 50
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 63 (1,396) 211
Cash and cash equivalents, beginning of period 2,371 2,434 1,038
-------- -------- --------
Cash and cash equivalents, end of period $ 2,434 $ 1,038 $ 1,249
======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid for:
Interest (including amounts capitalized) $ 815 $ 324 $ 1,206
======== ======== ========
Income taxes $ 109 $ 587 $ 2,010
======== ======== ========
The accompanying Notes to the Consolidated Financial Statements are an integral
part of these financial statements.
34
SUN HYDRAULICS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS EXCEPT PER SHARE DATA)
1. BUSINESS
Sun Hydraulics Corporation and its wholly-owned subsidiary (the
"Company") design, manufacture and sell screw-in cartridge valves and manifolds
used in hydraulic systems. The Company has facilities in the United States, the
United Kingdom and Germany. Sun Hydraulics Corporation ("Sun Hydraulics"),
located in Sarasota, Florida, designs, manufactures and sells through
independent distributors in the United States. Sun Hydraulik Holdings Limited
("Sun Holdings") was formed to provide a holding company vehicle for the
European market operations. Its wholly-owned subsidiaries are Sun Hydraulics
Limited (a British corporation, "Sun Ltd.") and Sun Hydraulik GmbH (a German
corporation, "GmbH"). Sun Ltd. was originally formed in 1985 and operates a
manufacturing and distribution facility located in Coventry, England. GmbH was
incorporated on January 1, 1991 to market the Company's products in
German-speaking European markets.
2. REORGANIZATION AND INITIAL PUBLIC OFFERING
The consolidated financial statements of the Company consist of the
financial position and results of operations of Sun Hydraulics and Sun Holdings.
Sun Hydraulics and Suninco, Inc. ("Suninco") completed a merger on June 28, 1996
by exchanging Sun Hydraulics' common stock for all of the outstanding stock of
Suninco. The share exchange was accounted for in a manner similar to a pooling
of interest, except for shares held by the minority shareholders which were
accounted for at the fair market values of the proportionate share of related
assets and liabilities. The fair market value of their minority interest shares
in excess of net book value were allocated to Sun Hydraulics' long-term assets
on a pro-rata basis, resulting in an increase of $38 and $245 to land and
buildings, respectively.
In January 1997, Sun Hydraulics effected a 9.90372627 for 1 stock
split. All prior year share amounts reflected in the financial statements
include the effect of the stock split. Additionally, Sun Hydraulics issued
374,811 shares of common stock and made a nominal cash payment of $52 in
exchange for all of the issued and outstanding stock of Sun Holdings (the
"Reorganization"). The Reorganization was accounted for in a manner similar to a
pooling of interest except for shares held by the minority shareholders which
were accounted for at the fair market value of their proportionate share of
related assets and liabilities, which approximated book value on the date of the
transaction. Accordingly, financial statements for 1997 are on a consolidated
basis, and financial statements for 1996 and 1995 are on a combined basis.
The Company filed a Registration Statement on Form S-1 with the
Securities and Exchange Commission effective January 9, 1997, and issued
2,300,000 shares of common stock in an initial public offering ("IPO"), with an
initial offering price of $9.50. The IPO net proceeds of $19,252, the exchange
of shares with Sun Holdings, and the distribution of previously taxed S
Corporation retained earnings are reflected in the statement of changes in
shareholders' equity.
The $19,252 of net proceeds from the IPO were used as follows: a
payment of $9,446 of the S Corporation distribution was made, representing 90%
35
of the total distribution of $10,545, $7,676 was paid to extinguish debt,
$1,000 was paid to reduce the mortgage on the manifold facility, and $1,130 was
retained as working capital.
The Company has 20,000,000 authorized shares of common stock, par value
$0.001, with 6,322,002 shares outstanding at December 31, 1997. The Company also
has 2,000,000 authorized shares of preferred stock, par value $0.001, with no
shares outstanding.
EARNINGS PER SHARE
During the first quarter of 1997, Statement on Financial Accounting
Standards No. 128 ("SFAS 128"), "Earnings per Share," was issued. SFAS 128 is in
effect for the year ended December 31, 1997 and requires a restatement of
previously reported earnings per share. SFAS 128 requires the Company to report
both basic earnings per common share, which is based on the weighted average
number of common shares outstanding, and diluted earnings per common share,
which is based on the weighted average number of common shares outstanding and
all dilutive potential common shares outstanding. All prior years' earnings per
share data in this report have been recalculated to reflect the provisions of
SFAS 128.
3. PRO FORMA NET INCOME (UNAUDITED)
PRO FORMA PRO FORMA ACTUAL
1995 1996 1997
(IN THOUSANDS EXCEPT PER SHARE DATA)
STATEMENT OF INCOME DATA:
Net sales $ 55,388 $ 54,572 $ 64,198
Cost of sales 34,581 37,185 44,621
-------- -------- --------
Gross profit 20,807 17,387 19,577
Selling, engineering and
administrative expenses 10,578 12,097 11,275
-------- -------- --------
Operating income 10,229 5,290 8,302
Interest expense 814 823 905
Miscellaneous (income) expense (79) 267 133
-------- -------- --------
Income before income taxes 9,494 4,200 7,264
Income tax provision (benefit) 3,611 1,583 2,554
-------- -------- --------
Net income $ 5,883 $ 2,617 $ 4,710
======== ======== ========
Basic net income
per common share $ .95 $ 0.42 $ 0.75
Weighted average
shares outstanding 6,224 6,300 6,308
Diluted net income
per common share $ .92 $ 0.40 $ 0.73
Weighted average
shares outstanding 6,433 6,519 6,499
Pro forma net income reflects a provision for income taxes as if Sun
Hydraulics had been a C Corporation for all periods presented. Additionally,
selling, engineering and administrative expense for the year ended December 31,
1996 reflects a $1,378 non-recurring, non-cash compensation expense related to
the termination of employee phantom stock compensation agreements and the
issuance of options to Directors. Without this expense, pro forma net income for
the year ended December 31, 1996 would have been $3,800, and pro forma basic and
diluted earnings per share would have been $.60 and $.58, respectively.
36
The computation of pro forma earnings per share is based on the pro
forma weighted average number of common shares outstanding during the period
plus vested common stock equivalents, if dilutive, consisting of certain shares
subject to stock options, after giving effect to the Reorganization and the IPO.
The assumed exercise of dilutive stock options less the number of treasury
shares assumed to be purchased from the proceeds were calculated using the
average market price for the period ended December 31, 1997, the appraised fair
market value of the Company from 1995 to 1996.
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies followed in the
preparation of the Company's consolidated financial statements is set forth
below:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts and
operations of Sun Hydraulics and its direct and indirect subsidiaries. All
significant intercompany accounts and transactions are eliminated in
consolidation. As a result of the Reorganization in 1996 (See Note 2), financial
statements for 1997 are on a consolidated basis, and financial statements for
1996 and 1995 are on a combined basis.
MANAGEMENT ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all short-term highly liquid investments
purchased with an original maturity of three months or less to be cash
equivalents.
INVENTORIES
Inventories are valued at the lower of cost or market, cost being
determined on a first-in, first-out basis.
37
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is stated at cost. Expenditures for
repairs and improvements that significantly add to the productive capacity or
extend the useful life of an asset are capitalized. Repairs and maintenance are
expensed as incurred. Depreciation is computed using the straight line method
over the following useful lives:
Years
-----
Machinery and equipment 4 - 12
Furniture and fixtures 4 - 10
Leasehold and land improvements 5 - 15
Buildings 40
Capitalized interest was $9, $293, and $160 in 1995, 1996 and 1997,
respectively.
VALUATION ASSESSMENT OF LONG-LIVED ASSETS
Management periodically evaluates long-lived assets for potential
impairment, and will reserve for impairment whenever events or changes in
circumstances indicate the carrying amount of the assets may not be fully
recoverable. As of December 31, 1997, management does not believe that an
impairment reserve is required.
OTHER ASSETS
Other assets at December 31, 1996 consisted primarily of deferred costs
associated with the IPO. Such costs have been charged against the proceeds of
the IPO in 1997.
REVENUE RECOGNITION
Sales are recognized when products are shipped. Sales incentives are
granted to customers based upon the volume of purchases. These sales incentives
are recorded at the time of sales as a reduction of gross sales.
RESEARCH AND DEVELOPMENT EXPENSE
Included in selling, engineering and administrative expenses are
amounts incurred for research and development costs paid to third parties for
the Company's manufacturing processes and related software which approximated
$1,337, $1,007 and $630 for the years ended December 31, 1995, 1996 and 1997,
respectively.
ADVERTISING COSTS
The Company expenses the costs for advertising and promotional
literature during the year incurred. Included in selling, engineering and
administrative expenses are amounts incurred for advertising and promotional
literature which approximated $792, $641 and $719 for the years ended December
31, 1995, 1996 and 1997, respectively.
38
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS
The Company follows the translation policy provided by Statement of
Financial Accounting Standards No. 52, "Foreign Currency Translation." The Pound
Sterling is the functional currency of Sun Ltd. The Deutsche Mark is the
functional currency of GmbH. The U.S. Dollar is the functional currency for Sun
Hydraulics and the reporting currency for the consolidated group. The assets and
liabilities of Sun Ltd. and GmbH are translated at the exchange rate in effect
at the balance sheet date, while income and expense items are translated at the
average annual rate of exchange for the period. The resulting unrealized
translation gains and losses are included in the component of shareholders'
equity designated "equity adjustment for foreign currency translation." Realized
gains and losses from foreign currency translations are included in
miscellaneous (income) expense.
INCOME TAXES
The Company follows the income tax policy provided by Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes." This
Statement provides for a liability approach under which deferred income taxes
are provided for based upon enacted tax laws and rates applicable to the periods
in which the taxes become payable. These differences result from items reported
differently for financial reporting and income tax purposes, primarily
depreciation and stock options.
Prior to December 31, 1996, Sun Hydraulics had elected to be taxed
under the S Corporation provisions of the Internal Revenue Code. Historically,
the shareholders of Sun Hydraulics included their pro rata share of income or
loss in their individual returns. A portion of the distributions to shareholders
was related to their individual income tax liabilities, resulting from S
Corporation taxable earnings (see Note 12). Effective December 31, 1996, Sun
Hydraulics converted to C Corporation status and Sun Hydraulics' subsequent
earnings are subject to corporate income taxes. Accordingly, for informational
purposes, the December 31, 1996 statement of income reflects an unaudited pro
forma income tax provision which would have been recorded if Sun Hydraulics had
been a C Corporation, based on the tax laws in effect during those periods.
STOCK-BASED COMPENSATION
The Company adopted Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" ("FAS 123") during 1996. Upon
adoption, the Company retained the intrinsic value method of accounting for
stock-based compensation and has disclosed the effects of adopting this
pronouncement in the notes to the financial statements (see Note 13).
RECLASSIFICATIONS
Certain prior year balances have been reclassified to be consistent
with current year presentation.
39
5. FAIR VALUE OF INVESTMENTS
The fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing parties,
other than in a forced sale or liquidation. The following methods and
assumptions were used to estimate the fair value of each class of financial
instruments.
The carrying amounts of cash and cash equivalents, accounts receivable,
other current assets, accounts payable, accrued expenses and other liabilities
approximate fair value because of their short maturity of those instruments.
The carrying amount of long-term debt approximates fair value, as the
interest rates on the debt approximate rates currently available to the Company
for debt with similar terms and remaining maturities.
The fair value of the notes payable to related parties is estimated
based on the current rates offered to the Company for similar debt. The
estimated fair value of the Company's related party notes payable is
approximately $2,111 and $1,630 at December 31, 1996 and 1997, respectively.
6. INVENTORIES
December 31, December 31,
1996 1997
Raw materials $ 147 $ 214
Work in process 2,758 4,348
Finished goods 1,546 2,213
------ ------
$4,451 $6,775
====== ======
7. PROPERTY, PLANT AND EQUIPMENT
December 31, December 31,
1996 1997
Machinery and equipment $24,930 $28,165
Furniture and fixtures 4,938 5,880
Buildings 5,071 17,663
Leasehold and land improvements 586 760
Construction in progress 14,558 838
Land 1,410 1,581
------- -------
51,493 54,887
Less: Accumulated depreciation (14,281) (15,098)
------- -------
$37,212 $39,789
======= =======
40
8. ACCRUED EXPENSES AND OTHER LIABILITIES
December 31, December 31,
1996 1997
Compensation and benefits $1,161 $1,348
Deferred grant 462 424
Taxes 112 117
Interest 93 75
Warranty expense 44 30
Other accrued expenses 89 180
------ ------
$1,961 $2,174
====== ======
41
9. LONG-TERM DEBT
December 31, December 31,
1996 1997
Lines of credit agreements, interest payable
at lender's prime rate (8.5% at December 31,
1996 and December 31, 1997) $ 1,512 $ 666
Construction line of credit at 8.25% converted
to a mortgage note in April 1997 with a maturity
of 10 years, 15 year amortization, due in monthly
principal and interest installments of
approximately $60 5,789 4,990
Construction line of credit at 6.47% converted
to a mortgage note in April 1997 with a maturity
of 12 years, due in monthly principal and interest
installments of approximately $42 2,078 1,999
Secured equipment loan, interest only payable
monthly at 8.25% at December 31, 1996 2,874 --
8.25% mortgage note payable secured by real
property due in monthly principal and
interest installments of $20 2,355 --
Notes payable secured by equipment, payable
in monthly principal and interest
installments with interest rates varying
from 4.90% to 5.60% with maturity dates
from March 1996 to June 1998 46 --
-------- --------
14,654 7,655
Less amounts due within one year (2,340) (1,035)
-------- --------
$ 12,314 $ 6,620
======== ========
The remaining principal payments are due as follows: 1999 - $400; 2000
- - $433; 2001 - $469; 2002 - $509; 2003 and thereafter $4,809.
The Company has three revolving lines of credit; one in the United
States, one in England, and one in Germany. None of these arrangements contain
pre-payment penalties. The United States had a $1,700 revolving credit
agreement, secured by all inventory and accounts receivable, bearing interest at
the lender's prime rate with a maturity date of March 1, 1997. In February 1997,
the Company negotiated a one-year, unsecured revolving credit facility to
replace the $1,700 revolving credit agreement. The new credit facility provides
for a maximum availability of $10,000, payable on demand at the lender's prime
rate of interest. There are no debt covenants related to this facility. At
December 31, 1997, $650 was outstanding under this credit facility. In February
1998, the Company renegotiated this unsecured credit facility with a
42
term of one year and an interest rate equal to the bank lender's prime rate less
1%, or LIBOR plus 1.9% for predetermined periods of time at the Company's
option.
In England, the Company has a $1.2 million line of credit, denominated
in British pounds, which bears interest at a floating rate equal to 2.25% over
the bank's base rate and is a demand note. At December 31, 1997 there was no
balance outstanding on this credit facility.
The German line of credit is a demand note denominated in German Marks
with interest payable at the lender's prime rate. At December 31, 1997, $16 was
outstanding under this credit facility.
A 10-year mortgage note of $6,187 was obtained at a fixed interest rate
of 8.25% for construction of the manifold facility. Terms on the new mortgage
note were interest-only on the balance drawn down through the completion of
construction and then conversion to a 10-year note with a 15-year amortization
schedule. The Company applied $1,000 of the IPO proceeds toward repayment of
this note. In March 1998, this mortgage note was renegotiated to an interest
rate of 7.875%. New terms are principal and interest payments of $43 for 8.25
years with remaining principal due July 1, 2006.
In May 1996, the Company obtained a mortgage loan of approximately $2.4
million, denominated in German marks, for the new facility in Erkelenz, Germany.
The loan has a term of 12 years and bears interest at 6.47%.
In January 1997, the Company repaid the secured equipment loan and the
8.25% mortgage note payable with proceeds from the IPO.
10. RELATED PARTIES
Notes payable to related parties include the following:
December 31, December 31,
1996 1997
15% unsecured note payable for repurchase and
retirement of stock, quarterly principal and
interest installments ranging from $43 to $142
through 2001 $ 2,303 $ 1,680
10% unsecured notes payable for phantom
compensation, quarterly principal and
interest payments of $14 payable through
2002 261 229
------- -------
2,564 1,909
Less amounts due within one year (655) (757)
------- -------
$ 1,909 $ 1,152
======= =======
The remaining principal payments are due as follows: 1999 - $586; 2000
- - $365; 2001 - $135; 2002 - $66.
43
The 15% notes payable represents the repurchase and retirement of stock
to related parties for the years 1989 to 1993. These notes represent the
repurchase of shares of common stock from four retiring employees, one employee
of retirement age who was still employed by the Company at the time the shares
were repurchased, and nine former shareholders related to the principal
shareholder of the Company. These agreements contain a provision disallowing
prepayment.
During 1995, Sun Hydraulics entered into a 35-month agreement with
SunOpTech ("SunOpTech"), a limited partnership formed to further the development
of the manufacturing software used in the Company's production process. A
significant shareholder of Sun Hydraulics, who owns approximately 36% of the
Company, owns 51% of the stock of SunOpTech. In exchange for the development of
computer software and computer support, Sun Hydraulics will pay approximately
$1,000 over the three-year period. Fees paid under this agreement for the year
ended December 31, 1997 were $317. For the years ended December 31, 1995, 1996
and 1997, Sun Hydraulics paid SunOpTech's expenses of $25, $203 and $291,
respectively. These expenses are included in selling, engineering and
administrative expenses. Additionally, Sun Hydraulics provided certain
administrative support and office space to SunOpTech at no charge.
A Director of the Company is the President, Chief Executive Officer and
controlling stockholder of a fluid power distributorship that purchases and
sells the Company's products pursuant to one of the Company's standard
distributor agreements. This distributorship purchased approximately $1,310,
$1,104 and $900 of products from the Company in fiscal 1995, 1996 and 1997,
respectively.
11. DISTRIBUTIONS AND DIVIDENDS TO SHAREHOLDERS
The Company declared distributions of $3,154, $2,901 and $10,545 to
shareholders in 1995, 1996 and 1997, respectively, a portion of which was to
fund shareholders' individual income tax liabilities related to the S
Corporation taxable earnings.
Subsequent to the IPO, the Company distributed all of Sun Hydraulics'
previously undistributed retained earnings totaling $10,545 related to the S
Corporation. A distribution of $9,446 representing 90% of the total
undistributed retained earnings was paid in January 1997. The remaining 10% of
$1,099 was paid in May 1997.
The Company declared quarterly cash dividends of $.035 per share, to
shareholders of record on March 31, 1997, July 3, 1997, October 1, 1997 and
December 31, 1997. These dividends were paid on April 15, 1997, July 15, 1997,
October 15, 1997 and January 15, 1998, respectively. The Company declared a cash
dividend of $.04 per share on March 4, 1998, to shareholders of record on March
31, 1998, payable on April 15, 1998.
44
12. INCOME TAXES
Pretax income from continuing operations is taxed under the following
jurisdictions:
Year ended December 31,
-----------------------
1995 1996 1997
---- ---- ----
United States $7,489 $2,190 $4,962
Foreign 2,005 2,010 2,302
------ ------ ------
Total $9,494 $4,200 $7,264
====== ====== ======
The income tax provision consists of the following:
Year ended December 31,
-----------------------
1995 1996 1997
---- ---- ----
Current tax expense (benefit):
United States $ (3) $ 7 $ 1,157
State and local -- -- 75
Foreign 746 621 697
------- ------- -------
Total current 743 628 1,929
------- ------- -------
Deferred tax expense (benefit):
United States (88) 2,170 615
State and local (16) 255 14
Foreign (6) 76 (4)
------- ------- -------
Total deferred (110) 2,501 625
------- ------- -------
Total income tax provision $ 633 $ 3,129 $ 2,554
======= ======= =======
The income tax provision for the year ended December 31, 1995 relates
to Suninco, which was a C corporation until June 28, 1996 when it was merged
with Sun Hydraulics.
45
The reconciliation between the effective income tax rate and the U.S.
federal statutory rate is as follows:
Year ended December 31,
-----------------------
1995 1996 1997
---- ---- ----
U.S. federal taxes at statutory rate $ 3,228 $ 1,428 $ 2,461
Increase(decrease):
Foreign income taxed at higher rate 28 14 (80)
Conversion of S to C Corporation -- 2,354 --
S Corporation income (2,684) (724) --
Nondeductible items 46 57 39
State and local taxes, net (16) -- 138
Other 31 -- (4)
------- ------- -------
Income tax provision $ 633 $ 3,129 $ 2,554
======= ======= =======
Deferred tax assets and liabilities at December 31 are as follows:
December 31,
--------------------
1996 1997
---- ----
Deferred taxes, non-current:
Assets
Accrued expenses and reserves
not currently deductible $ 182 $ 139
Compensation expense recognized
for book, not yet deductible for tax 558 451
Florida NOL carry forward 18 --
------ ------
Deferred tax asset, non-current 758 590
Liabilities
Depreciation 3,336 3,793
------ ------
Net deferred tax liability, non-current $2,578 $3,203
====== ======
Upon termination of the S Corporation status (see Note 2), the Company
was required to recognize deferred income taxes for financial and tax reporting
purposes and recognize deferred income taxes for cumulative temporary
differences.
46
PRO FORMA TAXES (UNAUDITED)
The reconciliation between the effective income tax rate and the U.S.
federal statutory rate is as follows:
Year ended December 31,
-------------------------
1995 1996
---- ----
U.S. federal taxes at statutory rate $3,228 $1,428
Increase:
Foreign income taxed at higher rates 28 14
Nondeductible items 81 57
State and local taxes, net 243 84
Other 31 --
------ ------
Income tax provision $3,611 $1,583
====== ======
Pro forma deferred tax assets and liabilities at December 31, 1996 are
as follows:
Pro forma deferred taxes, non-current:
Assets
Accrued expenses and reserves not currently deductible $ 182
Compensation expense recognized for book,
not yet deductible for tax 558
Florida NOL carry forward 18
------
Pro forma deferred tax asset, non-current 758
Liabilities
Depreciation 3,336
------
Pro forma net deferred tax liability, non-current $2,578
======
13. STOCK OPTION PLANS
During 1995 and part of 1996, the Company maintained a phantom stock
option plan (the "Plan"). Compensation cost was measured as the amount by which
the market value, as defined in the Plan, of the stock on the measurement date
exceeded the market value on the date the phantom stock options were granted.
The market value was defined in the Plan as the higher of: the last arm's length
sale price of said stock between unrelated parties if there had been a sale in
the preceding six-months period, or the book value of said stock. Compensation
cost was accrued over the service period and adjusted in periods subsequent to
the measurement date for changes in the market value of the stock.
During 1996, the Company adopted the 1996 Stock Option Plan (the "Stock
Option Plan"), which provides for the grant of incentive stock options and
nonqualified stock options for the purchase of up to an aggregate of 1,000,000
shares of the Company's common stock by officers, employees and Directors of the
Company. Under terms of the plan, incentive stock options may
47
be granted to employees at an exercise price per share of not less than the fair
value per common share on the date of the grant (not less than 110% of the fair
value in the case of holders of more than 10% of the Company's voting stock).
Nonqualified stock options may be granted at the discretion of the Company's
Board of Directors. The maximum term of an option may not exceed 10 years and
become exercisable at such times and in such installments as determined by the
Board of Directors.
Effective September 30, 1996, the Board of Directors approved the
granting of 319,960 nonqualified stock options and committed to granting 189,348
of qualified incentive options under the Stock Option Plan to replace the
phantom stock option plans. The employees and Directors were immediately vested
in the nonqualified options upon Reorganization. The qualified incentive options
vest over a period of six years from the date of grant. The Company recognized a
charge of $1,378 in 1996 related to the termination of the phantom stock option
plans.
A summary of the Company's stock option plan for each of the three
years ended December 31, 1997 is summarized as follows:
Exercise Weighted
Number price average
of shares range exercise price
Under option, December 31, 1994 141,758 $.001 - 18.68 $ 1.55
(141,758 shares exercisable)
Exercised (99,756) $.001 - 18.68 $ 1.49
------- -------------
Under option, December 31, 1995 42,002 $.001 - 18.68 $ 1.68
(42,002 shares exercisable)
Granted 319,960 $3.00 - 5.05 $ 3.96
Exercised (42,002) $ .66 - 18.68 $ 1.68
------- -------------
Under option, December 31, 1996 319,960 $3.00 - 5.05 $ 3.91
(319,960 shares exercisable)
Granted 289,348 $ 9.50 $ 9.50
Exercised (22,000) $3.00 - 3.47 $ 3.21
------- -------------
Under option, December 31, 1997 587,308 $3.00 - 9.50 $ 6.69
(356,660 shares exercisable)
48
A summary of outstanding and exercisable options at December 31, 1997
is summarized as follows:
Options Outstanding Options Exercisable
- --------------------------------------------------------------------- -----------------------------
Weighted- Weighted- Weighted-
Range of Number of average remaining average Number of average
exercise prices shares contractual life exercise price shares exercise price
$ 3.00 70,586 8.53 $3.00 70,586 $3.00
3.43 - 5.05 227,374 8.75 4.25 227,374 4.25
9.50 289,348 8.97 9.50 58,700 9.50
The Company has adopted the disclosure-only provisions of SFAS No. 123.
Accordingly, no compensation cost has been recognized for the stock option plans
other than for nonqualified stock options. Had compensation costs for the stock
option plans been determined based on the fair value at the grant date for
awards in 1997 and 1996 consistent with the provisions of SFAS No. 123, the
Company's net income and earnings per share would have been reduced to the pro
forma amounts indicated below:
Year ended December 31,
-------------------------
1996 1997
---- ----
Net income:
As reported $1,071 $4,710
Pro forma 989 4,394
Basic earnings per common share:
As reported 0.27 0.75
Pro forma 0.25 0.70
Diluted earnings per common share:
As reported 0.26 0.73
Pro forma 0.24 0.68
There was no pro forma effect for 1995 as no options were vested or
granted. These pro forma amounts may not be representative of future disclosures
since the estimated fair value of stock options is amortized to expense over the
vesting period and additional options may be granted in future years. The fair
value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1996 and 1997: cumulative volatility of 36.71%
and 39.56% for 1996 and 1997, respectively; dividend yields of 1.35% and 1.68%
for 1996 and 1997, respectively; risk-free interest rate of 6.60% and 5.72% for
1996 and 1997, respectively; and expected term of 5 years and 6.04 years for
1996 and 1997, respectively.
49
14. EARNINGS PER COMMON SHARE
Presented below is basic and diluted EPS under SFAS 128 for the years
ended December 31, 1995, 1996 and 1997:
Income Shares Per share amount
1995
Earnings per share - common stock $8,861 3,877,836 $2.29
Effect of dilutive securities:
Stock options 245,036
Earnings per share - common stock
assuming dilution 8,861 4,122,872 $2.15
1996
Earnings per share - common stock 1,071 3,978,138 $ .27
Effect of dilutive securities:
Stock options 199,522
Earnings per share - common stock
assuming dilution 1,071 4,177,660 $ .26
1997
Earnings per share - common stock 4,710 6,307,899 $ .75
Effect of dilutive securities:
Stock options 191,356
Earnings per share - common stock
assuming dilution 4,710 6,499,255 $ .73
15. EMPLOYEE BENEFITS
The Company has a defined contribution retirement plan covering
substantially all of its eligible United States employees. Employer
contributions under the retirement plan amounted to approximately $901, $586 and
$993 during 1995, 1996 and 1997, respectively.
During 1997, the Company terminated its medical benefit trust and
established a new health care plan. These plans cover substantially all eligible
United States employees. Employer contributions to the trust and health care
plan amounted to approximately $1,490, $1,348 and $1,954 during 1995, 1996 and
1997, respectively. Long-term disability and life insurance benefits are also
provided to employees, the premiums for which are paid directly by Sun
Hydraulics. Payments amounted to approximately $132, $157 and $159 for 1995,
1996 and 1997, respectively.
The Company provides supplemental pension benefits to its employees of
foreign operations in addition to mandatory benefits included in local country
payroll tax statutes. These supplemental pension benefits amounted to
approximately $56, $69 and $81 during 1995, 1996 and 1997, respectively.
50
16. INFORMATION ABOUT THE COMPANY'S OPERATIONS IN DIFFERENT GEOGRAPHIC
AREAS
The individual companies comprising the Company operate predominantly
in a single industry as manufacturers and distributors of hydraulic components.
The companies are multinational with operations in the United States, the United
Kingdom and Germany. In computing earnings from operations for the foreign
companies, no allocations of general corporate expenses, interest or income
taxes have been made.
Identifiable assets of the foreign companies are those assets related
to the operation of those companies. United States assets consist of all other
operating assets of the companies.
Geographic information is as follows:
United United
States Kingdom Germany Elimination Consolidated
------- ------- ------- ----------- ------------
1995
Sales to unaffiliated customers $43,099 $ 8,300 $ 3,989 $ -- $55,388
Intercompany sales 5,940 1,470 -- (7,410) --
Operating profits 8,090 1,446 693 -- 10,229
Identifiable assets 27,212 5,414 1,813 (575) 33,864
Depreciation expense 1,961 531 64 -- 2,556
Capital expenditures 6,230 700 727 -- 7,657
1996
Sales to unaffiliated customers $42,180 $ 8,866 $ 3,526 $ -- $54,572
Intercompany sales 5,194 1,895 -- (7,089) --
Operating profits 3,225 1,785 293 (13) 5,290
Identifiable assets 37,565 6,750 4,544 (443) 48,416
Depreciation expense 2,203 570 84 -- 2,857
Capital expenditures 12,626 1,175 3,162 -- 16,963
1997
Sales to unaffiliated customers $49,393 $10,779 $ 4,026 $ -- $64,198
Intercompany sales 6,584 2,346 69 (8,999) --
Operating profits 5,717 2,410 149 26 8,302
Identifiable assets 41,541 7,611 3,973 264 53,389
Depreciation expense 2,840 634 232 -- 3,706
Capital expenditures 5,972 617 286 -- 6,490
Total liabilities attributable to foreign operations were $2,674,
$4,940 and $3,867 at December 31, 1995, 1996 and 1997, respectively. Net foreign
currency gains (losses) reflected in results of operations were $10, ($104) and
($192) for the years ended 1995, 1996 and 1997, respectively. Operating profit
is total sales and other operating income less operating expenses. In computing
geographic operating profit, interest expense and net miscellaneous income
(expense) have not been deducted (added).
Included in U.S. sales to unaffiliated customers were export sales,
principally to Canada and Asia, of $6,468, $6,090 and $7,431 during 1995, 1996
and 1997, respectively.
51
17. COMMITMENTS AND CONTINGENCIES
The Company is not a part to any material legal proceedings other than
routine litigation incidental to its business. In the opinion of management, the
amount of ultimate liability with respect to these actions will not materially
affect the financial position of the Company.
In 1996, the Company was awarded a grant of $424 by the German
government, which helped to offset the cost of the German facility. This grant
requires that the German operation employ 26 people by June 30, 1998. The
Company anticipates that this headcount requirement will not be met until the
first half of 1999. The Company believes that an extension may be obtained from
the German authorities. If the Company fails to obtain an extension of time to
meet the terms of the grant the $424 will be repaid. This amount has been
recorded as a deferred grant. The repayment of $424 would affect cash and would
have no effect on net income.
The Company has submitted a business interruption insurance claim of
$2,300 to its insurance carrier. The claim is related to a fire in the manifold
plant in the United States which occurred while the plant was under
construction. The Company believes that this fire delayed the opening of the new
plant which in turn delayed the rearrangement of the cartridge operation and the
creation of the cellular production for high volume models. The validity and
amount of the claim is currently being evaluated by the Company's insurance
carrier.
52
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS AND EXECUTIVE OFFICERS
The Board of Directors ("Board") of the Company currently consists of six
members. The Board is divided into three classes of Directors serving staggered
three-year terms. Directors hold their positions until the annual meeting of
shareholders in the year in which their term expires, and until their respective
successors are elected and qualified or until their earlier resignation, removal
from office or death. Executive Officers serve at the pleasure of the Board of
Directors.
The following table sets forth the names and ages of the Company's Directors and
Executive Officers and the positions they hold with the Company.
NAME AGE POSITION
- -----------------------------------------------------
Robert E. Koski................. 68 Chairman of the Board of Directors
(term expiring in 2000) and a member of
the Compensation Committee
Clyde G. Nixon.................. 62 President, Chief Executive Officer,
Director (term expiring in 1998)
Jeffrey Cooper.................. 56 Engineering Manager
Russell G. Copeman.............. 58 Manufacturing Manager
Richard J. Dobbyn............... 54 Chief Financial Officer
Peter G. Robson .............. 54 General Manager, Sun Hydraulics Limited
Arthur B. Bodley................ 79 Director (term expiring in 2000) and a
member of the Audit Committee
James G. March.................. 69 Director (term expiring in 2000) and a
member of the Compensation Committee
53
Taco van Tijn .................. 73 Director (term expiring in 1999) and a
member of the Audit Committee
David N. Wormley................ 58 Director (term expiring in 1999) and a
member of the Compensation Committee
MR. KOSKI is a co-founder of the Company and has served as its Chairman of the
Board since it began operations in 1970. He was also its President and Chief
Executive Officer from that time until November 1988. He is a graduate of
Dartmouth College and past Chairman of the Board of the National Fluid Power
Association. Mr. Koski has over 36 years experience in the fluid power industry,
and has served as Chairman of the Fluid Power Systems and Technology Division of
the American Society of Mechanical Engineers, and as a member of the Board of
Directors of the National Association of Manufacturers.
MR. NIXON joined the Company in January 1988, and was named its President and
Chief Executive Officer in November 1988. From September 1985, to January 1988,
he served as Vice President of Cross & Trecker Corporation and was President of
Warner & Swasey Company, its wholly-owned subsidiary. From 1964 to 1985, he
served in various management capacities with Brown & Sharpe Manufacturing
Corporation, most recently as Vice President of its fluid power division and
President of Double A Products Company, its wholly-owned subsidiary. Mr. Nixon
is a graduate of Cornell University and the Harvard Business School, and is
Chairman of the Board of the National Fluid Power Association. Mr. Nixon has
over 30 years experience in the fluid power industry.
MR. COOPER joined the Company in December 1990, as an engineer and has been
Engineering Manager since September 1991. From August 1987, to December 1990, he
was Engineering Manager, Mobile Valves, of Vickers, Incorporated, a wholly-owned
subsidiary of Trinova Corporation, and from September 1979 to August 1986, he
served as Vice President of Engineering for Double A Products Company. Mr.
Cooper is an engineering graduate of Willesden College of Technology, London,
England. Mr. Cooper has over 29 years experience in the fluid power industry.
MR. COPEMAN joined the Company in July 1996, as Manufacturing Manager, in charge
of manufacturing operations and processes. From January 1996, to July 1996, Mr.
Copeman was the principal of Copeman Consulting, and performed consulting
services for the Company from March 1996 to July 1996. From January 1994, to
October 1995, Mr. Copeman was a partner with Coopers & Lybrand, Australia; from
July 1989, to December 1993, he was a Director of Coopers & Lybrand's
International Manufacturing Practice. From January 1985, to July 1989, he served
in various management positions with Vickers, Incorporated, most recently as
Vice President. From August 1967, to January 1985, he served in various
management positions with Double A Products Company, most recently as Vice
President. Mr. Copeman is a Certified Manufacturing Engineer and a graduate of
Georgia Institute of Technology and the Krannert Business
54
School of Purdue University. Mr. Copeman has over 23 years experience in the
fluid power industry.
MR. DOBBYN joined the Company in October 1995, and was named Chief Financial
Officer in July 1996. From June 1995 to October 1995, Mr. Dobbyn served as the
Controller of Protek Electronics. From July 1994 to June 1995, he served as the
Fiscal Director of a non-profit child care agency. From September 1984 to July
1994, Mr. Dobbyn was Senior Vice President-Finance and Administration for Loral
Data Systems, formerly Fairchild Weston Systems, a Schlumberger company. Mr.
Dobbyn is a Certified Public Accountant and a graduate of Boston College.
MR. ROBSON has served as a Director of Sun Hydraulics Limited, Coventry,
England, since May 1993, and has been employed by the Company as the General
Manager of its United Kingdom operations since 1982. Mr. Robson is a Chartered
Engineer and a graduate of Coventry University. Mr. Robson has over 31 years
experience in the fluid power industry.
MR. BODLEY has served as President and Chief Executive Officer of Atlas Fluid
Components Company, Inc., a fluid power distributorship in Akron, Ohio, since
January 1966. Mr. Bodley has over 31 years experience in the fluid power
industry. He has served as a Director of the Company since January 1973.
DR. MARCH is a Professor Emeritus at Stanford University, Palo Alto, California.
He was a senior member of the faculty at Stanford University and the Stanford
Business School from September 1970, to August 1995, and is the author of
numerous books and articles on organizational behavior and decision making. From
September 1964, to August 1970, Dr. March was a Professor of Psychology and
Sociology at the University of California, Irvine, where he was Dean of the
School of Social Sciences from 1964 to 1969. Dr. March served as a Director of
the Company from 1989 to 1992, and rejoined the Company's Board of Directors in
November 1995. He also is a member of the Board of Directors of Wally Industries
and Chair of the Citicorp Behavioral Sciences Research Council. Dr. March is a
graduate of the University of Wisconsin and received his Ph.D. from Yale
University.
MR. VAN TIJN is an attorney (solicitor), practicing law in London, England,
since May 1977. He has been a Director of the Company since February 1989, and
the principal statutory officer of Sun Hydraulik Holdings Limited since January
1991.
DR. WORMLEY is the Dean of the Engineering School at Pennsylvania State
University, where he has taught since 1992. He previously was a member of the
engineering faculty at the Massachusetts Institute of Technology. Dr. Wormley is
Vice-Chair of the National Science Foundation Engineering Directorate Advisory
Committee. Dr. Wormley has served as a Director of the Company since December
1992. He is an engineer and earned his Ph.D. from the Massachusetts Institute of
Technology.
55
No family relationships exist between any of the Company's Directors
and executive officers, except that Mr. Koski and Dr. March are step-brothers.
There are no arrangements or understandings between Director and any other
person concerning service as a Director.
The Board of Directors has Audit and Compensation Committees. The
Company does not have a Nominating Committee; instead, the entire Board of
Directors functions as a Nominating Committee.
The Audit Committee was appointed in February 1997 and held one meeting
in 1997. The functions of the Audit Committee are to recommend annually to the
Board of Directors the appointment of the independent public accountants of the
Company, to discuss and review the scope of and the fees for the prospective
annual audit with the independent public accountants, to review the results
thereof with the independent public accountants, to review and approve non-audit
services of the independent public accountants, to review compliance with
existing major accounting and financial policies of the Company, to review the
adequacy of the financial organization of the Company, to review management's
procedures and policies relative to the adequacy of the Company's internal
accounting controls, to review compliance with federal and state laws relating
to accounting practices and to review and approve (with the concurrence of a
majority of the disinterested Directors of the Company) transactions, if any,
with affiliated parties.
The Compensation Committee was appointed in December 1996 and did not
meet separately in 1997. The functions of the Compensation Committee are to
review and approve annual salaries and bonuses for all executive officers, to
review, approve and recommend to the Board of Directors the terms and conditions
of all employee benefit plans or changes thereto, to administer the Company's
stock option plans and carry out the responsibilities required by the rules of
the Securities and Exchange Commission.
The Board of Directors held four meetings during 1997. Each Director
attended all of the meetings of the Board and of each committee of which he was
a member in 1997.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's Directors, officers and holders of more than 10% of the Company's
Common Stock to file with the Securities and Exchange Commission initial reports
of ownership and reports of changes in ownership of Common Stock and any other
equity securities of the Company. To the Company's knowledge, based solely upon
a review of the forms, reports and certificates filed with the Company by such
persons, all of them complied with the Section 16(a) filing requirements in
1997.
56
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION
The following table is a summary of the compensation paid or accrued
by the Company for the last three fiscal years for services in all capacities
to the Company's Chief Executive Officer and each of its other most highly
compensated executive officers who earned more than $100,000 from the Company
in 1997 under the rules of the Securities and Exchange Commission (the "Named
Executive Officers").
SUMMARY COMPENSATION TABLE
- ------------------------------------------------------------------------------------------------
LONG TERM
COMPENSATION
AWARDS--
SECURITIES
NAME AND UNDERLYING OTHER ANNUAL
PRINCIPAL POSITION YEAR SALARY OPTIONS/SARS(#) COMPENSATION(4)
- ------------------------------------------------------------------------------------------------
Robert E. Koski, 1997 $106,000 --- $20,175
Chairman of the 1996 106,000 --- 18,798(5)
Board of Directors 1995 106,000 --- 28,033(5)
- ------------------------------------------------------------------------------------------------
Clyde G. Nixon, 1997 180,000 58,781(1) $22,927
President and 1996 180,000 94,765(2) 12,239
Chief Executive Officer 1995 165,000 110,739(3) 21,807(6)
- ------------------------------------------------------------------------------------------------
Robert J. Devereaux 1997 129,000 29,963(1) $18,461
Vice President (7) 1996 129,000 48,306(2) 11,160
1995 123,500 --- 19,771
- ------------------------------------------------------------------------------------------------
Jeffrey Cooper 1997 121,000 27,100(1) $13,567
Engineering Manager 1996 116,000 43,689(2) 9,314
1995 110,500 --- 10,280
- ------------------------------------------------------------------------------------------------
Russell G. Copeman 1997 134,000 65,000(1) $35,547(8)
Manufacturing Manager 1996 64,500 --- 92,931(8)
1995 --- --- ---
- ------------------------------------------------------------------------------------------------
Richard J. Dobbyn 1997 97,000 35,000(1) $ 7,054
Chief Financial Officer 1996 88,000 --- ---
1995 17,083 --- ---
- ------------------------------------------------------------------------------------------------
(1) Represents incentive stock options granted on January 9, 1997, the
date of the Company's initial public offering, at an exercise price
equal to the public offering price.
(2) Represents nonqualified stock options granted in conjunction with the
termination of the executive's phantom stock compensation agreement.
(3) Represents phantom stock compensation award.
57
(4) Except as otherwise noted, reflects primarily contributions made by the
Company on behalf of the employee to the Company's 401(k) plan and
excess life insurance premiums.
(5) Includes payment by the Company of certain professional fees on behalf
of Mr. Koski in 1996 and 1995 in the amounts of $11,478 and $7,250,
respectively.
(6) Includes payment by the Company of certain club dues on behalf of Mr.
Nixon in the amount of $12,000.
(7) Mr. Devereaux resigned as Vice President of the Company effective
December 31, 1997.
(8) Includes payment by the Company of certain consulting fees and moving
expenses.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
- --------------------------------------------------------------------------------------------------------------------------
INDIVIDUAL GRANTS
--------------------------------
NUMBER OF
SECURITIES PERCENT OF TOTAL EXERCISE POTENTIAL REALIZABLE VALUE AT ASSUMED
UNDERLYING OPTIONS GRANTED OR BASE ANNUAL RATES OF STOCK PRICE
OPTIONS TO EMPLOYEES IN PRICE EXPIRATION APPRECIATION FOR OPTION TERM(1)
NAME GRANTED(#) FISCAL YEAR ($/SH) DATE -------------------------------------
5%($) 10%($) 0%($)
(a) (b) (c) (d) (e) (f) (g) (h)
- --------------------------------------------------------------------------------------------------------------------------
Robert E. Koski --- --- --- --- --- --- ---
- --------------------------------------------------------------------------------------------------------------------------
Clyde G. Nixon 58,781 20.3% $9.5 1/09/07 $307,872 $758,304 ---
- --------------------------------------------------------------------------------------------------------------------------
Jeffrey Cooper 27,100 9.4% 9.5 1/09/07 141,939 349,604 ---
- --------------------------------------------------------------------------------------------------------------------------
Russell G. Copeman 65,000 22.5% 9.5 1/09/07 340,445 838,533 ---
- --------------------------------------------------------------------------------------------------------------------------
Richard J. Dobbyn 35,000 12.1% 9.5 1/09/07 183,317 451,518 ---
- --------------------------------------------------------------------------------------------------------------------------
Robert J. Devereaux 29,963 10.4% 9.5 1/09/07 156,935 386,538 ---
==========================================================================================================================
(1) These options were granted on January 9, 1997, the date of the
Company's initial public offering, at a price of $9.50, which was the
initial public offering price for the shares of Common Stock on such
date. The 5% and 10% assumed annual rates of stock price appreciation
are provided in compliance with Regulation S-K under the Securities
Exchange Act of 1934. The Company does not necessarily believe that
these appreciation calculations are indicative of actual future stock
option values or that the price of Common Stock will appreciate at such
rates.
58
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION VALUES
=======================================================================================
NUMBER OF
SECURITIES VALUE OF
UNDERLYING UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS/SARS OPTIONS/SARS
AT FISCAL AT FISCAL
SHARES YEAR-END(#) YEAR-END($)
ACQUIRED ON VALUE EXERCISABLE/ EXERCISABLE/
NAME EXERCISE(#) REALIZED($) UNEXERCISABLE UNEXERCISABLE
- ---------------------------------------------------------------------------------------
(a) (b) (c) (d) (e)
- ---------------------------------------------------------------------------------------
Robert E. Koski --- --- 0/0 0/0
- ---------------------------------------------------------------------------------------
Clyde G. Nixon --- --- 105,291/48,255 $694,408/$120,638
- ---------------------------------------------------------------------------------------
Robert J. Devereaux 10,000 $80,300 48,832/19,437 $353,065/$ 48,593
- ---------------------------------------------------------------------------------------
Jeffrey Cooper --- --- 49,109/21,680 $387,965/$ 54,200
- ---------------------------------------------------------------------------------------
Russell G. Copeman --- --- 10,526/54,474 $ 26,315/$136,185
- ---------------------------------------------------------------------------------------
Richard J. Dobbyn --- --- 7,000/28,000 $ 17,500/$ 70,000
=======================================================================================
(1) Based upon the December 31, 1997 closing stock price of $12.00 per
share, as reported on the Nasdaq National Market.
EXECUTIVE COMPENSATION AGREEMENTS
In September 1996, in connection with the termination of certain
individual phantom stock compensation agreements, the Company issued to eight
employees of the Company, including Messrs. Cooper, Nixon and Robson, who are
Executive Officers of the Company (and Mr. Devereaux who resigned as Vice
President of the Company effective December 31, 1997), options to purchase
305,260 shares of Common Stock. The exercise prices for such options ranged from
$3.00 to $5.05, with a weighted average of $3.95. Such options are exercisable
and have a term of 10 years. As part of the same agreements, following its
initial public offering, the Company also issued to such employees incentive
stock options to purchase 189,348 shares of Common Stock at the initial public
offering price of the Common Stock of $9.50 per share. Such incentive stock
options vest over varying periods of up to seven years.
59
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION IN COMPENSATION
DECISIONS
The Board of Directors, in conjunction with the Compensation Committee,
determined the compensation, including salary and bonus, of the Executive
Officers of the Company for the fiscal year ended December 31, 1997, and the
initial compensation for the current fiscal year through the date hereof. In the
future, the Compensation Committee of the Board of Directors will determine the
compensation of the Company's Executive Officers. See "Item 10. Directors and
Executive Officers of the Registrant."
DIRECTOR COMPENSATION
Directors who are not officers of the Company are paid $2,500 for
attendance at each meeting of the Board of Directors, as well as each meeting of
each Board Ccommittee on which they serve when the committee meeting is not held
within one day of a meeting of the Board of Directors. Directors also are
reimbursed for their expenses incurred in connection with their attendance at
such meetings.
In September 1996, the Company granted non-statutory options to
Directors Bodley and van Tijn, and to former Director Curtis J. Timm, to
purchase 3,920 shares of the Company's common stock. The Company also granted
non-statutory options to Director Wormley to purchase 2,940 shares of the
Company's Common Stock. All of the foregoing options were exercisable upon
grant, at an exercise price of $3.00 per share, and they expire in January 2007.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of March 25, 1998, information as to
the beneficial ownership of the Company's Common Stock by (i) each person or
entity known by the Company to be the beneficial owner of more than 5% of the
outstanding shares of Common Stock, (ii) each Director, (iii) Each Named
Executive Officer of the Company, and (iv) all Directors and executive officers
of the Company as a group. Except as otherwise indicated, the persons listed
below have sole voting and investment power with respect to all shares of Common
Stock owned by them, except to the extent such power may be shared with a
spouse.
NAME AND ADDRESS OF BENEFICIAL AMOUNT AND NATURE OF PERCENT OF
OWNER(1) BENEFICIAL OWNERSHIP CLASS(2)
- --------------------------------------------------------------------------------
Koski Family Limited Partnership
5619 Preston Oaks Road
Dallas, Texas 75240 2,258,543 35.7
Christine L. Koski (3)
5619 Preston Oaks Road
Dallas, Texas 75240 2,322,838 36.7
Robert C. Koski(3)(5)
315 Sycamore Street
Decatur, Georgia 30030 2,266,543 35.8
60
Thomas L. Koski(3)
Six New Street
East Norwalk, Connecticut 06855 2,258,543 35.7
Robert E. Koski(3)(4)(5) 2,544,921 40.2
Beverly Koski(3)(4)(5) 2,544,921 40.2
Robert S. and Ann R. Ferrell(6)
5924 Cranbrook Way, #101
Naples, Florida 34112 421,037 6.7
Clyde G. Nixon(7) 213,266 3.3
Peter G. Robson(8) 72,730 1.1
James G. March(9) 53,572 *
Jeffrey Cooper(8) 54,529 *
Arthur B. Bodley(10) 13,860 *
Russell G. Copeman(8) 21,052 *
Taco van Tijn(10) 8,920 *
Richard J. Dobbyn(11) 15,500 *
David N. Wormley(12) 3,940 *
All Directors and Executive Officers as a
Group (10 persons) 3,002,290 45.4
- --------------------
* Less than 1%.
(1) Unless otherwise indicated, the address of each of the persons listed
who own more than 5% of the Company's Common Stock is 1500 West
University Parkway, Sarasota, Florida 34243.
(2) This column set forth shares of the Company's Common Stock which are
deemed to be "beneficially owned" by the persons named in the table
under Rule 13d-3 of the Securities and Exchange Commission. All of the
persons named in the table have sole voting and investment power with
respect to all shares beneficially owned by them except as otherwise
described in the following footnotes.
(3) Includes 2,258,543 shares owned by the Koski Family Limited
Partnership, over which Christine L. Koski, Robert C. Koski, Thomas L.
Koski, Robert E. Koski and Beverly Koski share voting and dispositive
power as the general partners in the Partnership. Christine L. Koski,
Robert C. Koski and Thomas L. Koski are the adult children of Robert E.
Koski and Beverly Koski.
(4) Includes 151,216 shares owned by Beverly Koski and 127,162 shares owned
by Robert E. Koski. Beverly Koski is the spouse of Robert E. Koski.
(5) Includes 8,000 shares owned by the Koski Family Foundation, Inc., over
which Robert E. Koski, Beverly Koski and Robert C. Koski share voting
and dispositive power.
(6) According to information supplied to the Company by the Ferrells in
connection with the initial public stock offering of the Company on
January 9, 1997. Includes 240,125 shares owned by the Robert S. Ferrell
Trust, of which Robert S. Ferrell is the sole trustee, and 180,312
shares owned by the Ann R. Ferrell Trust, of which Ann R. Ferrell is
the sole trustee. Robert S. Ferrell is the spouse of Ann R. Ferrell.
Includes 600 shares owned individually by Ann R. Ferrell.
(7) Includes 47,927 shares which are owned jointly by Mr. Nixon and
his spouse. Also includes 115,817 shares subject to currently
exercisable options and 49,522 shares which are held by Lois Joan
Nixon Trust.
(8) Represents shares subject to currently exercisable options.
(9) Shares are owned by The March Family Trust, of which Dr.
March and his spouse are trustees.
(10) Includes 3,920 shares subject to currently exercisable options and
2,500 shares owned by Mr. van Tijn's spouse.
(11) Includes 14,000 shares subject to currently exercisable options.
(12) Includes 2,940 shares subject to currently exercisable options.
61
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information set forth herein briefly describes transactions during
the past fiscal year between the Company and its Directors, officers and 5%
shareholders. Management of the Company believes that such transactions have
been on terms no less favorable to the Company than those that could have been
obtained from unaffiliated parties. These transactions have been approved by a
majority of the Company's disinterested Directors. Future transactions, if any,
with affiliated parties will be approved by a majority of the Company's
disinterested Directors and the Audit Committee and will be on terms no less
favorable to the Company than those that could be obtained from unaffiliated
parties.
REORGANIZATION WITH SUN HYDRAULIK HOLDINGS LIMITED
Immediately prior to the Company's initial public offering of Common
Stock in January, 1997, the Company effected a 9.903732627 for 1 stock split of
its capital stock. The Company at the same time acquired all of the outstanding
shares of capital stock of Sun Hydraulik Holdings Limited, a private limited
company organized under the Laws of England and Wales ("SHHL"), pursuant to an
exchange offer made by the Company to all of the stockholders of SHHL (the
"Reorganization"). Pursuant to the terms of the exchange offer, the Company
issued 1.17013 shares of Common Stock (for a total of 374,810 shares of Common
Stock) and $0.16 in cash for each share of stock of SHHL acquired by it. No
registration rights were granted to the SHHL stockholders, and the shares of the
Company's Common Stock issued to them in the Reorganization are "restricted
securities" under the Securities Act of 1933.
Prior to the Reorganization, the Company and SHHL were controlled by
the same group of stockholders and were operated as a common enterprise, with
all of the Company's European operations carried out through subsidiaries of
SHHL operating in England and Germany. The relative values of the Company and
SHHL for purposes of the Reorganization were established by appraisals conducted
for this purpose. These appraisals also were used to establish the relative
values of the Company and Suninco, Inc. for the June 1996 merger of those two
corporations. See "Suninco Merger" below.
SUNOPTECH, LTD.
In October 1995, the Company contributed certain intangible assets to
SunOpTech, Ltd. ("SunOpTech"), a limited partnership formed to further the
development of manufacturing software. In January 1996, the Company distributed
to its stockholders the 65% limited partnership interest in SunOpTech which it
received in exchange for the contributed intangible assets. Robert E. Koski owns
51% of the common stock of the general partnership of SunOpTech, and Messrs.
Koski and Clyde G. Nixonand is a are members of the Bboard of Ddirectors of the
general partnership. The Company currently has no ownership interest in
SunOpTech.
62
The Company entered into a contract with SunOpTech for a 35-month term
beginning November 1995, for the development of computer software and computer
support to the Company. The Company will pay approximately $1,000,000 over the
contract term, provide office space and equipment and reimburse SunOpTech for
reasonable expenses related to the software development. During 1997, the
Company paid fees of $317,000 and expenses of $291,000 under the agreement, and
provided certain administrative support to SunOpTech at no charge. The software
is is being utilized in the Company's plants in Sarasota and Germany. Under its
agreement with SunOpTech, the Company has a perpetual, nonexclusive license to
use the software, as well as any future enhancements, without charge other than
the development and support fees to be provided during the 35-month term of the
agreement.
SUNINCO MERGER
On June 28, 1996, Suninco, Inc. ("Suninco") was merged into the
Company. Prior to the merger, the Company and Suninco were controlled by the
same group of stockholders and were operated as a common enterprise, with
Suninco as the owner and lessor of the Company's Sarasota, Florida,
manufacturing plant and certain equipment utilized by the Company at that
location. The relative values of the Company and Suninco in the merger were
established by appraisals conducted for this purpose. In structuring the merger,
the Company concluded that, based upon such appraisals, the issuance of 178,426
shares of Common Stock to the former Suninco stockholders represented fair value
for the acquired assets of Suninco.
ATLAS FLUID COMPONENTS COMPANY, INC.
Arthur B. Bodley, a Director of the Company, is the President, Chief
Executive Officer and controlling stockholder of Atlas Fluid Components Company,
Inc. ("Atlas"), a fluid power distributorship in Akron, Ohio, that purchases and
sells the Company's products pursuant to one of the Company's standard
distributor agreements. Atlas purchased approximately $1.3 million $1.1
million and $0.9 million of products from the Company in fiscal 1995, 1996,
1997, respectively.
63
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT
SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. The following financial statements are included in Part II, Item 8:
Report of Independent Certified Public Accountants 30
Consolidated Balance Sheets as of December 31, 1996 and 1997 31
Consolidated Statements of Income for the years ended
December 31, 1995, 1996, and 1997 32
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 1995, 1996, and 1997 33
Consolidated Statements of Cash Flows for the years ended
December 31, 1995, 1996, and 1997 34
Notes to Consolidated Financial Statements 35
2. All schedules are omitted because the required information is not
present or is not present in amounts sufficient to require submission
of the schedule or because the information required is included in the
financial statements or notes thereto or the schedule is not required
or inapplicable under the related instructions.
3. Exhibits:
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
3.1 Amended and Restated Articles of Incorporation of the Company
(previously filed as Exhibit 3.1 in the Pre-Effective Amendment No. 4
to the Company's Registration Statement on Form S-1 filed on December
19, 1996 (File No. 333-14183) and incorporated herein by reference).
3.2 Amended and Restated Bylaws of the Company (previously filed as Exhibit
3.2 in the Pre-Effective Amendment No. 4 to the Company's Registration
Statement on Form S-1 filed on December 19, 1996 (File No. 333-14183)
and incorporated herein by reference).
64
4.1 Revolving Credit Agreement, dated March 9, 1992, between Sun Hydraulics
Corporation and Northern Trust Bank of Florida/Sarasota, N.A.
(previously filed as Exhibit 4.1 in the Company's Registration
Statement on Form S-1 filed on October 15, 1996 (File No. 333-14183)
and incorporated herein by reference).
4.2 Modification Agreement, dated March 25, 1993, amending Revolving Credit
Agreement dated March 9, 1992, between Sun Hydraulics Corporation and
Northern Trust Bank of Florida, N.A. (previously filed as Exhibit 4.2
in the Company's Registration Statement on Form S-1 filed on October
15, 1996 (File No. 333-14183) and incorporated herein by reference).
4.3 Second Modification to Revolving Credit Agreement, dated May __, 1995,
between Sun Hydraulics Corporation and Northern Trust Bank of Florida,
N.A. (previously filed as Exhibit 4.3 in the Company's Registration
Statement on Form S-1 filed on October 15, 1996 (File No. 333-14183)
and incorporated herein by reference).
4.4 Revolving Line of Credit Renewal Note, dated May __, 1995, in the
amount of $1,700,000.00 given by Sun Hydraulics Corporation to Northern
Trust Bank of Florida, N.A. (previously filed as Exhibit 4.4 in the
Company's Registration Statement on Form S-1 filed on October 15, 1996
(File No. 333-14183) and incorporated herein by reference).
4.5 Mortgage and Security Agreement, dated January 9, 1992, between
Suninco, Inc., Sun Hydraulics Corporation, and Northern Trust Bank of
Florida, N.A. (previously filed as Exhibit 4.5 in the Company's
Registration Statement on Form S-1 filed on October 15, 1996 (File No.
333-14183) and incorporated herein by reference).
4.6 Loan Agreement, dated March 29, 1996, between Suninco, Inc., Sun
Hydraulics Corporation, and Northern Trust Bank of Florida, N.A.
(previously filed as Exhibit 4.6 in the Company's Registration
Statement on Form S-1 filed on October 15, 1996 (File No. 333-14183)
and incorporated herein by reference).
4.7 Security Agreement, dated March 29, 1996, between Suninco, Inc., Sun
Hydraulics Corporation, and Northern Trust Bank of Florida, N.A.
(previously filed as Exhibit 4.7 in the Company's Registration
Statement on Form S-1 filed on October 15, 1996 (File No. 333-14183)
and incorporated herein by reference).
65
4.8 Modification and Additional Advance Agreement, dated March 29, 1996,
between Suninco, Inc. and Northern Trust Bank of Florida, N.A.
(previously filed as Exhibit 4.8 in the Company's Registration
Statement on Form S-1 filed on October 15, 1996 (File No. 333-14183)
and incorporated herein by reference).
4.9 Consolidated Note, dated March 29, 1996, in the amount of
$2,475,000.00, given by Suninco, Inc. to Northern Trust Bank of
Florida, N.A. (previously filed as Exhibit 4.9 in the Company's
Registration Statement on Form S-1 filed on October 15, 1996 (File No.
333-14183) and incorporated herein by reference).
4.10 Loan Agreement, dated May 20, 1996, between Sun Hydraulics Corporation
and Northern Trust Bank of Florida, N.A. (previously filed as Exhibit
4.10 in the Company's Registration Statement on Form S-1 filed on
October 15, 1996 (File No. 333-14183) and incorporated herein by
reference).
4.11 Security Agreement, dated May 20, 1996, between Sun Hydraulics
Corporation and Northern Trust Bank of Florida, N.A. (previously filed
as Exhibit 4.11 in the Company's Registration Statement on Form S-1
filed on October 15, 1996 (File No. 333-14183) and incorporated herein
by reference).
4.12 Consolidated Note, dated May 20, 1996, in the amount of $3,063,157.00,
given by Sun Hydraulics Corporation to Northern Trust Bank of Florida,
N.A. (previously filed as Exhibit 4.12 in the Company's Registration
Statement on Form S-1 filed on October 15, 1996 (File No. 333-14183)
and incorporated herein by reference).
4.13 Loan Agreement, dated June 14, 1996, between Sun Hydraulics
Corporation, Suninco Inc., and Northern Trust Bank of Florida, N.A.
(previously filed as Exhibit 4.13 in the Company's Registration
Statement on Form S-1 filed on October 15, 1996 (File No. 333-14183)
and incorporated herein by reference).
4.14 Mortgage, dated June 14, 1996, between Sun Hydraulics Corporation,
Suninco Inc., and Northern Trust Bank of Florida, N.A. (previously
filed as Exhibit 4.14 in the Company's Registration Statement on Form
S-1 filed on October 15, 1996 (File No. 333-14183) and incorporated
herein by reference).
66
4.15 Security Agreement, dated June 14, 1996, between Sun Hydraulics
Corporation and Northern Trust Bank of Florida, N.A. (previously filed
as Exhibit 4.15 in the Company's Registration Statement on Form S-1
filed on October 15, 1996 (File No. 333-14183) and incorporated herein
by reference).
4.16 Promissory Note, dated June 14, 1996, in the amount of $6,187,000.00,
given by Sun Hydraulics Corporation and Suninco, Inc. to Northern Trust
Bank of Florida, N.A. (previously filed as Exhibit 4.16 in the
Company's Registration Statement on Form S-1 filed on October 15, 1996
(File No. 333-14183) and incorporated herein by reference).
4.17 Revolving Loan Facility letter agreement, dated July 30, 1996, in the
amount of (pound)800,000, between Sun Hydraulics Ltd. and Lloyds Bank
Plc. (previously filed as Exhibit 4.17 in the Company's Registration
Statement on Form S-1 filed on October 15, 1996 (File No. 333-14183)
and incorporated herein by reference).
4.18 Overdraft and Other Facilities letter agreement, dated June 7, 1996, in
an amount not to exceed (pound)250,000, between Sun Hydraulics Ltd. and
Lloyds Bank Plc. (previously filed as Exhibit 4.18 in the Company's
Registration Statement on Form S-1 filed on October 15, 1996 (File No.
333-14183) and incorporated herein by reference).
4.19 Mortgage, dated April 11, 1996, between Sun Hydraulik GmbH and Dresdner
Bank (previously filed as Exhibit 4.19 in the Company's Registration
Statement on Form S-1 filed on October 15, 1996 (File No. 333-14183)
and incorporated herein by reference).
4.20 Amendment to Recommended Offer by Sun Hydraulics Corporation to acquire
the whole of the issued share capital of Sun Hydraulik Holdings
Limited, dated December 17, 1996 (previously filed as Exhibit 2.1 in
the Pre-Effective Amendment No. 4 to the Company's Registration
Statement on Form S-1 filed on December 19, 1996 (File No. 333-14183)
and incorporated herein by reference).
4.21 Master Note, dated February 3, 1997, in the amount of $10,000,000.00,
made by the Company to evidence a line of credit granted to the Company
by Northern Trust Bank of Florida, N.A. (previously filed as Exhibit
4.21 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1996 and incorporated herein by reference).
67
10.1 Form of Distributor Agreement (Domestic) (previously filed as Exhibit
10.1 in the Company's Registration Statement on Form S-1 filed on
October 15, 1996 (File No. 333-14183) and incorporated herein by
reference).
10.2 Form of Distributor Agreement (International) (previously filed as
Exhibit 10.2 in the Company's Registration Statement on Form S-1 filed
on October 15, 1996 (File No. 333-14183) and incorporated herein by
reference).
10.3+ 1996 Sun Hydraulics Corporation Stock Option Plan (previously filed as
Exhibit 10.3 in the Pre-Effective Amendment No. 4 to the Company's
Registration Statement on Form S-1 filed on December 19, 1996 (File No.
333-14183) and incorporated herein by reference).
10.4+ Form of Indemnification Agreement (previously filed as Exhibit 10.4 in
the Pre-Effective Amendment No. 4 to the Company's Registration
Statement on Form S-1 filed on December 19, 1996 (File No. 333-14183)
and incorporated herein by reference).Amendment No. 1 to 1996 Stock
Option Plan (previously filed as Exhibit 10.4 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 and
incorporated herein by reference).
10.5+ Form of Indemnification Agreement (previously filed as Exhibit 10.4 in
the Pre-Effective Amendment No. 4 to the Company's Registration
Statement on Form S-1 filed on December 19, 1996 (File No. 333-14183)
and incorporated herein by reference).
11.1 Statement regarding Computation of Earnings Per Share.
21.1 Subsidiaries of the Company (previously filed as Exhibit 21 in the
Company's Annual Report on Form 10-K for the year ended December 31,
1996 and incorporated herein by reference). Subsidiaries of the
Company.
23.1 Consent of Independent Certified Public Accountants.
27.1 Financial Data Schedule for year ended December 31, 1997 (for SEC
purposes only).
+ Executive management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K.
Report on Form 8-K dated December 19, 1997, announcing a $0.035 per share
dividend on its common stock payable on January 15, 1998, to shareholders
of record on December 31, 1997.
(c) Exhibits -- The Exhibits listed in Item 14(a)(3) of this report are
filed with this Form 10-K.
(d) Financial Statement Schedules -- None.
68
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Sarasota, State of Florida on March 25, 1998.
SUN HYDRAULICS CORPORATION
By: /s/ Clyde G. Nixon
------------------
Clyde G. Nixon, President and
Chief Executive Officer
Pursuant to requirements of the Securities Exchange Act of 1934, this
Report has been signed by the following persons on behalf of the Registrant and
in the capacities indicated on March 25, 1998.
Signature Title
- --------------------------------------------------------------------------------
/s/ Robert E. Koski
- -------------------
Robert E. Koski Chairman of the Board of Directors
/s/ Clyde G. Nixon President, Chief Executive Officer
- ------------------ and Director
Clyde G. Nixon
/s/ Richard J. Dobbyn Chief Financial Officer (Principal
- --------------------- Financial and Accounting Officer)
Richard J. Dobbyn
/s/ Arthur B. Bodley Director
- --------------------
Arthur B. Bodley
/s/ James G. March Director
- ------------------
James G. March
/s/ Taco van Tijn Director
- -----------------
Taco van Tijn
/s/ David N. Wormley Director
- --------------------
David N. Wormley
69
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
3.1 Amended and Restated Articles of Incorporation of the Company
(previously filed as Exhibit 3.1 in the Pre-Effective Amendment No. 4
to the Company's Registration Statement on Form S-1 filed on December
19, 1996 (File No. 333-14183) and incorporated herein by reference).
3.2 Amended and Restated Bylaws of the Company (previously filed as Exhibit
3.2 in the Pre-Effective Amendment No. 4 to the Company's Registration
Statement on Form S-1 filed on December 19, 1996 (File No. 333-14183)
and incorporated herein by reference).
4.1 Revolving Credit Agreement, dated March 9, 1992, between Sun Hydraulics
Corporation and Northern Trust Bank of Florida/Sarasota, N.A.
(previously filed as Exhibit 4.1 in the Company's Registration
Statement on Form S-1 filed on October 15, 1996 (File No. 333-14183)
and incorporated herein by reference).
4.2 Modification Agreement, dated March 25, 1993, amending Revolving Credit
Agreement dated March 9, 1992, between Sun Hydraulics Corporation and
Northern Trust Bank of Florida, N.A. (previously filed as Exhibit 4.2
in the Company's Registration Statement on Form S-1 filed on October
15, 1996 (File No. 333-14183) and incorporated herein by reference).
4.3 Second Modification to Revolving Credit Agreement, dated May __, 1995,
between Sun Hydraulics Corporation and Northern Trust Bank of Florida,
N.A. (previously filed as Exhibit 4.3 in the Company's Registration
Statement on Form S-1 filed on October 15, 1996 (File No. 333-14183)
and incorporated herein by reference).
4.4 Revolving Line of Credit Renewal Note, dated May __, 1995, in the
amount of $1,700,000.00 given by Sun Hydraulics Corporation to Northern
Trust Bank of Florida, N.A. (previously filed as Exhibit 4.4 in the
Company's Registration Statement on Form S-1 filed on October 15, 1996
(File No. 333-14183) and incorporated herein by reference).
4.5 Mortgage and Security Agreement, dated January 9, 1992, between
Suninco, Inc., Sun Hydraulics Corporation, and Northern Trust Bank of
Florida, N.A. (previously filed as Exhibit 4.5 in the Company's
Registration Statement on Form S-1 filed on October 15, 1996 (File No.
333-14183) and incorporated herein by reference).
70
4.6 Loan Agreement, dated March 29, 1996, between Suninco, Inc., Sun
Hydraulics Corporation, and Northern Trust Bank of Florida, N.A.
(previously filed as Exhibit 4.6 in the Company's Registration
Statement on Form S-1 filed on October 15, 1996 (File No. 333-14183)
and incorporated herein by reference).
4.7 Security Agreement, dated March 29, 1996, between Suninco, Inc., Sun
Hydraulics Corporation, and Northern Trust Bank of Florida, N.A.
(previously filed as Exhibit 4.7 in the Company's Registration
Statement on Form S-1 filed on October 15, 1996 (File No. 333-14183)
and incorporated herein by reference).
4.8 Modification and Additional Advance Agreement, dated March 29, 1996,
between Suninco, Inc. and Northern Trust Bank of Florida, N.A.
(previously filed as Exhibit 4.8 in the Company's Registration
Statement on Form S-1 filed on October 15, 1996 (File No. 333-14183)
and incorporated herein by reference).
4.9 Consolidated Note, dated March 29, 1996, in the amount of
$2,475,000.00, given by Suninco, Inc. to Northern Trust Bank of
Florida, N.A. (previously filed as Exhibit 4.9 in the Company's
Registration Statement on Form S-1 filed on October 15, 1996 (File No.
333-14183) and incorporated herein by reference).
4.10 Loan Agreement, dated May 20, 1996, between Sun Hydraulics Corporation
and Northern Trust Bank of Florida, N.A. (previously filed as Exhibit
4.10 in the Company's Registration Statement on Form S-1 filed on
October 15, 1996 (File No. 333-14183) and incorporated herein by
reference).
4.11 Security Agreement, dated May 20, 1996, between Sun Hydraulics
Corporation and Northern Trust Bank of Florida, N.A. (previously filed
as Exhibit 4.11 in the Company's Registration Statement on Form S-1
filed on October 15, 1996 (File No. 333-14183) and incorporated herein
by reference).
4.12 Consolidated Note, dated May 20, 1996, in the amount of $3,063,157.00,
given by Sun Hydraulics Corporation to Northern Trust Bank of Florida,
N.A. (previously filed as Exhibit 4.12 in the Company's Registration
Statement on Form S-1 filed on October 15, 1996 (File No. 333-14183)
and incorporated herein by reference).
71
4.13 Loan Agreement, dated June 14, 1996, between Sun Hydraulics
Corporation, Suninco Inc., and Northern Trust Bank of Florida, N.A.
(previously filed as Exhibit 4.13 in the Company's Registration
Statement on Form S-1 filed on October 15, 1996 (File No. 333-14183)
and incorporated herein by reference).
4.14 Mortgage, dated June 14, 1996, between Sun Hydraulics Corporation,
Suninco Inc., and Northern Trust Bank of Florida, N.A. (previously
filed as Exhibit 4.14 in the Company's Registration Statement on Form
S-1 filed on October 15, 1996 (File No. 333-14183) and incorporated
herein by reference).
4.15 Security Agreement, dated June 14, 1996, between Sun Hydraulics
Corporation and Northern Trust Bank of Florida, N.A. (previously filed
as Exhibit 4.15 in the Company's Registration Statement on Form S-1
filed on October 15, 1996 (File No. 333-14183) and incorporated herein
by reference).
4.16 Promissory Note, dated June 14, 1996, in the amount of $6,187,000.00,
given by Sun Hydraulics Corporation and Suninco, Inc. to Northern Trust
Bank of Florida, N.A. (previously filed as Exhibit 4.16 in the
Company's Registration Statement on Form S-1 filed on October 15, 1996
(File No. 333-14183) and incorporated herein by reference).
4.17 Revolving Loan Facility letter agreement, dated July 30, 1996, in the
amount of (pound)800,000, between Sun Hydraulics Ltd. and Lloyds Bank
Plc. (previously filed as Exhibit 4.17 in the Company's Registration
Statement on Form S-1 filed on October 15, 1996 (File No. 333-14183)
and incorporated herein by reference).
4.18 Overdraft and Other Facilities letter agreement, dated June 7, 1996, in
an amount not to exceed (pound)250,000, between Sun Hydraulics Ltd. and
Lloyds Bank Plc. (previously filed as Exhibit 4.18 in the Company's
Registration Statement on Form S-1 filed on October 15, 1996 (File No.
333-14183) and incorporated herein by reference).
4.19 Mortgage, dated April 11, 1996, between Sun Hydraulik GmbH and Dresdner
Bank (previously filed as Exhibit 4.19 in the Company's Registration
Statement on Form S-1 filed on October 15, 1996 (File No. 333-14183)
and incorporated herein by reference).
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4.20 Amendment to Recommended Offer by Sun Hydraulics Corporation to acquire
the whole of the issued share capital of Sun Hydraulik Holdings
Limited, dated December 17, 1996 (previously filed as Exhibit 2.1 in
the Pre-Effective Amendment No. 4 to the Company's Registration
Statement on Form S-1 filed on December 19, 1996 (File No. 333-14183)
and incorporated herein by reference).
4.21 Master Note, dated February 3, 1997, in the amount of $10,000,000.00,
made by the Company to evidence a line of credit granted to the Company
by Northern Trust Bank of Florida, N.A. (previously filed as Exhibit
4.21 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1996 and incorporated herein by reference).
10.1 Form of Distributor Agreement (Domestic) (previously filed as Exhibit
10.1 in the Company's Registration Statement on Form S-1 filed on
October 15, 1996 (File No. 333-14183) and incorporated herein by
reference).
10.2 Form of Distributor Agreement (International) (previously filed as
Exhibit 10.2 in the Company's Registration Statement on Form S-1 filed
on October 15, 1996 (File No. 333-14183) and incorporated herein by
reference).
10.3+ 1996 Sun Hydraulics Corporation Stock Option Plan (previously filed as
Exhibit 10.3 in the Pre-Effective Amendment No. 4 to the Company's
Registration Statement on Form S-1 filed on December 19, 1996 (File No.
333-14183) and incorporated herein by reference).
10.4+ Amendment No. 1 to 1996 Stock Option Plan (previously filed as Exhibit
10.4 to the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1997 and incorporated herein by reference).
10.5+ Form of Indemnification Agreement (previously filed as Exhibit 10.4 in
the Pre-Effective Amendment No. 4 to the Company's Registration
Statement on Form S-1 filed on December 19, 1996 (File No. 333-14183)
and incorporated herein by reference).
21.1 Subsidiaries of the Company (previously filed as Exhibit 21 in the
Company's Annual Report on Form 10-K for the year ended December 31,
1996 and incorporated herein by reference).
23.1 Consent of Independent Certified Public Accountants.
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27.1 Financial Data Schedule for year ended December 31, 1997 (for SEC
purposes only).
+ Executive management contract or compensatory plan or arrangement.
74