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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003,
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-15603
NATCO GROUP INC.
(Exact name of registrant as specified in its charter)
DELAWARE 22-2906892
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
2950 NORTH LOOP WEST
7TH FLOOR
HOUSTON, TEXAS 77092
(Address of principal executive offices) (Zip Code)
713-683-9292
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
As of May 1, 2003, $0.01 par value per share, 15,854,067 shares
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NATCO GROUP INC.
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2003
TABLE OF CONTENTS
PAGE
NO.
----
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements ................................................... 3
Condensed Consolidated Balance Sheets -- March 31,
2003 (unaudited) and December 31, 2002 ................................. 3
Unaudited Condensed Consolidated Statements of
Operations -- Three Months Ended March 31, 2003 and 2002 ............... 4
Unaudited Condensed Consolidated Statements of Cash
Flows -- Three Months Ended March 31, 2003 and 2002 ................... 5
Notes to Unaudited Condensed Consolidated Financial
Statements ............................................................. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations .................................... 15
Item 3. Quantitative and Qualitative Disclosures About
Market Risk ............................................................ 22
Item 4. Controls and Procedures ................................................ 22
PART II -- OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds .............................. 23
Item 6. Exhibits and Reports on Form 8-K ....................................... 23
Signatures ..................................................................... 25
Certifications ................................................................. 26
2
PART I
ITEM 1. FINANCIAL STATEMENTS
NATCO GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
MARCH 31, DECEMBER 31,
2003 2002
------------ ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents .......................................... $ 1,282 $ 1,689
Trade accounts receivable, net ..................................... 80,914 74,677
Inventories ........................................................ 33,325 32,400
Prepaid expenses and other current assets .......................... 9,859 7,611
------------ ------------
Total current assets ......................................... 125,380 116,377
Property, plant and equipment, net ................................... 33,104 31,485
Goodwill, net ........................................................ 79,356 78,977
Deferred income tax assets, net ...................................... 2,846 2,984
Other assets, net .................................................... 1,584 1,772
------------ ------------
Total assets ................................................. $ 242,270 $ 231,595
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current installments of long-term debt ............................. $ 14,558 $ 7,097
Accounts payable ................................................... 42,094 36,074
Accrued expenses and other ......................................... 34,826 37,243
Customer advances .................................................. 536 1,354
------------ ------------
Total current liabilities .................................... 92,014 81,768
Long-term debt, excluding current installments ....................... 30,640 45,257
Postretirement benefit and other long-term liabilities ............... 12,544 12,718
------------ ------------
Total liabilities ............................................ 135,198 139,743
------------ ------------
Series B redeemable convertible preferred stock (aggregate
redemption value of $15,000), $.01 par value. 15,000 shares
authorized, issued and outstanding (net of issuance costs) ........ 14,101 --
Stockholders' equity:
Preferred stock $.01 par value. Authorized 5,000,000 shares
(of which 500,000 are authorized under Series A and 15,000
are authorized under Series B); no shares issued and
outstanding (except Series B shares above) ....................... -- --
Series A preferred stock, $.01 par value. Authorized 500,000
shares; no shares issued and outstanding ......................... -- --
Common stock, $.01 par value. Authorized
50,000,000 shares; issued and outstanding 15,803,797 shares
as of March 31, 2003 and December 31, 2002, respectively ......... 158 158
Additional paid-in capital ......................................... 97,223 97,223
Accumulated earnings ............................................... 8,764 8,734
Treasury stock, 795,692 shares at cost as of March 31, 2003
and December 31, 2002 ............................................ (7,182) (7,182)
Accumulated other comprehensive loss ............................... (2,266) (3,395)
Notes receivable from officers and stockholders .................... (3,726) (3,686)
------------ ------------
Total stockholders' equity ................................... 92,971 91,852
------------ ------------
Commitments and contingencies
Total liabilities and stockholders' equity ................... $ 242,270 $ 231,595
============ ============
See accompanying notes to unaudited condensed consolidated financial statements.
3
NATCO GROUP INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED
MARCH 31,
--------------------------------
2003 2002
------------- -------------
Revenues ....................................................... $ 68,013 $ 73,578
Cost of goods sold ............................................. 52,202 55,315
------------- -------------
Gross profit ......................................... 15,811 18,263
Selling, general and administrative expense .................... 12,644 13,545
Depreciation and amortization expense .......................... 1,230 1,159
Interest expense ............................................... 1,062 1,017
Interest cost on postretirement benefit liability .............. 209 122
Interest income ................................................ (49) (56)
Other, net ..................................................... 576 (397)
------------- -------------
Income before income taxes and cumulative
effect of change in accounting principle .......... 139 2,873
Income tax provision ........................................... 50 1,100
------------- -------------
Net income before cumulative effect of
change in accounting principle ....................... 89 1,773
Cumulative effect of change in accounting principle
(net of tax benefit of $18) ................................ 34 --
------------- -------------
Net income ........................................... $ 55 $ 1,773
============= =============
Earnings per share--basic:
Net income before cumulative effect of change in
accounting principle ........................................ $ -- $ 0.11
Cumulative effect of change in accounting principle ............ -- --
------------- -------------
Net income ........................................... $ -- $ 0.11
============= =============
Earnings per share--diluted:
Net income before cumulative effect of change in
accounting principle ........................................ $ -- $ 0.11
Cumulative effect of change in accounting principle ............ -- --
------------- -------------
Net income ........................................... $ -- $ 0.11
============= =============
Basic weighted average number of shares of
common stock outstanding ..................................... 15,804 15,804
Diluted weighted average number of shares
of common stock outstanding .................................. 15,874 15,936
See accompanying notes to unaudited condensed consolidated financial statements.
4
NATCO GROUP INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
------------------------------
2003 2002
------------ ------------
Cash flows from operating activities:
Net income .................................................... $ 55 $ 1,773
Adjustments to reconcile net income to net cash
used in operating activities:
Cumulative effect of change in accounting principle ........ 34 --
Deferred income tax expense ................................ 125 101
Depreciation and amortization expense ...................... 1,230 1,159
Non-cash interest income ................................... (40) (56)
Interest cost on postretirement benefit liability .......... 209 122
Gain on the sale of property, plant and equipment .......... (231) (8)
Change in assets and liabilities:
Increase in trade accounts receivable .................... (6,575) (8,774)
(Increase) decrease in inventories ....................... (653) 1,159
(Increase) decrease in prepaid expense and other
current assets ........................................ (1,985) 793
Increase in long-term assets ............................. (119) (61)
Increase in accounts payable ............................. 6,921 1,569
Increase (decrease) in accrued expenses and
other ................................................. (2,307) 455
Decrease in customer advances ............................ (818) (5,008)
------------ ------------
Net cash used in operating activities ................. (4,154) (6,776)
------------ ------------
Cash flows from investing activities:
Capital expenditures for property, plant and
equipment ................................................ (3,072) (1,480)
Proceeds from the sale of property, plant and
equipment ................................................ 618 23
Acquisitions, net ............................................. -- (242)
------------ ------------
Net cash used in investing activities ................. (2,454) (1,699)
------------ ------------
Cash flows from financing activities:
Change in bank overdrafts ..................................... (989) 406
Net borrowings (repayments) under long-term revolving
credit facilities ........................................... (5,592) 7,697
Repayments of long-term debt .................................. (1,775) (1,750)
Borrowings of long-term debt .................................. -- 1,460
Proceeds from the issuance of preferred stock, net ............ 14,101 --
Payments on postretirement benefit liability .................. (374) (562)
Other, net .................................................... 193 159
------------ ------------
Net cash provided by financing activities ............. 5,564 7,410
------------ ------------
Effect of exchange rate changes on cash and cash
equivalents .................................................. 637 (172)
------------ ------------
Change in cash and cash equivalents ............................. (407) (1,237)
Cash and cash equivalents at beginning of period ................ 1,689 3,093
------------ ------------
Cash and cash equivalents at end of period ...................... $ 1,282 $ 1,856
============ ============
Cash payments for:
Interest ...................................................... $ 1,022 $ 644
Income taxes .................................................. $ 340 $ 1,238
See accompanying notes to unaudited condensed consolidated financial statements.
5
NATCO GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The accompanying condensed consolidated interim financial statements and
related disclosures are unaudited and have been prepared by NATCO Group Inc.
("the Company" or "NATCO") pursuant to generally accepted accounting principles
for interim financial statements and the rules and regulations of the Securities
and Exchange Commission. As permitted by these regulations, certain information
and footnote disclosures that would typically be required in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. However, the Company's management believes that
these statements reflect all the normal recurring adjustments necessary for a
fair presentation, in all material respects, of the results of operations for
the periods presented, so that these interim financial statements are not
misleading. These condensed consolidated financial statements should be read in
conjunction with the financial statements and notes thereto included in the
Company's Annual Report on Form 10-K filing for the year ended December 31,
2002.
To prepare financial statements in accordance with generally accepted
accounting principles, the Company's management is required 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 reported amounts of revenues and expenses incurred during the
reporting period. Actual results could differ from those estimates. Furthermore,
certain reclassifications have been made to fiscal year 2002 amounts in order to
present these results on a comparable basis with amounts for fiscal year 2003.
These reclassifications had no impact on net income.
References to "NATCO" and "the Company" are used throughout this document
and relate collectively to NATCO Group Inc. and its consolidated subsidiaries.
(2) EMPLOYEE STOCK OPTIONS
The Company accounts for its employee stock option plans by applying the
provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees," as permitted by SFAS No. 123, "Accounting for
Stock-Based Compensation." SFAS No. 123 allows entities to recognize as expense
over the vesting period the fair value of all stock-based awards on the date of
grant. If entities continued to apply the provision of APB Opinion No. 25, pro
forma net income and earnings per share disclosures would be required for all
employee stock option grants made in 1995 and subsequent years, as if the fair
value-based method defined in SFAS No. 123 had been applied. In December 2002,
SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and
Disclosure, an amendment to FASB Statement No. 123," was issued and provided
alternative methods to transition to the fair value method of accounting for
stock-based compensation, on a volunteer basis, and required additional
disclosures at annual and interim reporting dates. The Company has elected to
continue to apply the provisions of APB Opinion No. 25 and to provide the pro
forma disclosures required by SFAS No. 123.
The Company determines pro forma net income and earnings per share by
applying the Black-Sholes Single Option--Reduced Term valuation method. This
valuation model requires management to make highly subjective assumptions about
volatility of NATCO's common stock, the expected term of outstanding stock
options, the Company's risk-free interest rate and expected dividend payments
during the contractual life of the options. These pro forma net earnings and
earnings per share amounts for the quarters ended March 31, 2003 and 2002,
summarize as follows:
6
QUARTER QUARTER
ENDED ENDED
MARCH 31, MARCH 31,
2003 2002
------------ ------------
(UNAUDITED, IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
Net income before cumulative effect of
change in accounting principle -- as reported ................... $ 89 $ 1,773
Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects ............. (151) (241)
------------ ------------
Pro forma net income (loss) ..................................... $ (62) $ 1,532
============ ============
Earnings (loss) per share:
Basic -- as reported ......................................... $ -- $ 0.11
Basic -- pro forma ........................................... $ -- $ 0.10
Diluted -- as reported ....................................... $ -- $ 0.11
Diluted -- pro forma ......................................... $ -- $ 0.10
(3) CAPITAL STOCK AND REDEEMABLE CONVERTIBLE PREFERRED STOCK
On March 13, 2003, the Company executed an agreement, which subsequently
closed on March 25, 2003, to issue 15,000 shares of its Series B Convertible
Preferred Stock ("Series B Preferred Shares"), and warrants to purchase 248,800
shares of NATCO's common stock, to Lime Rock Partners II, L.P., a private
investment fund, for an aggregate purchase price of $15.0 million. Of the
aggregate purchase price, approximately $99,000 was allocated to the warrants.
Proceeds from the issuance of these securities, net of related estimated
issuance costs of approximately $800,000, were used to reduce the Company's
outstanding revolving debt balances and for other general corporate purposes.
Each of the Series B Preferred Shares has a face value of $1,000 and pays a
cumulative dividend of 10% per annum of face value, which is payable
semi-annually on June 15 and December 15 of each year, except the initial
dividend payment which is payable on July 1, 2003. Each of the Series B
Preferred Shares is convertible, at the option of the holder thereof, into (i) a
number of shares of common stock equal to the face value of such Series B
Preferred Share divided by the conversion price, which was $7.805 (or an
aggregate of 1,921,845 shares) at March 31, 2003, and (ii) a cash payment equal
to the amount of dividends on such share that have accrued since the prior
semi-annual dividend payment date. As of March 31, 2003, the Company accrued
dividends payable of $25,000 related to the Series B Preferred Shares.
In the event of a change in control, as defined in the agreement, each
holder of the Series B Preferred Shares has the right to convert the Series B
Preferred Shares into common stock or to cause the Company to redeem for cash
some or all of the Series B Preferred Shares at an aggregate redemption price
equal to the sum of (i) $1,000 (adjusted for stock splits, stock dividends,
etc.) multiplied by the number of shares to be redeemed, plus (ii) an amount
(not less than zero) equal to the product of $500 (adjusted for stock splits,
stock dividends, etc.) multiplied by the aggregate number of the Series B
Preferred Shares to be redeemed less the sum of the aggregate amount of
dividends paid in cash since the issuance date, plus any gain on the related
stock warrants. If the holder of the Series B Preferred Shares converts upon a
change in control occurring on or before March 25, 2006, the holder would also
be entitled to receive cash in an amount equal to the dividends that would have
accrued through March 25, 2006 less the sum of the aggregate amount of dividends
paid in cash through the date of conversion, and the aggregate amount of
dividends accrued in prior periods but not yet paid.
The Company has the right to redeem the Series B Preferred Shares for cash
on or after March 25, 2008, at a redemption price per share equal to the face
value of the Series B Preferred Shares plus the amount of dividends that have
been accrued but not paid since the most recent semi-annual dividend payment
date.
7
Due to the cash redemption features upon a change in control as described
above, the Series B Preferred Shares do not qualify for permanent equity
treatment in accordance with the Emerging Issues Task Force Topic D-98:
"Classification and Measurement of Redeemable Securities," which specifically
requires that permanent equity treatment be precluded for any security with
redemption features that are not solely within the control of the issuer.
Therefore, the Company has accounted for the Series B Preferred Shares as
temporary equity in the accompanying balance sheet, as required by the SEC rules
and regulations. No value has been assigned to the Company's right to redeem the
Series B Preferred Shares on or after March 25, 2008.
If the Series B Preferred Shares are converted under contingent redemption
features, any redemption amount greater than carrying value would be recorded as
a reduction of income available to common shareholders when the event becomes
probable.
If the Company fails to pay dividends or any redemption price due with
respect to the Series B Preferred Shares for a period of sixty days following
the payment date, the Company will be in default under the terms of such shares.
During a default period, (1) the dividend rate on the Series B Preferred Shares
would increase to 10.25%, (2) the holders of Series B Preferred Shares would
have the right to elect or appoint a second director to the Board of Directors
and (3) the Company would be restricted from paying dividends on, or redeeming
or acquiring its common or other outstanding stock, with limited exceptions. If
the Company fails to set aside or make payments in cash of any redemption price
due with respect to the Series B Preferred Shares, and the holders elect, the
Company's right to redeem the shares may be terminated.
The warrants issued to Lime Rock Partners II, L.P. have an exercise price of
$10.00 per share of common stock and expire on March 25, 2006. The Company can
force the exercise of the warrants if NATCO's common stock trades above $13.50
per share for 30 consecutive days. The warrants contain a provision whereby the
holder could require the Company to make a net-cash settlement for the warrants
in the case of a change in control. The warrants were deemed to be derivative
instruments and, therefore, the warrants were recorded at fair value as of the
issuance date. Fair value, as agreed with the counter-party to the agreement,
was calculated by applying a pricing model that included subjective assumptions
for stock volatility, expected term that the warrants would be outstanding, a
dividend rate of zero and an overall liquidity factor. The resulting liability
of $99,000 was recorded at March 31, 2003. Changes in fair value in subsequent
periods will be recorded as charges to net income during the period of the
change.
On January 1, 2002, all outstanding shares of the Company's Class B Common
Stock, 334,719 shares, were converted automatically to Class A Common Stock, on
a share for share basis, in accordance with the terms under which the Class B
Common Stock was originally issued, resulting in a single class that was
re-designated "Common Stock."
(4) EARNINGS PER SHARE
The Company computed basic earnings per share by dividing net income
available to common shareholders by the weighted average number of shares
outstanding for the period. Net income available to common shareholders at March
31, 2003, represented net income before cumulative effect of change in
accounting principle less preferred stock dividends accrued. The Company
determined diluted earnings per common and potential common share at March 31,
2003, as net income before the cumulative effect of change in accounting
principle divided by the weighted average number of shares outstanding for the
period, after applying the if-converted method to determine any incremental
shares associated with convertible preferred stock and warrants outstanding.
Since the effect of the incremental shares associated with convertible preferred
stock and warrants was anti-dilutive at March 31, 2003, these shares were not
considered common and potential common shares for purposes of calculating
earnings per share at March 31, 2003, in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 128, "Earnings per Share." However,
outstanding employee stock options were considered potential common shares for
purposes of this calculation. For the quarter ended March 31, 2003, 70,525
potential common shares related to employee stock options were included in
diluted weighted average shares. Diluted shares for the quarter ended March 31,
2002 included potential common shares related to employee stock options of
132,402 shares. Anti-dilutive stock options were excluded from the calculation
of potential common shares. If anti-dilutive shares were included for the
quarters ended March 31, 2003 and 2002, the impact would have been a reduction
of 465,598 shares and 252,141 shares, respectively. The following table presents
the computation of basic and diluted earnings per common and potential common
share at March 31, 2003 and 2002, respectively:
8
FOR THE QUARTER ENDED MARCH 31, 2003
--------------------------------------------
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- -----------
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
Income before cumulative effect of change in
accounting principle ................................... $ 89
Less: Preferred stock dividends accrued .................. (25)
-----------
BASIC EPS:
Income available to common stockholders before
cumulative effect of change in accounting principle .... $ 64 15,804 $ --
===========
EFFECT OF DILUTIVE SECURITIES:
Stock options ............................................. -- 70
----------- -----------
DILUTED EPS:
Income available to common stockholders before
cumulative effect of change in accounting
principle + assumed conversions ........................ $ 64 15,874 $ --
=========== =========== ===========
FOR THE QUARTER ENDED MARCH 31, 2002
----------------------------------------------
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
------------ ------------- ------------
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
Income before cumulative effect of change in
accounting principle .................................... $ 1,773
------------
BASIC EPS:
Income available to common stockholders before
cumulative effect of change in accounting principle ..... $ 1,773 15,804 $ 0.11
============
EFFECT OF DILUTIVE SECURITIES:
Stock options .............................................. -- 132
------------ ------------
DILUTED EPS:
Income available to common stockholders before
cumulative effect of change in accounting
principle + assumed conversions ......................... $ 1,773 15,936 $ 0.11
============ ============ ============
(5) INVENTORIES
Inventories consisted of the following amounts:
MARCH 31, DECEMBER 31,
2003 2002
------------ ------------
(UNAUDITED)
(IN THOUSANDS)
Finished goods .................... $ 12,862 $ 13,088
Work-in-process ................... 7,212 6,486
Raw materials and supplies ........ 14,789 14,362
------------ ------------
Inventories at FIFO ............. 34,863 33,936
Excess of FIFO over LIFO cost ..... (1,538) (1,536)
------------ ------------
$ 33,325 $ 32,400
============ ============
9
(6) COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS
Cost and estimated earnings on uncompleted contracts were as follows:
MARCH 31, DECEMBER 31,
2003 2002
------------ ------------
(UNAUDITED)
(IN THOUSANDS)
Cost incurred on uncompleted contracts .................................... $ 108,296 $ 87,586
Estimated earnings ........................................................ 20,862 19,656
------------ ------------
129,158 107,242
Less billings to date ..................................................... 102,342 87,187
------------ ------------
$ 26,816 $ 20,055
============ ============
Included in the accompanying balance sheet under the captions:
Trade accounts receivable ............................................... $ 26,927 $ 20,262
Advance payments ........................................................ (111) (207)
------------ ------------
$ 26,816 $ 20,055
============ ============
(7) CLOSURE AND OTHER
As of December 31, 2002, the Company had recorded a liability totaling
$304,000, related to certain restructuring costs incurred in connection with the
closure of a manufacturing facility in Edmonton, Alberta, Canada. As of March
31, 2003, this liability totaled $249,000. The following table summarizes
changes to the restructuring liability by cost type:
BALANCE AT EFFECT OF BALANCE AT
DECEMBER 31, AMOUNTS PAID EXCHANGE RATE MARCH 31,
2002 AND ADJUSTMENTS CHANGES 2003
------------- --------------- ------------- -------------
(UNAUDITED, IN THOUSANDS)
Employee severance $ 21 $ (7) $ 2 $ 16
Lease termination and other 283 (65) 15 233
------------- ------------- ------------- -------------
Total $ 304 $ (72) $ 17 $ 249
============= ============= ============= =============
The accrual related to lease termination and other at March 31, 2003,
included an adjustment of approximately $25,000, related to an agreement to
sublet a portion of the facility to another tenant. The Company recorded
non-operating expense associated with this restructuring plan of $233,000 during
the quarter ended March 31, 2003, including equipment moving costs, employee
relocations and certain severance cost totaling $116,000 that was not
identified as a restructuring cost as of the plan date. The Company expects to
continue to incur costs associated with this restructuring plan through June 30,
2003.
(8) LONG-TERM DEBT
The consolidated borrowings of the Company were as follows:
MARCH 31, DECEMBER 31,
2003 2002
------------ ------------
(UNAUDITED)
(IN THOUSANDS, EXCEPT
PERCENTAGES)
BANK DEBT
Term loan with variable interest rate (3.81% at March 31, 2003
and 4.21% at December 31, 2002) and quarterly payments of
principal ($1,750) and interest, due March 15, 2006 ..................... $ 36,000 $ 37,750
Revolving credit bank loans with variable interest rate
(4.77% at March 31, 2003 and 4.43% at December 31, 2002)
and quarterly interest payments, due March 15, 2004 ..................... 7,461 8,967
Promissory note with variable interest rate (4.60% at March 31,
2003 and 4.65% at December 31, 2002) and quarterly payments
of principal ($24) and interest, due February 8, 2007 ................... 1,362 1,387
Revolving credit bank loans (export sales facility) with variable
interest rate (4.25% at March 31, 2003 and 4.25% at December 31,
2002) and monthly interest payments, due July 23, payments, due
July 23, 2004 .......................................................... 375 4,250
------------ ------------
Total ................................................................. $ 45,198 $ 52,354
Less current installments ............................................. (14,558) (7,097)
------------ ------------
Long-term debt ..................................................... $ 30,640 $ 45,257
============ ============
10
The Company maintains a credit facility that consists of a $50.0 million
term loan, a $30.0 million U.S. revolving facility, a $10.0 million Canadian
revolving facility and a $10.0 million U.K. revolving facility. The term loan
matures on March 15, 2006, and each of the revolving facilities matures on March
15, 2004.
In July 2002, the Company's lenders approved the amendment of various
provisions of the term loan and revolving credit facility agreement, effective
April 1, 2002. This amendment revised certain restrictive debt covenants,
modified certain defined terms, allowed for future capital investment in the
Company's CO2 processing facility in West Texas, facilitates the issuance of up
to $7.5 million of subordinated indebtedness, increased the aggregate amount of
operating lease expense allowed during a fiscal year and permitted an increase
in borrowings under the export sales credit facility, without further consent,
up to a maximum of $20.0 million. These modifications will result in higher
commitment fee percentages and interest rates if the Funded Debt to EBITDA
ratio, as defined, exceeds 3 to 1.
Amounts borrowed under the term loan bear interest at a rate of 3.81% per
annum as of March 31, 2003. Amounts borrowed under the revolving portion of the
facility bear interest at a rate based upon the ratio of Funded Debt to EBITDA
and ranging from, at the Company's election, (1) a high of the London Inter-bank
Borrowing Rate ("LIBOR") plus 3.00% to a low of LIBOR plus 1.75% or, (2) a high
of a base rate plus 1.50% to a low of a base rate plus 0.25%.
NATCO will pay commitment fees of 0.30% to 0.625% per year depending upon
the ratio of Funded Debt to EBITDA, on the undrawn portion of the facility.
The revolving credit facility is guaranteed by all of the Company's
domestic subsidiaries and is secured by a first priority lien on substantially
all inventory, accounts receivable and other material tangible and intangible
assets. NATCO has also pledged 65% of the voting stock of its active foreign
subsidiaries.
On February 6, 2002, the Company borrowed $1.5 million under a long-term
promissory note. This note accrues interest at the 90-day LIBOR plus 3.25% per
annum, and requires quarterly payments of principal of approximately $24,000 and
interest for five years beginning May 2002, with a final balloon payment due
February 2007. This promissory note is collateralized by a manufacturing
facility in Magnolia, Texas that the Company purchased in the fourth quarter of
2001.
The Company maintains a working capital facility for export sales that
provides for aggregate borrowings of $10.0 million, subject to borrowing base
limitations, under which borrowings of $375,000 were outstanding at March 31,
2003. Letters of credit outstanding under the export sales credit facility as of
March 31, 2003 totaled $170,000. The export sales credit facility is secured by
specific project inventory and receivables, and is partially guaranteed by the
EXIM Bank. The export sales credit facility loans mature in July 2004.
On March 31, 2003, the Company was in compliance with all restrictive debt
covenants. NATCO had letters of credit outstanding under the revolving credit
facilities totaling $17.9 million at March 31, 2003. These letters of credit
support contract performance and warranties and expire at various dates through
January 2006.
The Company had unsecured letters of credit, guarantees and bonds totaling
$432,000 at March 31, 2003.
(9) INCOME TAXES
NATCO's effective income tax rate for the quarter ended March 31, 2003 was
35.7%, which exceeded the amount that would have resulted from applying the U.S.
federal statutory tax rate due to the impact of state income taxes, foreign
income tax rate differentials, losses in foreign subsidiaries and certain
permanent book-to-tax differences.
(10) INDUSTRY SEGMENTS
The Company's operations are organized into three separate business
segments: North American operations, a segment which primarily provides
traditional, standard and small custom production equipment and components,
replacement parts, used equipment and components, equipment servicing and field
operating support including operations of our domestic membrane facility;
engineered systems, a segment which primarily provides customized and more
complex technological equipment, large scale integrated oil and gas production
systems, and equipment and services provided by certain international
operations, including Axsia; and automation and control systems, a segment which
provides control panels and systems that monitor and control oil and gas
production, as well as installation and start-up and other field services
related to instrumentation and electrical systems.
11
The accounting policies of the reportable segments were consistent with the
policies used to prepare the Company's condensed consolidated financial
statements for the respective periods presented. The Company evaluates the
performance of its operating segments based on income before net interest
expense, income taxes, depreciation and amortization and accounting changes.
Summarized financial information concerning the Company's reportable segments is
shown in the following table.
NORTH AUTOMATION
AMERICAN ENGINEERED & CONTROL CORPORATE &
OPERATIONS SYSTEMS SYSTEMS OTHER TOTAL
------------ ------------ ------------ ------------ ------------
(UNAUDITED, IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31, 2003
Revenues from unaffiliated customers ........ $ 27,965 $ 26,016 $ 14,032 $ -- $ 68,013
Inter-segment revenues ...................... 650 30 1,209 (1,889) --
Segment profit (loss) ....................... 1,264 972 1,319 (964) 2,591
Total assets ................................ 94,793 113,544 21,277 12,656 242,270
Capital expenditures ........................ 2,483 489 99 1 3,072
Depreciation and amortization ............... 575 473 93 89 1,230
THREE MONTHS ENDED
MARCH 31, 2002
Revenues from unaffiliated customers ........ $ 38,288 $ 24,797 $ 10,493 $ -- $ 73,578
Inter-segment revenues ...................... 88 312 1,372 (1,772) --
Segment profit (loss) ....................... 3,928 1,336 912 (1,061) 5,115
Total assets ................................ 101,381 104,378 21,507 11,711 238,977
Capital expenditures ........................ 623 543 228 86 1,480
Depreciation and amortization ............... 667 296 95 101 1,159
The following table reconciles total segment profit to net income before
cumulative effect of change in accounting principle:
FOR THE QUARTER ENDED MARCH 31,
-------------------------------
2003 2002
------------ -------------
(UNAUDITED)
Total segment profit ............................. $ 2,591 $ 5,115
Net interest expense ............................. 1,222 1,083
Income taxes ..................................... 50 1,100
Depreciation and amortization .................... 1,230 1,159
------------ ------------
Net income before cumulative effect of
change in accounting principle .............. $ 89 $ 1,773
============ ============
(11) COMMITMENTS AND CONTINGENCIES
The Porta-Test International, Inc. purchase agreement, executed in January
2000, contains a provision to calculate a payment to certain former stockholders
of Porta-Test Systems, Inc. for a three-year period ended January 23, 2003,
based upon sales of a limited number of specified products designed by or
utilizing technology that existed at the time of the acquisition. Liability
under this arrangement is contingent upon attaining certain performance
criteria, including gross margins and sales volumes for the specified products.
If applicable, payment is required annually. In January 2002, the Company
accrued $219,000 under this arrangement for the twelve-month period ended
January 23, 2002, resulting in an increase in goodwill, of which $197,000 was
paid in August 2002. No accrual was recorded under this arrangement for the
twelve-month period ended January 23, 2003.
(12) GOODWILL IMPAIRMENT TESTING
The Financial Accounting Standards Board ("FASB") approved SFAS No. 142,
"Goodwill and Other Intangible Assets" in June 2001. This pronouncement requires
that intangible assets with indefinite lives, including goodwill, cease being
amortized and be evaluated on an impairment basis. Intangible assets with a
defined term, such as patents, would continue to be amortized over the useful
life of the asset.
12
The Company adopted SFAS No. 142 on January 1, 2002. Intangible assets
subject to amortization under the pronouncement as of March 31, 2003 and 2002
are summarized in the following table:
AS OF MARCH 31, 2003 AS OF MARCH 31, 2002
----------------------------- -----------------------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
TYPE OF INTANGIBLE ASSET AMOUNT AMORTIZATION AMOUNT AMORTIZATION
------------------------------ ------------ ------------ ------------ ------------
(UNAUDITED, IN THOUSANDS)
Deferred financing fees ...... $ 3,324 $ 2,157 $ 2,953 $ 1,370
Patents ...................... 152 24 101 10
Other ....................... 299 208 267 128
------------ ------------ ------------ ------------
Total ...................... $ 3,775 $ 2,389 $ 3,321 $ 1,508
============ ============ ============ ============
Amortization and interest expense of $219,000 and $184,000 were recognized
related to these assets for the quarters ended March 31, 2003 and 2002,
respectively. The estimated aggregate amortization and interest expense for
these assets for each of the following five fiscal years is: 2003--$632,000;
2004--$390,000; 2005--$348,000; 2006--$153,000; and 2007--$27,000. For segment
reporting purposes, these intangible assets and the related amortization expense
were recorded under "Corporate and Other."
Goodwill was the Company's only intangible asset that required no periodic
amortization as of the date of the adoption of SFAS No. 142. Net goodwill at
March 31, 2003 was $79.4 million. The Company tested impairment of goodwill at
December 31, 2002 and management determined that goodwill was not impaired.
(13) CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 2003, NATCO recorded the cumulative effect of change in
accounting principle related to the adoption of SFAS No. 143, "Accounting for
Asset Retirement Obligations." This standard required the Company to record the
fair value of an asset retirement obligation as a liability in the period in
which a legal obligation associated with the retirement of tangible long-lived
assets that result from acquisition, construction, development and/or normal use
of the assets, was incurred. In addition, the standard requires the Company to
record a corresponding asset that will be depreciated over the life of the asset
that gave rise to the liability. Subsequent to the initial measurement of the
asset retirement obligation, the Company will be required to adjust the related
liability at each reporting date to reflect changes in estimated retirement cost
and the passage of time. A loss of $34,000, net of tax, was recorded as of
January 1, 2003, as a result of this change in accounting principle. The related
asset retirement obligation and asset cost of $96,000, associated with an
obligation to remove certain leasehold improvements upon termination of lease
arrangements, including concrete pads and equipment. The asset cost will be
depreciated over the remaining useful life of the related assets. There was no
significant change in the asset or liability during the quarter ended March 31,
2003.
(14) NEW ACCOUNTING PRONOUNCEMENTS
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections."
This statement amends existing guidance on reporting gains and losses on
extinguishment of debt, prohibiting the classification of the gain or loss as
extraordinary. SFAS No. 145 also amends SFAS No. 13 to require sale-leaseback
accounting for certain lease modifications that have economic effects similar to
sale-leaseback arrangements. The Company adopted SFAS No. 145 with respect to
the revision of Statement No. 13 on May 15, 2002, and with respect to the
amendment of SFAS No. 4, on January 1, 2003, with no material impact on the
Company's financial condition or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal
Activities," which addresses significant issues regarding the recognition,
measurement and reporting of costs that are associated with exit and disposal
activities, including restructuring activities that were previously accounted
for pursuant to the guidance set forth in EITF Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity." SFAS No. 146 became effective for the Company on January 1, 2003. The
adoption of SFAS No. 146 had no material impact on the Company's financial
condition or results of operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Guarantees of
Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107
and a rescission of FASB Interpretation No. 34." This interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annual
13
financial statements about its obligations under guarantees issued. The
interpretation also clarifies that a guarantor is required to recognize, at the
inception of a guarantee, a liability for the fair value of the obligation
taken. The initial recognition and measurement provisions of the interpretation
are applicable to guarantees issued or modified after December 31, 2002.
Application of this interpretation did not have a material impact on the
Company's financial condition or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure, an amendment to FASB Statement No.
123." This statement amends SFAS No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods to transition, on a volunteer
basis, to the fair value method of accounting for stock-based employee
compensation. Additionally, this statement amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements. Certain disclosure modifications are required for fiscal
years ending after December 31, 2002, if a transition to SFAS No. 123 is
elected. The Company has not elected transition to SFAS No. 123 as of March 31,
2003. See Note 2, Employee Stock Options.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This statement provides
additional guidance to account for derivative instruments, including certain
derivative instruments embedded in other contracts as well as hedging activities
under SFAS No. 133. This pronouncement becomes effective for new contract
arrangements and hedging transactions entered into after June 30, 2003, with
exceptions for certain SFAS No. 133 implementation issues begun prior to June
15, 2003. The Company has not yet determined the impact that this pronouncement
will have on its financial condition or results of operations.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Management's Discussion and Analysis includes forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. The words
"believe," "expect," "plan," "intend," "estimate," "project," "will," "could,"
"may" and similar expressions are intended to identify forward-looking
statements. Forward-looking statements in this document include, but are not
limited to, discussions regarding indicated trends in the level of oil and gas
exploration and production and the effect of such conditions on our results of
operations (see "--Industry and Business Environment"), future uses of and
requirements for financial resources (see "--Liquidity and Capital Resources"),
and anticipated backlog levels for 2003 (see "--Liquidity and Capital
Resources"). Our expectations about our business outlook, customer spending, oil
and gas prices, our business environment and that of the industry in general are
only our expectations regarding these matters. Actual results may differ
materially from those expressed in the forward-looking statements for reasons
including, but not limited to; market factors such as pricing and demand for
petroleum related products, the level of petroleum industry exploration and
production expenditures, the effects of competition, world economic conditions,
the level of drilling activity, the legislative environment in the United States
and other countries, policies of the Organization of Petroleum Exporting
Countries ("OPEC"), conflict involving the United States or in major petroleum
producing or consuming regions, acts of terrorism, the development of technology
which could lower overall finding and development costs, weather patterns and
the overall condition of capital and equity markets for countries in which we
operate.
The following discussion should be read in conjunction with the financial
statements, related notes and other financial information appearing elsewhere in
this Quarterly Report on Form 10-Q. Readers also are urged to review and
consider carefully the various disclosures advising interested parties of the
factors that affect our business, including without limitation, the disclosures
made under the caption "Risk Factors" and the other factors and risks discussed
in our Annual Report on Form 10-K as of December 31, 2002, and in subsequent
reports filed with the Securities and Exchange Commission. We expressly
disclaims any obligation or undertaking to release publicly any updates or
revisions to any forward-looking statement to reflect any change in our
expectations or any change in events, conditions or circumstances on which any
forward-looking statement is based.
OVERVIEW
References to "NATCO" "we" and "our" are used throughout this document and
relate collectively to NATCO Group Inc. and its consolidated subsidiaries.
We organize our operations into three separate business segments: North
American operations, a segment that primarily provides traditional, standard and
small custom production equipment and components, replacement parts, used
equipment and components, equipment servicing and field operating support
including operations of our domestic membrane facility; Engineered Systems, a
segment that primarily provides customized and more complex technological
equipment, large scale integrated oil and gas production systems, and equipment
and services provided by certain international operations, including Axsia; and
Automation and Control Systems, a segment that provides control panels and
systems that monitor and control oil and gas production, as well as installation
and start-up and other field services related to instrumentation and electrical
systems.
CRITICAL ACCOUNTING POLICIES
Our management makes certain estimates and assumptions in preparing our
consolidated financial statements that affect the results reported in the
accompanying notes. We base these estimates and assumptions on historical
experience and on future expectations that we believe to be reasonable under the
circumstances. Note 2 to the consolidated financial statements filed in our
Annual Report on Form 10-K at December 31, 2002, contains a summary of our
significant accounting policies. We believe the following accounting policies
are the most critical in the preparation of our condensed consolidated financial
statements:
Revenue Recognition: Percentage-of-Completion Method. We recognize revenues
from significant contracts (greater than $250,000 and longer than four months in
duration) and certain automation and controls contracts and orders on the
percentage-of-completion method of accounting. Earned revenue is based on the
percentage that costs incurred to date relate to total estimated costs of the
project, after giving effect to the most recent estimates of total cost. The
timing of costs incurred, and therefore recognition of revenue, could be
affected by various internal or external factors including, but not limited to:
changes in project scope (change orders), changes in productivity, scheduling,
the cost and availability of labor, the cost and availability of raw materials,
the weather, client delays in providing approvals at benchmark stages of the
project and the timing of deliveries from third-party providers of key
components. The cumulative impact of revisions in total cost estimates during
the progress of work is reflected in the period in which these changes become
known. Earned revenues reflect the original contract price adjusted for agreed
claims and change order
15
revenues, if applicable. Losses expected to be incurred on the jobs in progress,
after consideration of estimated probable minimum recoveries from claims and
change orders, are charged to income as soon as such losses are known. Claims
for additional contract revenue are recognized if it is probable that the claim
will result in additional revenue and the amount can be reliably estimated. We
generally recognize revenue and earnings to which the percentage-of-completion
method applies over a period of two to six quarters. In the event a project is
terminated by our customer before completion, our customer is liable for costs
incurred under the contract. We believe that our operating results should be
evaluated over a term of several years to evaluate performance under long-term
contracts, after all change orders, scope changes and cost recoveries have been
negotiated and realized. We record revenues and profits on all other sales as
shipments are made or services are performed.
Impairment Testing: Goodwill. As required by Statement of Financial
Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets,"
we evaluate goodwill annually for impairment by comparing the fair value of
operating assets to the carrying value of those assets, including any related
goodwill. As required by SFAS No. 142, we identify separate reportable units for
purposes of this evaluation. In determining carrying value, we segregate assets
and liabilities that, to the extent possible, are clearly identifiable by
specific reportable unit. All inter-company receivables/payables are excluded.
Certain corporate and other assets and liabilities, that are not clearly
identifiable by specific reportable unit, are allocated based on the ratio of
each unit's net assets relative to total net assets. The fair value is then
compared to the carrying value of the reportable unit to determine whether or
not impairment has occurred at the reportable unit level. In the event an
impairment is indicated, an additional test is performed whereby an implied fair
value of goodwill is determined through an allocation of the fair value to the
reporting unit's assets and liabilities, whether recognized or unrecognized, in
a manner similar to a purchase price allocation, in accordance with SFAS No.
141, "Business Combinations." Any residual fair value after this purchase price
allocation would be assumed to relate to goodwill. If the carrying value of the
goodwill exceeded the residual fair value, we would record an impairment charge
for that amount. No impairment charge was recorded at December 31, 2002, and no
indications of impairment were noted during the three months ended March 31,
2003. Net goodwill was $79.4 million and $79.0 million at March 31, 2003 and
December 31, 2002, respectively.
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board ("FASB") approved SFAS No. 142,
"Goodwill and Other Intangible Assets" in June 2001. This pronouncement requires
that intangible assets with indefinite lives, including goodwill, cease being
amortized and be evaluated on an impairment basis. Intangible assets with a
defined term, such as patents, would continue to be amortized over the useful
life of the asset. We adopted SFAS No. 142 on January 1, 2002, and continued to
amortize certain net assets totaling $1.4 million at March 31, 2003, and
recorded amortization and interest expense related to those assets for the
quarter ended March 31, 2003 of $219,000. We ceased periodic amortization of
goodwill on the date of adoption.
In accordance with SFAS No. 142, we tested impairment of goodwill as of
December 31, 2002. Based upon the testing performed, we determined that goodwill
was not impaired. Goodwill will be tested for impairment annually on December
31. No indications of impairment were noted during the three months ended March
31, 2003. Therefore, no impairment charge was recorded under SFAS No. 142 for
the quarter ended March 31, 2003.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." This standard provides guidance on reporting and accounting for
obligations associated with the retirement of long-lived tangible assets and the
related retirement costs. This standard is effective for financial statements
issued for fiscal years beginning after June 15, 2002. On January 1, 2003, we
adopted this pronouncement and recorded a loss of $34,000, net of tax effect, as
the cumulative effect of change in accounting principle. In addition, we
recorded an asset retirement obligation liability and asset cost of $96,000,
associated with an obligation to remove certain leasehold improvements upon
termination of lease arrangements, including concrete pads and equipment. The
asset cost will be depreciated over the remaining useful life of the related
assets.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections."
This statement provides guidance for income statement classification of gains
and losses on extinguishment of debt and accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions. SFAS No. 145 became effective and was adopted on January 1, 2003,
with no material impact on our financial condition or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal
Activities," which addresses significant issues regarding the recognition,
measurement and reporting of costs that are associated with exit and disposal
activities, including restructuring activities that were previously accounted
for pursuant to the guidance set forth in EITF Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity." SFAS No. 146 became effective on January 1, 2003. The adoption of
SFAS No. 146 had no material impact on our financial condition or results of
operations.
16
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This statement provides
additional guidance to account for derivative instruments, including certain
derivative instruments embedded in other contracts as well as hedging activities
under SFAS No. 133. This pronouncement becomes effective for new contract
arrangements and hedging transactions entered into after June 30, 2003, with
exceptions for certain SFAS No. 133 implementation issues begun prior to June
15, 2003. We have not yet determined the impact that this pronouncement will
have on our financial condition or results of operations.
INDUSTRY AND BUSINESS ENVIRONMENT
As a leading provider of wellhead process equipment, systems and services
used in the production of crude oil and natural gas, our revenues and results of
operations are closely tied to demand for oil and gas products and spending by
oil and gas companies for exploration and development of oil and gas reserves.
These companies generally invest more in exploration and development efforts
during periods of favorable oil and gas commodity prices, and invest less during
periods of unfavorable oil and gas prices. As supply and demand change,
commodity prices fluctuate producing cyclical trends in the industry. During
periods of lower demand, revenues for service providers such as NATCO generally
decline, as existing projects are completed and new projects are postponed.
During periods of recovery, revenues for service providers can lag behind the
industry due to the timing of new project awards.
Changes in commodity prices have impacted our business over the past several
years. The following table summarizes the price of domestic crude oil per barrel
and the wellhead price of natural gas per thousand cubic feet ("mcf") for the
quarters ended March 31, 2003 and 2002, as well as averages for the years ended
December 31, 2002 and 2001, derived from published reports by the U.S.
Department of Energy, and the rotary rig count, as published by Baker Hughes
Incorporated.
THREE MONTHS ENDED YEAR ENDED
MARCH 31, DECEMBER 31,
-------------------------------- -----------------------------
2003 2002 2002 2001
------------ ------------ ------------ ------------
Average price of crude oil per barrel in the U.S. $ 31.21(a) $ 17.64 $ 22.51 $ 21.86
Average wellhead price of natural gas per mcf in $ 4.14(a) $ 2.34 $ 2.95 $ 4.12
the U.S.
Average North American rig count 1,389 1,191 1,093 1,497
----------
(a) Calculated using actual and projected data from the U.S. Department of
Energy
At March 31, 2003, the spot price of West Texas Intermediate crude oil per
barrel was $30.43 per barrel, the price of natural gas was $5.00 per mcf, and
the North American rig count was 1,250. At April 30, 2003, the spot price of
West Texas Intermediate crude oil was $28.43 per barrel, the price of Henry Hub
natural gas was $5.35 per mcf, as per the New York Mercantile Exchange, and the
North American rig count was 1,084, per Baker Hughes Incorporated. These spot
prices reflect the overall volatility of oil and gas commodity prices in the
current and recent periods.
Historically, we have viewed operating rig counts as a benchmark of spending
in the oil and gas industry for exploration and development efforts. Our
traditional equipment sales and services business generally correlates to
changes in rig activity, but tends to lag behind the North American rig count
trend. With the North American rig count increasing significantly in the first
quarter of 2003, we expect traditional equipment and services in the U.S. and
Canada to show improving results during the second half of 2003.
The following discussion of our historical results of operations and
financial condition should be read in conjunction with our condensed
consolidated financial statements and notes thereto.
RESULTS OF OPERATIONS
Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002
Revenues. Revenues of $68.0 million for the three months ended March 31,
2003 decreased $5.6 million, or 8%, from $73.6 million for the three months
ended March 31, 2002. The following table summarizes revenues by business
segment for the quarters ended March 31, 2003 and 2002, respectively.
17
THREE MONTHS ENDED
MARCH 31,
------------------------------
PERCENTAGE
2003 2002 CHANGE CHANGE
------------ ------------ ------------ ------------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PERCENTAGE CHANGE)
North American Operations ......... $ 28,615 $ 38,376 $ (9,761) (25%)
Engineered Systems ................ 26,046 25,109 937 4%
Automation and Control Systems .... 15,241 11,865 3,376 28%
Corporate and Other ............... (1,889) (1,772) (117) (7%)
------------ ------------ ------------
Total ................... $ 68,013 $ 73,578 $ (5,565) (8%)
============ ============ ============
North American Operations revenues decreased $9.8 million, or 25%, for the
quarter ended March 31, 2003, as compared to the quarter ended March 31, 2002,
despite a 17% increase in the number of operating rotary rigs in North America,
from an average of 1,191 rigs for the quarter ended March 31, 2002 to an average
of 1,389 rigs for the quarter ended March 31, 2003. We experienced a decline
in demand primarily for our traditional equipment and services due to the timing
of project awards and a decline in new project bookings. Revenues related to our
Canadian operations also declined, with fewer projects in progress in 2003
compared to 2002. Inter-segment revenues for this business segment were $650,000
for the quarter ended March 31, 2003, as compared to $88,000 for the quarter
ended March 31, 2002.
Revenues for the Engineered Systems segment increased $937,000, or 4%, for
the quarter ended March 31, 2003, as compared to the quarter ended March 31,
2002. This increase was primarily due to an increase in revenues contributed by
our U.K.-based operations, which provided $14.1 million of revenues for the
quarter ended March 31, 2003 as compared to $9.8 million for the quarter ended
March 31, 2002. Partially offsetting this increase was a decline in other
engineered systems projects. Engineered Systems revenues of $26.0 million for
the quarter ended March 31, 2003 included approximately $30,000 of inter-segment
revenues, as compared to $312,000 of inter-segment revenues for the quarter
ended March 31, 2002.
Revenues for the Automation and Control Systems segment increased $3.4
million, or 28%, for the quarter ended March 31, 2003, as compared to the
quarter ended March 31, 2002. This increase in revenues was the result of more
large projects in progress during 2003 relative to the first quarter of 2002,
including several deep-water projects in the Gulf of Mexico as well as control
system and implementation projects in West Africa and Thailand. Inter-segment
sales declined from $1.4 million for the quarter ended March 31, 2002 to $1.2
million for the quarter ended March 31, 2003.
The change in revenues for Corporate and Other represents the elimination of
inter-segment revenues as discussed above.
Gross Profit. Gross profit for the quarter ended March 31, 2003 decreased
$2.5 million, or 13%, to $15.8 million, compared to $18.3 million for the
quarter ended March 31, 2002. As a percentage of revenue, gross margins declined
from 25% for the quarter ended March 31, 2002 to 23% for the quarter ended March
31, 2003. The following table summarizes gross profit by business segment for
the quarters then ended:
THREE MONTHS ENDED
MARCH 31,
-----------------------------
PERCENTAGE
2003 2002 CHANGE CHANGE
------------ ------------ ------------ ------------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PERCENTAGE CHANGE)
North American Operations ......... $ 7,354 $ 10,250 $ (2,896) (28%)
Engineered Systems ................ 5,871 5,852 19 --
Automation and Control Systems .... 2,586 2,161 425 20%
------------ ------------ ------------
Total ................... $ 15,811 $ 18,263 $ (2,452) (13%)
============ ============ ============
Gross profit for the North American Operations business segment decreased
$2.9 million, or 28%, for the quarter ended March 31, 2003, as compared to the
quarter ended March 31, 2002, due to a 25% decline in revenues for the
respective periods. As a percentage of revenue, gross margins were 26% and 27%
for the quarters ended March 31, 2003 and 2002, respectively.
18
Gross profit for the Engineered Systems segment for the quarter ended March
31, 2003 remained relatively constant with gross profit earned for the quarter
ended March 31, 2002, despite a 4% increase in revenues for the business segment
for the respective periods. Gross margin as a percentage of revenues for
Engineered Systems was 22.5% and 23.3% for the quarters ended March 31, 2003 and
2002, respectively.
Gross profit for the Automation and Control Systems segment increased
$425,000, or 20%, for the quarter ended March 31, 2003, as compared to the
quarter ended March 31, 2002, due primarily to a 28% increase in revenues for
the respective period. Gross margin as a percentage of revenue for the quarters
ended March 31, 2003 and 2002, was 17% and 18%, respectively.
Selling, General and Administrative Expense. Selling, general and
administrative expense of $12.6 million decreased $901,000, or 7%, for the
quarter ended March 31, 2003, as compared to the quarter ended March 31, 2002.
This decrease was primarily related to cost savings resulting from certain
restructuring activities in the U.S. and Canada, including the closure of a
manufacturing facility in Canada during late 2002 and overall headcount
reductions, from 1,831 employees at March 31, 2002 to 1,721 employees at March
31, 2003.
Depreciation and Amortization Expense. Depreciation and amortization expense
of $1.2 million for the quarter ended March 31, 2003, increased $71,000, or 6%,
compared to the results for the quarter ended March 31, 2002. Depreciation
expense of $1.2 million for the quarter ended March 31, 2003, increased $73,000,
or 6%, as compared to the respective period for 2002, related to the addition of
capital assets purchased and constructed during 2002, including a significant
expansion of the Sacroc gas processing facility. Amortization expense of $23,000
for the quarter ended March 31, 2003 was consistent with the results for the
respective period in 2002.
Interest Expense. Interest expense of $1.1 million for the quarter ended
March 31, 2003, increased $45,000, or 4%, from $1.0 million for the quarter
ended March 31, 2002.
Other, net. Other, net was $576,000 for the quarter ended March 31, 2003 and
included severance and relocation costs associated with reductions in force in
the U.S. and the consolidation of operations at our Canadian subsidiary, as well
as foreign exchange transaction losses, primarily on inter-company balances.
Other, net for the quarter ended March 31, 2002 represented net foreign currency
exchange transaction gains of $397,000, primarily related to our U.K.-based
operations.
Provision for Income Taxes. Income tax expense for the quarter ended March
31, 2003 was $50,000 compared to $1.1 million for the quarter ended March 31,
2002. The primary reason for this decrease in tax expense was a decline in
income before income taxes from $2.9 million for the quarter ended March 31,
2002 to $139,000 for the quarter ended March 31, 2003. The effective tax rate
declined from 38.3% for the first quarter of 2002 to 35.7% for the first quarter
of 2003, as a larger percentage of pre-tax income was earned by subsidiaries in
lower tax jurisdictions in 2003 relative to 2002.
Cumulative Effect of Change in Accounting Principle. The cumulative effect
of change in accounting principle of $34,000, net of tax effect, related to the
adoption of SFAS No. 143, "Accounting for Asset Retirement Obligations," on
January 1, 2003. See Recent Accounting Pronouncements.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2003, we had cash and working capital of $1.3 million and
$33.4 million, respectively, as compared to cash and working capital of $1.7
million and $34.6 million, respectively, at December 31, 2002.
Net cash used in operating activities for the quarter ended March 31, 2003
was $4.2 million, compared to $6.8 million for the quarter ended March 31, 2002.
Factors that contributed to the decline in cash used in operating activities
during 2003 included a decrease in trade accounts receivable, an increase in
trade accounts payable and customer advances, offset by a decline in net income
and increase in other current assets.
Net cash used in investing activities for the quarter ended March 31, 2003
was $2.5 million, of which $3.1 million was used for capital expenditures,
partially offset by proceeds from the sale of fixed assets totaling $618,000.
For the quarter ended March 31, 2002, cash used in investing activities was $1.7
million and related primarily to capital expenditures.
Net cash provided by financing activities for the quarter ended March 31,
2003 was $5.6 million. The primary source of funds for financing activities for
the quarter ended March 31, 2003 was proceeds from the issuance of our Series B
Convertible Preferred Stock and related warrants of $14.1 million, net of
issuance costs, offset by repayments of long-term borrowings under our term loan
facility and revolving credit facilities of $1.8 million and $5.6 million,
respectively, as well as a decline in bank overdrafts of $989,000. Net cash
provided by financing activities for the quarter ended March 31, 2002 was $7.4
million. The primary source of funds for
19
financing activities during the quarter ended March 31, 2002 was borrowings of
$7.7 million under our revolving credit facilities and borrowings of $1.5
million under a long-term promissory note arrangement related to the purchase of
our Magnolia manufacturing facility, offset by repayments of $1.8 million under
our term loan facility.
We borrowed $1.5 million under a long-term promissory note arrangement on
February 6, 2002. This note accrues interest at the 90-day London Inter-bank
Offered Rate ("LIBOR") plus 3.25% per annum, and requires quarterly payments of
principal of approximately $24,000 and interest for five years beginning May
2002, with a final balloon payment due February 2007. This promissory note is
collateralized by our manufacturing facility in Magnolia, Texas that we
purchased in the fourth quarter of 2001.
We maintain a credit facility that consists of a $50.0 million term loan, a
$30.0 million U.S. revolving facility, a $10.0 million Canadian revolving
facility and a $10.0 million U.K. revolving facility. The term loan matures on
March 15, 2006, and each of the revolving facilities matures on March 15, 2004.
On or before that date, we expect to extend or refinance our loan agreements to
have continued access to comparable credit facilities on reasonable terms.
In July 2002, our lenders approved the amendment of various provisions of
the term loan and revolving credit facility agreement, effective April 1, 2002.
This amendment revised certain restrictive debt covenants, modified certain
defined terms, allowed for future capital investment in our CO2 processing
facility in West Texas, facilitates the issuance of $7.5 million of subordinated
debt, increased the aggregate amount of operating lease expense allowed during a
fiscal year and permitted an increase in borrowings under the export sales
credit facility, without further consent, up to a maximum of $20.0 million.
These modifications will result in higher commitment fee percentages and
interest rates if the Funded Debt to EBITDA ratio, as defined, exceeds 3 to 1.
Borrowings outstanding under the term loan facility totaled $36.0 million at
March 31, 2003, and bear interest at 3.81% per annum. Amounts borrowed under the
revolving facilities bear interest at a rate based upon the ratio of Funded Debt
to EBITDA and ranging from, at our election, (1) a high of LIBOR plus 3.00% to a
low of LIBOR plus 1.75% or, (2) a high of a base rate plus 1.50% to a low of a
base rate plus 0.25%.
As of March 31, 2003, the weighted average interest rate of our borrowings
under the revolving credit facilities was 4.77%.
We will pay commitment fees of 0.30% to 0.625% per year, depending upon the
ratio of Funded Debt to EBITDA, on the undrawn portion of the facility.
The revolving credit facility is guaranteed by all of our domestic
subsidiaries and is secured by a first priority lien on substantially all
inventory, accounts receivable and other material tangible and intangible
assets. We have also pledged 65% of the voting stock of our active foreign
subsidiaries.
We had letters of credit outstanding under the revolving credit facilities
of $17.9 million at March 31, 2003. These letters of credit support contract
performance and warranties and expire at various dates through January 2006.
We maintain a working capital facility for export sales that provides for
aggregate borrowings of $10.0 million, subject to borrowing base limitations,
under which borrowings of $375,000 were outstanding as of March 31, 2003.
Letters of credit outstanding under this facility at March 31, 2003 totaled
$170,000. The export sales credit facility is secured by specific project
inventory and receivables, and is partially guaranteed by the EXIM Bank. The
export sales credit facility loans mature in July 2004.
We had unsecured letters of credit, guarantees and bonds outstanding at
March 31, 2003 of $432,000.
Our sales backlog at March 31, 2003 was $82.8 million compared to $77.0
million at March 31, 2002. Backlog increased primarily in Engineered Systems,
which offset a decline in bookings for traditional equipment sales and services
in our North American Operations segment.
On March 13, 2003, we executed an agreement, which subsequently closed on
March 25, 2003, to issue 15,000 shares of our Series B Convertible Preferred
Stock ("Series B Preferred Shares"), and warrants to purchase 248,800 shares of
our common stock, to Lime Rock Partners II, L.P., a private investment fund, for
an aggregate purchase price of $15.0 million. Of the aggregate purchase price,
approximately $99,000 was allocated to the warrants. Proceeds from the issuance
of these securities, net of related estimated issuance costs of approximately
$800,000, were used to reduce our outstanding revolving debt balances and for
other general corporate purposes.
Each of the Series B Preferred Shares has a face value of $1,000 and pays a
cumulative dividend of 10% per annum of face value, which is payable
semi-annually on June 15 and December 15 of each year, except the initial
dividend payment which is payable on
20
July 1, 2003. Each of the Series B Preferred Shares is convertible, at the
option of the holder thereof, into (i) a number of shares of common stock equal
to the face value of such Series B Preferred Share divided by the conversion
price, which was $7.805 (or an aggregate of 1,921,845 shares at March 31, 2003),
and (ii) a cash payment equal to the amount of dividends on such share that have
accrued since the prior semi-annual dividend payment date. As of March 31, 2003,
we accrued dividends payable of $25,000 related to the Series B Preferred
Shares.
In the event of a change in control, as defined in the agreement, each
holder of the Series B Preferred Shares has the right to convert the Series B
Preferred Shares into common stock or to cause the Company to redeem for cash
some or all of the Series B Preferred Shares at an aggregate redemption price
equal to the sum of (i) $1,000 (adjusted for stock splits, stock dividends,
etc.) multiplied by the number of shares to be redeemed, plus (ii) an amount
(not less than zero) equal to the product of $500 (adjusted for stock splits,
stock dividends, etc.) multiplied by the aggregate number of Series B Preferred
Shares to be redeemed less the sum of the aggregate amount of dividends paid in
cash since the issuance date, plus any gain on the related stock warrants. If
the holder of the Series B Preferred Shares converts upon a change in control
occurring on or before March 25, 2006, the holder would also be entitled to
receive cash in an amount equal to the dividends that would have accrued through
March 25, 2006 less the sum of the aggregate amount of dividends paid in cash
through the date of conversion, and the aggregate amount of dividends accrued in
prior periods but not yet paid.
We have the right to redeem the Series B Preferred Shares for cash on or
after March 25, 2008, at a redemption price per share equal to the face value of
the Series B Preferred Shares plus the amount of dividends that have been
accrued but not paid since the most recent semi-annual dividend payment date.
Due to the cash redemption features upon a change in control as described
above, the Series B Preferred Shares do not qualify for permanent equity
treatment in accordance with the Emerging Issues Task Force Topic D-98:
"Classification and Measurement of Redeemable Securities," which specifically
requires that permanent equity treatment be precluded for any security with
redemption features that are not solely within the control of the issuer.
Therefore, we have accounted for the Series B Preferred Shares as temporary
equity in the accompanying balance sheet, as required by the SEC rules and
regulations. No value has been assigned to our right to redeem the Series B
Preferred Shares on or after March 25, 2008.
If the Series B Preferred Shares are redeemed under contingent redemption
features, any redemption amount greater than carrying value would be recorded
as a reduction of income available to common shareholders when the event becomes
probable.
If we fail to pay dividends or any redemption price due with respect to the
Series B Preferred Shares for a period of sixty days following the payment date,
we will be in default under the terms of such shares. During a default period,
(1) the dividend rate on the Series B Preferred Shares would increase to 10.25%,
(2) the holders of Series B Preferred Shares would have the right to elect or
appoint a second director to the Board of Directors and (3) we would be
restricted from paying dividends on, or redeeming or acquiring our common or
other outstanding stock, with limited exceptions. If we fail to set aside or
make payments in cash of any redemption price due with respect to the Series B
Preferred Shares, and the holders elect, our right to redeem the shares may be
terminated.
The warrants issued to Lime Rock Partners II, L.P. have an exercise price
of $10.00 per share of common stock and expire on March 25, 2003. We can force
the exercise of the warrants if our common stock trades above $13.50 per share
for 30 consecutive days. The warrants contain a provision whereby the holder
could require us to make a net-cash settlement for the warrants in the case of a
change in control. The warrants were deemed to be derivative instruments and,
therefore, the warrants were recorded at fair value as of the issuance date.
Fair value, as agreed with the counter-party to the agreement, was calculated by
applying a pricing model that included subjective assumptions for stock
volatility, expected term that the warrants would be outstanding, a dividend
rate of zero and an overall liquidity factor. The resulting liability of $99,000
was recorded at March 31, 2003. Changes in fair value in subsequent periods will
be recorded as charges to net income during the period of the change.
At March 31, 2003, available borrowing capacity under the term loan and
revolving credit agreement and the export sales credit agreement were $24.4
million and $5.3 million, respectively. We were in compliance with all
restrictive debt covenants in our loan agreements as of March 31, 2003. Under
our agreement, certain of our debt covenants become more restrictive at June 30,
2003, and we may not be in compliance with such covenants at that date. We may
be required to request amendments or waivers of some or all of these covenants
in the future. We believe these amendments or waivers can be obtained, if
necessary, on reasonable terms. If we are unable to obtain a waiver on
reasonable terms, we would be required to classify our term loan as a current
obligation and we may be required to amend the terms of our credit facility or
seek alternative financing. Although no assurances can be given, we believe that
our operating cash flow, supported by our borrowing capacity, will be adequate
to fund operations for at least the next twelve months. Should we decide to
pursue acquisition opportunities, the determination of our ability to finance
these acquisitions will be a critical element of the analysis of the
opportunities.
21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our operations are conducted around the world in a number of different
countries. Accordingly, future earnings are exposed to changes in foreign
currency exchange rates. The majority of our foreign currency transactions
relate to operations in Canada and the U.K. In Canada, most contracts are
denominated in Canadian dollars, and most of the costs incurred are in Canadian
dollars, which mitigates risks associated with currency fluctuations. In the
U.K., many of our sales contracts and material purchases are denominated in a
currency other than British pounds sterling, primarily U.S. dollars and euros,
whereas our engineering and overhead costs are principally denominated in
British pounds sterling. Consequently, we have currency risk in our U.K.
operations. No forward contracts or other currency-related derivative hedge
arrangements existed at March 31, 2003, and we do not currently intend to enter
into such contracts or arrangements as part of our currency risk management
strategy.
The warrants issued to the holders of our Series B Preferred Shares provide
for a net-cash settlement in the event of a change in control, as defined in the
warrants. Consequently, we use derivative accounting to record the warrant
transaction. At March 31, 2003, we recorded a $99,000 liability, representing
the fair value of this derivative arrangement. Fair value, as agreed with the
counter-party to the agreement, was based on a pricing model that included
subjective assumptions concerning the volatility of our common stock, the
expected term that the warrants would be outstanding, an expected dividend rate
of zero and an overall liquidity factor. At each reporting date, the liability
will be adjusted to current fair value with any changes in fair value reported
in earning during the period of change. As such, we may be exposed to certain
income fluctuations based upon changes in the fair market value of this
liability due to changes in the price of our common stock, as well as other
factors.
Our financial instruments are subject to changes in interest rates,
including our revolving credit and term loan facilities and our working capital
facility for export sales. At March 31, 2003, we had borrowings of $36.0 million
outstanding under the term loan portion of the revolving credit and term loan
facilities, at an interest rate of 3.81%. Borrowings, which bear interest at
floating rates, outstanding under the revolving credit agreement at March 31,
2003, totaled $7.5 million. As of March 31, 2003, the weighted average interest
rate of our borrowings under revolving credit facilities was 4.77%. Borrowings
under the working capital facility for export sales at March 31, 2003 totaled
$375,000 and accrued interest at 4.25%, while borrowings under the long-term
arrangement secured by our Magnolia manufacturing facility totaled $1.4 million
and accrued interest at 4.60%.
Based on past market movements and possible near-term market movements, we
do not believe that potential near-term losses in future earnings, fair values
or cash flows from changes in interest rates are likely to be material. Assuming
our current level of borrowings, a 100 basis point increase in interest rates
under our variable interest rate facilities would decrease our current quarter
net income and cash flow from operations by less than $100,000. In the event of
an adverse change in interest rates, we could take action to mitigate our
exposure. However, due to the uncertainty of actions that could be taken and the
possible effects, this calculation assumes no such actions. Furthermore, this
calculation does not consider the effects of a possible change in the level of
overall economic activity that could exist in such an environment.
ITEM 4. CONTROLS AND PROCEDURES
CONTROLS AND PROCEDURES
Members of our management team, including our chief executive officer and
our principal financial officer (who currently is fulfilling the functions of
chief financial officer), have reviewed our disclosure controls and procedures,
as defined by the Securities and Exchange Commission in Rule 13a-14(c) of the
Securities Exchange Act of 1934, within 90 days of this Quarterly Report on Form
10-Q, in an effort to evaluate the effectiveness of the design and operation of
these controls. Based upon this review, our management has determined that
disclosure controls and procedures operate such that important information is
collected in a timely manner, provided to management and made known to our chief
executive officer and chief financial officer (or officer performing the
functions of the chief financial officer), as appropriate, to allow timely
decisions regarding disclosure in our public filings.
Furthermore, no significant changes have been made to our internal controls
and procedures subsequent to March 31, 2003 but prior to filing this Quarterly
Report on Form 10-Q, and no corrective actions are anticipated as we noted no
significant deficiencies or material weaknesses in our control structure.
22
PART II
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On March 13, 2003, we executed an agreement, which subsequently closed on
March 25, 2003, to issue 15,000 shares of our Series B Convertible Preferred
Stock ("Series B Preferred Shares"), and warrants to purchase 248,800 shares of
our common stock, to Lime Rock Partners II, L.P., a private investment fund, for
an aggregate purchase price of $15.0 million. Of the aggregate purchase price,
approximately $99,000 was allocated to the warrants. Proceeds from the issuance
of these securities, net of related estimated issuance costs of approximately
$800,000, were used to reduce our outstanding revolving debt balances and for
other general corporate purposes. These securities were issued in a private
offering to a single purchaser and were exempt from registration under Section
4(2) of the Securities Act of 1933, as amended.
Each of the Series B Preferred Shares has a face value of $1,000 and pays a
cumulative dividend of 10% per annum of face value, which is payable
semi-annually on June 15 and December 15 of each year, except the initial
dividend payment which is payable on July 1, 2003. Each of the Series B
Preferred Shares is convertible, at the option of the holder thereof, into (i) a
number of shares of common stock equal to the face value of such Series B
Preferred Share divided by the conversion price, which was $7.805 (or an
aggregate of 1,921,845 shares at March 31, 2003), and (ii) a cash payment equal
to the amount of dividends on such share that have accrued since the prior
semi-annual dividend payment date. As of March 31, 2003, we accrued dividends
payable of $25,000 related to the Series B Preferred Shares.
In the event of a change in control, as defined in the agreement, each
holder of the Series B Preferred Shares has the right to convert the Series B
Preferred Shares into common stock or to cause the Company to redeem for cash
some or all of the Series B Preferred Shares at an aggregate redemption price
equal to the sum of (i) $1,000 (adjusted for stock splits, stock dividends,
etc.) multiplied by the number of shares to be redeemed, plus (ii) an amount
(not less than zero) equal to the product of $500 (adjusted for stock splits,
stock dividends, etc.) multiplied by the aggregate number of Series B Preferred
Shares to be redeemed less the sum of the aggregate amount of dividends paid in
cash since the issuance date, plus any gain on the related stock warrants. If
the holder of the Series B Preferred Shares elects redemption in cash upon a
change in control occurring on or before March 25, 2006, the holder would also
be entitled to receive cash in an amount equal to the dividends that would have
accrued through March 25, 2006, less the sum of the aggregate amount of
dividends paid in cash through the date of conversion, and the aggregate amount
of dividends accrued in prior periods but not yet paid.
We have the right to redeem the Series B Preferred Shares for cash on or
after March 25, 2008, at a redemption price per share equal to the face value of
the Series B Preferred Shares plus the amount of dividends that have been
accrued but not yet paid since the most recent semi-annual dividend payment
date.
If the Series B Preferred Shares are redeemed under contingent redemption
features, any redemption amount greater than carrying value would be recorded
as a reduction of income available to common shareholders when the event becomes
probable.
If we fail to pay dividends or any redemption price due with respect to the
Series B Preferred Shares for a period of sixty days following the payment date,
we will be in default under the terms of such shares. During a default period,
(1) the dividend rate on the Series B Preferred Shares would increase to 10.25%,
(2) the holders of Series B Preferred Shares would have the right to elect or
appoint a second director to the Board of Directors and (3) we would be
restricted from paying dividends on, or redeeming or acquiring our common or
other outstanding stock, with limited exceptions. If we fail to set aside or
make payments in cash of any redemption price due with respect to the Series B
Preferred Shares, and the holders elect, our right to redeem the shares may be
terminated.
The warrants issued to Lime Rock Partners II, L.P. have an exercise price of
$10.00 per share of common stock and expire on March 25, 2006. We can force the
exercise of the warrants if our common stock trades above $13.50 per share for
30 consecutive days. The warrants contain a provision whereby the holder could
require us to make a net-cash settlement for the warrants in the case of a
change in control.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) See Index of Exhibits for a list of those exhibits filed herewith.
(b) Reports on Form 8-K.
o Report on Form 8-K filed February 25, 2003, to report Fourth
Quarter and Year 2002 Results.
o Report on Form 8-K filed March 7, 2003, to announce key
personnel changes.
o Report on Form 8-K filed March 14, 2003, to announce the sale of
$15.0 million of convertible preferred stock and warrants to a
private equity firm.
o Report on Form 8-K filed March 25, 2003, announcing the
completion of a $15.0 million convertible preferred stock and
warrant private placement to a private equity firm.
o Report on Form 8-K filed May 7, 2003, to report First Quarter
2003 Results.
23
(c) Index of Exhibits
EXHIBIT NO. DESCRIPTION
2.3 -- Securities Purchase Agreement by and among Lime Rock
Partners II, L.P. and NATCO Group Inc., dated March
13, 2003 (incorporated by reference to Exhibit 99.2 of
the Company's Current Report on Form 8-K filed March
14, 2003).
3.1 -- Restated Certificate of Incorporation of the Company
dated March 6, 1998, as amended by Certificates of
Amendment dated November 18, 1998 and November 29,
1999 and January 21, 2000 (incorporated by reference
to Exhibit 3.1 of the Company's Registration Statement
No. 333-48851 on Form S-1).
3.2 -- Certificate of Designations of Series A Junior
Participating Preferred Stock (incorporated by
reference to Exhibit 3.2 of the Company's Registration
Statement No. 333-48851 on Form S-1).
3.3* -- Composite Amended and Restated By-laws of the Company,
as amended
3.4 -- Certificate of Designations of Series B Convertible
Preferred Stock of NATCO Group Inc. dated March 25,
2003 (incorporated by reference to Exhibit 3.1 of the
Company's Current Report on Form 8-K filed on March
27, 2003).
4.3 -- Registration Rights Agreement by and between Lime Rock
Partners II, L.P. and NATCO Group Inc. dated March 25,
2003 (incorporated by reference to Exhibit 4.1 of the
Company's Current Report on Form 8-K filed on March
27, 2003).
4.4 -- Rights Agreement dated as of May 15, 1998 by and among
the Company and Chase Mellon Shareholder Services, LLC
(incorporated by reference to Exhibit 4.2 of the
Company's Registration Statement No. 333-48851 on Form
S-1)
4.5 -- First Amendment to Rights Agreement between NATCO
Group Inc. and Mellon Investor Services L.L.C. (as
successor to ChaseMellon Shareholder Services,
L.L.C.), as Rights Agent dated March 25, 2003
(incorporated by reference to Exhibit 4.2 of the
Company's Current Report on Form 8-K filed on March
27, 2003).
99.1* -- Certification of Chief Executive Officer of NATCO
Group Inc. pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
99.2* -- Certification of Principal Financial Officer of NATCO
Group Inc. pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
----------
* Filed with this report
24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NATCO Group Inc.
By: /s/ NATHANIEL A. GREGORY
------------------------------
Name: Nathaniel A. Gregory
Chairman of the Board and
Chief Executive Officer
Date: May 15, 2003
By: /s/ RYAN S. LILES
------------------------------
Name: Ryan S. Liles
Vice President and Controller
(Principal Financial Officer)
Date: May 15, 2003
25
CERTIFICATIONS
I, Nathaniel A. Gregory, certify that:
1. I have reviewed this quarterly report on Form 10-Q of NATCO Group Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during
the period in which this quarterly report is being
prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this quarterly report (the
"Evaluation Date"); and
c. presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b. any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: May 15, 2003
---------------------------
/s/ NATHANIEL A. GREGORY
------------------------------------------
Nathaniel A. Gregory
Chief Executive Officer
26
CERTIFICATIONS
I, Ryan S. Liles, certify that:
1. I have reviewed this quarterly report on Form 10-Q of NATCO Group Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during
the period in which this quarterly report is being
prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this quarterly report (the
"Evaluation Date"); and
c. presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b. any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: May 15, 2003
-----------------------------
/s/ RYAN S. LILES
------------------------------------------
Ryan S. Liles,
Vice President and Controller
(Principal Financial Officer*)
* Currently performing the function of chief financial officer, following the
chief financial officer's resignation on March 21, 2003.
27
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
----------- -----------
2.3 -- Securities Purchase Agreement by and among Lime Rock
Partners II, L.P. and NATCO Group Inc., dated March
13, 2003 (incorporated by reference to Exhibit 99.2 of
the Company's Current Report on Form 8-K filed March
14, 2003).
3.1 -- Restated Certificate of Incorporation of the Company
dated March 6,, 1998, as amended by Certificates of
Amendment dated November 18, 1998 and November 29,
1999 and January 21, 2000 (incorporated by reference
to Exhibit 3.1 of the Company's Registration Statement
No. 333-48851 on Form S-1).
3.2 -- Certificate of Designations of Series A Junior
Participating Preferred Stock (incorporated by
reference to Exhibit 3.2 of the Company's Registration
Statement No. 333-48851 on Form S-1).
3.3* -- Composite Amended and Restated By-laws of the Company,
as amended
3.4 -- Certificate of Designations of Series B Convertible
Preferred Stock of NATCO Group Inc. dated March 25,
2003 (incorporated by reference to Exhibit 3.1 of the
Company's Current Report on Form 8-K filed on March
27, 2003).
4.3 -- Registration Rights Agreement by and between Lime Rock
Partners II, L.P. and NATCO Group Inc. dated March 25,
2003 (incorporated by reference to Exhibit 4.1 of the
Company's Current Report on Form 8-K filed on March
27, 2003).
4.4 -- Rights Agreement dated as of May 15, 1998 by and among
the Company and Chase Mellon Shareholder Services, LLC
(incorporated by reference to Exhibit 4.2 of the
Company's Registration Statement No. 333-48851 on Form
S-1)
4.5 -- First Amendment to Rights Agreement between NATCO
Group Inc. and Mellon Investor Services L.L.C. (as
successor to ChaseMellon Shareholder Services,
L.L.C.), as Rights Agent dated March 25, 2003
(incorporated by reference to Exhibit 4.2 of the
Company's Current Report on Form 8-K filed on March
27, 2003).
99.1* -- Certification of Chief Executive Officer of NATCO
Group Inc. pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
99.2* -- Certification of Principal Financial Officer of NATCO
Group Inc. pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
----------
* Filed with this report
28