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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 SEPTEMBER 30, 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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12 b-2 of the Exchange Act). 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 November 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 SEPTEMBER 30, 2003
TABLE OF CONTENTS
PAGE
NO.
---
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements................................ 3
Condensed Consolidated Balance Sheets -- September
30, 2003 (unaudited) and December 31, 2002.......... 3
Unaudited Condensed Consolidated Statements of
Operations -- Three and Nine Months Ended September
30, 2003 and 2002.................................. 4
Unaudited Condensed Consolidated Statements of Cash
Flows -- Nine Months Ended September 30, 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................. 19
Item 3. Quantitative and Qualitative Disclosures About
Market Risk......................................... 31
Item 4. Controls and Procedures.............................. 32
PART II -- OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K..................... 33
Signatures ..................................................... 34
2
PART I
ITEM 1. FINANCIAL STATEMENTS
NATCO GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------ -----------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents.................................. $ 1,134 $ 1,689
Trade accounts receivable, net............................. 69,444 74,677
Inventories................................................ 37,976 32,400
Prepaid expenses and other current assets.................. 7,588 7,611
---------- ---------
Total current assets................................. 116,142 116,377
Property, plant and equipment, net........................... 35,201 31,485
Goodwill, net................................................ 79,831 78,977
Deferred income tax assets, net.............................. 2,581 2,984
Other assets, net............................................ 1,436 1,772
---------- ---------
Total assets......................................... $ 235,191 $ 231,595
========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current installments of long-term debt..................... $ 16,992 $ 7,097
Accounts payable........................................... 36,379 36,074
Accrued expenses and other................................. 31,679 37,243
Customer advances.......................................... 3,517 1,354
---------- ---------
Total current liabilities............................ 88,567 81,768
Long-term debt, excluding current installments............... 26,716 45,257
Postretirement benefit and other long-term liabilities....... 12,080 12,718
---------- ---------
Total liabilities.................................... 127,363 139,743
---------- ---------
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 designated as Series A and 15,000 are
designated as 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 15,854,067 and
15,803,797 shares as of September 30, 2003 and
December 31, 2002, respectively.......................... 159 158
Additional paid-in capital................................. 97,343 97,223
Accumulated earnings....................................... 8,511 8,734
Treasury stock, 795,692 shares at cost as of September
30, 2003 and December 31, 2002........................... (7,182) (7,182)
Accumulated other comprehensive loss....................... (1,301) (3,395)
Notes receivable from officers............................. (3,803) (3,686)
----------- ---------
Total stockholders' equity........................... 93,727 91,852
---------- ---------
Commitments and contingencies
Total liabilities and stockholders' equity........... $ 235,191 $ 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2003 2002 2003 2002
---------- ---------- ---------- ---------
Revenues .......................................... $ 65,801 $ 66,563 $ 204,427 $ 214,537
Cost of goods sold ................................ 49,777 51,655 156,045 163,704
--------- --------- --------- ---------
Gross profit ............................ 16,024 14,908 48,382 50,833
Selling, general and administrative expense ....... 12,647 13,299 38,291 39,863
Depreciation and amortization expense ............. 1,167 1,288 3,651 3,640
Closure and other ................................. 722 -- 947 --
Interest expense .................................. 950 1,280 3,089 3,423
Interest cost on postretirement benefit liability . 209 122 628 367
Interest income ................................... (42) (47) (141) (174)
Other, net ........................................ (74) (271) 830 (236)
--------- --------- --------- ---------
Income (loss) before income taxes and cumulative
effect of change in accounting principle .... 445 (763) 1,087 3,950
Income tax provision (benefit) .................... 255 (427) 499 1,379
--------- --------- --------- ---------
Net income (loss) before cumulative effect of
change in accounting principle .............. 190 (336) 588 2,571
Cumulative effect of change in accounting
principle (net of tax benefit of $18)............. -- -- 34 --
--------- --------- --------- ---------
Net income (loss) ....................... $ 190 $ (336) $ 554 $ 2,571
Preferred stock dividends.......................... 378 -- 777 --
--------- --------- --------- ---------
Net income (loss) available to
common stockholders.................... $ (188) $ (336) $ (223) $ 2,571
========= ========= ========= =========
Earnings (loss) per share--basic:
Net income (loss) before cumulative effect of
change in accounting principle ................. $ (0.01) $ (0.02) $ (0.01) $ 0.16
Cumulative effect of change in accounting principle -- -- -- --
--------- --------- --------- ---------
Net income (loss) ....................... $ (0.01) $ (0.02 $ (0.01) $ 0.16
========= ========= ========= =========
Earnings (loss) per share--diluted:
Net income (loss) before cumulative effect of
change in accounting principle ................. $ (0.01) $ (0.02) $ (0.01) $ 0.16
Cumulative effect of change in accounting principle -- -- -- --
--------- --------- --------- ---------
Net income (loss) ....................... $ (0.01) $ (0.02) $ (0.01) $ 0.16
========= ========= ========= =========
Basic weighted average number of shares of
common stock outstanding ........................ 15,854 15,804 15,836 15,804
Diluted weighted average number of shares
of common stock outstanding ..................... 15,854 15,804 15,836 15,937
See accompanying notes to unaudited condensed consolidated financial statements.
4
NATCO GROUP INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
2003 2002
---- ----
Cash flows from operating activities:
Net income ............................................... $ 552 $ 2,571
Adjustments to reconcile net income to net cash
provided by operating activities:
Cumulative effect of change in accounting
principle ........................................... 34 --
Deferred income tax expense ........................... 1,433 1,894
Depreciation and amortization expense ................. 3,651 3,640
Non-cash interest income .............................. (116) (159)
Revaluation of warrants ............................... (15) --
Interest cost on postretirement benefit liability ..... 628 367
Gain on the sale of property, plant and equipment ..... (265) (14)
Change in assets and liabilities:
(Increase) decrease in trade accounts receivable .... 6,389 (4,747)
(Increase) decrease in inventories .................. (3,755) 2,572
Increase in prepaid expense and other current
assets ............................................ (683) (450)
Increase in long-term assets ........................ (299) (422)
Increase in accounts payable ........................ 3,039 1,114
Decrease in accrued expenses and other .............. (6,731) (3,522)
Increase (decrease) in customer advances ............ 2,133 (1,800)
-------- --------
Net cash provided by operating activities ........ 5,995 1,044
-------- --------
Cash flows from investing activities:
Capital expenditures for property, plant and
equipment .............................................. (8,347) (3,882)
Proceeds from the sale of property, plant and
equipment .............................................. 670 44
Issuance of related party note receivable ................ -- (216)
Acquisitions, net ........................................ -- (240)
-------- --------
Net cash used in investing activities ............ (7,677) (4,294)
-------- --------
Cash flows from financing activities:
Change in bank overdrafts ................................ (3,450) 155
Net borrowings (repayments) under long-term revolving
credit facilities ...................................... (3,877) 6,594
Repayments of long-term debt ............................. (5,324) (5,299)
Borrowings of long-term debt ............................. -- 1,460
Proceeds from the issuance of preferred stock, net ....... 14,101 --
Issuance of common stock ................................. 111 --
Payments on postretirement benefit liability ............. (1,338) (1,434)
Dividends paid ........................................... (399) --
Other, net ............................................... 558 541
-------- --------
Net cash provided by financing activities ........ 382 2,017
-------- --------
Effect of exchange rate changes on cash and cash
equivalents ............................................. 745 506
-------- --------
Change in cash and cash equivalents ........................ (555) (727)
Cash and cash equivalents at beginning of period ........... 1,689 3,093
-------- --------
Cash and cash equivalents at end of period ................. $ 1,134 $ 2,366
======== ========
Cash payments for:
Interest ................................................. $ 2,260 $ 2,277
Income taxes ............................................. $ 782 $ 2,350
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.
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 Statement of Financial
Accounting Standards ("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. SFAS No. 148,
"Accounting for Stock-Based Compensation--Transition and Disclosure, an
amendment to FASB Statement No. 123," issued in December 2002, 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-Scholes Single Option--Reduced Term valuation method. This
valuation model requires management to make highly subjective assumptions about
the 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. The following table summarizes these
pro forma net earnings and earnings per share amounts for the three-month and
nine-month periods ended September 30, 2003 and 2002.
6
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2003 2002 2003 2002
---- ---- ---- ----
(UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net income (loss) before cumulative effect
of change in accounting principle--as
reported ............................................ $ 190 $ (336) $ 588 $ 2,571
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of related
tax effects.......................................... 118 236 439 721
------- ------- ------- ---------
Pro forma net income (loss) ........................... $ 72 $ (572) $ 149 $ 1,850
======= ======= ======= =========
Earnings (loss) per share:
Basic -- as reported ............................... $ (0.01) $ (0.02) $ (0.01) $ 0.16
Basic -- pro forma ................................. $ (0.02) $ (0.04) $ (0.04) $ 0.12
Diluted -- as reported ............................. $ (0.01) $ (0.02) $ (0.01) $ 0.16
Diluted -- pro forma ............................... $ (0.02) $ (0.04) $ (0.04) $ 0.12
Pursuant to the NATCO Group Inc. Directors Compensation Plan, as amended,
and the NATCO Group Inc. 2001 Stock Incentive Plan, the Company granted 2,500
restricted shares to each of its five non-employee directors during June 2003.
These restricted shares vest 100% on June 3, 2006, but are forfeitable if
service discontinues prior to this date (other than for death, disability or
retirement). The Company will recognize expense of $85,000 related to these
grants ratably over the vesting period. In addition, the Company granted each of
these non-employee directors options to purchase 2,500 shares of the Company's
common stock at the fair market value on the date of grant. These options vest
100% following one year of service, on the anniversary date of their issuance.
(3) CAPITAL STOCK AND REDEEMABLE CONVERTIBLE PREFERRED STOCK
On March 13, 2003, the Company issued 15,000 shares of 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 price of $15.0 million. Approximately $99,000
of the aggregate purchase price 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 was payable on July 1, 2003. Each of the Series B
Preferred Shares is convertible, at the option of the holder, 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 September 30, 2003, and (ii) a cash payment equal to the
amount of dividends on such shares that have accrued since the prior semi-annual
dividend payment date. As of September 30, 2003, the Company had accrued
dividends payable of $378,000 related to the Series B Preferred Shares. The
Company paid dividends of $399,000 on July 1, 2003, to the holders of the Series
B Preferred Shares.
In the event of a change in control, as defined in the certificate of
designations for the preferred shares, 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.
7
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.
The Company adopted SFAS No. 150, "Accounting for Certain Instruments with
Characteristics of both Liabilities and Equity," on July 1, 2003. Under SFAS No.
150, the Series B Preferred Shares would be classified as permanent equity.
However, 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, and has not assigned any
value to its 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 for two consecutive periods or any
redemption price due with respect to the Series B Preferred Shares for a period
of 60 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 the
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 Company recorded the
resulting liability of $99,000 as of the issuance date. At September 30, 2003,
this liability was $84,000, reflecting a decline in fair market value of the
warrants since the date of acquisition of $15,000. Changes in fair value in
future periods will be recorded as charges or credits to net income during the
period of the change, as applicable.
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."
8
(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
September 30, 2003, represented net income before cumulative effect of change in
accounting principle less preferred stock dividends accrued and paid. The
Company determined diluted earnings per common and potential common share at
September 30, 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, warrants and
restricted stock outstanding. Since the effect of such incremental shares was
anti-dilutive at September 30, 2003, these shares were not considered common and
potential common shares for purposes of calculating earnings per share at
September 30, 2003, in accordance with SFAS No. 128, "Earnings per Share."
Outstanding employee stock options were considered potential common shares for
purposes of this calculation. However, potential common shares related to
employee stock options were anti-dilutive for the three-month periods ended
September 30, 2003 and 2002, and for the nine months ended September 30, 2003,
as the Company recorded a net loss available to common shareholders during these
periods. Diluted shares for the nine months ended September 30, 2002 included
potential common shares related to employee stock options of 133,677 shares.
Anti-dilutive stock options were excluded from the calculation of potential
common shares. If anti-dilutive shares were included in the calculation for the
three and nine months ended September 30, 2003, the impact would have been a
reduction of 407,211 shares and 495,320 shares, respectively. If anti-dilutive
shares were included for the three and nine months ended September 30, 2002, the
impact would have been a reduction of 409,192 shares and 250,119 shares,
respectively. The following table presents the computation of basic and diluted
earnings per common and potential common share for the three and nine months
ended September 30, 2003 and 2002, respectively:
THREE MONTHS ENDED SEPTEMBER 30, 2003 THREE MONTHS ENDED SEPTEMBER 30, 2002
------------------------------------- -------------------------------------
INCOME SHARES PER-SHARE INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ------ ----------- ------------- ------
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Income (loss) before
cumulative effect of change
in accounting principle ..................... $ 190 $ (336)
Less: Preferred stock
dividends accrued and paid .................. (378) --
-------- -----
Basic EPS:
Loss available to common
stockholders before
cumulative effect of change
in accounting principle ..................... $ (188) 15,854 $ (0.01) $ (336) 15,804 $ (0.02)
======== ========
Effect of dilutive securities:
Stock options ................................. -- -- -- --
-------- ------ ------ ------
Diluted EPS:
Loss available to common
stockholders before
cumulative effect of change
in accounting principle +
assumed conversions ......................... $ (188) 15,854 $ (0.01) $ (336) 15,804 $ (0.02)
======== ====== ======== ====== ====== ========
9
NINE MONTHS ENDED SEPTEMBER 30, 2003 NINE MONTHS ENDED SEPTEMBER 30, 2002
------------------------------------ ------------------------------------
INCOME SHARES PER-SHARE INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- --------- ----------- ------------- ---------
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Income before cumulative
effect of change in
accounting principle ................................ $ 588 $ 2,571
Less: Preferred stock
dividends accrued and paid .......................... (777) --
------- -------
Basic EPS:
Income (loss) available to
common stockholders before
cumulative effect of change
in accounting principle ............................. $ (189) 15,836 $ (0.01) $ 2,571 15,804 $ 0.16
======== ==========
Effect of dilutive securities:
Stock options ......................................... -- -- -- 133
------- ------ ------- ------
Diluted EPS:
Income (loss) available to
common stockholders before
cumulative effect of change
in accounting principle +
assumed conversions ................................. $ (189) 15,836 $ (0.01) $ 2,571 15,937 $ 0.16
======= ====== ======== ======= ====== ==========
(5) INVENTORIES
Inventories consisted of the following amounts:
SEPTEMBER 30, DECEMBER 31,
2003 2002
---- ----
(UNAUDITED)
(IN THOUSANDS)
Finished goods................. $ 14,964 $13,088
Work-in-process................ 8,549 6,486
Raw materials and supplies..... 16,044 14,362
-------- -------
Inventories at FIFO.......... 39,557 33,936
Excess of FIFO over LIFO cost.. (1,581) (1,536)
-------- -------
$ 37,976 $32,400
======== =======
(6) COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS
Cost and estimated earnings on uncompleted contracts were as follows:
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- -----------
(UNAUDITED)
(IN THOUSANDS)
Cost incurred on uncompleted contracts............... $ 94,242 $87,586
Estimated earnings................................... 25,480 19,656
-------- -------
119,722 107,242
Less billings to date................................ 100,213 87,187
-------- -------
$ 19,509 $20,055
======== =======
Included in the accompanying balance sheet under
the captions:
Trade accounts receivable.......................... $ 20,549 $20,262
Advance payments................................... (1,040) (207)
-------- -------
$ 19,509 $20,055
======== =======
10
(7) CLOSURE AND OTHER
In September 2003, the Company recorded expenses of $722,000 associated with
a management-approved restructuring plan, which included the involuntary
termination of certain administrative and operating personnel in connection with
the closure of a manufacturing facility in Covington, Louisiana, the Company's
corporate headquarters, the Company's research and development facility in
Tulsa, Oklahoma, and the consolidation of operations in the U.K. As a result of
this restructuring plan, the Company incurred post-employment costs for these
terminated employees, as provided by the Company's severance policy, in
accordance with SFAS No. 112, "Employers' Accounting for Post-employment
Benefits, an amendment of FASB Statements No. 5 and 43." These post-employment
costs totaled $640,000, of which $290,000 was paid during September 2003. The
Company accrued the remaining $350,000 of post-employment costs as of September
30, 2003, and expects to pay this amount during the fourth quarter. In addition,
the Company incurred $78,000 related to consultant's fees, equipment moving
costs and employee relocations. Approximately $300,000 of additional costs
related to this restructuring are expected during the fourth quarter of 2003 and
will be expensed as incurred in accordance with SFAS No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities."
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
September 30, 2003, this liability totaled $84,000. The following table
summarizes changes to the restructuring liability by cost type:
BALANCE AT EFFECT OF BALANCE AT
DECEMBER 31, AMOUNTS PAID EXCHANGE RATE SEPTEMBER
2002 AND ADJUSTMENTS CHANGES 30, 2003
----------- --------------- ------------- ----------
(UNAUDITED, IN THOUSANDS)
Employee severance .................................... $ 21 $ (23) $ 2 $--
Lease termination and other ........................... 283 (234) 35 84
----- ----- ----- -----
Total .............................................. $ 304 $(257) $ 37 $ 84
===== ===== ===== =====
The portion of the accrual related to lease termination and other during the
nine months ended September 30, 2003, was reduced by approximately $234,000, of
which $110,000 related to amounts paid and $124,000 related to a change in the
assessment of liability under the lease arrangement for this facility.
During the nine months ended September 30, 2003, the Company recorded
closure and other expense associated with the Canadian restructuring plan of
$229,000, related to equipment moving costs and employee relocations, including
severance costs of $125,000 that was not identified as a restructuring cost as
of the plan measurement date.
(8) LONG-TERM DEBT
The consolidated borrowings of the Company were as follows:
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PERCENTAGES)
BANK DEBT
Term loan with variable interest rate (3.99% at September 30, 2003 and 4.21% at
December 31, 2002) and quarterly payments of principal ($1,750) and interest,
due March 31, 2006.................................................................... $ 32,500 $ 37,750
Revolving credit bank loans with variable interest rate (4.90% at September 30,
2003 and 4.43% at December 31, 2002) and quarterly interest payments, due March 31,
2004.................................................................................. 9,895 8,967
Promissory note with variable interest rate (4.55% at September 30, 2003 and
4.65% at December 31, 2002) and quarterly payments of principal ($24) and
interest, due February 8, 2007.............................. 1,313 1,387
Revolving credit bank loans (export sales facility) with variable interest rate
(4.25% December 31, 2002) and monthly interest payments, due July 23, 2004............ -- 4,250
-------- --------
Total............................................................................... $ 43,708 $ 52,354
Less current installments........................................................... (16,992) (7,097)
-------- --------
Long-term debt................................................................... $ 26,716 $ 45,257
======== ========
11
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 31, 2006, and each of the revolving facilities matures on March
31, 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 Sacroc 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 resulted in
higher commitment fee percentages and interest rates than in the original loan
agreement, based on the Funded Debt to EBITDA ratio, as defined in the
underlying agreement, as amended.
In July 2003, the Company's lenders approved an amendment of the existing
term loan and revolving credit facility, effective April 1, 2003, and as of
September 30, 2003, the Company was in compliance with all restrictive debt
covenants, as amended. The amendment modified several restrictive covenant
terms, including the Fixed Charge Coverage Ratio and Funded Debt to EBITDA
Ratio, each as defined in the agreement. Under the Company's term loan and
revolving credit facility agreement, certain debt covenants become more
restrictive during the fourth quarter of 2003, and the Company may not be in
compliance with these or certain other debt covenants at December 31, 2003. The
Company may be required to request amendments or waivers of some or all of
these covenants in the future, which management believes would be obtainable
from the majority banks upon reasonable terms.
Amounts borrowed under the term loan bear interest at a rate of 3.99% per
annum as of September 30, 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, a high of the London
Inter-bank Borrowing Rate ("LIBOR") plus 3.00% to a low of LIBOR plus 1.75% or,
a high of a base rate plus 1.50% to a low of a base rate plus 0.25%.
NATCO is required to 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. As of September 30, 2003, the Company's commitment fees were
calculated at a rate of 0.625%.
The revolving credit facilities are guaranteed by the Company and its
operating subsidiaries and are secured by a first lien or first priority
security interest in or pledge of substantially all of the assets of the
borrowers, including accounts receivable, inventory, equipment, intangibles,
equity interests in U.S. subsidiaries and 65% of the equity interest in active,
non-U.S. subsidiaries. Assets of the Company and its active U.S. subsidiaries
secure the U.S. facility, assets of the Company's Canadian subsidiary secure
the Canadian facility and assets of the Company's U.K. subsidiaries secure the
U.K. facility. The U.S. facility is guaranteed by each U.S. subsidiary of the
Company, while the Canadian and U.K. facilities are guaranteed by the Company,
each of its U.S. subsidiaries and the Canadian subsidiary or the U.K.
subsidiaries, as applicable.
On February 6, 2002, the Company borrowed $1.5 million under a long-term
promissory note to finance the purchase of a manufacturing facility in Magnolia,
Texas. 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 the manufacturing facility in
Magnolia, Texas acquired in the fourth quarter of 2001.
12
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 no borrowings were outstanding at September 30, 2003.
Letters of credit outstanding under this facility as of September 30, 2003
totaled $1.0 million. Fees related to these letters of credit at September 30,
2003, were approximately 1% of the outstanding balance. The export sales credit
facility is secured by specific project inventory and receivables, and is
partially guaranteed by the EXIM Bank. The facility loans mature in July 2004.
NATCO had letters of credit outstanding under the revolving credit
facilities totaling $19.5 million at September 30, 2003. Fees related to these
letters of credit at September 30, 2003, ranged from approximately 1% to 3.25%
of the outstanding balance. These letters of credit support contract performance
and warranties and expire at various dates through April 2007.
The Company also had unsecured letters of credit and bonds totaling $564,000
and guarantees totaling $7.4 million at September 30, 2003.
(9) INCOME TAXES
NATCO's effective income tax rate for the nine months ended September 30,
2003 was 46%, 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, 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, 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, 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.
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, closure and other, other,
net and accounting changes.
In September 2003, the Company changed the presentation of its reportable
segments by reclassifying certain research and development costs and bonus
expenses among the business segments from the "Corporate and Other" segment. In
addition, Other, net was excluded from the determination of segment profit
(loss). These changes were made as a result of a change in management's
internal reporting to better state total costs and profits of each segment and
have been retroactively reflected in all periods presented.
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
SEPTEMBER 30, 2003
Revenues from unaffiliated customers.. $ 32,553 $ 20,528 $ 12,720 $ -- $ 65,801
Inter-segment revenues................ 165 308 684 (1,157) --
Segment profit (loss)................. 2,891 192 1,254 (960) 3,377
Total assets.......................... 100,319 103,543 21,521 9,808 235,191
Capital expenditures.................. 1,616 348 2 4 1,970
Depreciation and amortization......... 669 375 28 95 1,167
13
THREE MONTHS ENDED
SEPTEMBER 30, 2002
Revenues from unaffiliated customers.. $ 31,230 $ 23,484 $ 11,849 $ -- $ 66,563
Inter-segment revenues................ 306 210 1,016 (1,532) --
Segment profit (loss)................. 1,608 (168) 1,016 (847) 1,609
Total assets.......................... 102,079 103,905 19,871 10,443 236,298
Capital expenditures.................. 521 349 103 50 1,023
Depreciation and amortization......... 660 477 138 13 1,288
NINE MONTHS ENDED
SEPTEMBER 30, 2003
Revenues from unaffiliated customers.. $ 91,297 $ 73,769 $ 39,361 $ -- $204,427
Inter-segment revenues................ 992 375 3,291 (4,658) --
Segment profit (loss)................. 6,923 2,250 3,821 (2,903) 10,091
Total assets.......................... 100,319 103,543 21,521 9,808 235,191
Capital expenditures.................. 7,034 1,157 132 24 8,347
Depreciation and amortization......... 1,831 1,312 223 285 3,651
NINE MONTHS ENDED
SEPTEMBER 30, 2002
Revenues from unaffiliated customers.. $102,032 $ 78,190 $ 34,315 $ -- $214,537
Inter-segment revenues................ 616 923 3,545 (5,084) --
Segment profit (loss)................. 7,762 2,418 3,282 (2,492) 10,970
Total assets.......................... 102,079 103,905 19,871 10,443 236,298
Capital expenditures.................. 1,536 1,803 381 162 3,882
Depreciation and amortization......... 1,774 1,381 332 153 3,640
The following table reconciles total segment profit to net income before
cumulative effect of change in accounting principle:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- --------------------------
2003 2002 2003 2002
---- ---- ---- ----
(UNAUDITED, IN THOUSANDS)
Total segment profit $ 3,377 $ 1,609 $ 10,091 $ 10,970
Net interest expense 1,117 1,355 3,576 3,616
Depreciation and amortization 1,167 1,288 3,651 3,640
Closure and other 722 -- 947 --
Other, net (74) (271) 830 (236)
------- ------- -------- --------
Net income (loss) before income taxes and
cumulative effect of change in
accounting principle 445 (763) 1,087 3,950
Income tax provision (benefit) 255 (427) 499 1,379
------- ------- -------- --------
Net income (loss) before cumulative
effect of change in accounting principle $ 190 $ (336) $ 588 $ 2,571
======= ======= ======== ========
The impact on segment profit (loss) of the September 2003 change in
measurement method used was as follows:
THREE MONTHS ENDED SEPTEMBER 30, 2003
---------------------------------------------------------------------------------
NORTH AMERICAN ENGINEERED AUTOMATION & CORPORATE
OPERATIONS SYSTEMS CONTROL SYSTEMS & OTHER TOTAL
---------- ------- --------------- ------- -----
(UNAUDITED, IN THOUSANDS)
Original segment
profit (loss): $ 2,961 $ (161) $ 1,253 $(1,324) $ 2,729
Other expense, net and
closure 52 39 -- 557 648
R&D and other (122) 314 1 (193) --
------- ------ ------- ------- -------
Segment profit (loss) $ 2,891 $ 192 $ 1,254 $ (960) $ 3,377
======= ====== ======= ======= =======
14
THREE MONTHS ENDED SEPTEMBER 30, 2002
--------------------------------------------------------------------------------
NORTH AMERICAN ENGINEERED AUTOMATION & CORPORATE
OPERATIONS SYSTEMS CONTROL SYSTEMS & OTHER TOTAL
---------- ------- --------------- ------- -----
(UNAUDITED, IN THOUSANDS)
Original segment
profit (loss): $ 2,247 $ (771) $ 1,049 $ (645) $ 1,880
Other expense, net (122) 160 7 (316) (271)
R&D and other (517) 443 (40) 114 --
------- ------ ------- ------ -------
Segment profit (loss) $ 1,608 $ (168) $ 1,016 $ (847) $ 1,609
======= ====== ======= ====== =======
NINE MONTHS ENDED SEPTEMBER 30, 2003
----------------------------------------------------------------------------------
NORTH AMERICAN ENGINEERED AUTOMATION & CORPORATE
OPERATIONS SYSTEMS CONTROL SYSTEMS & OTHER TOTAL
--------- ------- --------------- ------- -----
(UNAUDITED, IN THOUSANDS)
Original segment
profit (loss): $ 6,596 $ 1,103 $ 3,821 $(3,206) $ 8,314
Other expense, net and
closure 805 124 -- 848 1,777
R&D and other (478) 1,023 -- (545) --
------- ------- ------- ------- -------
Segment profit (loss) $ 6,923 $ 2,250 $ 3,821 $(2,903) $10,091
======= ======= ======= ======= =======
NINE MONTHS ENDED SEPTEMBER 30, 2002
----------------------------------------------------------------------------------
NORTH AMERICAN ENGINEERED AUTOMATION & CORPORATE
OPERATIONS SYSTEMS CONTROL SYSTEMS & OTHER TOTAL
--------- ------- --------------- ------- -----
(UNAUDITED, IN THOUSANDS)
Original segment
profit (loss): $ 8,847 $ 1,456 $ 3,465 $ (2,562) $ 11,206
Other expense, net (254) (41) -- 59 (236)
R&D and other (831) 1,003 (183) 11 --
------- ------- ------- -------- --------
Segment profit (loss) $ 7,762 $ 2,418 $ 3,282 $ (2,492) $ 10,970
======= ======= ======= ======== ========
(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 was contingent upon attaining certain performance
criteria, including gross margins and sales volumes for the specified products.
If applicable, payment was required annually. In August 2002, the Company paid
$197,000 under this arrangement for the twelve-month period ended January 23,
2002, resulting in an increase in goodwill. Because the performance criteria was
not met, the Company did not record additional liability 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 required
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.
15
The Company adopted SFAS No. 142 on January 1, 2002. Intangible assets
subject to amortization under the pronouncement as of September 30, 2003 and
2002 were:
AS OF SEPTEMBER 30, 2003 AS OF SEPTEMBER 30, 2002
--------------------------- -----------------------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
TYPE OF INTANGIBLE ASSET AMOUNT AMORTIZATION AMOUNT AMORTIZATION
------------------------ ------ ------------ ------ ------------
(UNAUDITED, IN THOUSANDS)
Deferred financing fees $ 3,528 $ 2,520 $ 3,300 $ 1,752
Patents 160 33 141 15
Other 361 254 257 165
------- ------- -------- -------
Total $ 4,049 $ 2,807 $ 3,698 $ 1,932
======= ======= ======= =======
Amortization and interest expense of $209,000 and $230,000 were recognized
related to these assets for the three months ended September 30, 2003 and 2002,
respectively, and $637,000 and $639,000 for the nine months ended September 30,
2003 and 2002, respectively. The estimated aggregate amortization and interest
expense for these assets for each of the following five fiscal years is:
2003--$738,000; 2004--$478,000; 2005--$436,000; 2006--$143,000; and
2007--$31,000. 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
September 30, 2003 was $79.8 million. The increase in goodwill during 2003 was
attributable primarily to currency exchange rate fluctuations. The Company
tested impairment of goodwill at December 31, 2002 and management determined
that goodwill was not impaired. The Company will test each business segment for
goodwill impairment on December 31, 2003, in accordance with the annual testing
requirements of SFAS No. 142.
(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 three or nine months
ended September 30, 2003.
16
(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
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 September
30, 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 adopted this pronouncement on July 1, 2003, with no
material impact on its financial condition or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
provides guidance on how to classify and measure certain financial instruments
that have characteristics of both liabilities and equity, and generally requires
treatment of these instruments as liabilities, including certain obligations
that the issuer can or must settle by issuing its own equity securities. This
pronouncement, which was effective for all financial instruments entered into or
modified after May 31, 2003, and otherwise became effective on July 1, 2003,
required cumulative effect of a change in accounting principle treatment upon
adoption. The Company adopted this pronouncement on July 1, 2003, with no
material impact on its financial condition or results of operation.
17
(15) RELATED PARTY TRANSACTIONS
Under the terms of an employment agreement in effect prior to 1999, the
Company loaned its Chief Executive Officer $1.2 million in July 1999 to purchase
136,832 shares of common stock. During February 2000, after the Company
completed the initial public offering of its Class A common stock, also pursuant
to the terms of that employment agreement, the Company paid this executive
officer a bonus equal to the principal and interest accrued under this note
arrangement and recorded compensation expense of $1.3 million. The officer used
the proceeds of this settlement, net of tax, to repay the Company approximately
$665,000. In addition, on October 27, 2000, the Company's board of directors
agreed to provide a full recourse loan to this executive officer to facilitate
the exercise of certain outstanding stock options. The amount of the loan was
equal to the cost to exercise the options plus any personal tax burdens that
resulted from the exercise. The maturity of these loans was July 31, 2003, and
interest accrued at rates ranging from 6% to 7.8% per annum. As of June 30,
2002, these outstanding notes receivable totaled $3.4 million, including
principal and accrued interest. Effective July 1, 2002, the notes were reviewed
by the Company's board and amended to extend the maturity dates to July 31,
2004, and to require interest to be calculated at an annual rate based on LIBOR
plus 300 basis points, adjusted quarterly, applied to the notes balances as of
June 30, 2002, including previously accrued interest. As of September 30, 2003,
the balance of the notes (principal and accrued interest) due from this officer
under these loan arrangements was $3.6 million. These loans to this executive
officer, which were made on a full recourse basis in prior periods to facilitate
direct ownership in the Company's common stock, are currently subject to and in
compliance with provisions of the Sarbanes-Oxley Act of 2002.
As previously agreed in 2001, the Company loaned an employee who is an
executive officer and director $216,000 on April 15, 2002, under a full-recourse
note arrangement which accrued interest at 6% per annum and was to mature on
July 31, 2003. The funds were used to pay the exercise cost and personal tax
burdens associated with stock options exercised during 2001. Effective July 1,
2002, the note was amended to extend the maturity date to July 31, 2004, and to
require interest to be calculated at an annual rate based on LIBOR plus 300
basis points, adjusted quarterly, applied to the note balance as of June 30,
2002, including previously accrued interest. As of September 30, 2003, the
balance of the note (principal and interest) due from this officer under this
loan arrangement was approximately $230,000. This loan to this executive
officer, which was made on a full recourse basis from in prior periods to
facilitate direct ownership in the Company's common stock, is currently subject
to and in compliance with provisions of the Sarbanes-Oxley Act of 2002.
18
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 the Company's
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 disclaim
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.
19
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 for the year ended 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 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 the 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. While
no indications of impairment were noted during the three-month or nine-month
periods ended September 30, 2003, we will test each business segment for
goodwill impairment on December 31, 2003, in accordance with the annual testing
requirements of SFAS No. 142. Net goodwill was $79.8 million and $79.0 million
at September 30, 2003 and December 31, 2002, respectively. The increase in
goodwill during 2003 was attributable primarily to currency exchange rate
fluctuations.
20
RECENT ACCOUNTING PRONOUNCEMENTS
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. We
will depreciate the asset cost 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.
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 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 our financial condition or
results of operations.
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 became 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 adopted this pronouncement on July 1, 2003, with no material impact
on our financial condition or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
provides guidance on how to classify and measure certain financial instruments
that have characteristics of both liabilities and equity, and generally requires
treatment of these instruments as liabilities, including certain obligations
that the issuer can or must settle by issuing its own equity securities. This
pronouncement, which was effective for all financial instruments entered into or
modified after May 31, 2003, and otherwise became effective on July 1, 2003,
required cumulative effect of a change in accounting principle treatment upon
adoption. We adopted this pronouncement on July 1, 2003, with no material impact
on our financial condition or results of operation.
21
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
nine months ended September 30, 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.
NINE MONTHS ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
----------------------- ----------------------
2003 2002 2002 2001
---- ---- ---- ----
Average price of domestic first-purchase crude
oil per barrel in the U.S. $ 27.84 (a) $ 21.82 $ 22.51 $ 21.86
Average wellhead price of natural gas per mcf in
the U.S. $ 5.09 (b) $ 2.74 $ 2.95 $ 4.12
Average North American rig count 1,363 1,081 1,093 1,497
--------------------
(a) Calculated using published data from the U.S. Department of Energy for
the eight months ended August 31, 2003; data for September 2003 was not
yet available.
(b) Calculated based upon estimates by the U.S. Department of Energy,
Energy Information Administration for the nine months ended September
30, 2003.
At September 30, 2003, the spot price of West Texas Intermediate crude oil
was $27.73 per barrel, the price of Henry Hub natural gas was $4.67 per mcf per
the New York Mercantile Exchange ("NYMEX") and the North American rig count was
1,403, per Baker Hughes Incorporated. At October 31, 2003, the spot price of
West Texas Intermediate crude oil was $29.28 per barrel, the price of Henry Hub
natural gas was $4.00 per mcf per the NYMEX, and the North American rig count
was 1,479, 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 during the nine months ended
September 30, 2003, we expect our traditional equipment and services business in
the U.S. and Canada to continue to show improving results based upon our past
experience in the industry.
Our Engineered Systems business is impacted largely by the awarding and
completion of larger, more complex oil and gas projects, primarily for
international offshore locations. These projects typically have a longer
bidding, evaluation, awarding and construction period than our traditional
equipment and services business and are more subject to our customers'
long-term view of the oil and gas supply and demand outlook for the related
region, as well as expected commodity prices and political or governmental
situations. In recent periods, we have experienced the absence of, delays in,
or lack of large international projects with favorable economic terms, which
has impacted our Engineered Systems business results as well as our current
level of project bookings for this segment.
The following discussion of our historical results of operations and
financial condition should be read in conjunction with our condensed
consolidated financial statements and related notes.
22
RESULTS OF OPERATIONS
Three Months Ended September 30, 2003 Compared to Three Months Ended September
30, 2002 (unaudited)
Revenues. Revenues of $65.8 million for the three months ended September 30,
2003 decreased $762,000, or 1%, from $66.6 million for the three months ended
September 30, 2002. The following table summarizes revenues by business segment
for the three-month periods ended September 30, 2003 and 2002, respectively.
THREE MONTHS ENDED
SEPTEMBER 30,
------------- PERCENTAGE
2003 2002 CHANGE CHANGE
---- ---- ------ ------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PERCENTAGE CHANGE)
North American Operations......... $ 32,718 $ 31,536 $ 1,182 4%
Engineered Systems................ 20,836 23,694 (2,858) (12%)
Automation and Control Systems.... 13,404 12,865 539 4%
Corporate and Other............... (1,157) (1,532) 375 (24%)
-------- -------- -------
Total................... $ 65,801 $ 66,563 $ (762) (1%)
======== ======== =======
North American Operations revenues increased $1.2 million, or 4%, for the
three months ended September 30, 2003, compared to the three months ended
September 30, 2002, which correlates to an increase in the average number of
operating rotary rigs in North America, from 1,102 for the three months ended
September 30, 2002 to 1,473 for the three months ended September 30, 2003. The
increase in revenues was primarily due to higher sales for our North American
parts and services business, due partially to the increase in operating rig
counts. Inter-segment revenues for this business segment were $165,000 for the
three months ended September 30, 2003, compared to $306,000 for the three months
ended September 30, 2002.
Revenues for the Engineered Systems segment decreased $2.9 million, or 12%,
for the three months ended September 30, 2003, compared to the three months
ended September 30, 2002. This decrease was primarily due to reduced sales of
larger international production system jobs for the three months ended September
30, 2003 relative to the comparable period in 2002, reflecting project bid and
award delays, increased competition and the completion of several large jobs for
our U.K.-based operations that were in progress during the three months ended
September 30, 2002, but completed prior to the three months ended September 30,
2003. Engineered Systems revenues of $20.8 million for the three months ended
September 30, 2003 included approximately $308,000 of inter-segment revenues,
compared to $210,000 of inter-segment revenues for the three months ended
September 30, 2002.
Revenues for the Automation and Control Systems segment increased $539,000,
or 4%, for the three months ended September 30, 2003, compared to the three
months ended September 30, 2002. Activity levels for the three months ended
September 30, 2003 remained high with a relatively large number of jobs in
progress, consistent with the results for the quarter ended September 30, 2002.
Inter-segment sales decreased from $1.0 million for the three months ended
September 30, 2002 to $684,000 for the three months ended September 30, 2003.
The change in revenues for Corporate and Other represents the elimination of
inter-segment revenues discussed above.
23
Gross Profit. Gross profit for the three months ended September 30, 2003
increased $1.1 million, or 7%, to $16.0 million, compared to $14.9 million for
the three months ended September 30, 2002. As a percentage of revenue, gross
profit increased from 22% for the three months ended September 30, 2002 to 24%
for the three months ended September 30, 2003. The following table summarizes
gross profit by business segment for the three-month periods then ended:
THREE MONTHS ENDED
SEPTEMBER 30,
------------- PERCENTAGE
2003 2002 CHANGE CHANGE
---- ---- ------ ------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PERCENTAGE CHANGE)
North American Operations......... $ 8,566 $ 8,092 $ 474 6%
Engineered Systems................ 5,029 4,599 430 9%
Automation and Control Systems.... 2,429 2,217 212 10%
-------- ------- ------
Total................... $ 16,024 $14,908 $1,116 7%
======== ======= ======
Gross profit for the North American Operations business segment increased
$474,000, or 6%, for the three months ended September 30, 2003, compared to the
three months ended September 30, 2002, primarily due to a 4% increase in
revenues for the respective periods. As a percentage of revenue, gross margins
were 26% for the three-month periods ended September 30, 2003 and 2002.
Gross profit for the Engineered Systems segment for the three months ended
September 30, 2003 increased $430,000, or 9%, compared to the three months ended
September 30, 2002, despite a 12% decline in revenues for the segment for the
respective periods. This increase in gross margin was primarily due to favorable
performance on several large West African jobs that were near completion at
September 30, 2003, and improved utilization of engineering resources relative
to the respective period in 2002. Gross margin as a percentage of revenues for
Engineered Systems was 24% and 19% for the three-month periods ended September
30, 2003 and 2002, respectively.
Gross profit for the Automation and Control Systems segment increased
$212,000, or 10%, for the three months ended September 30, 2003, compared to the
three months ended September 30, 2002, due to a 4% increase in revenues for the
segment during the period, and more favorable margins on several quote job
projects during the three months ended September 30, 2003. Gross margin as a
percentage of revenue for the three-month periods ended September 30, 2003 and
2002, was 18% and 17%, respectively.
Selling, General and Administrative Expense. Selling, general and
administrative expense of $12.6 million for the three months ended September 30,
2003, declined $652,000, or 5%, compared to the results for the three months
ended September 30, 2002. Overall expense declines related to cost savings
attributable to a decrease in variable compensation based on operating results
and the impact of restructuring activities in the United States and Canada
during late 2002 and the third quarter of 2003. These expense decreases were
partially offset by higher employee medical costs, professional fees and
corporate insurance policies. Overall headcount declined from 1,774 employees at
September 30, 2002 to 1,645 employees at September 30, 2003.
Depreciation and Amortization Expense. Depreciation and amortization expense
of $1.2 million for the three months ended September 30, 2003, decreased
$121,000, or 9%, compared to the results for the three months ended September
30, 2002. Depreciation expense of $1.1 million for the three months ended
September 30, 2003, decreased $137,000, or 11%, compared to the respective
period for 2002. This decrease reflected the run-off of depreciation associated
with older assets that became fully depreciated prior to September 30, 2003. We
expect depreciation to increase in the fourth quarter with the Sacroc CO2
expansion placed into service. Amortization expense of $33,000 for the three
months ended September 30, 2003 increased 94% from $17,000 for the three months
ended September 30, 2002, and related primarily to the amortization of certain
intangibles placed in service during late 2002 and 2003.
24
Closure and Other. Closure and Other expense of $722,000 for the three
months ended September 30, 2003 resulted from certain restructuring activities,
including the closure of a manufacturing facility in Covington, Louisiana and
the consolidation of operations in the U.K., and related primarily to
post-employment benefits for terminated personnel. We expect to incur an
additional $300,000 of costs related to these restructuring activities primarily
during the fourth quarter of 2003. These restructuring efforts are expected to
generate approximately $4.0 million of annual savings beginning in 2004.
Interest Cost on Postretirement Benefit Liability. Interest cost on
postretirement liability of $209,000 for the three months ended September 30,
2003, increased $87,000, or 71%, compared to the three months ended September
30, 2002. This increase in expense was due to a change in the discount rate used
to actuarially determine our obligation under this arrangement.
Other, net. Other, net was a gain of $74,000 and $271,000 for the
three-month periods ended September 30, 2003 and 2002, respectively, and
primarily related to net unrealized foreign exchange transaction gains for our
U.K.-based operations. Other, net was a gain of $271,000 for the three months
ended September 30, 2002, and was primarily attributable to unrealized gains on
foreign currency exchange transactions associated with our Canadian and
U.K-based operations.
Provision for Income Taxes. Income tax expense for the three months ended
September 30, 2003 was $255,000 compared to a tax benefit of $427,000 for the
three months ended September 30, 2002. The primary reason for this increase in
tax expense was an increase in income before income taxes from a loss of
$763,000 for the three months ended September 30, 2002 to income of $445,000 for
the three months ended September 30, 2003. The effective tax rate increased from
56% for the three months ended September 30, 2002 to 57% for the three months
ended September 30, 2003.
Nine Months Ended September 30, 2003 Compared to Nine Months Ended September 30,
2002 (unaudited)
Revenues. Revenues of $204.4 million for the nine months ended September 30,
2003 decreased $10.1 million, or 5%, from $214.5 million for the nine months
ended September 30, 2002. The following table summarizes revenues by business
segment for the nine-month periods ended September 30, 2003 and 2002,
respectively.
NINE MONTHS ENDED
SEPTEMBER 30,
------------- PERCENTAGE
2003 2002 CHANGE CHANGE
---- ---- ------ ------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PERCENTAGE CHANGE)
North American Operations......... $ 92,289 $102,648 $(10,359) (10%)
Engineered Systems................ 74,144 79,113 (4,969) (6%)
Automation and Control Systems.... 42,652 37,860 4,792 13%
Corporate and Other............... (4,658) (5,084) 426 (8%)
-------- -------- --------
Total................... $204,427 $214,537 $(10,110) (5%)
======== ======== ========
25
North American Operations revenues decreased $10.4 million, or 10%, for the
nine months ended September 30, 2003, compared to the nine months ended
September 30, 2002, despite an increase in the average North American operating
rotary rig count from 1,081 to 1,363 for the nine months ended September 30,
2002 and 2003, respectively. We experienced a reduction in sales primarily for
our traditional equipment as well as certain project delays for our operations
in Mexico, partially offset by an increase in sales for our North American parts
and service business and CO2 field service operations. Inter-segment revenues
for this business segment were $992,000 for the nine months ended September 30,
2003, compared to $616,000 for the nine months ended September 30, 2002.
Revenues for the Engineered Systems segment decreased $5.0 million, or 6%,
for the nine months ended September 30, 2003, compared to the nine months ended
September 30, 2002. This decrease was primarily due to a decline in the number
of large international production system jobs in 2003 relative to 2002,
partially due to project delays and increased competition. Furthermore, several
large jobs were nearing completion at September 30, 2002. Partially offsetting
this decrease was an increase in revenues provided by our U.K.-based operations
and our operations in Southeast Asia. Engineered Systems revenues of $74.1
million for the nine months ended September 30, 2003 included approximately
$375,000 of inter-segment revenues, as compared to $923,000 of inter-segment
revenues for the nine months ended September 30, 2002.
Revenues for the Automation and Control Systems segment increased $4.8
million, or 13%, for the nine months ended September 30, 2003, compared to the
nine months ended September 30, 2002. This increase was primarily related to a
general increase in the number of jobs in progress for the nine months ended
September 30, 2003 relative to the comparable period in 2002. Inter-segment
sales decreased from $3.5 million for the nine months ended September 30, 2002
to $3.3 million for the nine months ended September 30, 2003.
The change in revenues for Corporate and Other represents the elimination of
inter-segment revenues discussed above.
Gross Profit. Gross profit for the nine months ended September 30, 2003
decreased $2.5 million, or 5%, to $48.4 million, compared to $50.8 million for
the nine months ended September 30, 2002. As a percentage of revenue, gross
profit was 24% for the nine months ended September 30, 2003 and 2002. The
following table summarizes gross profit by business segment for the periods then
ended:
NINE MONTHS ENDED
SEPTEMBER 30,
------------- PERCENTAGE
2003 2002 CHANGE CHANGE
---- ---- ------ ------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PERCENTAGE CHANGE)
North American Operations......... $ 24,180 $26,972 $(2,792) (10%)
Engineered Systems................ 16,819 16,923 (104) (1%)
Automation and Control Systems.... 7,383 6,938 445 6%
-------- ------- -------
Total................... $ 48,382 $50,833 $(2,451) (5%)
======== ======= =======
26
Gross profit for the North American Operations business segment decreased
$2.8 million, or 10%, for the nine months ended September 30, 2003, compared to
the nine months ended September 30, 2002, due to a 10% decline in revenues for
the respective periods. As a percentage of revenue, gross margins were 26% for
the nine-month periods ended September 30, 2003 and 2002.
Gross profit for the Engineered Systems segment for the nine months ended
September 30, 2003 decreased $104,000, or 1%, compared to the nine months ended
September 30, 2002, despite a 7% decline in revenues for the respective periods.
Gross margin as a percentage of revenues for Engineered Systems was 23% for the
nine-month period ended September 30, 2003, compared to 21% for the nine-month
period ended September 30, 2002. Margin improvements were largely attributable
to several West African projects.
Gross profit for the Automation and Control Systems segment increased
$445,000, or 6%, for the nine months ended September 30, 2003, as compared to
the nine months ended September 30, 2002, due to a 13% increase in revenues for
the respective period, partially offset by lower margins due to the mix of sales
jobs for the nine months ended September 30, 2003 relative to the comparable
period in 2002, and competition for jobs in the Gulf of Mexico. Gross margin as
a percentage of revenue for the nine-month periods ended September 30, 2003 and
2002, was 17% and 18%, respectively.
Selling, General and Administrative Expense. Selling, general and
administrative expense of $38.3 million decreased $1.6 million, or 4%, for the
nine months ended September 30, 2003, compared to the nine months ended
September 30, 2002. This decrease was primarily related to cost savings from the
impact of restructuring activities in the U.S. and Canada as well as a decline
in variable compensation based on operating results, partially offset by higher
employee medical costs, professional fees and corporate insurance policies.
Overall headcount declined from 1,774 employees at September 30, 2002 to 1,645
employees at September 30, 2003.
Closure and Other. Closure and Other expense was $947,000 for the nine
months ended September 30, 2003, of which $718,000 related primarily to
post-employment benefits for employees terminated in connection with certain
restructuring activities in September 2003, including the closure of a
manufacturing facility in Covington, Louisiana and the consolidation of
operations in the U.K., and $229,000 related to certain employee relocation and
equipment moving costs associated with the closure of a manufacturing facility
in Edmonton, Alberta, Canada, in the fourth quarter of 2002. We expect to incur
an additional $300,000 of costs related to these restructuring activities,
primarily in the fourth quarter of 2003. These restructuring efforts are
expected to generate approximately $4.0 million of annual savings beginning in
2004.
Interest Cost on Postretirement Benefit Liability. Interest cost on
postretirement benefit liability of $628,000 for the nine months ended September
30, 2003, increased $261,000, or 71%, compared to the nine months ended
September 30, 2002. This increase in expense was due to a change in the discount
rate used to actuarially determine our obligation under this arrangement.
Other, net. Other, net was an expense of $830,000 for the nine months ended
September 30, 2003 and related primarily to net foreign exchange transaction
losses on inter-company balances with our Canadian subsidiary and on transaction
balances at our U.K.-based operations. Other, net for the nine months ended
September 30, 2002, primarily represented net foreign currency exchange
transaction gains of $236,000.
Provision for Income Taxes. Income tax expense for the nine months ended
September 30, 2003 was $499,000 compared to $1.4 million for the nine months
ended September 30, 2002. The primary reason for this decrease was a decline in
income before income taxes from $4.0 million for the nine months ended September
30, 2002 to $1.1 million for the nine months ended September 30, 2003. The
effective tax rate was 35% for the nine months ended September 30, 2002,
compared to 46% for the nine months ended September 30, 2003. The increase in
the effective tax rate relates primarily to a change in the composition of the
sources of income and the impact of permanent book-to-tax differences as a
percentage of net income.
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.
27
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2003, we had cash and working capital of $1.1 million
and $27.6 million, respectively, as compared to cash and working capital of $1.7
million and $34.6 million, respectively, at December 31, 2002. The decline in
working capital was primarily attributable to an increase in the current portion
of long-term debt.
Net cash provided by operating activities for the nine months ended
September 30, 2003 was $6.0 million, compared to $1.0 million for the nine
months ended September 30, 2002. Factors that contributed to the increase in
cash provided by operating activities during 2003 included an decrease in trade
accounts receivable and an increase in trade accounts payable and customer
advances, partially offset by an increase in inventory, a decrease in accrued
expenses and a decrease in net income.
Net cash used in investing activities for the nine months ended September
30, 2003 was $7.7 million, of which $8.3 million was used for capital
expenditures, primarily related to the expansion of our Sacroc CO2
gas-processing facility, partially offset by proceeds from the sale of fixed
assets totaling $670,000, which related primarily to the sale of a building in
the U.K. For the nine months ended September 30, 2002, cash used in investing
activities was $4.3 million and related primarily to capital expenditures.
Net cash provided by financing activities for the nine months ended
September 30, 2003 was $382,000. The primary source of funds for financing
activities for the nine months ended September 30, 2003 was proceeds from the
issuance of our Series B Convertible Preferred Stock of $14.1 million, net of
issuance costs, offset by repayments of long-term borrowings and revolving
credit borrowings of $5.3 million and $3.9 million, respectively, as well as a
decline in bank overdrafts of $3.5 million and payments on postretirement
benefit obligations of $1.3 million. Net cash provided by financing activities
for the nine months ended September 30, 2002 was $2.0 million. The primary
source of funds for financing activities during the nine months ended September
30, 2002 was borrowings of $6.6 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, partially offset
by repayments of $5.3 million under our long-term facilities and post-retirement
benefit payments of $1.4 million.
We borrowed $1.5 million under a long-term promissory note arrangement on
February 6, 2002, to finance the purchase of a manufacturing facility in
Magnolia, Texas. 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, acquired 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 31, 2006, and each of the revolving facilities matures on March 31, 2004.
On or before March 31, 2004, 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 Sacroc 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 resulted in higher commitment fee percentages and
interest rates than in the original agreements, based on the Funded Debt to
EBITDA ratio, as defined in the underlying agreement, as amended.
28
In July 2003, the Company's lenders approved an amendment of the existing
term loan and revolving credit facilities, effective April 1, 2003, and as of
September 30, 2003, we were in compliance with all restrictive debt covenants,
as amended. The amendment modified several restrictive covenant terms, including
the Fixed Charge Coverage Ratio and Funded Debt to EBITDA Ratio, each as defined
in the agreement. Under our term loan and revolving credit facility agreement,
certain of our debt covenants become more restrictive during the fourth quarter
of 2003, and we may not be in compliance with these or certain other debt
covenants at December 31, 2003. We may be required to request amendments or
waivers of some or all of these covenants in the future, which we believe would
be obtainable from the majority banks upon reasonable terms.
Borrowings outstanding under the term loan facility totaled $32.5 million
at September 30, 2003, and bear interest at 3.99% 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, a high of LIBOR plus
3.00% to a low of LIBOR plus 1.75% or a high of a base rate plus 1.50% to a low
of a base rate plus 0.25%.
As of September 30, 2003, the weighted average interest rate of our
borrowings under the revolving credit facilities was 4.90%.
We are required to 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. As of September 30, 2003, our commitment fees were calculated at a
rate of 0.625%.
We and our operating subsidiaries guarantee our revolving credit
facilities, which are secured by a first lien or first priority security
interest in or pledge of substantially all of the assets of the borrowers,
including accounts receivable, inventory, equipment, intangibles, equity
interests in U.S. subsidiaries and 65% of the equity interest in active,
non-U.S. subsidiaries. Our assets and those of our active U.S. subsidiaries
secure the U.S. facility, assets of our Canadian subsidiary secure the Canadian
facility and assets of our U.K. subsidiaries secure the U.K. facility. The U.S.
facility is guaranteed by each of our U.S. subsidiaries, while the Canadian and
U.K. facilities are guaranteed by us, each of our U.S. subsidiaries and the
Canadian subsidiary or the U.K. subsidiaries, as applicable.
We had letters of credit outstanding under the revolving credit facilities
of $19.5 million at September 30, 2003. Fees related to these letters of credit
at September 30, 2003, ranged from approximately 1% to 3.25% of the outstanding
balance. These letters of credit support contract performance and warranties and
expire at various dates through April 2007.
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 no borrowings were outstanding as of September 30, 2003. Letters of
credit outstanding under this facility at September 30, 2003 totaled $1.0
million. Fees related to these letters of credit at September 30, 2003, were
approximately 1% of the outstanding balance. The export sales credit facility is
secured by specific project inventory and receivables, and is partially
guaranteed by the EXIM Bank. The facility loans mature in July 2004.
We had unsecured letters of credit and bonds totaling $564,000 and
guarantees totaling $7.4 million at September 30, 2003.
Our sales backlog at September 30, 2003 was $71.5 million, compared to
$108.3 million at September 30, 2002. Backlog decreased primarily in Engineered
Systems, due to several large project bookings in 2002, which were substantially
completed prior to September 30, 2003, partially offset by increased bookings
for North American Operations and Automation and Control Systems.
On March 25, 2003, we issued 15,000 shares of 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 price of $15.0 million. Approximately $99,000 of the
aggregate purchase price 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.
29
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 was payable on July 1, 2003. Each of the Series B
Preferred Shares is convertible, at the option of the holder, 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 September 30, 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 September 30, 2003, we had accrued dividends
payable of $378,000 related to the Series B Preferred Shares. We paid dividends
totaling $399,000 on July 1, 2003.
In the event of a change in control, as defined in the certificate of
designations for the preferred shares, 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.
We adopted SFAS No. 150, "Accounting for Certain Instruments with
Characteristics of both Liabilities and Equity," on July 1, 2003. Under SFAS No.
150, the Series B Preferred Shares would be classified as permanent equity.
However, 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, and have not assigned any value 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 for two consecutive periods or any redemption
price due with respect to the Series B Preferred Shares for a period of 60 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 the 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.
30
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. 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,
originally recorded at $99,000, was decreased to $84,000 as of September 30,
2003, as a result of the change in fair value of the warrants. Similarly,
changes in fair value in future periods will be recorded as charges or credits
to net income during the period of the change.
Our revolving credit facilities expire on March 31, 2004 and our term loan
facility expires on March 31, 2006. We are evaluating our alternatives with
regard to extinguishing this debt or replacing these facilities. If we
extinguish the debt or materially modify the terms of the facilities, we may
incur a charge related to our unamortized deferred financing costs, which
totaled $1.0 million at September 30, 2003. We believe our credit facilities can
be extended or replaced, and that we will have adequate borrowing capacity in
the future to meet our debt requirements. However, there can be no assurance as
to the terms and provisions of any future financing arrangements.
At September 30, 2003, available borrowing capacity under the term loan and
revolving credit agreement and the export sales credit agreement were $14.6
million and $1.4 million, respectively. We were in compliance with all
restrictive debt covenants in our loan agreements, as amended, as of September
30, 2003. Under our agreement, certain of our debt covenants become more
restrictive at December 31, 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. 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.
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 September 30, 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. The liability representing the fair value of this derivative
arrangement was recorded at $99,000 as of March 31, 2003, and was adjusted to
$84,000 as of September 30, 2003, to reflect the projected change in fair value
of the warrants during the period, resulting in a $15,000 revaluation gain for
the six months then ended. 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 earnings 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.
31
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 September 30, 2003, we had borrowings of $32.5
million outstanding under the term loan portion of the revolving credit and term
loan facilities, at an interest rate of 3.99%. Borrowings, which bear interest
at floating rates, outstanding under the revolving credit agreement at September
30, 2003, totaled $9.9 million. As of September 30, 2003, the weighted average
interest rate of our borrowings under revolving credit facilities was 4.90%. No
borrowings were outstanding under the working capital facility for export sales
at September 30, 2003. Borrowings under the long-term arrangement secured by our
Magnolia manufacturing facility totaled $1.3 million and accrued interest at
4.55%.
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 Chief Financial Officer, have reviewed our disclosure controls and
procedures, as defined by the Securities and Exchange Commission in Rule
13(a)-15(e) of the Securities Exchange Act of 1934, as of September 30, 2003, in
an effort to evaluate the effectiveness of the design and operation of these
controls. Based upon this review, our management has determined that, as of the
end of the period covered by this Quarterly Report on Form 10-Q, our 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 to allow timely decisions regarding
disclosure in our public filings.
Furthermore, no significant changes have been made to our internal controls
and procedures during the three months ended September 30, 2003, or 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 internal control structure.
32
PART II
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Reports on Form 8-K.
- Report on Form 8-K filed August 5, 2003 to report Second Quarter 2003
Results.
- Report on Form 8-K filed September 8, 2003 to announce changes to our
organization and steps to reduce our cost structure.
- Report on Form 8-K filed November 4, 2003 to report Third Quarter 2003
Results.
Index of Exhibits
EXHIBIT NO. DESCRIPTION
10.35 - Senior Management Change in Control Agreement dated
October 7, 2003, between Katherine P. Ellis and NATCO
Group Inc.
10.36 - Senior Management Change in Control Agreement dated
October 7, 2003, between Richard W. FitzGerald and NATCO
Group Inc.
10.37 - Second Extension Agreement and Extension Agreement for
the Second Amended and Restated Service and Reimbursement
Agreement between Capricorn Management, G.P. and NATCO
Group Inc.
31.1 - Certification of Chief Executive Officer of NATCO Group
Inc. pursuant to 15 U.S.C. Section 7241, as adopted
pursuant to Section 302 of the Sarbanes- Oxley Act of
2002
31.2 - Certification of Chief Financial Officer of NATCO Group
Inc. pursuant to 15 U.S.C. Section 7241, as adopted
pursuant to Section 302 of the Sarbanes- Oxley Act of
2002
32.1 - Certification of Chief Executive Officer and Chief
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
33
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: November 14, 2003
By: /s/ Richard W. FitzGerald
--------------------------
Name: Richard W. FitzGerald
Senior Vice President and Chief
Financial Officer
Date: November 14, 2003
34
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
10.35 - Senior Management Change in Control Agreement dated
October 7, 2003, between Katherine P. Ellis and NATCO
Group Inc.
10.36 - Senior Management Change in Control Agreement dated
October 7, 2003, between Richard W. FitzGerald and NATCO
Group Inc.
10.37 - Second Extension Agreement and Extension Agreement for
the Second Amended and Restated Service and Reimbursement
Agreement between Capricorn Management, G.P. and NATCO
Group Inc.
31.1 - Certification of Chief Executive Officer of NATCO Group
Inc. pursuant to 15 U.S.C. Section 7241, as adopted
pursuant to Section 302 of the Sarbanes- Oxley Act of
2002
31.2 - Certification of Chief Financial Officer of NATCO Group
Inc. pursuant to 15 U.S.C. Section 7241, as adopted
pursuant to Section 302 of the Sarbanes- Oxley Act of
2002
32.1 - Certification of Chief Executive Officer and Chief
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
35