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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR QUARTER ENDED JUNE 30, 2004
COMMISSION FILE NO. 1-3920
NORTH AMERICAN GALVANIZING & COATINGS, INC.
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(Exact name of the registrant as specified in its charter)
DELAWARE 710268502
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(State of Incorporation) (I.R.S. Employer Identification No.)
2250 EAST 73RD STREET
TULSA, OKLAHOMA 74136
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(Address of principal executive offices)
Registrant's telephone number: (918) 494-0964
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 and 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 12b-2 of the Exchange Act). YES [_] NO [X]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of August 9, 2004.
Common Stock $ .10 Par Value ..................... 6,788,690
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NORTH AMERICAN GALVANIZING & COATINGS, INC.
AND SUBSIDIARY
INDEX TO QUARTERLY REPORT ON FORM 10-Q
PAGE
----
PART I. FINANCIAL INFORMATION
Forward Looking Statements or Information ...................... 2
Item 1. Financial Statements
Independent Accountants' Review Report ................ 3
Condensed Consolidated Balance Sheets as of June
30, 2004 (unaudited), and December 31, 2003 ...... 4
Condensed Consolidated Statements of Operations
and Comprehensive Income for the three and six
months ended June 30, 2004 and 2003 (unaudited) .. 5
Condensed Consolidated Statements of Cash Flows
for the sx months ended June 30, 2004
and 2003 (unaudited) ............................. 6
Notes to Condensed Consolidated Interim Financial
Statements for the three and six months ended
June 30, 2004 and 2003 (unaudited) ............... 7-13
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations .............. 14-23
Item 3. Quantitative and Qualitative Disclosure About
Market Risks ..................................... 23-24
Item 4. Controls and Procedures ............................... 25
PART II. OTHER INFORMATION .............................................. 26-27
SIGNATURES AND CERTIFICATIONS ............................................ 28-32
FORWARD LOOKING STATEMENTS OR INFORMATION
Certain statements in this Form 10-Q, including information set forth under the
caption "Management's Discussion and Analysis of Financial Condition and Results
of Operations", constitute "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. Such statements are typically
punctuated by words or phrases such as "anticipates," "estimate," "should,"
"may," "management believes," and words or phrases of similar import. The
Company cautions investors that such forward-looking statements included in this
Form 10-Q, or hereafter included in other publicly available documents filed
with the Securities and Exchange Commission, reports to the Company's
stockholders and other publicly available statements issued or released by the
Company involve significant risks, uncertainties, and other factors which could
cause the Company's actual results, performance (financial or operating) or
achievements to differ materially from the future results, performance
(financial or operating) or achievements expressed or implied by such
forward-looking statements. Factors that could cause or contribute to such
differences could include, but are not limited to, changes in demand, prices,
and the raw materials cost of zinc, changes in economic conditions of the
various markets the Company serves, as well as the other risks detailed herein
and in the Company's reports filed with the Securities and Exchange Commission.
The Company believes that the important factors set forth in the Company's
cautionary statements at Exhibit 99 to this Form 10-Q could cause such a
material difference to occur and investors are referred to Exhibit 99 for such
cautionary statements.
2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
North American Galvanizing & Coatings, Inc.
We have reviewed the accompanying condensed consolidated balance sheet of North
American Galvanizing & Coatings, Inc. and subsidiary ("NAGC" or the "Company")
as of June 30, 2004, and the related condensed consolidated statements of
operations and comprehensive income for the three- and six-month periods ended
June 30, 2004 and 2003 and cash flows for the six months ended June 30, 2004 and
2003. These interim financial statements are the responsibility of the Company's
management.
We conducted our reviews in accordance with standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with the Public Company Accounting Oversight Board (United States), the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to such condensed consolidated interim financial statements for them to
be in conformity with accounting principles generally accepted in the United
States of America.
We have previously audited, in accordance with standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheet of
North American Galvanizing & Coatings, Inc. and subsidiary as of December 31,
2003, and the related consolidated statements of operations and comprehensive
income, stockholders' equity, and cash flows for the year then ended (not
presented herein); and in our report dated March 26, 2004, we expressed an
unqualified opinion on those consolidated financial statements.
/s/Deloitte & Touche LLP
------------------------------
Tulsa, Oklahoma
August 12, 2004
3
NORTH AMERICAN GALVANIZING & COATINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
UNAUDITED
JUNE 30 December 31
(DOLLARS IN THOUSANDS) 2004 2003
-------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash $ 243 $ 56
Investments -- 73
Trade receivables, net 5,857 4,594
Inventories 5,725 5,408
Prepaid expenses and other assets 463 87
Deferred tax asset, net 760 746
---------- ----------
TOTAL CURRENT ASSETS 13,048 10,964
---------- ----------
PROPERTY, PLANT AND EQUIPMENT, AT COST
Land 1,962 1,962
Galvanizing plants and equipment 34,485 34,941
---------- ----------
36,447 36,903
Less: Allowance for depreciation 14,361 14,529
Construction in progress 224 286
---------- ----------
TOTAL PROPERTY, PLANT AND EQUIPMENT, NET 22,310 22,660
---------- ----------
GOODWILL, NET OF ACCUMULATED AMORTIZATION 3,389 3,389
OTHER ASSETS 331 354
---------- ----------
TOTAL ASSETS $ 39,078 $ 37,367
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long-term obligations $ 1,376 $ 1,408
Current portion of bonds payable 677 656
Trade accounts payable 1,228 480
Accrued payroll and employee benefits 737 623
Other taxes 299 316
Other accrued liabilities 731 874
---------- ----------
TOTAL CURRENT LIABILITIES 5,098 4,357
---------- ----------
DEFERRED TAX LIABILITY, NET 830 774
LONG-TERM OBLIGATIONS 7,764 6,768
BONDS PAYABLE 6,286 6,626
SUBORDINATED NOTES PAYABLE 965 957
---------- ----------
TOTAL LIABILITIES 20,893 19,842
---------- ----------
COMMITMENTS AND CONTINGENCIES (NOTE 8)
STOCKHOLDERS' EQUITY
Common stock 819 819
Additional paid-in capital 17,286 17,343
Retained earnings 5,812 5,496
Other comprehensive income -- 6
Common shares in treasury at cost (5,732) (5,779)
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 18,185 17,885
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 39,078 $ 37,367
========== ==========
See notes to condensed consolidated interim financial statements.
4
NORTH AMERICAN GALVANIZING & COATINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
UNAUDITED
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
--------------------- ----------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2004 2003 2004 2003
------------------------------------------------ -------- -------- -------- --------
SALES $ 9,333 $ 8,398 $ 17,891 $ 16,438
Cost of sales 6,635 5,835 12,640 11,837
Selling, general & administrative expenses 1,622 1,413 3,017 2,866
Depreciation expense 698 696 1,382 1,471
-------- -------- -------- --------
TOTAL COSTS AND EXPENSES 8,955 7,944 17,039 16,174
-------- -------- -------- --------
OPERATING INCOME 378 454 852 264
Other (income), net -- -- (25) --
Interest expense, net 206 299 367 607
-------- -------- -------- --------
Income (loss) from Continuing Operations
before income taxes 172 155 510 (343)
Income tax expense (benefit) 66 79 194 (130)
-------- -------- -------- --------
INCOME (LOSS) FROM CONTINUING OPERATIONS 106 76 316 (213)
Discontinued Operations:
Loss on discontinued operations, net -- (36) -- (77)
Loss on write-off of assets of
discontinued operations, net -- (754) -- (754)
-------- -------- -------- --------
NET INCOME (LOSS) $ 106 $ (714) $ 316 $ (1,044)
-------- -------- -------- --------
OTHER COMPREHENSIVE INCOME
Reclassification adjustment for realized
gain included in net income -- -- (25) --
-------- -------- -------- --------
OTHER COMPREHENSIVE INCOME $ -- $ -- $ (25) $ --
-------- -------- -------- --------
COMPREHENSIVE INCOME (LOSS) $ 106 $ (714) $ 291 $ (1,044)
======== ======== ======== ========
NET INCOME (LOSS) PER COMMON SHARE
Continuing Operations:
Basic $ 0.02 $ 0.01 $ 0.05 $ (0.03)
Diluted $ 0.01 $ 0.01 $ 0.04 $ (0.03)
Discontinued Operations:
Basic and Diluted $ -- $ (0.12) $ -- $ (0.12)
Net Income (Loss):
Basic $ 0.02 $ (0.11) $ 0.05 $ (0.15)
Diluted $ 0.01 $ (0.11) $ 0.04 $ (0.15)
See notes to condensed consolidated interim financial statements.
5
NORTH AMERICAN GALVANIZING & COATINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED
SIX MONTHS ENDED
JUNE 30
---------------------
(DOLLARS IN THOUSANDS) 2004 2003
-----------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income (loss) $ 316 $ (1,044)
Loss from discontinued operations -- 1,197
Loss from disposal of fixed assets 3 --
Depreciation 1,382 1,471
Gain on sale of investment (25) --
Deferred income taxes 42 (660)
Non-cash directors' fees 35 32
Changes in assets and liabilities:
Accounts receivable, net (1,263) (151)
Inventories and other assets (676) 272
Accounts payable, accrued liabilities and other 702 (500)
-------- --------
Net cash provided by (used in) continuing operations 516 617
Net cash provided by discontinued operations -- 79
-------- --------
CASH PROVIDED BY OPERATING ACTIVITIES 516 696
INVESTING ACTIVITIES
Proceeds from sale of investment 92 --
Capital expenditures (1,029) (661)
-------- --------
CASH USED IN INVESTING ACTIVITIES (937) (661)
FINANCING ACTIVITIES
Purchase of treasury shares (45) --
Proceeds from long-term obligations 9,038 8,095
Payments on long-term obligations (8,066) (7,827)
Payment on bonds (319) (302)
-------- --------
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 608 (34)
-------- --------
INCREASE IN CASH 187 1
CASH AT BEGINNING OF PERIOD 56 3
-------- --------
CASH AT END OF PERIOD $ 243 $ 4
======== ========
See notes to condensed consolidated interim financial statements.
6
NORTH AMERICAN GALVANIZING & COATINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2004 AND 2003
UNAUDITED
NOTE 1. BASIS OF PRESENTATION
The condensed consolidated interim financial statements included in this report
have been prepared by North American Galvanizing & Coatings, Inc. (the
"Company") pursuant to its understanding of the rules and regulations of the
Securities and Exchange Commission for interim reporting and include all normal
and recurring adjustments which are, in the opinion of management, necessary for
a fair presentation. The condensed consolidated interim financial statements
include the accounts of the Company and its subsidiary.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted pursuant to such
rules and regulations for interim reporting. The Company believes that the
disclosures are adequate to make the information presented not misleading.
However, these interim 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 for the year ended December 31, 2003. The financial data for
the interim periods presented may not necessarily reflect the results to be
anticipated for the complete year.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the balance
sheet dates and the reported amounts of revenues and expenses for each of the
years. Actual results will be determined based on the outcome of future events
and could differ from those estimates.
The Company's sole business is hot dip galvanizing and coatings which is
conducted through its wholly owned subsidiary, North American Galvanizing
Company ("NAG").
NOTE 2. STOCK OPTIONS
The Company accounts for its stock option plans in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees",
under which no compensation cost has been recognized for stock option awards.
Had compensation cost for the Company's stock option plans been determined
according to the methodology of Statement of Financial Accounting Standard
No.123, "Accounting for Stock Based Compensation" ("SFAS No. 123"), the
Company's pro forma net earnings (loss) and basic and diluted earnings (loss)
per share for the three and six months ended June 30, 2004 and 2003 would have
been as follows:
7
Three Months Ended June 30
--------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2004 2003
-----------------------------------------------------------------------------
Net Income (Loss), as reported $ 106 $ (714)
Deduct: Total stock-based employee compensation
expense determined under fair value based methods,
net of tax $ (3) $ (4)
-------- --------
Pro forma net income (loss) $ 103 $ (710)
-------- --------
Earnings (loss) per share:
Basic - as reported $ .02 $ (.11)
-------- --------
Basic - pro forma $ .02 $ (.11)
-------- --------
Diluted - as reported $ .01 $ (.11)
-------- --------
Diluted - pro forma $ .01 $ (.10)
-------- --------
Six Months Ended June 30
------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2004 2003
-----------------------------------------------------------------------------
Net Income (Loss), as reported $ 316 $ (1,044)
Deduct: Total stock-based employee compensation
expense determined under fair value based methods,
net of tax $ (7) $ (8)
-------- --------
Pro forma net income (loss) $ 309 $ (1,052)
-------- --------
Earnings (loss) per share:
Basic - as reported $ .05 $ (.15)
-------- --------
Basic - pro forma $ .05 $ (.16)
-------- --------
Diluted - as reported $ .04 $ (.15)
-------- --------
Diluted - pro forma $ .04 $ (.15)
-------- --------
The fair value of options granted under the Company's stock option plans was
estimated using the Black-Scholes option-pricing model with the following
assumptions used:
Three Months Ended June 30 Six Months Ended June 30
-------------------------- ------------------------
2004 2003 2004 2003
------------------- -------------------
Volatility 66% 66% 66% 66%
Discount Rate 5% 5% 5% 5%
Dividend Yield 0% 0% 0% 0%
Fair Value $.97 $.83 $.93 $.83
In the first six months of 2004, the Company issued stock options for 25,000
shares at $1.70 per share. The Company issued stock options for 50,000 shares at
$1.50 per share in the first six months of 2003.
NOTE 3. INCOME (LOSS) PER COMMON SHARE
Basic earnings (loss) per common share for the periods presented are computed
based upon the weighted average number of shares outstanding. Diluted earnings
(loss) per common share for the periods presented are based on the weighted
average shares outstanding, adjusted for the assumed exercise of stock options
and
8
warrants using the treasury stock method. The Company had a net loss for the
three and six-month periods ended June 30, 2003 and the effect of including
dilutive securities in the earnings per common share would have been
anti-dilutive. Accordingly, options to purchase 676,199 and 677,397 common
shares were excluded from the calculation of diluted loss per share for the
three and six-month periods ended June 30, 2003.
Three Months Ended June 30 Number of Shares
-------------------------- -----------------------------------------
2004 2003
-------------- ---------------
Basic 6,786,341 6,756,452
Diluted 7,486,185 6,756,452
Six Months Ended June 30 Number of Shares
------------------------ -----------------------------------------
2004 2003
-------------- ---------------
Basic 6,789,168 6,751,321
Diluted 7,485,893 6,751,321
The numbers of options excluded from the calculation of diluted earnings per
share, due to the option price being higher than the share market value, are
311,500 and 319,000 at June 30, 2004 and 2003, respectively.
NOTE 4. INVENTORIES
Inventories consist of raw zinc "pigs," molten zinc in galvanizing kettles and
other chemicals and materials used in the galvanizing process. Inventories are
stated at the lower of cost or market with market value based on estimated
realizable value from the galvanizing process. Zinc cost is determined on a
last-in first-out (LIFO) basis. Other inventories are valued primarily on an
average cost basis.
NOTE 5. GOODWILL
The Company ceased amortization of goodwill on January 1, 2002, when it adopted
the provisions of SFAS No. 141, "Business Combinations" and SFAS No. 142,
"Goodwill and Other Intangible Assets." During the second quarter of 2004, the
Company completed the annual impairment test of goodwill for 2004 and concluded
goodwill was not impaired. The Company will complete the annual impairment test
of goodwill during the second quarter of each year unless circumstances arise
that require more frequent testing.
NOTE 6. BONDS PAYABLE
In 2000, the Company issued $9,050,000 of Harris County Industrial Development
Corporation Adjustable Rate Industrial Development Bonds, Series 2000 (the
"Bonds") for the purchase of land and construction of a hot dip galvanizing
plant in Harris County, Texas. The principal amount outstanding on these Bonds
was $6,963,000,000 at June 30, 2004. The Bonds are senior to other debt of the
Company.
The Bonds bear interest at a variable rate (3.5% at June 30, 2004) that can be
converted to a fixed rate upon certain conditions outlined in the bond
agreement. Under the amended Reimbursement Agreement with the bank trustee, the
Company is permitted to withdraw excess interest from the trustee's Interest
Account on or about March 31, June 30, September 30 and December 31 of each
year. In the first quarter of 2004, the Company withdrew excess interest of
$72,000 from the Interest Account and applied the proceeds to pay-down the
outstanding balance on its bank revolving credit facility. In the second quarter
of 2004, the Company determined that the trustee's Interest Account included
excess interest of approximately $40,000, which was recognized as a reduction of
interest expense by the Company during the quarter.
9
The Bonds are subject to sinking fund redemption, which was $633,750 for the
twelve months ended June 30, 2004 and increases annually thereafter to a maximum
redemption of $960,000 on June 15, 2012. The Company makes monthly principal and
interest payments of approximately $74,000 into a sinking fund. The final
maturity date of the Bonds is June 15, 2013. The Company has the option of early
redemption of the Bonds at par unless the Bonds are converted to a fixed
interest rate, in which case they are redeemable at a premium during a period
specified in the bond agreement. The Company's obligation under the bond
agreement is secured through a letter of credit with a bank which must remain in
effect as long as any Bonds are outstanding. The letter of credit is
collateralized by substantially all the assets of the Company.
NOTE 7. SUBORDINATED DEBT
In 2001, the Company completed a $1,000,000 private placement of unsecured
subordinated debt. The Company utilized the proceeds to partially fund
construction of a new galvanizing facility in St. Louis, Missouri in 2002. The
amount outstanding on these notes, net of discount, was $965,000 and $957,000 at
June 30, 2004 and December 31, 2003, respectively. The notes, which mature
February 17, 2006 and bear interest at 10% payable annually, were issued with
warrants to purchase 666,666 shares of common stock of the Company. Terms of the
warrants, which expire February 17, 2008, permit the holder to purchase shares
of the Company's common stock at any time prior to the expiration date. The
exercise price of $.856 per share reflects the fair value of the Company's
common stock at the time the warrants were issued, as determined by an
independent financial advisor. As of June 30, 2004, no warrants had been
exercised.
NOTE 8. LONG-TERM OBLIGATIONS
June 30 December 31
(Dollars in Thousands) 2004 2003
---------------------- -------- --------
Revolving line of credit $ 5,523 $ 3,867
Term loan 1,041 1,567
Construction Loan 2,556 2,722
9.5% note due 2015 20 20
-------- --------
$ 9,140 $ 8,176
Less current portion (1,376) (1,408)
-------- --------
$ 7,764 $ 6,768
-------- --------
In September 2003, the Company amended a three-year bank credit agreement that
was scheduled to expire in June 2004 and extended its maturity to January 1,
2005. During 2004, the bank has extended maturities under the bank credit
agreement to July 1, 2005. Subject to borrowing base limitations, the amended
bank credit agreement provided (i) a $7,000,000 maximum revolving line of credit
for working capital and general corporate purposes, (ii) a $1,911,924 term loan
and (iii) a $2,833,332 construction loan.
Term loan payments are based on a three-year amortization schedule with equal
monthly payments of principal and interest, and the loan may be prepaid without
penalty. The revolving line of credit may be paid down without penalty, or
additional funds may be borrowed up to the maximum line of credit. At June 30,
2004, the Company had available borrowing capacity of $569,000 under the line of
credit, based on the underlying borrowing base of accounts receivable and
inventory. Payments on the construction loan are based on a 108-month
amortization schedule, plus interest, that commenced March 1, 2003, and the loan
may be prepaid without penalty.
10
At June 30, 2004, $9,120,000 was outstanding under the bank credit agreement,
and $400,000 was reserved for outstanding irrevocable letters of credit to
secure payment of current and future workers' compensation claims.
Substantially all of the Company's accounts receivable, inventories, fixed
assets and the common stock of its subsidiary are pledged as collateral under
the bank credit agreement, and the bank credit agreement is secured by a full
and unconditional guaranty from NAG. Amounts borrowed under the agreement bear
interest at the prime rate of Bank One, Oklahoma or the LIBOR rate, at the
option of the Company, subject to a rate margin adjustment determined by the
Company's consolidated debt service coverage ratio. In the event the Company
fails to maintain a consolidated debt service coverage ratio for any fiscal
quarter of at least 1.25 to 1.00, the Applicable LIBOR Rate Margin will be
increased to 5.75% and the Applicable Prime Rate Margin will be increased to
3.00%. Thereafter, the increased rate margin will remain in effect until such
time as the Company has maintained a consolidated debt service coverage ratio
greater than or equal to 1.25 to 1.0 for a subsequent fiscal quarter.
In the event the Company fails to maintain a consolidated EBITDA to capital
expenditures plus current maturity of long-term debt ratio for any fiscal
quarter of not less than 1.00 to 1.00, the increase in the Applicable LIBOR Rate
Margin ranges from 3.75% to 5.75%, and the increase in the Applicable Prime Rate
Margin ranges from 1.00% to 3.00%.
The bank credit agreement requires the Company to maintain compliance with
covenant limits for current ratio, debt to tangible net worth ratio, debt
service coverage ratio and a capital expenditures ratio. At June 30, 2004, the
Company's actual financial ratios compared to the required ratios, were as
follows: Current Ratio - Actual 1.23 to 1.0 vs minimum required of 1.0 to 1.0;
Debt to Tangible Net Worth - Actual 1.41 to 1.0 vs maximum permitted of 2.50 to
1.0; Debt Service Coverage - Actual 1.43 to 1.0 vs minimum permitted of 1.25 to
1.0; Capital Expenditures - Actual .94 to 1.0 vs minimum required of 1.0 to 1.0.
The Company's capital expenditures ratio of .94 to 1.0 at June 30, 2004 was
below the covenant minimum of 1.0 to 1.0. This variance from the capital
expenditures covenant minimum was waived by the bank on August 11, 2004
NOTE 9. COMMITMENTS AND CONTINGENCIES
The Company has commitments with domestic and foreign zinc producers and brokers
to purchase zinc used in its hot dip galvanizing operations. Commitments for the
future delivery of zinc reflect rates then quoted on the London Metals Exchange
and are not subject to price adjustment or are based on such quoted prices at
the time of delivery. At June 30, 2004 the aggregate commitments for the
procurement of zinc at fixed prices were approximately $6.6 million. The Company
reviews these fixed price contracts for losses using the same methodology
employed to estimate the market value of its zinc inventory. The Company had
unpriced commitments for the purchase of approximately 2.2 million pounds of
zinc at June 30, 2004.
The Company's financial strategy includes evaluating the selective use of
derivative financial instruments to manage zinc and interest costs. As part of
its inventory management strategy, the Company expects to continue evaluating
hedging instruments to minimize the impact of zinc price fluctuations. The
Company had no derivative instruments required to be reported at fair value at
June 30, 2004 or December 31, 2003, and did not utilize derivatives in the six
months ended June 30, 2004 or the year ended December 31, 2003, except for those
forward purchase agreements which are accounted for as normal purchases.
The Company's total off-balance sheet contractual obligations at June 30, 2004,
consist of $2,173,000 for long-term operating leases for two galvanizing
facilities and galvanizing equipment and approximately $6,600,000 for zinc
purchase commitments. The various leases for galvanizing facilities, including
option renewals, expire from 2015 to 2017. A lease for galvanizing equipment
expires in 2007.
11
NAG was notified in 1997 by the Illinois Environmental Protection Agency
("IEPA") that it was one of more than 50 potentially responsible parties
("PRPs") for cleanup of an abandoned site formerly owned by Sandoval Zinc
Company. Since then approximately 30 additional PRPs have been identified by the
IEPA.
A number of the PRPs (approximately 12 to 15) have agreed to work together and
with IEPA on a voluntary basis. The Company has been and continues to
participate in this volunteer group. The group has retained consultants and
legal representatives familiar with IEPA regulations. This volunteer group, with
its consultants, has cooperated with IEPA in attempting to better define the
environmental issues associated with the Sandoval Zinc site. To that extent,
this voluntary group prepared and submitted to IEPA in August 2000 a work plan.
The purpose of this work plan is to attempt to define the extent of
environmental remediation that might be required, assess risks, and review
alternatives to addressing potential remediation. The IEPA has yet to respond to
this proposed work plan or suggest any other course of action. Therefore, the
Company has no basis for determining potential exposure and estimated
remediation costs at this time.
The Company will continue to have additional environmental compliance costs
associated with operations in the galvanizing business. The Company is committed
to complying with the environmental legislation and regulations affecting its
operations. Due to the uncertainties associated with future environmental
technologies, regulatory interpretations, and prospective legislative activity,
management cannot reasonably quantify the Company's potential future costs in
this area.
The Company expenses or capitalizes, where appropriate, environmental
expenditures that relate to current operations as they are incurred. Such
expenditures are expensed when they are attributable to past operations and are
not expected to contribute to current or future revenue generation. The Company
records liabilities when remediation or other environmental assessment or
clean-up efforts are probable and the cost can be reasonably estimated.
Various litigation arising in the ordinary course of business is pending against
the Company. Management believes that resolution of the Company's litigation and
environmental matters should not materially affect the Company's consolidated
financial position or liquidity. Should future developments cause the Company to
record an additional liability for environmental matters, litigation or customer
claims, the recording of such a liability could have a material impact on the
results of operations for the period involved.
NOTE 10. TREASURY STOCK
In the first six months of 2004, the Company issued 22,706 shares of its common
stock from Treasury to outside Directors of the Company as payment for their
quarterly board fee in lieu of cash payments, and added 26,456 shares to the
Treasury from private transaction purchases. Shares issued in lieu of board fees
were valued at the average closing price of the Company's common stock for a
prior 30-day period, as reported by the American Stock Exchange. Such shares
were issued pursuant to the Directors' prior election and notice to the Company
to receive up to all of their 2004 quarterly board fees in the Company's stock
in lieu of cash. During the first half of 2003, the Company issued 21,263 shares
for such purpose. Shares acquired in private transactions were purchased at the
then closing price of the Company's common stock, as reported by the American
Stock Exchange.
NOTE 11. DISCONTINUED OPERATIONS
In the six months ended June, 2003, the Company recorded a net loss from a
discontinued operation of $77,000, net of taxes of $45,000, and wrote-off its
investment in the formerly idled Houston-Cunningham galvanizing plant as a
discontinued operation.
12
In 2002, the Board of Directors authorized the Company to pursue alternative
uses for the Houston-Cunningham plant, which was temporarily idled in late 2001.
Management believed the carrying value of the plant and the related galvanizing
assets would be realized through future operations of the plant. Accordingly, no
write-down was recognized in 2002. However, in late April 2003, new events,
combined with a further contraction of the galvanizing business in the Houston
market, resulted in the likely inability to maintain the plant as part of the
Company's continuing operations. The write-off resulted in a net loss on the
abandoned assets of $754,000, net of taxes of $443,000, in the second quarter of
2003.
NOTE 12. BUSINESS DEVELOPMENT
As reported previously, the lease term of a galvanizing facility occupied by
Reinforcing Services, Inc. ("RSI"), one of NAG's subsidiaries, expired July 31,
2003 and has not been renewed. RSI has exercised an option to purchase the
facility, and the landlord is contesting the Company's right to exercise this
option. RSI has filed a lawsuit against the landlord seeing enforcement of the
right to exercise the option. The litigation is in the discovery stage and
management expects there will be no disruption to its galvanizing business being
conducted at the facility.
NOTE 13. SUBSEQUENT EVENTS
The following proposals were approved by the Company's stockholders at its
annual meeting held on July 21, 2004: (a) the 2004 Incentive Stock Plan, to
replace a prior stock option plan; (b) The Director Stock Unit Program, a new
deferred compensation program to tie a percentage of each director's
compensation to the long-term value of the Company's common stock and (c)
amendments to the Company's Restated Certificate of Incorporation to provide for
a reverse split followed by a forward split of the Company's common stock, at
the discretion of the Board of Directors. No date for the Reverse/Forward Split
has been set. If the Board determines to implement the Reverse/Forward Split,
the Company will publicly announce its decision in a press release at that time
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
North American Galvanizing is a leading provider of corrosion protection for
iron and steel components fabricated by its customers. Based on the number of
its operating plants, the Company is one of the largest merchant market hot dip
galvanizing companies in the United States. Hot dip galvanizing is the process
of applying a zinc coating to fabricated iron or steel material by immersing the
material in a bath consisting primarily of molten zinc.
During the six months ended June 30 , 2004, there were no significant changes to
the Company's critical accounting policies previously disclosed in the Company's
annual report on Form 10-K for the year ended December 31, 2003. The Company
generates revenue by providing galvanizing and other coating services to
customers' products. Revenue is recognized when the galvanizing and customer
billing processes are completed. For the majority of our business, our customers
directly arrange for and are responsible for material transportation and
transportation expenses. In those circumstances where the Company incurs freight
and handling expenses, they are recorded in cost of goods sold.
The Company's galvanizing plants offer a broad line of services including
centrifuge galvanizing for small threaded products, sandblasting, chromate
quenching, polymeric coatings, and proprietary INFRASHIELDSM Coating Application
Systems for polyurethane protective linings and coatings over galvanized
surfaces. The Company's structural and chemical engineers provide customized
assistance with initial fabrication design, project estimates and steel
chemistry selection.
The Company's galvanizing and coating operations are managed through two regions
with ten facilities located in Colorado, Kentucky, Missouri, Oklahoma, Tennessee
and Texas. These facilities operate galvanizing kettles ranging in length from
30 feet to 62 feet, and have lifting capacities ranging from 12,000 pounds to
40,000 pounds.
The Company maintains a sales and service network coupled with its galvanizing
plants, supplemented by national account business development at the corporate
level. In a typical year, the Company will galvanize in excess of 300,000,000
pounds of steel products for approximately 1,800 customers nationwide. Due to
the lower demand for galvanizing throughout 2003, the Company experienced a
decline of 17% in pounds of steel products galvanized at its facilities in 2003.
During the first six months of 2004, the Company has experienced a steady, but
modest, increase in order volume compared to 2003, but sustained demand from
fabricators has been erratic and larger project work has not developed as
anticipated. In the first half of 2004, the surge in steel prices and some
limitation on the availability of steel experienced by our customers has
affected the timing of many projects.
All of the Company's sales are generated for domestic customers whose end
markets are principally in the United States. The Company markets its
galvanizing and coating services directly to its customers and does not utilize
agents or distributors. Although hot dip galvanizing is considered a mature
service industry, the Company is actively engaged in developing new markets
through participation in industry trade shows, metals trade associations and
presentation of technical seminars by its national marketing service team.
Pricing of the Company's galvanizing services is primarily driven by competitive
market conditions and the price of zinc used in the galvanizing process. The
galvanizing services business is a mature industry and these pricing factors are
well known within the industry. As a value added service provider, the Company
offers its after-fabrication galvanizing services to large and small
fabricators, competing against numerous independent and captive galvanizers, as
well as alternative forms of corrosion protection, such as paint. Flexibility in
14
pricing to meet both competition and the short-term turn-around time
requirements of fabricators is essential to the Company's pricing strategies.
Hot dip galvanizing provides metals corrosion protection for many product
applications used in commercial, construction and industrial markets. The
Company's galvanizing can be found in almost every major application and
industry that requires corrosion protection where iron or steel is used,
including the following end user markets:
o highway and transportation,
o power transmission and distribution,
o wireless and telecommunications,
o utilities,
o petrochemical processing,
o infrastructure including buildings, airports, bridges and power
generation
o industrial grating,
o wastewater treatment; fresh water storage and transportation
o pulp and paper,
o pipe and tube,
o food processing,
o agricultural (irrigation systems)
o recreation (boat trailers, marine docks, stadium scaffolds)
o original equipment manufactured products, including general
fabrication
As a value-added service provider, the Company's revenues are directly
influenced by the level of economic activity in the various end markets that it
serves. Economic activity in those markets that results in the expansion and/or
upgrading of physical facilities (i.e., construction) may involve a time-lag
factor of several months before translating into a demand for galvanizing
fabricated components. Despite the inherent seasonality associated with large
project construction work, the Company maintains a relatively stable revenue
stream throughout the year by offering fabricators, large and small, reliable
and rapid turn-around service. The Company records revenues when the galvanizing
and customer billing processes are completed. The Company generates all of its
operating cash from such revenues, and utilizes a line of credit secured by the
underlying accounts receivable and zinc inventory to facilitate working capital
needs.
Each of the Company's galvanizing plants operate in a highly competitive
environment underscored by pricing pressures, primarily from other public and
privately-owned galvanizers and alternative forms of corrosion protection, such
as paint. The Company's long-term response to these challenges has been a
sustained strategy focusing on providing a reliable quality of galvanizing to
industry ASTM specifications and rapid turn-around time on every project, large
and small. Key to the success of this strategy is the Company's continuing
commitment and long-term record of reinvesting earnings to upgrade its
galvanizing facilities and provide technical innovations to improve production
efficiencies; and to construct new facilities when market conditions present
opportunities for growth. The Company is addressing long-term opportunities to
expand its galvanizing and coatings business through programs to increase
industry awareness of the proven, unique benefits of galvanizing for metals
corrosion protection. Each of the Company's independently operated galvanizing
plants is linked to a centralized control system involving sales order entry,
facility maintenance and operating procedures, quality assurance, purchasing and
credit and accounting that enable the plant to focus on providing galvanizing
and coating services in the most cost-effective manner.
The principal raw materials essential to the Company's galvanizing and coating
operations are zinc and various chemicals which are normally available for
purchase in the open market.
15
KEY INDICATORS
Key industries which historically have provided the Company some indication of
the potential demand for galvanizing in the near-term (i.e., primarily within a
year) include highway and transportation, power transmission and distribution,
telecommunications and the level of quoting activity for regional metal
fabricators. In general, growth in the commercial/industrial sectors of the
economy generates new construction and capital spending which ultimately impacts
the demand for galvanizing.
Key operating measures utilized by the Company include new orders, zinc
inventory, tons of steel galvanized, revenue, pounds and labor costs per hour,
zinc usage related to tonnage galvanized, and lost-time safety performance.
These measures are reported and analyzed on various cycles, including daily,
weekly and monthly.
The Company utilizes a number of key financial measures to evaluate the
operations at each of its galvanizing plants, to identify trends and variables
impacting operating productivity and current and future business results, which
include: sales, gross profit, fixed and variable costs, selling and general
administrative expenses, operating cash flows, capital expenditures, interest
expense, and a number of ratios such as profit from operations and accounts
receivable turnover. These measures are reviewed by the Company's operating and
executive management monthly, or more frequently, and compared to prior periods,
the current business plan and to standard performance criteria, as applicable.
RESULTS OF OPERATIONS
The following table shows the Company's results of operations for the three and
six months ended June 30, 2004, 2003 and 2002:
THREE MONTHS ENDED JUNE 30
--------------------------
2004 2003 2002
------------------- -------------------- --------------------
(DOLLARS IN THOUSANDS) AMOUNT % OF SALES AMOUNT % OF SALES AMOUNT % OF SALES
--------------------- -------- -------- -------- -------- -------- --------
Sales $ 9,333 100.0% $ 8,398 100.0% $ 10,103 100.0%
Cost of sales 6,635 71.1% 5,835 69.5% 6,857 67.9%
-------- -------- -------- -------- -------- --------
Gross profit 2,698 28.9% 2,563 30.5% 3,246 32.1%
Selling, general & administrative expenses 1,622 17.4% 1,413 16.8% 1,495 14.8%
Depreciation and amortization 698 7.5% 696 8.3% 749 7.4%
-------- -------- -------- -------- -------- --------
Operating income (loss) 378 4.0% 454 5.4% 1,002 9.9%
Interest expense, net 206 2.2% 299 3.6% 279 2.8%
Other (income), net -- -- -- -- -- --
-------- -------- -------- -------- -------- --------
Income (loss) from continuing operations
before income taxes 172 1.8% 155 1.8% 723 7.1%
Income tax expense (benefit) 66 0.7% 78 0.9% 282 2.8%
-------- -------- -------- -------- -------- --------
Income (loss) from continuing operations
before effect of discontinued operations 106 1.1% 76 0.9% 441 4.3%
Income (loss) from discontinued operations -- -- (790) (9.4)% (49) (0.4)%
-------- -------- -------- -------- -------- --------
Net Income (Loss) $ 106 1.1% $ (714) (8.5)% $ 392 3.9%
======== ======== ======== ======== ======== ========
16
SIX MONTHS ENDED JUNE 30
--------------------------
2004 2003 2002
------------------- -------------------- --------------------
(DOLLARS IN THOUSANDS) AMOUNT % OF SALES AMOUNT % OF SALES AMOUNT % OF SALES
--------------------- -------- -------- -------- -------- -------- --------
Sales $ 17,891 100.0% $ 16,438 100.0% $ 19,320 100.0%
Cost of sales 12,640 70.7% 11,837 72.0% 13,217 68.4%
-------- -------- -------- -------- -------- --------
Gross profit 5,251 29.3% 4,601 28.0% 6,103 31.6%
Selling, general & administrative expenses 3,017 16.8% 2,866 17.4% 2,873 14.9%
Depreciation and amortization 1,382 7.7% 1,471 9.0% 1,499 7.8%
-------- -------- -------- -------- -------- --------
Operating income (loss) 852 4.8% 264 1.6% 1,731 8.9%
Interest expense, net 367 2.0% 607 3.7% 566 2.3%
Other (income), net (25) (0.1)% -- -- -- --
-------- -------- -------- -------- -------- --------
Income (loss) from continuing operations
before income taxes 510 2.9% (343) (2.1)% 1,165 6.0%
Income tax expense (benefit) 194 1.1% (130) (0.8)% 451 2.3%
-------- -------- -------- -------- -------- --------
Income (loss) from continuing operations
before effect of discontinued operations 316 1.8% (213) (1.3)% 714 3.7%
Income (loss) from discontinued operations -- -- (831) (5.1)% (98) (0.5)%
-------- -------- -------- -------- -------- --------
Net Income (Loss) $ 316 1.8% $ (1,044) (6.4)% $ 616 3.2%
======== ======== ======== ======== ======== ========
17
KEY DEVELOPMENTS.
KEY DEVELOPMENTS. During the period 2003 and 2004, the Company reported a number
of developments supporting its strategic program to reposition its galvanizing
business in the national market.
The Company's new St. Louis galvanizing plant completed its first full year of
operations in 2003 with a 71% increase in tonnage over the smaller plant that it
replaced. This larger, new facility is providing NAG a strategic base for
extending its geographic area of service. In the first six months of 2004,
tonnage increased 97% over the same period of 2003. A 51-foot kettle at this new
facility provides the largest galvanizing capacity in the St. Louis region.
In January 2003, the Company expanded services at its Nashville galvanizing
plant with the installation of a state-of-the-art Spinner line to galvanize
small products, including bolts and threaded material.
As reported previously, the Company wrote-off its investment in the formerly
idled Houston-Cunningham galvanizing plant in the second quarter ended June 30,
2003. The write-off resulted in a net loss on the abandoned assets of $754,000,
net of taxes of $443,000 in 2003. The net loss from operations for the
Cunningham plant was $77,000 and $205,000, net of taxes of $45,000 and $133,000,
for the years ended December 31, 2003 and 2002, respectively. The abandoned
Cunningham plant has been classified as a discontinued operation and its
expenses are not included in the results of continuing operations discussed
below.
2004 COMPARED TO 2003
SALES. North American Galvanizing's sales for the second quarter ended June 30,
2004 were $9,333,000, an increase of 11.1% over sales of $8,398,000 for the same
period in 2003. Total production volume in the second quarter of 2004 increased
9.9% over the second quarter of 2003, reflecting increases in construction
related demand for galvanizing. Slightly stronger average selling prices also
contributed to increased sales revenue in the second quarter of 2004. In 2003,
the lower demand for galvanizing due to weaknesses in the economy, and in
particular the capital goods sector, adversely impacted North American
Galvanizing's sales. As the capital goods spending segment of the economy
recovers we expect the demand for galvanizing also to increase.
Sales for the six-months ended June 30, 2004 rose 8.8% to $17,891,000 compared
to sales of $16,438,000 in the first six months of 2003. The increase in sales
was due primarily to higher production volume as galvanizing tonnage for the
first half of 2004 was up 8% compared to the first half of 2003. Slightly higher
average selling prices also contributed to increased sales in the first half of
2004 compared to the year earlier period.
GROSS PROFIT. Gross profit for the second quarter of 2004 increased 5.3% to
$2,698,000, compared to $2,563,000 in the second quarter of 2003. However, gross
profit as a percentage of sales was 28.9% in the second quarter of 2004,
compared to 30.5% for the same quarter of 2003. The decline in the gross margin
rate reflected higher costs for zinc, energy and general operating supplies in
the second quarter of 2004. In view of the highly competitive environment for
galvanizing and the upward pressure on operating costs, the Company expects
gross profit margins will remain fairly stable for the remainder of the current
year.
Gross profit for the first half of 2004 rose at a higher rate than the
underlying increases in production volume and sales, primarily due to lower
insurance costs and improvement in labor productivity. Gross profit increased
14.1% to $5,251,000 compared to gross profit of $4,601,000 for the first half of
2003.
DEPRECIATION EXPENSE. Depreciation expense for the second quarter of 2004 was
$698,000, compared to $696,000
18
for the same period a year ago. Depreciation expense was $1,382,000 and
$1,471,000 for the six months ended June 30, 2004 and 2003, respectively.
SELLING, GENERAL AND ADMINISTRATIVE (SG&A) EXPENSES. The Company's SG&A expenses
include the combined operating expenses of its centralized corporate functions,
as well as the sales and administrative functions at the operating facilities.
In the second quarter of 2004, SG&A increased $209,000, or 14.8%, to $1,622,000
from $1,413,000 in 2003. Increases totaling $267,000 were primarily due to
additions of $125,000 to the reserve for collection of doubtful accounts,
increased legal expenses of $41,000, increased audit expenses of $23,000 and
other increases for administrative salaries, travel expenses and professional
services, which were partially offset by lower costs of insurance premiums of
$58,000. The Company's reserve for doubtful accounts is based on the level of
trade receivables over 90 days and, accordingly, is subject to quarterly
increases or decreases reflecting the turnover of accounts.
The Company anticipates its 2004 insurance costs will continue to compare
favorably with 2003 due to a restructuring of its insurance program, but higher
travel expenses related to the Company's sales and marketing programs are
expected to continue for the remainder of 2004. In addition to sales and service
support teams assigned to each of its regional galvanizing plants, NAG is
committing corporate-level marketing resources to expand and develop new
national account business. The Company believes its SG&A should continue at
approximately the present level for the remainder of 2004.
Despite the marked increase in SG&A in the second quarter of 2004, SG&A of
$3,017,000 for the first half of 2004 increased only 5.2% from $2,866,000 in the
comparable period of 2003. The Company's administrative support staff has been
maintained at a constant level and further benefits have been realized from
long-term programs to streamline the Company's telecommunications and technology
networks, while providing improved service company-wide.
INTEREST EXPENSE. Interest expense for the second quarter of 2004 decreased
$93,000 to $206,000, compared to $299,000 for the second quarter of 2003. The
reduction in interest expense was attributable to lower average interest rates
on variable rate debt, reduction in term loan balances and lower fees for
letters of credit. The interest rate on variable rate debt decreased from 4.5%
to 4.25% as a result of changes in the prime rate. Interest expense also
decreased due to a lower interest rate on the Company's industrial revenue
bonds. In September 2003, the Company amended the bond agreement to more nearly
reflect the interest rate earned by the bondholders. The amendment provides that
the bond trustee will evaluate the interest account at the end of each calendar
quarter and refund the excess amount determined, if any, and rebate such excess
to the Company. The Company has elected to apply any such rebates to offset the
cost of a letter of credit related to the industrial revenue bonds. In the
second quarter of 2004, the Company recognized as a reduction of interest
expense excess bond interest of $40,000. There was no comparable recognition of
excess bond interest in the second quarter of 2003. The Company's interest
expense for the second quarter of 2004 was not impacted by inflation.
Interest expense for the first half of 2004 was $367,000 compared to $607,000
for the first half of 2003. Lower interest expense related to lower average
borrowings on the line of credit, plus a lower rate of interest on industrial
revenue bonds, primarily accounted for the reduced interest expense in 2004.
OTHER (INCOME), NET. In the first quarter of 2004, the Company liquidated its
total investment in equity securities and realized a gain of $25,000.
INCOME TAXES. The Company's effective income tax rates, including taxes related
to discontinued operations in 2003, for the second quarters of 2004 and 2003
were 38.4% and 51.0%, respectively. The rate for 2003 differed from the federal
statutory rate primarily due to state income taxes and adjustments to the
estimate of the deferred tax asset accounts. The rate for 2004 differed from the
federal statutory rate primarily due to state income taxes.
20
For the six months ended June 30, 2004 and 2003, the effective tax rates were
38.0% and 37.9%, respectively.
DISCONTINUED OPERATIONS. NET (LOSS). In the quarter ended June 30, 2003, the
Company recorded a net loss from a discontinued operation of an idled
galvanizing plant of $36,000, net of taxes of $22,000. The Company also wrote
off its investment in the idled galvanizing plant in the second quarter of 2003,
and recorded a net loss of $754,000, net of taxes of $443,000. See Note 11,
Discontinued Operations, Notes to Condensed Consolidated Interim Financial
Statements.
2003 COMPARED TO 2002
The Company's second quarter 2003 galvanizing and coatings business recorded
increased sales and returned to profitable continuing operations compared to the
first quarter 2003 as order volume from fabricators began the expected, but
gradual, improvement from the depressed economic conditions that began to impact
the Company in mid-2002.
SALES for the second quarter of 2003 were $8,398,000, a decrease of $1,705,000,
or 16.9% from second quarter 2002 sales of $10,103,000. Total production volume
in the second quarter of 2003, measured by tons of steel galvanized, decreased
22.4% from second quarter 2002 volume. Underlying production volume at the
Company's galvanizing facilities varied significantly by region, with the
weakness in some industrial markets still impacting small and medium
fabricators.
SALES for the six-months ended June 30, 2003 were $16,438,000 compared to sales
of $19,320,000 in the first six months of 2002, reflecting an 18.7% decrease in
tonnage due to the weak economy impacting construction and fabrication activity
requiring galvanizing. For the first six months of 2003, a continuation of
downward pressure on selling prices due to the weak market and competitive
conditions, combined with increased natural gas costs, adversely impacted NAG's
operations.
OPERATING INCOME. For the second quarter of 2003, the Company reported operating
income, before interest expense and taxes, of $454,000 compared to an operating
income of $1,002,000 in the second quarter of 2002. Gross profit of $2,563,000
for the second quarter of 2003 decreased 21.0% from gross profit of $3,246,000
for the second quarter of 2002. This quarter-to-quarter decrease in 2003 gross
profit and operating earnings resulted primarily from lower volume associated
with a weak economy.
Operating income for the six-months ended June 30, 2003 was $264,000 compared to
$1,731,000 in the first six months of 2002, primarily due to lower sales and
increased costs due to higher natural gas and insurance premiums.
Depreciation expense for the second quarter of 2003 was $696,000 compared to
$749,000 for the same period of 2002.
The Company's selling, general and administrative expenses of $1,413,000 for the
second quarter of 2003 decreased 5.5% from $1,495,000 for the second quarter of
2002, reflecting measures taken by management to align administrative overhead
with the current level of sales.
Net interest expense for the second quarter of 2003 was $299,000 compared to
$279,000 for the second quarter of 2002. The increase in interest expense for
the second quarter of 2003 is primarily the result of financing for the
Company's new galvanizing plant in St. Louis which began production in 2003.
The Company's effective income tax rate for the second quarter of 2003 and 2002
were 51% and 39%, respectively. For the six months ended June 30, 2003 and 2002,
the effective tax rates were 38% and 39%, respectively. The tax rate was
adjusted in the second quarter of 2003 to bring the rate in line with an
expected effective tax rate of 38% for 2003.
20
For the second quarter of 2003, income from continuing operations before income
tax expense was $155,000 compared to income before taxes of $723,000 for the
second quarter of 2002. For the six months ended June 30, 2003, the loss from
continuing operations was $213,000 compared to income of $714,000 for the same
period of 2002. The decrease in income in 2003 primarily reflects lower sales
volume resulting from a measurable downturn in commercial, industrial and OEM
capital spending.
The Company's net loss for the second quarter of 2003, including discontinued
operations, was $714,000, or $.11 per share basic and diluted. This compared to
second quarter 2002 net income of $392,000, or $.06 per share basic and $.05 per
share diluted. For the six months ended June 30, 2003, the Company reported a
net loss $1,044,000, or $.15 per share basic and diluted.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash flow from operations and borrowings under credit facilities
have consistently been adequate to fund its working capital and current
facilities' capital spending requirements. During the three years ended June 30,
2004, operating cash flow and borrowings under credit facilities have been the
primary source of liquidity, supplemented by funds from issuance of a private
placement of notes and a term loan to finance a new galvanizing plant. The
Company monitors working capital and planned capital spending to assess
liquidity and minimize cyclical cash flow.
The Company employs a system of cash management, encompassing all of its
operations, that concentrates cash in a central bank account for maximum
utilization and control. As a matter of policy, all of the Company's cash
inflows are applied daily to a revolving line of credit, and zero balance
disbursement accounts are funded from the central account only as required. By
employing a daily sweep of cash balances and just-in-time disbursement funding,
the Company minimizes its outstanding borrowings from the revolver and also
reduces the related interest expense incurred.
Cash flow from operating activities for the first six months of 2004 and 2003
was $516,000 and $696,000, respectively. The decrease in first-half 2004 cash
flow from operations was due primarily to increases in working capital to
support increased sales revenue, partially offset by the increase in net income.
The Company anticipates that it will be able to satisfy cash requirements for
its ongoing business operations for the foreseeable future with cash generated
by operations and borrowings under its existing credit facilities.
Cash of $937,000 used in investing activities in the first half of 2004
consisted of capital expenditures of $1,029,000 for material handling equipment
and process equipment to maintain galvanizing facilities, offset by proceeds of
$92,000 from the sale of investment securities. Capital expenditures of $661,000
in the first half of 2003 included budgeted capital programs to upgrade existing
galvanizing facilities and for the completion of a new galvanizing plant in St.
Louis, Missouri. For the remainder of 2004, expected capital expenditures of
approximately $500,000 are budgeted for the Company's existing galvanizing
facilities.
In the first half of 2004, the Company's total debt (current and long-term
obligations) increased $653,000 to $17,068. Financing activities in the first
half of 2004 included payments of $319,000 to a bond sinking fund, payments of
$693,000 on bank term loans and other obligations and proceeds of $1,665,000
from a bank line of credit . In the first half of 2004, the Company added 3,750
shares to its Treasury account, resulting from the purchase of 26,456 shares in
private transactions, which were offset by the issuance 22,706 shares in lieu of
cash for payment of quarterly board fees to its directors. At June 30, 2004 and
2003, the Company held 1,430,538 and 1,451,743 shares, respectively, in its
Treasury account.
21
In September 2003, the Company amended a three-year bank credit agreement that
was scheduled to expire in June 2004 and extended its maturity to January 1,
2005. During 2004, the bank has extended maturities under the credit agreement
to July 1, 2005. Subject to borrowing base limitations, the amended agreement
provides (i) a $7,000,000 maximum revolving credit facility for working capital
and general corporate purposes, (ii) a $1,911,924 term note and (iii) a
$2,833,332 advancing construction note.
At June 30, 2004, $9,120,000 was outstanding under the bank credit agreement,
and $400,000 was reserved for outstanding irrevocable letters of credit for
workers' compensation insurance coverage. The Company's commitment to repay
$9,050,000 of tax-exempt adjustable rate industrial revenue bonds issued in 2000
is fully secured by an irrevocable letter of credit issued by Bank One Oklahoma,
N.A., in favor of Bank One Trust Company (See Note 6 to Condensed Consolidated
Financial Statements). At June 30, 2004, the Company had $569,000 available
borrowing capacity, net of outstanding letters of credit, under its revolving
line of credit based on the borrowing base calculated under the agreement.
Available borrowing capacity under the revolving line of credit improved to
$1,186,000 at the end of July. The Company believes that its ability to continue
to generate cash from operations and its bank credit facilities will provide
adequate capital resources and liquidity to support operations and capital
expenditures plans for 2004.
The Company has various commitments primarily related to long-term debt,
industrial revenue bonds, operating lease commitments, zinc purchase commitments
and vehicle operating leases. The Company's off-balance sheet contractual
obligations at June 30, 2004, consist of $1,857,000 for long-term operating
leases for two galvanizing facilities and galvanizing equipment, $316,000 for
vehicle operating leases and $6,607,000 for zinc purchase commitments. The
various leases for galvanizing facilities, including option renewals, expire
from 2015 to 2017. A lease for galvanizing equipment expires in 2007. The
vehicle leases expire annually on various schedules through 2008. NAG
periodically enters into fixed price purchase commitments with domestic and
foreign zinc producers to purchase a portion of its requirements for its hot dip
galvanizing operations; commitments for the future delivery of zinc are
typically up to one year.
The Company expects to fund these commitments with cash generated from
operations and continuation of existing bank credit agreements as they mature.
The Company's contractual obligations and commercial commitments as of June 30,
2004 are as follows (in thousands):
PAYMENT DUE OR COMMITMENT EXPIRATION BY PERIOD
--------------------------------------------------------------------------
TOTAL 2004 2005 2006 2007 2008 5 YEARS
-------- -------- -------- -------- -------- -------- --------
Industrial revenue bonds $ 6,964 $ 338 $ 693 $ 731 $ 767 $ 806 $ 3,629
Long-term debt 9,139 706 8,415 1 1 1 15
Subordinated notes 1,000 -- -- 1,000 -- -- --
Facilities operating leases 1,857 249 491 411 379 36 291
Vehicle operating leases 316 60 95 70 54 37 --
Zinc purchase commitments 6,607 3,913 2,694 -- -- -- --
-------- -------- -------- -------- -------- -------- --------
Total contractual cash
obligations $ 25,883 $ 5,266 $ 12,388 $ 2,213 $ 1,201 $ 880 $ 3,935
======== ======== ======== ======== ======== ======== ========
Other contingent commitments:
Letters of credit* $ 7,364 $ 738 $ 693 $ 731 $ 767 $ 806 $ 3,629
*Amount includes letter of credit relating to debt outstanding under the
industrial revenue bond agreement (See Note 6 to Condensed Consolidated Interim
Financial Statements).
ENVIRONMENTAL MATTERS
The Company's facilities are subject to extensive environmental legislation and
regulations affecting their operations and the discharge of wastes. The cost of
compliance with such regulations in the first half of 2004 and 2003 were
approximately $476,000 and $543,000, respectively, for the disposal and
recycling of wastes generated by the galvanizing operations.
NAG was notified in 1997 by the Illinois Environmental Protection Agency
("IEPA") that it was one of more than 50 potentially responsible parties
("PRPs") for cleanup of an abandoned site formerly owned by Sandoval Zinc
Company. Since then approximately 30 additional PRPs have been identified by the
IEPA.
A number of the PRPs (approximately 12 to 15) have agreed to work together and
with IEPA on a voluntary basis. The Company has been and continues to
participate in this volunteer group. The group has retained consultants and
legal representatives familiar with IEPA regulations. This volunteer group, with
its consultants, has cooperated with IEPA in attempting to better define the
environmental issues associated with the Sandoval Zinc site. To that extent,
this voluntary group prepared and submitted to IEPA in August 2000 a work plan.
The purpose of this work plan is to attempt to define the extent of
environmental remediation that might be required, assess risks, and review
alternatives to addressing potential remediation. The IEPA has yet to respond to
this proposed work plan or suggest any other course of action. Therefore, the
Company has no basis for determining potential exposure and estimated
remediation costs at this time.
The Company is committed to complying with all federal, state and local
environmental laws and regulations and using its best management practices to
anticipate and satisfy future requirements. As is typical in the galvanizing
business, the Company will have additional environmental compliance costs
associated with past, present, and future operations. Management is committed to
discovering and eliminating environmental issues as they arise. Because of the
frequent changes in environmental technology, laws and regulations management
cannot reasonably quantify the Company's potential future costs in this area.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's operations include managing market risks related to changes in
interest rates and zinc commodity prices.
INTEREST RATE RISK. The Company is exposed to financial market risk related to
changes in interest rates. Changing interest rates will affect interest paid on
the Company's variable rate debt. At June 30, 2004, the Company's outstanding
debt of $17,068,000, net of a $35,000 discount related to subordinated debt,
consisted of the following: Variable rate debt aggregating $9,119,000 under the
bank credit agreement, with an effective rate of 4.2%; $6,964,000 under the
industrial revenue bond agreement, with an effective rate of 3.5%; and fixed
rate debt consisting of $1,000,000 of 10% subordinated promissory notes and a
9.5% term note of $20,000. The borrowings under all of the Company's debt
obligations at June 30, 2004 are due as follows: $1,044,000 in 2004; $9,108,000
in 2005; $1,732,000 in 2006 and $5,219,000 in years 2007 through 2013. Each
increase of 10 basis points in the effective interest rate would result in an
annual increase in interest charges on variable rate debt of approximately
$16,000 based on June 30, 2004 outstanding borrowings. The actual effect of
changes in interest rates is dependent on actual amounts outstanding under the
various loan agreements. The Company monitors interest rates and has sufficient
flexibility to renegotiate the loan agreement, without penalty, in the event
market conditions and interest rates change.
23
ZINC PRICE RISK. NAG periodically enters into fixed price purchase commitments
with domestic and foreign zinc producers to purchase a portion of its zinc
requirements for its hot dip galvanizing operations. Commitments for the future
delivery of zinc, typically up to one year, reflect rates quoted on the London
Metals Exchange. At June 30, 2004, the aggregate fixed price commitments for the
procurement of zinc was approximately $6,707,000. With respect to these zinc
fixed price purchase commitments, a hypothetical decrease of 10% in the market
price of zinc from the June 30, 2004 level represented a potential lost gross
margin opportunity of approximately $670,000; however, lower zinc prices
potentially could benefit future earnings for the zinc purchases that are made
at the lower market price.
The Company's financial strategy includes evaluating the selective use of
derivative financial instruments to manage zinc and interest costs. As part of
its inventory management strategy, the Company recognizes that hedging
instruments may be effective in minimizing the impact of zinc price
fluctuations. The Company's current zinc forward purchase commitments (See Note
9) are considered derivatives, but the Company has elected to account for these
purchase commitments as normal purchases.
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ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, management, including our
chief executive officer and chief financial officer, evaluated the effectiveness
of the design and operation of our disclosure controls and procedures. Based
upon, and as of the date of, the evaluation, our chief executive officer and
chief financial officer concluded that the disclosure controls and procedures
were effective, in all material respects, to ensure that information required to
be disclosed in the reports we file and submit under the Exchange Act is
recorded, processed, summarized and reported as and when required.
There have been no significant changes in our internal controls over financial
reporting that occurred during our last fiscal quarter that has materially
affected, or is reasonably likely to materially affect, our internal controls
over financial reporting. There were no significant deficiencies or material
weaknesses identified in the evaluation, and therefore, no corrective actions
were taken.
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PART II OTHER INFORMATION
Item 1. Legal Proceedings
Various litigation arising in the ordinary course of business is pending against
the Company. Management believes that resolution of the Company's litigation and
environmental matters should not materially affect the Company's consolidated
financial position or liquidity.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchase of Equity
Securities
The following table contains information about our purchases of our equity
securities during the second quarter of 2004.
Issuer Purchases of Equity Securities
Average Total Number of Approximate Dollar
Total Number Price Shares Purchased as Value That May Yet
of Shares Paid per Part of a Publicly Be Purchased
Period Purchased Share Announced Plan (1) Under the Plan (1)
------ --------- ----- ------------------ ------------------
April 1-30, 2004 600 $ 1.70 600 $780,943
May 1-31, 2004 25,806 $ 1.71 25,806 $736,815
June 1-30, 2004 -- -- -- $736,815
-----------------------------------------------------------------------
Total 26,406 $ 1.71 26,406 $736,815
(1) In July 1998, the Board of Directors authorized a share repurchase plan.
Shares of common stock may be purchased in private or open market
transactions, with an aggregate purchase price limit of no more than $1
million. As of June 30, 2004, the number of shares purchased and held in
Treasury under this plan was 142,652. Unless terminated earlier by
resolution of our Board, the plan will expire when we have repurchased
all shares authorized for repurchase under the plan.
Item 3. Defaults Upon Senior Securities - Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
The Company held its Annual Meeting of Stockholders on Wednesday July 21, 2004
in New York City, NY. At the meeting, stockholders elected seven incumbent
directors to serve until the 2005 annual meeting. Stockholders also approved the
following proposals: (a) the 2004 Incentive Stock Plan, to replace a prior stock
option plan; (b) the Director Stock Unit Program, a program to tie a percentage
of each director's compensation to the long-term value of Company's common stock
and (d) amendments to the Company's Restated Certificate of Incorporation to
effect a reverse split followed by a forward split of the Company's common
stock, at the discretion of the Board of Directors. Stockholders also ratified
the appointment of Deloitte & Touche LLP as independent accountants to conduct
the 2004 audit of the Company's financial statements. The votes for the election
of directors and other proposals were as follows:
ELECTION OF DIRECTORS For Withheld
--------------------- --- --------
Linwood J. Bundy 5,983,554 304,458
Paul R. Chastain 5,983,428 304,584
Ronald J. Evans 5,981,157 306,855
26
Gilbert L. Klemann, II 5,983,554 304,458
Patrick J. Lynch 5,983,554 304,458
Joseph J. Morrow 5,983,554 304,458
John H. Sununu 5,982,354 305,658
2004 INCENTIVE STOCK PLAN For: 4,016,271 Against: 456,278
Abstain: 8,733 Broker Non-Votes: 1,806,730
DIRECTORS STOCK UNIT PROGRAM For: 4,063,261 Against: 406,118
Abstain: 11,903 Broker Non-Votes: 1,806,730
REVERSE/FORWARD STOCK SPLIT For: 4,142,655 Against: 334,477
Abstain: 4,150 Broker Non-Votes: 1,806,730
APPOINTMENT OF DELOITTE & TOUCHE
For: 6,281,730 Against: 4,020 Abstain: 2,262
Item 5. Other Information - Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.1 The Company's Restated Certificate of Incorporation
(incorporated by reference to Exhibit 3.1 to the Company's
Pre-Effective Amendment No. 1 to Registration Statement on
Form S-3 (Reg. No. 333-4937) file on June 7, 1996).
3.2 The Company's Amended and Restated Bylaws (incorporated by
reference to Exhibit 3.2 to the Company's Quarterly Report
on Form 10-Q dated March 31, 1996).
31 Certifications pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
32 Certifications pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
99 Cautionary Statements by the Company Related to
Forward-Looking Statements.
(b) Reports on Form 8-K
May 3, 2004: Our First Quarter 2004 Earnings Announcement was
furnished to the Securities and Exchange Commision on a Form 8-K.
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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:
NORTH AMERICAN GALVANIZING & COATINGS, INC.
-------------------------------------------
(Registrant)
/s/ Paul R. Chastain
-------------------------------------
Vice President and
Chief Financial Officer
(Principal Financial Officer and
Duly Authorized Officer)
Date: August 13, 2004
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