================================================================================
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 THE QUARTERLY PERIOD ENDED MARCH 31, 2007
Commission File No. 1-3920
NORTH AMERICAN GALVANIZING & COATINGS, INC.
(Exact name of the registrant as specified in its charter)
DELAWARE
(State of Incorporation)
71-0268502
(I.R.S. Employer Identification No.)
5314 S. YALE AVENUE, SUITE 1000, TULSA, OKLAHOMA 74135
(Address of principal executive offices)
Former address of registrant: 2250 East 73rd Street, Tulsa, Oklahoma 74136
(918) 494-0964
(Registrant's telephone number)
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 a large accelerated filer,
an accelerated filer, or a non-accelerated filer, as defined in Rule 12b-2 of
the Exchange Act (Check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (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 March 31, 2007: Common Stock $ .10 Par Value....8,165,981
================================================================================
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
Report of Independent Registered 3
Public Accounting Firm
Condensed Consolidated Balance Sheets as of
March 31, 2007 (unaudited), and
December 31, 2006 4
Condensed Consolidated Statements of Income for the
three months ended March 31, 2007 and 2006 (unaudited) 5
Condensed Consolidated Statements of Cash Flows
for the three months ended
March 31, 2007 and 2006 (unaudited) 6
Notes to Condensed Consolidated Interim Financial
Statements for the three months ended
March 31, 2007 and 2006 (unaudited) 7-13
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations 14-22
Item 3. Quantitative and Qualitative Disclosure
About Market Risks 22
Item 4. Controls and Procedures 22
PART II. OTHER INFORMATION 23-25
SIGNATURES AND CERTIFICATIONS 25
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,
the raw materials cost of zinc and the cost of natural gas; 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 (the "Company") as of March
31, 2007, and the related condensed consolidated statements of income and of
cash flows for the three-month periods ended March 31, 2007 and 2006. These
interim financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with the
standards of 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 the 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, 2006, and the related consolidated statements of income and
comprehensive income, stockholders' equity and cash flows for the year then
ended (not presented herein); and in our report dated February 14, 2007, we
expressed an unqualified opinion on those consolidated financial statements and
included an explanatory paragraph related to the adoption of Statement of
Financial Accounting Standards No. 123 (R), Share-Based Payment. In our opinion,
the information set forth in the accompanying condensed consolidated balance
sheet as of December 31, 2006 is fairly stated, in all material respects, in
relation to the consolidated balance sheet from which it has been derived.
/s/ Deloitte & Touche LLP
Tulsa, Oklahoma
May 15, 2007
3
NORTH AMERICAN GALVANIZING & COATINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------------------------------------------------------------------------------------------------
UNAUDITED
MARCH 31, DECEMBER 31,
ASSETS 2007 2006
CURRENT ASSETS:
Cash $ 976 $ 1,979
Trade receivables -- less allowances of $232 for 2007 and
$197 for 2006 14,904 13,032
Inventories 6,423 6,755
Prepaid expenses and other assets 707 836
Deferred tax asset -- net 767 784
---------- ----------
Total current assets 23,777 23,386
PROPERTY, PLANT AND EQUIPMENT -- AT COST:
Land 2,167 2,167
Galvanizing plants and equipment 37,378 36,843
---------- ----------
39,545 39,010
Less -- allowance for depreciation (19,732) (18,894)
Construction in progress 1,048 1,019
---------- ----------
Total property, plant and equipment -- net 20,861 21,135
GOODWILL 3,448 3,448
OTHER ASSETS 53 242
---------- ----------
TOTAL ASSETS $ 48,139 $ 48,211
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term obligations $ 3,636 $ 778
Current portion of bonds payable 5,078 830
Trade accounts payable 4,647 7,444
Accrued payroll and employee benefits 877 1,082
Accrued taxes 1,498 762
Other accrued liabilities 3,226 3,194
---------- ----------
Total current liabilities 18,962 14,027
---------- ----------
DEFERRED TAX LIABILITY -- Net 698 802
LONG-TERM OBLIGATIONS 302 3,318
BONDS PAYABLE -- 4,435
---------- ----------
Total liabilities 19,962 22,645
---------- ----------
COMMITMENTS AND CONTINGENCIES (NOTE 6)
STOCKHOLDERS' EQUITY:
Common stock -- $.10 par value, 18,000,000 shares authorized:
Issued--8,209,925 shares in 2007 and 2006 821 821
Additional paid-in capital 14,108 14,061
Retained earnings 13,424 11,078
Common shares in treasury at cost -- 43,944 in 2007 and
98,253 in 2006 (176) (394)
---------- ----------
Total stockholders' equity 28,177 25,566
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 48,139 $ 48,211
========== ==========
See notes to condensed consolidated interim financial statements.
4
NORTH AMERICAN GALVANIZING & COATINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2007 AND 2006
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------------------------------------------------------------------------------------------------
2007 2006
SALES $ 23,499 $ 15,411
COSTS AND EXPENSES:
Cost of sales 16,212 10,996
Selling, general and administrative expenses 2,364 1,841
Depreciation and amortization 838 647
---------- ----------
Total costs and expenses 19,414 13,484
---------- ----------
OPERATING INCOME 4,085 1,927
Interest expense 187 241
Interest income (18) --
---------- ----------
INCOME BEFORE INCOME TAXES 3,916 1,686
INCOME TAX EXPENSE 1,570 704
---------- ----------
NET INCOME $ 2,346 $ 982
========== ==========
NET INCOME PER COMMON SHARE:
Net income
Basic $ 0.29 $ 0.14
Diluted $ 0.28 $ 0.13
See notes to condensed consolidated interim financial statements.
5
NORTH AMERICAN GALVANIZING & COATINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2007 AND 2006
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------------------------------------------------------------------------------------------------
2007 2006
OPERATING ACTIVITIES:
Net income $ 2,346 $ 982
Gain on disposal of assets -- 7
Depreciation 838 647
Deferred income taxes (87) 57
Non-cash directors' fees 107 122
Non-cash share-based compensation 83 19
Changes in operating assets and liabilities:
Accounts receivable--net (1,872) (2,654)
Inventories and other assets 650 403
Accounts payable, accrued liabilities and other (2,233) (195)
---------- ----------
Cash used in operating activities (168) (612)
INVESTING ACTIVITIES:
Capital expenditures (525) (154)
---------- ----------
Cash used in investing activities (525) (154)
FINANCING ACTIVITIES:
Payments on long-term obligations (420) (6,789)
Proceeds from long-term obligations 223 7,191
Payment on bonds (188) (235)
Proceeds from exercise of stock options 75 --
---------- ----------
Cash (used in) provided by financing activities (310) 167
DECREASE IN CASH AND CASH EQUIVALENTS (1,003) (599)
CASH AND CASH EQUIVALENTS:
Beginning of period 1,979 1,367
---------- ----------
End of period $ 976 $ 768
========== ==========
CASH PAID DURING THE PERIOD FOR:
Interest $ 129 $ 410
========== ==========
Income taxes $ 667 $ 277
========== ==========
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Acquisitions of fixed assets under capital lease obligations $ 39 $ --
========== ==========
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 MONTHS ENDED MARCH 31, 2007 AND 2006
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, 2006. 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
periods. Actual results will be determined based on the outcome of future events
and could differ from the 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").
The Company adopted the provisions of FASB Interpretation No. 48, "Accounting
for Uncertainty in Income Taxes", or FIN 48, on January 1, 2007. FIN 48
clarifies whether or not to recognize assets or liabilities for tax positions
taken that may be challenged by a taxing authority. The Company files income tax
returns in the U.S. federal jurisdiction and various state jurisdictions. With
few exceptions, the Company is no longer subject to U.S. federal and state
income tax examinations by tax authorities for years before 2003. In the second
quarter of 2006, the Internal Revenue Service (IRS) commenced an examination of
the Company's Federal income tax return for 2004 and subsequently added years
2003 and 2005 to the examination. The Company anticipates that the IRS will
complete this examination by the end of the second quarter of 2007. The Company
had previously recorded $162,000 relating to anticipated additional federal
income taxes as a result of this examination, and does not anticipate that
further adjustments resulting from this examination, if any, would result in a
material change to its financial position or results of operations. This amount
is included in income taxes payable at March 31, 2007.
Upon the adoption of FIN 48, the Company commenced a review of all open tax
years in all jurisdictions. The Company does not believe it has included any
"uncertain tax positions" in its Federal income tax return or any of the state
income tax returns it is currently filing. The Company has made an evaluation of
the potential impact of additional state taxes being assessed by jurisdictions
in which the Company does not currently consider itself liable. The Company does
not anticipate that such additional taxes, if any, would result in a material
change to its financial position. In connection with the adoption of FIN 48, the
Company will include future interest and penalties, if any, related to uncertain
tax positions as a component of its provision for taxes.
7
NOTE 2. STOCK OPTIONS
At March 31, 2007 the Company has two share-based compensation plans, which are
shareholder-approved, the 2004 Incentive Stock Plan and the Director Stock Unit
Program (Note 6). The Company's 2004 Incentive Stock Plan (the Plan) permits the
grant of share options and shares to its employees and directors for up to
1,250,000 shares of common stock. The Company believes that such awards better
align the interests of its employees and directors with those of its
shareholders. Option awards are granted with an exercise price equal to the
market price of the Company's stock at the date of grant; those option awards
usually vest based on 4 years of continuous service and have 10-year contractual
terms.
The compensation cost for the Plan was $83,000 and $19,000 for the three- months
ended March 31, 2007 and 2006, respectively. No tax benefit was recognized for
the 2007 incentive stock plan compensation cost. There was no share-based
compensation cost capitalized during 2006 or 2007.
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:
Quarter Ended March 31
--------------------------------------------------------------------------------
Dollars in Thousands, Except per Share Amounts 2007 2006
--------------------------------------------------------------------------------
Volatility 66% 55%
Discount Rate 4.6% 4.7%
Dividend Yield -- --
Fair Value $3.54 $1.47
In the first quarter of 2007, the Company issued stock options for 335,000
shares at $5.20 per share, and issued stock options for 157,500 shares at $2.10
per share in the first quarter of 2006.
NOTE 3. EARNINGS PER COMMON SHARE
Basic earnings per common share for the periods presented are computed based
upon the weighted average number of shares outstanding, adjusted for stock unit
grants. Diluted earnings per common share for the periods presented are based on
the weighted average shares outstanding, adjusted for stock unit grants and for
the assumed exercise of stock options and warrants using the treasury stock
method.
THREE MONTHS ENDED MARCH 31 NUMBER OF SHARES
--------------------------- ----------------------------
2007 2006
----------- -----------
Basic 8,143,747 7,022,181
Diluted 8,337,157 7,790,182
The options excluded from the calculation of diluted earnings per share, due to
the option price exceeding the share market price are 335,000 and 295,000 at
March 31, 2007 and 2006, respectively.
8
NOTE 4. LONG-TERM OBLIGATIONS
March 31 December 31
(DOLLARS IN THOUSANDS) 2007 2006
---------------------- ---------- ----------
Capital lease obligations $ 349 $ 328
Term loan 3,573 3,751
Other 16 17
---------- ----------
$ 3,938 $ 4,096
Less current portion (3,636) (778)
---------- ----------
$ 302 $ 3,318
---------- ----------
The Company's bank credit agreement expires February 28, 2008. Subject to
borrowing base limitations, the amended agreement provides (i) an $8,000,000
maximum revolving credit facility for working capital and general corporate
purposes and (ii) a $5,001,000 term loan that combined the outstanding principal
balance of the existing term loan with additional financing for the purchase of
assets of a galvanizing facility in February of 2005.
Term loan payments are based on a seven-year amortization schedule with equal
monthly payments of principal and interest, and a final balloon payment in
February 2008. The term 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 March 31, 2007, the Company had unused
borrowing capacity of $7,612,000 under the line of credit, based on the
underlying borrowing base of accounts receivable and inventory. At March 31,
2007, there were no borrowings outstanding under the bank credit agreement, and
$388,000 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 agreement, and the credit agreement is secured by a full and unconditional
guaranty from NAG. Amounts borrowed under the agreement bear interest at the
prime rate of JPMorgan Chase Bank 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. The interest rate on these borrowings
was 8.50% at March 31, 2007. 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 from 3.0% to 5.75%
and the Applicable Prime Rate Margin will be increased from .25% 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 1.00 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 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 March 31, 2007, the Company
was in compliance with the covenants, with the exception of the Debt Service
Coverage Ratio and Capital Expenditures Coverage Ratio. The covenant violations
occurred due to the reclassification of the bonds payable as short-term, based
on the agreement with the Internal Revenue Service discussed in Note 5. The
Company has obtained a commitment for a new long-term facility financed by
another bank and has notified its existing bank that it plans to repay and
terminate the current facility. The actual financial ratios compared to the
required ratios, were as follows: Current Ratio - actual 1.7 versus minimum
required of 1.10; Debt to Tangible Net Worth Ratio - actual .77 vs. maximum
permitted of 2.50; Debt Service Coverage Ratio - actual 1.02 versus minimum
permitted of 1.25; Capital Expenditures Coverage Ratio - actual .85 versus
minimum required of 1.0.
9
The company has a signed commitment letter from a bank for a $25,000,000
revolving credit facility, and the right to increase the facility up to
$10,000,000 in minimum increments of $5,000,000. The purpose of the new facility
is to refinance existing revolving line of credit, term debt, bond debt, issue
standby letters of credit, finance acquisitions, and for other general corporate
purposes. The credit facility will have a maturity of five years with no
principal payments required and no prepayment penalty. The Company plans to
complete the refinancing before the bank commitment expires on June 29th, 2007.
NOTE 5. BONDS PAYABLE
During the first quarter of 2000, the Company issued $9,050,000 of Harris County
Industrial Development Corporation Adjustable Rate Industrial Development Bonds,
Series 2000 (the "Bonds"). The Bonds are senior to other debt of the Company.
All of the bond proceeds, which were held in trust by Bank One Trust Company,
N.A. ("Trustee"), were used by NAG for the purchase of land and construction of
a hot dip galvanizing plant in Harris County, Texas. The galvanizing plant was
completed and began operation in the first quarter of 2001. The principal amount
outstanding on these bonds was $5,078,000 at March 31, 2007.
The Internal Revenue Service has reviewed the Harris County Industrial
Development Corporation Adjustable Rate Industrial Development Bonds and
compliance with the Internal Revenue Code section (IRC) 144(a)(4)(ii)'s dollar
limitation on capital expenditures within a relevant period. The IRS review
concerned whether two operating leases commencing in January 2001 were
conditional sales contracts, not true leases, according to Revenue Ruling
55-540. As a result of the review, in March, 2007, the Company entered into a
settlement agreement (the "Closing Agreement") with the Harris County Industrial
Development Corporation and the Commissioner of the Internal Revenue Service
("IRS"). Pursuant to the terms of the Closing Agreement, the Company agreed to
make a payment to the IRS of $101,260 in settlement of the issues referenced
above. As of December 31, 2006 the Company had recorded an estimated liability
of $145,000 related to this matter. Furthermore, the Company agreed to redeem
all outstanding Bonds on or before June 30, 2007. As a result, the bonds payable
of $5,078,000 are included in short-term liabilities as of March 31, 2007. The
Company currently has sufficient borrowing capacity to redeem the Bonds.
NOTE 6. 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 March 31, 2007 the aggregate commitments for the
procurement of zinc at fixed prices were approximately $900,000. 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 no
unpriced commitments for zinc purchases at March 31, 2007.
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
March 31, 2007 or December 31, 2006, and did not utilize derivatives in the
three-month period ended March 31, 2007 or the year ended December 31, 2006,
except for the forward purchase agreements described above, which are accounted
for as normal purchases.
The Company's total off-balance sheet contractual obligations at March 31, 2007,
consist of approximately $1,466,000 for long-term operating leases for vehicles,
office space, office equipment, galvanizing facilities and galvanizing equipment
and approximately $900,000 for zinc purchase commitments. The various leases for
galvanizing facilities, including option renewals, expire from 2007 to 2017. A
lease for galvanizing equipment expires in 2007.
On August 30, 2004, the Company was informed by counsel for the Metropolitan
Water Reclamation District of Greater Chicago (the "Water District") that the
Water District had, on August 25, 2004 filed a Second Amended
10
Complaint in the United States District Court, Northern District of Illinois,
Eastern Division, naming North American Galvanizing & Coatings, Inc. (formerly
known as Kinark Corporation) as an added defendant. Counsel for the Water
District also gave the Company notice of the Water District's intent to file (or
amend the Complaint to include) a Citizens Suit under the Resource Compensation
and Recovery Act ("RCRA") against North American Galvanizing & Coatings, Inc.,
pursuant to Section 7002 of RCRA, 42 U.S.C. Section 6972. This Second Amended
Complaint seeks enforcement of an August 12, 2004 default judgment in the amount
of $1,810,463.34 against Lake River Corporation and Lake River Holding Company,
Inc. in connection with the operation of a storage terminal by Lake River
Corporation in violation of environmental laws. Lake River Corporation conducted
business as a subsidiary of the Company until September 30, 2000, at which time
Lake River Corporation was sold to Lake River Holding Company, Inc. and ceased
to be a subsidiary of the Company. The Second Amended Complaint asserts that
prior to the sale of Lake River Corporation, the Company directly operated the
Lake River facility and, accordingly, seeks to have the Court pierce the
corporate veil of Lake River Corporation and enforce the default judgment order
of August 12, 2004 against the Company. The Company denied the assertions set
forth in the Water District's Complaint and on November 13, 2004 filed a partial
motion for dismissal of the Second Amended Complaint.
In December 2004, the Water District filed a Third Amended complaint in the
litigation, adding two claims: (1) a common law claim for nuisance; and (2) a
claim under the federal Resource Conservation and Recovery Act, in which the
Water District argues that the Company is responsible for conditions on the
plaintiff's property that present an "imminent and substantial endangerment to
human health and the environment." In January 2005, the Company filed a partial
motion to dismiss the Third Amended Complaint. On April 12, 2005, the Court
issued an order denying in part and granting in part the Company's partial
motion to dismiss plaintiff's third amended complaint. The Company filed an
appeal with the Seventh Circuit Court of Appeals requesting dismissal of the
sole CERCLA claim contained in the Third Amended Complaint that was not
dismissed by the United States District Court's April 12, 2005 order. On January
17, 2007, the Seventh Circuit affirmed the judgment of the United States
District Court, stating that the Water District has a right of action under
CERCLA. The Company is evaluating the judgment and expects to file a motion for
reconsideration with the Seventh Circuit. Meanwhile, litigation and discovery in
the trial court have been stayed pending mediation.
As a result of the mediation, on April 11, 2007, the Company entered into an
Agreement in Principle establishing terms for a conditional settlement. Under
the terms of the Agreement in Principle, the Company has agreed to fund 50% of
the cost, up to $350,000, to enroll the site in the Illinois Voluntary Site
Remediation Program. These funds will be used to prepare environmental reports
for approval by the Illinois Environmental Protection Agency. The parties'
shared objective is to obtain a "no further remediation determination" from the
Illinois EPA based on a commercial / industrial cleanup standard. If the cost to
prepare these reports equals or exceed $700,000, additional costs above $700,000
($350,000 per party) will be borne 100% by the Water District.
If a remediation plan is required based on the site assessment, the Company has
also agreed to fund 50% of the cost to implement the remediation plan, up to a
maximum of $1 million. If the cost to implement the plan is projected to exceed
$2 million, then the Water District will have the option to terminate the
agreement and resume the litigation. The Water District will have to choose
whether to accept or reject the $1 million funding commitment from the Company
before accepting any payments from the Company for implementation of the
remediation plan. The Company does not believe that it can determine whether any
cleanup is required or if any final cleanup cost is likely to exceed $2 million
until additional data has been collected and analyzed in connection with the
environmental reports. If the Water District elects to accept the maximum
funding commitment, the Company has also agreed to remove certain piping and
other equipment from one of the parcels. The cost to remove the piping is
estimated to be between $35,000 and $60,000.
Although the boards of both the Water District and the Company have approved the
Agreement in Principle, the agreement of the parties must be embodied in a
formal settlement agreement, which is currently in process.
The Company has recorded a liability for $350,000 related to the Water District
claim in recognition of its currently known and estimable funding commitment
under the Agreement in Principle. In the event that the Water
11
District rejects the funding commitment described above, the potential claim
could exceed the amount of the previous default judgment. As neither a site
evaluation nor a remediation plan has been developed, the Company is unable to
make a reasonable estimate of the amount or range of further loss, if any, that
could result. Such a liability, if any, could have a material adverse effect on
the Company's financial condition, results of operations, or liquidity.
During the first quarter of 2000, the Company issued $9,050,000 of Harris County
Industrial Development Corporation Adjustable Rate Industrial Development Bonds,
Series 2000 (the "Bonds"). The Bonds are senior to other debt of the Company.
All of the bond proceeds, which were held in trust by Bank One Trust Company,
N.A. ("Trustee"), were used by NAG for the purchase of land and construction of
a hot dip galvanizing plant in Harris County, Texas. The galvanizing plant was
completed and began operation in the first quarter of 2001. The principal amount
outstanding on these bonds was $5,078,000 at March 31, 2007.
The Internal Revenue Service has reviewed the Harris County Industrial
Development Corporation Adjustable Rate Industrial Development Bonds and
compliance with the Internal Revenue Code section (IRC) 144(a)(4)(ii)'s dollar
limitation on capital expenditures within a relevant period. The IRS review
concerned whether two operating leases commencing in January 2001 were
conditional sales contracts, not true leases, according to Revenue Ruling
55-540. As a result of the review, in March, 2007, the Company entered into a
settlement agreement (the "Closing Agreement") with the Harris County Industrial
Development Corporation and the Commissioner of the Internal Revenue Service
("IRS"). Pursuant to the terms of the Closing Agreement, the Company agreed to
make a payment to the IRS of $101,260 in settlement of the issues referenced
above. As of December 31, 2006 the Company had recorded an estimated liability
of $145,000 related to this matter. Furthermore, the Company agreed to redeem
all outstanding Bonds on or before June 30, 2007. As a result, the bonds payable
of $5,078,000 are included in short-term liabilities as of March 31, 2007. The
Company currently has sufficient borrowing capacity to redeem the Bonds.
NAG was notified in 1997 by the Illinois Environmental Protection Agency
("IEPA") that it was one of approximately 60 potentially responsible parties
("PRPs") under the Comprehensive Environmental Response, Compensation, and
Liability Information System ("CERCLIS") in connection with cleanup of an
abandoned site formerly owned by Sandoval Zinc Co. A number of the PRPs 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 estimated timeframe
for resolution of the IEPA contingency is unknown. The IEPA has yet to respond
to this proposed work plan or suggest any other course of action, and there has
been no activity in regards to this issue since 2001. The Company does not have
any liability accrued relating to the IEPA matter. Until the work plan is
approved and completed, the range of potential loss or remediation, if any, is
unknown. In addition, the allocation of potential loss between the 60
potentially responsible parties is unknown and not reasonably estimable.
Therefore, the Company has no basis for determining potential exposure and
estimated remediation costs at this time.
The lease term of a galvanizing facility located in Tulsa, Oklahoma, occupied by
Reinforcing Services, Inc. ("RSI"), a subsidiary of North American Galvanizing
Company, 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
seeking enforcement of the right to exercise the option and requested a summary
judgment in its favor. The court ruled in favor of RSI and as a result, RSI is
negotiating terms of the purchase and related items with the landlord. The
Company expects this matter to be resolved during 2007 without negative
financial impact.
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
12
future operations. Management is committed to discovering and eliminating
environmental issues as they arise. Because of frequent changes in environmental
technology, laws and regulations management cannot reasonably quantify the
Company's potential future costs in this area.
North American Galvanizing & Coatings, Inc. and its subsidiary are parties to a
number of other lawsuits and environmental matters which are not discussed
herein. Management of the Company, based upon their analysis of known facts and
circumstances and reports from legal counsel, does not believe that any other
such matter will have a material adverse effect on the results of operations,
financial conditions or cash flows of the Company.
NOTE 7. DIRECTOR STOCK UNIT PROGRAM
On January 1, 2005, the Company implemented the Director Stock Unit Program
(approved by the stockholders at the Annual Meeting held July 21, 2004) under
which a Director is required to defer 50% of his or her board fee and may elect
to defer up to 100% of his or her board fee, plus a matching contribution by the
Company that varies from 25% to 75% depending on the level of deferral. Such
deferrals are converted into a stock unit grant, payable to the Director five
years following the year of deferral. For 2006 and 2007, all of the Company's
Outside Directors elected to defer 100% of the annual board fee and the
Company's chief executive officer and Inside Director has elected to defer a
corresponding amount of his salary. Outside Directors currently receive an
annual fee of $35,000, which includes attendance at board meetings and service
on committees of the board. In the first three months of 2006, fees and salary
deferred by the Directors represented a total of 60,345 stock unit grants valued
at $2.03 per stock unit. In the first three months of 2007, fees and salary
deferred by the Directors represented a total of 20,384 stock unit grants valued
at $5.26 per stock unit. The value of a stock unit grant is the average of the
closing prices for a share of the Company's stock for the 10 trading days before
the date the director fees otherwise would have been payable in cash.
NOTE 8. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
T. Stephen Gregory, a director of North American Galvanizing & Coatings, Inc. is
the chairman of the board and a shareholder of Gregory Industries, Inc., a
customer of the Company. Total sales to Gregory Industries, Inc. for the
three-month periods ended March 31, 2007 and 2006 were approximately $385,000
and $293,000, respectively. The amount due from Gregory Industries, Inc.
included in trade receivables at March 31, 2007 and December 31, 2006 was
$199,000 and $278,000, respectively.
13
NORTH AMERICAN GALVANIZING & COATINGS, INC. AND SUBSIDIARY
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. 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. 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.
During the three-month period ended March 31, 2007, there were no significant
changes to the Company's critical accounting policies previously disclosed in
Form 10-K for the year ended December 31, 2006.
The Company adopted the provisions of FASB Interpretation No. 48, "Accounting
for Uncertainty in Income Taxes", or FIN 48, on January 1, 2007. FIN 48
clarifies whether or not to recognize assets or liabilities for tax positions
taken that may be challenged by a taxing authority. The Company files income tax
returns in the U.S. federal jurisdiction and various state jurisdictions. With
few exceptions, the Company is no longer subject to U.S. federal and state
income tax examinations by tax authorities for years before 2003. In the second
quarter of 2006, the Internal Revenue Service (IRS) commenced an examination of
the Company's Federal income tax return for 2004 and subsequently added years
2003 and 2005 to the examination. The Company anticipates that the IRS will
complete this examination by the end of the second quarter of 2007. The Company
had previously recorded $162,000 relating to anticipated additional federal
income taxes as a result of this examination, and does not anticipate that
further adjustments resulting from this examination, if any, would result in a
material change to its financial position or results of operations. This amount
is included in income taxes payable at March 31, 2007.
Upon the adoption of FIN 48, the Company commenced a review of all open tax
years in all jurisdictions. The Company does not believe it has included any
"uncertain tax positions" in its Federal income tax return or any of the state
income tax returns it is currently filing. The Company has made an evaluation of
the potential impact of additional state taxes being assessed by jurisdictions
in which the Company does not currently consider itself liable. The Company does
not anticipate that such additional taxes, if any, would result in a material
change to its financial position. In connection with the adoption of FIN 48, the
Company will include future interest and penalties, if any, related to uncertain
tax positions as a component of its provision for taxes
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 mechanical and chemical engineers provide customized
assistance with initial fabrication design, project estimates and steel
chemistry selection.
The Company's galvanizing and coating operations are composed of eleven
facilities located in Colorado, Kentucky, Missouri, Ohio, Oklahoma, Tennessee
and Texas. These facilities operate galvanizing kettles ranging in length from
16 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 2006, the Company galvanized in excess of 400,000,000 pounds of steel
products for approximately 1,700 customers nationwide.
All of the Company's sales are generated for 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
14
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.
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 industrial grating,
o infrastructure including buildings, airports, bridges and power
generation;
o wastewater treatment,
o 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 bridge and pedestrian handrail,
o commercial and residential lighting poles, and
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 coating 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
standard industry technical 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 galvanizing plants is linked
to a centralized 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.
15
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.
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: return on capital employed, 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 each month, or more frequently,
and compared to prior periods, the current business plan and to standard
performance criteria, as applicable.
16
RESULTS OF OPERATIONS
The following table shows the Company's results of operations for the three
months ended March 31, 2007 and 2006:
(Dollars in thousands)
THREE MONTHS ENDED MARCH 31,
-----------------------------------------------
2007 2006
--------------------- ---------------------
% OF % OF
AMOUNT SALES AMOUNT SALES
Sales $ 23,499 100.0% $ 15,411 100.0%
Cost of sales 16,212 69.0% 10,996 71.4%
Selling, general and
administrative expenses 2,364 10.1% 1,841 11.9%
Depreciation and
amortization 838 3.6% 647 4.2%
--------- ------- --------- -------
Operating income 4,085 17.4% 1,927 12.5%
Interest expense 187 0.8% 241 1.6%
Interest Income (18) -0.1% -- --
--------- ------- --------- -------
Income
before income taxes 3,916 16.7% 1,686 10.9%
Income tax expense 1,570 6.7% 704 4.6%
--------- ------- --------- -------
Net income $ 2,346 10.0% $ 982 6.4%
========= ======= ========= =======
2007 COMPARED TO 2006
SALES. Sales for the first quarter ended March 31, 2007 increased 52% over the
prior year. First quarter 2007 volumes are close to volumes in the first quarter
of 2006.
Sales prices have increased in the quarter related to increases in zinc costs.
In the three-months ended March 31, 2007, average selling prices for galvanizing
and related coating services were 55% higher than the prior year first quarter.
The London Metals Exchange (LME) market price for zinc for the first quarter of
2007 averaged $1.57 per pound, compared to $1.02 per pound in the first quarter
of 2006, representing a 54% increase. At March 31, 2007, the LME market price
for zinc was $1.49 per pound. The Company's zinc forward purchase program in
2006 resulted in some zinc purchases at lower prices than market during the
first quarter of 2006. As of March 31, 2007 pricing on the Company's forward
purchase contracts does not differ significantly from market.
COST OF SALES. The increase in cost of sales from 2006 to 2007 resulted mainly
from an increase in zinc costs. Forward purchases of zinc at prices lower than
current market during the first three months of 2006 reduced cost of sales by
$915,000. Other items impacting cost of sales include increased overhead of
$738,000, including $350,000 related to Lake River environmental site assessment
costs, as agreed to in the mediation discussed in Note 6, increased labor costs,
$497,000, and decreased utility costs, $110,000.
SELLING, GENERAL AND ADMINISTRATIVE (SG&A) EXPENSES. SG&A increased $523,000, or
28.0%, from the prior year
17
first quarter, but decreased as a percent of revenues from 11.9%, first quarter
2006 to 10.1%, first quarter 2007. The increase is due to increases in personnel
costs, primarily incentive compensation, $192,000, amortization of deferred bond
and loan origination costs related to the IRB Bond agreement, $186,000, and
other increases in bad debt reserves, shareholder services, audit fees, and
other totaling $145,000.
DEPRECIATION EXPENSE. Depreciation expense for the first quarter of 2007
increased $191,000 from 2006, resulting primarily from a change in depreciation
method for two newer galvanizing facilities. The Company previously used the
units of production method for machinery and equipment at these facilities.
Effective July 1, 2006, the Company changed to the straight-line method.
OPERATING INCOME. Operating income increased $2,158,000 from the first three
months of 2006 to the first three months of 2007. Operating income as a percent
of sales increased 4.9% for the first quarter of 2007 versus the first quarter
of 2006. Increases in operating income result from the factors explained above.
INCOME TAXES. The Company's effective income tax rates for the first quarter of
2007 and 2006 were 40.1% and 41.7%, respectively. The effective tax rates differ
from the federal statutory rate primarily due to state income taxes.
NET INCOME. For the first quarter of 2007, the Company reported net income of
$2,346,000 compared to net income of $982,000 for the first quarter of 2006. The
increase in net income is primarily due to the increase in average selling price
from the first three months of 2006 to the first three months of 2007.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash flow from operations and borrowings under credit facilities
have consistently been adequate to fund its current facilities' working capital
and base capital spending requirements. During 2007 and 2006, operating cash
flow and borrowings under credit facilities have been the primary sources of
liquidity. The Company monitors working capital and planned capital spending to
assess liquidity and minimize cyclical cash flow.
Cash flow from operating activities for the first three months of 2007 and 2006
was ($168,000) and ($612,000), respectively. The increase of $444,000 in 2007
cash flow from operations was due to increased net income, offset by increased
working capital needs, primarily a decrease in accounts payable and accrued
liabilities due to reduction in amounts due to zinc suppliers.
Cash of $525,000 used in 2007 investing activities through March 31 consisted of
capital expenditures for equipment and upgrade of existing galvanizing
facilities. Investing activities in the first quarter of 2006 included $154,000
in capital expenditures. The Company expects base capital expenditures for 2007
to approximate $4,000,000.
During the first three months of 2007, total debt (current and long-term
obligations and bonds payable) decreased $345,000 to $9,016,000. Other financing
activity during the first quarter of 2007 was proceeds from stock option
exercises of $75,000. During the first three months of 2006, total debt (current
and long-term obligations) increased $167,000 to $14,888,000. Financing
activities for first quarter of 2006 included: payments of $235,000 to a bond
sinking fund, proceeds of $7,191,000 from a bank line of credit, and payments of
$6,789,000 on the bank line of credit and term loans.
In February 2005, the Company amended a three-year bank credit agreement that
was scheduled to expire in December 2007 and extended its maturity to February
28, 2008. Subject to borrowing base limitations, the amended agreement provides
(i) an $8,000,000 maximum revolving credit facility for working capital and
general corporate purposes and (ii) a $5,001,000 term loan that combined the
outstanding principal balance of the existing term loan with additional
financing for the purchase of assets of a galvanizing facility.
Term loan payments are based on a seven-year amortization schedule with equal
monthly payments of principal and interest, and a final balloon payment in
February 2008. The term 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
18
maximum line of credit. At March 31, 2007, the Company had unused borrowing
capacity of $7,612,000 under the line of credit, based on the underlying
borrowing base of accounts receivable and inventory. At March 31, 2007, there
were no borrowings outstanding under the bank credit agreement, and $388,000 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 agreement, and the credit agreement is secured by a full and unconditional
guaranty from NAG. Amounts borrowed under the agreement bear interest at the
prime rate of JPMorgan Chase Bank 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. The interest rate on these borrowings
was 8.50% at March 31, 2007. 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 from 3.0% to 5.75%
and the Applicable Prime Rate Margin will be increased from .25% 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 1.00 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 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 March 31, 2007, the Company
was in compliance with the covenants, with the exception of the Debt Service
Coverage Ratio and Capital Expenditures Coverage Ratio. The covenant violations
occurred due to the reclassification of the bonds payable as short-term, based
on the agreement with the Internal Revenue Service discussed in Note 5. The
Company has obtained a commitment for a new long-term facility financed by
another bank and has notified its existing bank that it plans to repay and
terminate the current facility. The actual financial ratios compared to the
required ratios, were as follows: Current Ratio - actual 1.7 versus minimum
required of 1.10; Debt to Tangible Net Worth Ratio - actual .77 vs. maximum
permitted of 2.50; Debt Service Coverage Ratio - actual 1.02 versus minimum
permitted of 1.25; Capital Expenditures Coverage Ratio - actual .85 versus
minimum required of 1.0.
The company has a signed commitment letter from a bank for a $25,000,000
revolving credit facility, and the right to increase the facility up to
$10,000,000 in minimum increments of $5,000,000. The purpose of the new facility
is to refinance existing revolving line of credit, term debt, bond debt, issue
standby letters of credit, finance acquisitions, and for other general corporate
purposes. The credit facility will have a maturity of five years with no
principal payments required and no prepayment penalty. The Company plans to
complete the refinancing before the bank commitment expires on June 29th, 2007.
During the first quarter of 2000, the Company issued $9,050,000 of Harris County
Industrial Development Corporation Adjustable Rate Industrial Development Bonds,
Series 2000 (the "Bonds"). The Bonds are senior to other debt of the Company.
All of the bond proceeds, which were held in trust by Bank One Trust Company,
N.A. ("Trustee"), were used by NAG for the purchase of land and construction of
a hot dip galvanizing plant in Harris County, Texas. The galvanizing plant was
completed and began operation in the first quarter of 2001. The principal amount
outstanding on these bonds was $5,078,000 at March 31, 2007.
The Internal Revenue Service has reviewed the Harris County Industrial
Development Corporation Adjustable Rate Industrial Development Bonds and
compliance with the Internal Revenue Code section (IRC) 144(a)(4)(ii)'s dollar
limitation on capital expenditures within a relevant period. The IRS review
concerned whether two operating leases commencing in January 2001 were
conditional sales contracts, not true leases, according to Revenue Ruling
55-540. As a result of the review, in March, 2007, the Company entered into a
settlement agreement (the "Closing Agreement") with the Harris County Industrial
Development Corporation and the Commissioner of the Internal
19
Revenue Service ("IRS"). Pursuant to the terms of the Closing Agreement, the
Company agreed to make a payment to the IRS of $101,260 in settlement of the
issues referenced above. As of December 31, 2006 the Company had recorded an
estimated liability of $145,000 related to this matter. Furthermore, the Company
agreed to redeem all outstanding Bonds on or before June 30, 2007. As a result,
the bonds payable of $5,078,000 are included in short-term liabilities as of
March 31, 2007. The Company currently has sufficient borrowing capacity to
redeem the Bonds.
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 total off-balance sheet contractual
obligations at March 31, 2007, consist of approximately $1,466,000 for long-term
operating leases for vehicles, office space, office equipment, galvanizing
facilities and galvanizing equipment and approximately $900,000 for zinc
purchase commitments. The various leases for galvanizing facilities, including
option renewals, expire from 2007 to 2017. A lease for galvanizing equipment
expires in 2007. 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 can be for up to one year.
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 three months of 2007 and 2006 was
approximately $802,000 and $308,000, respectively, for the disposal and
recycling of wastes generated by the galvanizing operations.
On August 30, 2004, the Company was informed by counsel for the Metropolitan
Water Reclamation District of Greater Chicago (the "Water District") that the
Water District had, on August 25, 2004 filed a Second Amended Complaint in the
United States District Court, Northern District of Illinois, Eastern Division,
naming North American Galvanizing & Coatings, Inc. (formerly known as Kinark
Corporation) as an added defendant. Counsel for the Water District also gave the
Company notice of the Water District's intent to file (or amend the Complaint to
include) a Citizens Suit under the Resource Compensation and Recovery Act
("RCRA") against North American Galvanizing & Coatings, Inc., pursuant to
Section 7002 of RCRA, 42 U.S.C. Section 6972. This Second Amended Complaint
seeks enforcement of an August 12, 2004 default judgment in the amount of
$1,810,463.34 against Lake River Corporation and Lake River Holding Company,
Inc. in connection with the operation of a storage terminal by Lake River
Corporation in violation of environmental laws. Lake River Corporation conducted
business as a subsidiary of the Company until September 30, 2000, at which time
Lake River Corporation was sold to Lake River Holding Company, Inc. and ceased
to be a subsidiary of the Company. The Second Amended Complaint asserts that
prior to the sale of Lake River Corporation, the Company directly operated the
Lake River facility and, accordingly, seeks to have the Court pierce the
corporate veil of Lake River Corporation and enforce the default judgment order
of August 12, 2004 against the Company. The Company denied the assertions set
forth in the Water District's Complaint and on November 13, 2004 filed a partial
motion for dismissal of the Second Amended Complaint.
In December 2004, the Water District filed a Third Amended complaint in the
litigation, adding two claims: (1) a common law claim for nuisance; and (2) a
claim under the federal Resource Conservation and Recovery Act, in which the
Water District argues that the Company is responsible for conditions on the
plaintiff's property that present an "imminent and substantial endangerment to
human health and the environment." In January 2005, the Company filed a partial
motion to dismiss the Third Amended Complaint. On April 12, 2005, the Court
issued an order denying in part and granting in part the Company's partial
motion to dismiss plaintiff's third amended complaint. The Company filed an
appeal with the Seventh Circuit Court of Appeals requesting dismissal of the
sole CERCLA claim contained in the Third Amended Complaint that was not
dismissed by the United States District Court's April 12, 2005 order. On January
17, 2007, the Seventh Circuit affirmed the judgment of the United States
District Court, stating that the Water District has a right of action under
CERCLA. The Company is evaluating the judgment and expects to file a motion for
reconsideration with the Seventh Circuit. Meanwhile, litigation and discovery in
the trial court have been stayed pending mediation.
20
As a result of the mediation, on April 11, 2007, the Company entered into an
Agreement in Principle establishing terms for a conditional settlement. Under
the terms of the Agreement in Principle, the Company has agreed to fund 50% of
the cost, up to $350,000, to enroll the site in the Illinois Voluntary Site
Remediation Program. These funds will be used to prepare environmental reports
for approval by the Illinois Environmental Protection Agency. The parties'
shared objective is to obtain a "no further remediation determination" from the
Illinois EPA based on a commercial / industrial cleanup standard. If the cost to
prepare these reports equals or exceed $700,000, additional costs above $700,000
($350,000 per party) will be borne 100% by the Water District.
If a remediation plan is required based on the site assessment, the Company has
also agreed to fund 50% of the cost to implement the remediation plan, up to a
maximum of $1 million. If the cost to implement the plan is projected to exceed
$2 million, then the Water District will have the option to terminate the
agreement and resume the litigation. The Water District will have to choose
whether to accept or reject the $1 million funding commitment from the Company
before accepting any payments from the Company for implementation of the
remediation plan. The Company does not believe that it can determine whether any
cleanup is required or if any final cleanup cost is likely to exceed $2 million
until additional data has been collected and analyzed in connection with the
environmental reports. If the Water District elects to accept the maximum
funding commitment, the Company has also agreed to remove certain piping and
other equipment from one of the parcels. The cost to remove the piping is
estimated to be between $35,000 and $60,000.
Although the boards of both the Water District and the Company have approved the
Agreement in Principle, the agreement of the parties must be embodied in a
formal settlement agreement, which is currently in process.
The Company has recorded a liability for $350,000 related to the Water District
claim in recognition of its currently known and estimable funding commitment
under the Agreement in Principle. In the event that the Water District rejects
the funding commitment described above, the potential claim could exceed the
amount of the previous default judgment. As neither a site evaluation nor a
remediation plan has been developed, the Company is unable to make a reasonable
estimate of the amount or range of further loss, if any, that could result. Such
a liability, if any, could have a material adverse effect on the Company's
financial condition, results of operations, or liquidity.
NAG was notified in 1997 by the Illinois Environmental Protection Agency
("IEPA") that it was one of approximately 60 potentially responsible parties
("PRPs") under the Comprehensive Environmental Response, Compensation, and
Liability Information System ("CERCLIS") in connection with cleanup of an
abandoned site formerly owned by Sandoval Zinc Co. A number of the PRPs 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 estimated timeframe
for resolution of the IEPA contingency is unknown. The IEPA has yet to respond
to this proposed work plan or suggest any other course of action, and there has
been no activity in regards to this issue since 2001. The Company does not have
any liability accrued relating to the IEPA matter. Until the work plan is
approved and completed, the range of potential loss or remediation, if any, is
unknown. In addition, the allocation of potential loss between the 60
potentially responsible parties is unknown and not reasonably estimable.
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
frequent changes in environmental technology, laws and regulations management
cannot reasonably
21
quantify the Company's potential future costs in this area.
North American Galvanizing & Coatings, Inc. and its subsidiary are parties to a
number of other lawsuits and environmental matters which are not discussed
herein. Management of the Company, based upon their analysis of known facts and
circumstances and reports from legal counsel, does not believe that any such
matter will have a material adverse effect on the results of operations,
financial conditions or cash flows of the Company.
ITEM 3. 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 March 31, 2007, the Company's outstanding
debt of $9,016,000 consisted of the following: Variable rate debt aggregating
$3,573,000 under the bank credit agreement, with an effective rate of 8.5% and
variable rate debt of $5,078,000 under the industrial revenue bond agreement,
with an effective rate of 4.0%. The borrowings under all of the Company's debt
obligations at March 31, 2007 are due as follows: : $8,712,000 in 2007; $289,000
in 2008; $1,000 in 2009 and $14,000 in years 2010 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 $9,000 based
on March 31, 2007 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.
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 (1) year, reflect rates quoted on the
London Metals Exchange. At March 31, 2007, the aggregate fixed price commitments
for the procurement of zinc were approximately $900,000 (Note 6). With respect
to these zinc fixed price purchase commitments, a hypothetical decrease of 10%
in the market price of zinc from the March 31, 2007 level represented a
potential lost gross margin opportunity of approximately $9,000.
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 are
considered derivatives, but the Company has elected to account for these
purchase commitments as normal purchases.
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.
The Company's certifying officers have indicated that there were no significant
changes in internal controls over financial reporting that have occurred during
the fiscal quarter ended March 31, 2007 that materially affected, or were
reasonably likely to materially affect, internal controls over financial
reporting.
22
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On August 30, 2004, the Company was informed by counsel for the Metropolitan
Water Reclamation District of Greater Chicago (the "Water District") that the
Water District had, on August 25, 2004 filed a Second Amended Complaint in the
United States District Court, Northern District of Illinois, Eastern Division,
naming North American Galvanizing & Coatings, Inc. (formerly known as Kinark
Corporation) as an added defendant. Counsel for the Water District also gave the
Company notice of the Water District's intent to file (or amend the Complaint to
include) a Citizens Suit under the Resource Compensation and Recovery Act
("RCRA") against North American Galvanizing & Coatings, Inc., pursuant to
Section 7002 of RCRA, 42 U.S.C. Section 6972. This Second Amended Complaint
seeks enforcement of an August 12, 2004 default judgment in the amount of
$1,810,463.34 against Lake River Corporation and Lake River Holding Company,
Inc. in connection with the operation of a storage terminal by Lake River
Corporation in violation of environmental laws. Lake River Corporation conducted
business as a subsidiary of the Company until September 30, 2000, at which time
Lake River Corporation was sold to Lake River Holding Company, Inc. and ceased
to be a subsidiary of the Company. The Second Amended Complaint asserts that
prior to the sale of Lake River Corporation, the Company directly operated the
Lake River facility and, accordingly, seeks to have the Court pierce the
corporate veil of Lake River Corporation and enforce the default judgment order
of August 12, 2004 against the Company. The Company denied the assertions set
forth in the Water District's Complaint and on November 13, 2004 filed a partial
motion for dismissal of the Second Amended Complaint.
In December 2004, the Water District filed a Third Amended complaint in the
litigation, adding two claims: (1) a common law claim for nuisance; and (2) a
claim under the federal Resource Conservation and Recovery Act, in which the
Water District argues that the Company is responsible for conditions on the
plaintiff's property that present an "imminent and substantial endangerment to
human health and the environment." In January 2005, the Company filed a partial
motion to dismiss the Third Amended Complaint. On April 12, 2005, the Court
issued an order denying in part and granting in part the Company's partial
motion to dismiss plaintiff's third amended complaint. The Company filed an
appeal with the Seventh Circuit Court of Appeals requesting dismissal of the
sole CERCLA claim contained in the Third Amended Complaint that was not
dismissed by the United States District Court's April 12, 2005 order. On January
17, 2007, the Seventh Circuit affirmed the judgment of the United States
District Court, stating that the Water District has a right of action under
CERCLA. The Company is evaluating the judgment and expects to file a motion for
reconsideration with the Seventh Circuit. Meanwhile, litigation and discovery in
the trial court have been stayed pending mediation.
As a result of the mediation, on April 11, 2007, the Company entered into an
Agreement in Principle establishing terms for a conditional settlement. Under
the terms of the Agreement in Principle, the Company has agreed to fund 50% of
the cost, up to $350,000, to enroll the site in the Illinois Voluntary Site
Remediation Program. These funds will be used to prepare environmental reports
for approval by the Illinois Environmental Protection Agency. The parties'
shared objective is to obtain a "no further remediation determination" from the
Illinois EPA based on a commercial / industrial cleanup standard. If the cost to
prepare these reports equals or exceed $700,000, additional costs above $700,000
($350,000 per party) will be borne 100% by the Water District.
If a remediation plan is required based on the site assessment, the Company has
also agreed to fund 50% of the cost to implement the remediation plan, up to a
maximum of $1 million. If the cost to implement the plan is projected to exceed
$2 million, then the Water District will have the option to terminate the
agreement and resume the litigation. The Water District will have to choose
whether to accept or reject the $1 million funding commitment from the Company
before accepting any payments from the Company for implementation of the
remediation plan. The Company does not believe that it can determine whether any
cleanup is required or if any final cleanup cost is likely to exceed $2 million
until additional data has been collected and analyzed in connection with the
environmental reports. If the Water District elects to accept the maximum
funding commitment, the Company has also agreed to remove certain piping and
other equipment from one of the parcels. The cost to remove the piping is
estimated to be between $35,000 and $60,000.
Although the boards of both the Water District and the Company have approved the
Agreement in Principle, the
23
agreement of the parties must be embodied in a formal settlement agreement,
which is currently in process.
The Company has recorded a liability for $350,000 related to the Water District
claim in recognition of its currently known and estimable funding commitment
under the Agreement in Principle. In the event that the Water District rejects
the funding commitment described above, the potential claim could exceed the
amount of the previous default judgment. As neither a site evaluation nor a
remediation plan has been developed, the Company is unable to make a reasonable
estimate of the amount or range of further loss, if any, that could result. Such
a liability, if any, could have a material adverse effect on the Company's
financial condition, results of operations, or liquidity.
The lease term of a galvanizing facility located in Tulsa, Oklahoma, occupied by
Reinforcing Services, Inc. ("RSI"), a subsidiary of North American Galvanizing
Company, 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
seeking enforcement of the right to exercise the option and requested a summary
judgment in its favor. The court ruled in favor of RSI and as a result, RSI is
negotiating terms of the purchase and related items with the landlord. The
Company expects this matter to be resolved during 2007 without negative
financial impact.
North American Galvanizing & Coatings, Inc. and its subsidiary are parties to a
number of other lawsuits and environmental matters which are not discussed
herein. Management of the Company, based upon their analysis of known facts and
circumstances and reports from legal counsel, does not believe that any such
matter will have a material adverse effect on the results of operations,
financial conditions or cash flows of the Company.
ITEM 1A. RISK FACTORS.
There are no material changes from risk factors as previously disclosed in the
Company's Annual Report on Form 10-K filed on February 14, 2007.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS - NOT
APPLICABLE.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - NOT APPLICABLE.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - NOT APPLICABLE.
ITEM 5. OTHER INFORMATION - NOT APPLICABLE.
ITEM 6. EXHIBITS
NO. DESCRIPTION
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) filed 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).
10.1 Executive Employment Agreement, Ronald J. Evans, dated April 1, 2007.
10.2 Metropolitan Water District of Greater Chicago and North American
Galvanizing & Coatings, Inc. Agreement in Principle, dated April 11,
2007.
24
15 Letter from Deloitte & Touche LLP regarding interim financial
information.
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32 Certifications pursuant to 18 U.S.C. Section 1350, as adopted by
Section 906 of the Sarbanes-Oxley Act of 2002.
99 Cautionary Statements by the Company Regarding Forward-Looking
Statements.
SIGNATURES
Pursuant to the requirements of Section 13 and 15(d) of the Securities and
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)
BY: /S/ BETH B. HOOD
--------------------------
Vice President and
Chief Financial Officer
(Principal Financial Officer)
Date: May 15, 2007
25