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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 The Quarterly Period Ended June 30, 2006
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 June 30, 2006:
Common Stock $ .10 Par Value . . . . . 7,187,246
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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
Report of Independent Registered 3
Public Accounting Firm
Condensed Consolidated Balance Sheets as of
June 30, 2006 (unaudited), and
December 31, 2005 4
Condensed Consolidated Statements of Income for the
three-and six-month periods ended June 30, 2006 and
2005 (unaudited) 5
Condensed Consolidated Statements of Cash Flows
for the six months ended
June 30, 2006 and 2005 (unaudited) 6
Condensed Consolidated Statement of Stockholders' Equity
for the six months ended June 30, 2006 (unaudited) 7
Notes to Condensed Consolidated Interim Financial
Statements for the three- and six-month periods ended
June 30, 2006 and 2005 (unaudited) 8-14
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations 15-22
Item 3. Quantitative and Qualitative Disclosure
About Market Risks 22
Item 4. Controls and Procedures 23
PART II. OTHER INFORMATION 23-24
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, market substitution of other
corrosion protection alternatives, such as paint, 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 June
30, 2006, and the related condensed consolidated statements of income for the
three- and six-month periods ended June 30, 2006 and 2005, stockholders' equity
for the six-month period ended June 30, 2006, and of cash flows for the
six-month periods ended June 30, 2006 and 2005. 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 and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with 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 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,
2005, 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 February 10, 2006, we expressed an
unqualified opinion on those consolidated financial statements. In our opinion,
the information set forth in the accompanying condensed consolidated balance
sheet as of December 31, 2005 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
July 31, 2006
3
NORTH AMERICAN GALVANIZING & COATINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
--------------------------------------------------------------------------------------------------------
Unaudited
June 30, December 31,
ASSETS 2006 2005
CURRENT ASSETS:
Cash $ 831 $ 1,367
Trade receivables--less allowances of $191 for 2006 and $124 for 2005 10,784 6,808
Inventories 6,364 6,077
Prepaid expenses and other assets 593 966
Deferred tax asset--net 449 243
---------- ----------
Total current assets 19,021 15,461
PROPERTY, PLANT AND EQUIPMENT--AT COST:
Land 2,167 2,167
Galvanizing plants and equipment 35,913 35,330
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38,080 37,497
Less--allowance for depreciation (17,231) (15,954)
Construction in progress 603 325
---------- ----------
Total property, plant and equipment--net 21,452 21,868
GOODWILL--Net 3,448 3,448
OTHER ASSETS 328 278
---------- ----------
TOTAL ASSETS $ 44,249 $ 41,055
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term obligations $ 756 $ 715
Current portion of bonds payable 752 731
Subordinated notes payable 1,000 1,000
Trade accounts payable 2,036 1,838
Accrued payroll and employee benefits 1,027 1,222
Accrued taxes 1,063 591
Other accrued liabilities 3,162 2,338
---------- ----------
Total current liabilities 9,796 8,435
---------- ----------
DEFERRED TAX LIABILITY--Net 980 1,047
LONG-TERM OBLIGATIONS 5,888 7,072
BONDS PAYABLE 4,763 5,203
---------- ----------
Total liabilities 21,427 21,757
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COMMITMENTS AND CONTINGENCIES (NOTES 6 AND 7)
STOCKHOLDERS' EQUITY:
Common stock--$.10 par value:
Issued--8,209,925 shares in 2006 and 2005 821 821
Additional paid-in capital 17,127 17,391
Retained earnings 8,968 6,543
Common shares in treasury at cost-- 1,022,679 in 2006 and 1,362,977 in 2005 (4,094) (5,457)
---------- ----------
Total stockholders' equity 22,822 19,298
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 44,249 $ 41,055
========== ==========
See notes to condensed consolidated interim financial statements.
4
NORTH AMERICAN GALVANIZING & COATINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In thousands, except per share amounts)
--------------------------------------------------------------------------------------------------
For the Three Months For the Six Months
Ended June 30 Ended June 30
----------------------- -----------------------
2006 2005 2006 2005
SALES $ 18,227 $ 12,801 $ 33,638 $ 22,081
COSTS AND EXPENSES:
Cost of sales 12,706 9,691 23,702 16,533
Selling, general and administrative expenses 2,246 1,983 4,087 3,431
Depreciation and amortization 645 646 1,292 1,265
---------- ---------- ---------- ----------
Total costs and expenses 15,597 12,320 29,081 21,229
---------- ---------- ---------- ----------
OPERATING INCOME 2,630 481 4,557 852
INTEREST EXPENSE 238 278 479 503
---------- ---------- ---------- ----------
INCOME FROM OPERATIONS BEFORE INCOME TAXES 2,392 203 4,078 349
INCOME TAX EXPENSE 949 89 1,653 138
---------- ---------- ---------- ----------
NET INCOME $ 1,443 $ 114 $ 2,425 $ 211
========== ========== ========== ==========
NET INCOME PER COMMON SHARE:
Net income
Basic $ 0.20 $ 0.02 $ 0.34 $ 0.03
Diluted $ 0.18 $ 0.02 $ 0.30 $ 0.03
See notes to condensed consolidated interim financial statements.
5
NORTH AMERICAN GALVANIZING & COATINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2006 AND 2005
(In thousands, except per share amounts)
2006 2005
OPERATING ACTIVITIES:
Net income $ 2,425 $ 211
Gain on disposal of assets 7 --
Depreciation 1,292 1,265
Non-cash directors' fees 245 97
Deferred income taxes (273) 478
Non-cash share-based compensation 29 --
Changes in operating assets and liabilities, net of purchase of assets
from Gregory Industries, Inc. (Note 2):
Accounts receivable--net (3,976) (1,585)
Inventories and other assets 36 100
Accounts payable, accrued liabilities and other 1,299 522
---------- ----------
Cash provided by operating activities 1,084 1,088
INVESTING ACTIVITIES:
Capital expenditures (883) (537)
Payment for purchase of Gregory Industries' galvanizing operation -- (4,166)
---------- ----------
Cash used in investing activities (883) (4,703)
FINANCING ACTIVITIES:
Payments on long-term obligations (16,420) (10,636)
Proceeds from long-term obligations 15,277 14,599
Proceeds from exercise of stock options 658 --
Payment on bonds (419) (340)
Tax benefit realized from stock options exercised 167 --
---------- ----------
Cash provided by/(used in) financing activities (737) 3,623
INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS (536) 8
CASH AND CASH EQUIVALENTS:
Beginning of period 1,367 634
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End of period $ 831 $ 642
========== ==========
CASH PAID DURING THE PERIOD FOR:
Interest $ 588 $ 543
========== ==========
Income taxes $ 1,287 $ 10
========== ==========
See notes to condensed consolidated interim financial statements.
6
NORTH AMERICAN GALVANIZING & COATINGS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2006
(In thousands, except per share amounts)
----------------------------------------------------------------------------------------------------------------------------------
Common Stock
$.10 Par Value Additional Treasury Stock
----------------------- Paid-in Retained ------------------------
Shares Amount Capital Earnings Shares Amount Total
BALANCE--January 1, 2006 8,209,925 $ 821 $ 17,391 $ 6,543 1,362,977 $ (5,457) $ 19,298
Net income -- -- -- 2,425 -- -- 2,425
Stock units for Director Stock
Unit Program -- -- 245 -- -- -- 245
Incentive Stock Plan Compensation -- -- 29 -- -- -- 29
Purchase of common stock for the
treasury -- -- -- -- 275 -- --
Issuance of treasury shares for
stock option transactions, net
of shares tendered for payment
and including tax benefit -- -- (538) -- (340,573) 1,363 825
---------- ---------- ---------- ---------- ---------- ---------- ----------
BALANCE--June 30, 2006 8,209,925 $ 821 $ 17,127 $ 8,968 1,022,679 $ (4,094) $ 22,822
========== ========== ========== ========== ========== ========== ==========
See notes to consolidated financial statements.
7
NORTH AMERICAN GALVANIZING & COATINGS, INC.AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
FOR THE THREE- AND SIX-MONTH PERIODS ENDED JUNE 30, 2006 and 2005
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, 2005. 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").
NOTE 2. BUSINESS EXPANSION - PURCHASE OF ASSETS
On February 28, 2005, NAGalv-Ohio, Inc., a subsidiary of North American
Galvanizing Company, purchased certain galvanizing assets of Gregory Industries,
Inc., located in Canton, Ohio, for a cash purchase price of $3.7 million plus
approximately $0.5 million in purchase related expenses. The purchase expands
the service area of North American Galvanizing into the northeast region of the
United States. The results of the operations of NAGalv-Ohio, Inc. have been
included in the consolidated financial statements since February 28, 2005.
Goodwill of less than $0.1 million was recognized in the purchase. The net
purchase price was allocated as follows:
Current assets $1.8 million
Net property, plant & equipment 2.3
Goodwill 0.1
----
Purchase price $4.2 million
----
Pro-forma unaudited results of operations of the Company for the three-and
six-month periods ended June 30, 2005, prepared as if the purchase had taken
place on January 1, 2005 would have been as follows:
Three Months Six Months
Ended June 30 Ended June 30
--------------------------------------------------------------------------------------
Dollars in Thousands, Except per Share Amounts 2005 2005
--------------------------------------------------------------------------------------
Sales $ 12,801 $ 23,185
Net Income 114 91
Earnings per share:
Basic $ .02 $ .01
Diluted $ .01 $ .01
8
NOTE 3. STOCK OPTIONS
On June 30, 2006 the Company has two share-based compensation plans, which are
shareholder-approved, the 2004 Incentive Stock Plan and the Director Stock Unit
Plan (Note 7). The Company's 2004 Incentive Stock (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 vest based on 4 years
of continuous service and have 10-year contractual terms.
The Company adopted Statement of Financial Accounting Standards No. 123(R),
"Share-Based Payment" ("SFAS No. 123(R)") under the modified prospective method
on January 1, 2006. Under the "modified prospective" method, compensation cost
is recognized in the financial statements beginning with the effective date,
based on the requirements of SFAS No. 123(R) for all share-based payments
granted after that date, and based on the requirements of Statement of Financial
Accounting Standards No.123, "Accounting for Stock Based Compensation" ("SFAS
No. 123") for all unvested awards granted prior to the effective date of SFAS
No. 123(R).
SFAS No. 123(R) eliminates the intrinsic value measurement method of accounting
in APB Opinion 25 and generally requires measuring the cost of the employee
services received in exchange for an award of equity instruments based on the
fair value of the award on the date of the grant. The standard requires grant
date fair value to be estimated using either an option-pricing model which is
consistent with the terms of the award or a market observed price, if such a
price exists. Such costs must be recognized over the period during which an
employee is required to provide service in exchange for the award. The standard
also requires estimating the number of instruments that will ultimately be
issued, rather than accounting for forfeitures as they occur.
The compensation cost for the Plan was $10,000 for the three-months ended June
30, 2006 and $29,000 for the first six-months of 2006. No tax benefit was
recognized for the incentive stock plan compensation cost. There was no
share-based compensation cost capitalized during the first six months of 2006.
In the first half of 2005, the Company accounted 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 was recognized for
stock option awards. Had compensation cost for the Company's stock option plans
been determined according to the methodology of SFAS No. 123, the Company's pro
forma net earnings and basic and diluted earnings per share for the three- and
six-month periods ended June 30, 2005 would have been as follows:
Three Months Six Months
Ended June 30 Ended June 30
--------------------------------------------------------------------------------------
Dollars in Thousands, Except per Share Amounts 2005 2005
--------------------------------------------------------------------------------------
Net Income, as reported $ 114 $ 211
Deduct: Total stock-based employee compensation expense
determined under fair value based methods, net of tax $ (16) $ (25)
---------- ----------
Pro forma net income $ 98 $ 186
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Earnings per share:
Basic and Diluted - as reported $ .02 $ .03
---------- ----------
Basic and Diluted - pro forma $ .01 $ .02
---------- ----------
9
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
------------------------------------------------------------------------------------------------------
Dollars in Thousands, Except per Share Amounts 2006 2005 2006 2005
------------------------------------------------------------------------------------------------------
Volatility 49% 55% 54% 55%
Discount Rate 5.1% 4.7% 4.7% 4.7%
Dividend Yield -- -- -- --
Fair Value $ 1.91 $ 1.69 $ 1.50 $ 1.69
In the first six months of 2006, the Company issued stock options for 167,500
shares at $2.14 per share, and issued stock options for 105,000 shares at $2.46
per share in the first six months of 2005. The fair value of options vesting
during the first six months of 2006 was $32,550. The intrinsic value of options
exercised during the first half of 2006 was $1,048,000.
Number of Weighted Average
Shares Exercise Price
--------------------------
Outstanding, December 31, 2005 (518,333 exercisable) 713,333 $ 2.11
Granted 167,500 2.14
Exercised (342,500) 2.32
Surrendered/expired/cancelled (40,000) 2.42
---------- ----------
Outstanding, June 30, 2006 (247,083 exercisable) 498,333 $ 1.95
========== ==========
Information about stock options as of June 30, 2006:
Options Outstanding Options Exercisable
------------------------------------------ ------------------------------------------
Weighted- Weighted-
Weighted- Average Weighted- Average
Average Remaining Average Remaining
Range of Number of Exercise Contractual Number of Exercise Contractual
Exercise Prices Shares Price Life (Years) Shares Price Life (Years)
-------- -------- -------- -------- -------- --------
$1.00 to $1.39 113,333 $ 1.21 5.7 113,333 $ 1.21 5.7
$1.50 31,250 1.50 6.7 21,250 1.50 6.7
$1.70 to $2.10 235,000 2.04 9.0 75,000 1.95 7.9
$2.41 to $2.85 98,750 2.50 8.8 17,500 2.47 8.6
$3.06 to $3.50 20,000 3.16 1.5 20,000 3.16 1.5
-------- -------- -------- -------- -------- --------
498,333 $ 1.95 7.8 247,083 $ 1.71 6.3
======== ======== ======== ======== ======== ========
As of June 30, 2006, the total compensation cost related to nonvested awards not
yet recognized was $334,500, which is expected to be recognized over a weighted
average period of 1.71 years. The aggregate intrinsic value of options
outstanding and options exercisable was $1,797,339 and $952,277, respectively,
at June 30, 2006.
NOTE 4. INCOME 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.
10
Three Months Ended June 30 Number of Shares
------------------------ -----------------------------
2006 2005
--------- ---------
Basic 7,255,407 6,840,888
Diluted 8,236,091 7,553,524
Six Months Ended June 30 Number of Shares
------------------------ -----------------------------
2006 2005
--------- ---------
Basic 7,138,794 6,832,036
Diluted 8,013,137 7,559,903
The options excluded from the calculation of diluted earnings per share, due to
the option price being higher than the share market value is 124,600 at June 30,
2005. There were no options priced higher than the share market value at June
30, 2006.
NOTE 5. LONG-TERM OBLIGATIONS
June 30 December 31
(Dollars in Thousands) 2006 2005
---------------------- ---------- ----------
Revolving line of credit $ 2,343 $ 3,304
Term loan 4,049 4,465
Capital lease obligations 235 --
9.5% note due 2015 17 18
---------- ----------
$ 6,644 $ 7,787
Less current portion (756) (715)
---------- ----------
$ 5,888 $ 7,072
---------- ----------
In February 2006, North American Galvanizing & Coatings, Inc. offered the
noteholders of its $1 million subordinated promissory notes the opportunity to
extend the maturity date one year to February 17, 2007. All other note terms
remained unchanged. The extension, which was offered on a voluntary basis, was
100% subscribed.
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 (Note 2).
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 June 30, 2006, the Company had unused
borrowing capacity of $5,103,741 under the line of credit, based on the
underlying borrowing base of accounts receivable and inventory. At June 30,
2006, $2,342,754 was outstanding under the bank credit agreement, and $553,505
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
11
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 8.25% at June 30,
2006. 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 June 30, 2006, the Company
was in compliance with the covenants. The actual financial ratios compared to
the required ratios, were as follows: Current Ratio - actual 1.95 versus minimum
required of 1.10; Debt to Tangible Net Worth Ratio - actual 1.11 vs. maximum
permitted of 2.50; Debt Service Coverage Ratio - actual 2.48 versus minimum
permitted of 1.25; Capital Expenditures Coverage Ratio - actual 1.68 versus
minimum required of 1.0.
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 June 30, 2006 the aggregate commitments for the
procurement of zinc at fixed prices were approximately $3.3 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 no
unpriced commitments for the purchase of zinc at June 30, 2006.
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, 2006 or December 31, 2005, and did not utilize derivatives in the
six-month period ended June 30, 2006 or the year ended December 31, 2005, 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 June 30, 2006,
consist of approximately $2.0 million for long-term operating leases for
vehicles, office space, office equipment, galvanizing facilities and galvanizing
equipment and approximately $3.3 million for zinc purchase commitments. The
various leases for galvanizing facilities, including option renewals, expire
from 2006 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 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 June 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
12
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
denies 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 has 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. The Water
District has also attempted to appeal those rulings contained in the April 12,
2005 that are adverse to the Water District. Meanwhile, litigation in the United
States District Court continues.
The Company has denied any liability with respect to this claim and intends to
vigorously defend this case. At this time, the Company has not determined the
amount of any liability that may result from this matter or whether such
liability, if any, would have a material adverse effect on the Company's
financial condition, results of operations, or liquidity.
The Internal Revenue Service is reviewing 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
concerns whether two operating leases commencing in January 2001 are conditional
sales contracts, not true leases, according to Revenue Ruling 55-540. Should the
Company be completely unsuccessful in its position that the bonds meet the
tax-exempt financing requirements, the bonds could lose their tax exempt status,
the Company could be required to redeem the bonds, which had a principal balance
of $5,515,000 at June 30, 2006, and the Company could be required to pay up to
$145,000 in additional income tax on the interest payments made to the
bondholders. Management of the Company, based upon their analysis of known facts
and circumstances and advice from legal counsel, does not believe that this
matter will have a material adverse effect on the results of operations,
financial conditions or cash flows of the Company and continues to classify
$4,763,000 of the bond liability as long-term according to the original terms of
the bond agreement. In addition, management believes the Company has sufficient
long-term borrowing capacity to repay the bonds in the unlikely event it is
required.
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 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 during 2006. Therefore, the
Company has no basis for determining potential exposure and estimated
remediation costs at this time.
13
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 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 2005 and 2006, 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.
Fees and salary deferred by the Directors for the three- and six-month periods
ended June 30, 2006 and 2005, are following:
Three Months Ended June 30 Six Months Ended June 30
---------------------------------------------------------------------------------------------------------------------
2006 2005 2006 2005
---------------------------------------------------------------------------------------------------------------------
Deferred director stock units 41,525 17,676 101,870 43,926
Average value per stock unit $ 2.95 $ 2.97 $ 2.41 $ 2.39
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
A subsidiary of North American Galvanizing Company (NAGalv-Ohio, Inc.) purchased
the after-fabrication hot dip galvanizing assets of Gregory Industries, Inc.
located in Canton, Ohio on February 28, 2005. Gregory Industries, Inc. is a
manufacturer of products for the highway industry. T. Stephen Gregory, appointed
a director of North American Galvanizing & Coatings, Inc. on June 22, 2005 is
the chairman of the board and a shareholder of Gregory Industries, Inc. Total
sales to Gregory Industries, Inc. for the three-month periods ended June 30,
2006 and 2005 were approximately $451,000 and $435,000, respectively. Total
sales to Gregory Industries, Inc. for the six-month periods ended June 30, 2006
and 2005 were approximately $744,000 and $553,000, respectively. The amount due
from Gregory Industries, Inc. included in trade receivables at June 30, 2006 and
December 31, 2005 was $208,200 and $254,000, respectively.
14
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 June 30, 2006, there were no significant
changes to the Company's critical accounting policies previously disclosed in
Form 10-K for the year ended December 31, 2005.
On February 28, 2005, NAGalv-Ohio, Inc., a subsidiary North American Galvanizing
Company, purchased the hot-dip galvanizing assets of a galvanizing facility
located in Canton, Ohio. The transaction was structured as an asset purchase,
pursuant to an Asset Purchase Agreement dated February 28, 2005 by and between
NAGalv-Ohio, Inc., and the privately owned Gregory Industries, Inc. for all of
the plant, property and equipment of Gregory Industries' after-fabrication hot
dip galvanizing operation. Operating results of the purchased galvanizing
business are included in the Company's financial statements commencing from the
date of the purchase on February 28, 2005.
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 a typical year, the Company will galvanize in excess of 365,000,000
pounds of steel products for approximately 2,000 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 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,
15
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.
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.
16
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.
KEY DEVELOPMENTS
During the period of January, 2003 through February 2005, the Company reported a
number of developments supporting its strategic program to reposition its
galvanizing business in the national market.
On February 28, 2005, NAGalv-Ohio, Inc., a subsidiary of North American
Galvanizing Company, purchased the hot-dip galvanizing assets of a galvanizing
facility located in Canton, Ohio. The transaction was structured as an asset
purchase, pursuant to an Asset Purchase Agreement dated February 28, 2005 by and
between NAGalv-Ohio, Inc., and the privately owned Gregory Industries, Inc. for
all of the plant, property, and equipment of Gregory Industries'
after-fabrication hot dip galvanizing operation. Operating results of the
purchased galvanizing business are included in the Company's financial
statements commencing from the date of purchase on February 28, 2005.
This strategic expansion provides NAG an important, established customer base of
major fabricators serving industrial, OEM, and highway markets as well as
residential and commercial markets for lighting poles. Canton's 52 foot long
dipping kettle is designed to handle large steel structures, such as bridge
beams, utility poles and other steel structural components that require
galvanizing for extended-life corrosion protection. The Canton plant also
processes small parts used in construction, such as nuts and anchor rods, in a
dedicated facility with a smaller 16 foot dipping kettle and a spinner
operation.
In January 2003, the Company opened its St. Louis galvanizing plant, replacing a
smaller plant at the same location. This larger facility is providing NAG a
strategic base for extending its geographic area of service. A 51-foot kettle at
this facility provides the largest galvanizing capacity in the St. Louis region.
In 2004, production tonnage at St. Louis more than doubled compared to
production at the plant it replaced.
In January 2003, the Company expanded services at its Nashville galvanizing
plant with the announced installation of a state-of-the-art spinner line to
galvanize small products, including bolts and threaded material.
17
RESULTS OF OPERATIONS
The following table shows the Company's results of operations for the three- and
six-month periods ended June 30, 2006 and 2005:
(Dollars in thousands)
Three Months Ended June 30,
---------------------------------------------------------
2006 2005
------------------------ ------------------------
% of % of
Amount Sales Amount Sales
-------- -------- -------- --------
Sales $ 18,227 100.0% $ 12,801 100.0%
Cost of sales 12,706 69.7% 9,691 75.7%
-------- -------- -------- --------
Gross profit 5,521 30.3% 3,110 24.3%
Selling, general and administrative expenses 2,246 12.3% 1,983 15.5%
Depreciation and amortization 645 3.5% 646 5.0%
-------- -------- -------- --------
Operating income 2,630 14.4% 481 3.8%
Interest expense 238 1.3% 278 2.2%
-------- -------- -------- --------
Income before income taxes 2,392 13.1% 203 1.6%
Income tax expense 949 5.2% 89 0.7%
-------- -------- -------- --------
Net income (loss) $ 1,443 7.9% $ 114 0.9%
======== ======== ======== ========
(Dollars in thousands)
Six Months Ended June 30,
---------------------------------------------------------
2006 2005
------------------------ ------------------------
% of % of
Amount Sales Amount Sales
-------- -------- -------- --------
Sales $ 33,638 100.0% $ 22,081 100.0%
Cost of sales 23,702 70.5% 16,533 74.9%
-------- -------- -------- --------
Gross profit 9,936 29.5% 5,548 25.1%
Selling, general and administrative expenses 4,087 12.1% 3,431 15.5%
Depreciation and amortization 1,292 3.8% 1,265 5.7%
-------- -------- -------- --------
Operating income 4,557 13.5% 852 3.9%
Interest expense 479 1.4% 503 2.3%
-------- -------- -------- --------
Income before income taxes 4,078 12.1% 349 1.6%
Income tax expense 1,653 4.9% 138 0.0%
-------- -------- -------- --------
Net income (loss) $ 2,425 7.2% $ 211 1.0%
======== ======== ======== ========
18
2006 COMPARED TO 2005
SALES. Sales for the three-months and six-months ended June 30, 2006 increased
42% and 52%, respectively, over the prior year. The main reason for the increase
in second quarter revenues was a higher average sales price and a 2% increase in
volume. Sales prices have increased in response to increases in zinc and energy
costs. The increase in revenues for the first half is due to a higher average
sales price and an 18% increase in volume over the same period in 2005.
For 2006, average selling prices for galvanizing and related coating services
were 40% higher than the prior year second quarter and 29% higher than the first
half of 2005.
The London Metals Exchange (LME) market price for zinc in the first half of 2006
averaged $1.26 per pound, compared to $.59 in the first half of 2005. At June
30, 2006 the LME market price for zinc was $1.48 per pound. With these increases
in zinc costs, the market could react by using other corrosion protection
alternatives, such as paint, or by postponing projects. The Company cannot be
assured that continuing zinc price increases will be absorbed by the market.
The Canton, Ohio galvanizing facility was purchased on February 28, 2005. The
first half 2006 results include six months for Ohio versus only four months in
the first half of 2005. The impact of Ohio revenue on variances of second
quarter and first half total revenues, current to prior year, is minimal.
GROSS PROFIT. For the quarter ended June 30, 2006, gross profit was $5.5 million
compared to $3.1 million for the second quarter of 2005. The Company's ability
to increase average selling prices with general account customers due to zinc
and energy cost increases had a favorable impact on gross profit of $4.6
million. Zinc and energy cost increases had a negative impact of $3.5 million,
offset by a favorable impact from forward purchases of zinc at prices lower than
current market. Increased volumes for the quarter of 2% had a minimal impact on
gross profit.
The gross profit for the six-months ended June 30, 2006 was $9.9 million
compared to $5.5 million for the same 2005 period. Increased volumes contributed
$2.0 million to gross profit. The Company's ability to increase average selling
prices with general account customers due to zinc and energy cost increases had
a favorable impact on gross profit of $6.5 million. Zinc and energy cost
increases had a negative impact of $7.0 million, offset by a favorable impact
from forward purchases of zinc at prices lower than current market. Pricing on
the Company's open forward zinc purchase commitments at June 30, 2006 do not
vary significantly from current market prices.
SELLING, GENERAL AND ADMINISTRATIVE (SG&A) EXPENSES. SG&A increased $263,000, or
13%, in the second quarter of 2006 compared to the prior year, but lowered as a
percentage of revenues from 15.5% in 2005 to 12.3% in 2006. In the first half of
2006, SG&A increased $656,000, or 19%, compared to the same period in the prior
year, but lowered as a percentage of revenues from 15.5% in 2005 to 12.1% in
2006. Increases in both periods were primarily due to increases in personnel
costs, legal and tax expenses, board of director fees, and the provision for
doubtful accounts.
INCOME TAXES. The Company's effective income tax rates for the second quarter of
2006 and 2005 were 39.7% and 43.8%, respectively. For the six months ended June
30, 2006 and 2005, the effective tax rates were 40.5% and 39.5%, respectively.
The effective tax rates differ from the federal statutory rate primarily due to
state income taxes and, in 2005, minor adjustments to previous tax estimates
based on actual tax returns filed.
NET INCOME. For the second quarter of 2006, the Company reported net income of
$1,443,000 compared to net income of $114,000 for the second quarter of 2005.
For the six months ended June 30, 2006, the net income was $2,425,000 compared
to $211,000 for the six months ended June 30, 2005. The increase in net income
is due to an increase in average selling prices and volume.
19
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 2006 and 2005, 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 six months of 2006 and 2005
was $1,084,000 and $1,088,000, respectively. The net change in cash flow from
operations was minimal. Cash flow from improved net income was offset by
increased working capital requirements for accounts receivable.
Cash of $883,000 used in 2006 investing activities through June 30 consisted of
capital expenditures for equipment and upgrade of existing galvanizing
facilities. Investing activities in the first half of 2005 included $4,166,000
to acquire certain assets of Gregory Industries' Inc. and capital expenditures
of $537,000 for equipment to maintain galvanizing facilities. The Company
expects base capital expenditures for 2006 to approximate $1,450,000.
Total debt (current and long-term obligations) decreased $1,562,000 to
$13,159,000 in the first half of 2006. Financing activities for first six months
of 2006 included: payments of $419,000 to a bond sinking fund, proceeds of
$658,000 from the exercise of stock options, proceeds of $15,277,000 from a bank
line of credit, and payments of $16,420,000 on the bank line of credit and term
loans.
To preserve liquidity, the Company offered to the subordinated noteholders an
opportunity to extend the maturity of the debt one year, to February 17, 2007.
One hundred percent of the subordinated noteholders agreed to extend the
maturity of their notes. All other terms of the notes remained the same. There
were no fees associated with the extension.
In February 2005, the Company amended the 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 provided
(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 (Note 2). 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 June 30, 2006, the Company had unused borrowing
capacity of $5,103,741 under the line of credit, based on the underlying
borrowing base of accounts receivable and inventory. At June 30, 2006,
$2,342,754 was outstanding under the bank credit agreement, and $553,505 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 8.25% at June 30, 2006. 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.
20
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 June 30, 2006, the Company
was in compliance with the covenants. The actual financial ratios compared to
the required ratios, were as follows: Current Ratio - actual 1.95 versus minimum
required of 1.10; Debt to Tangible Net Worth Ratio - actual 1.11 vs. maximum
permitted of 2.50; Debt Service Coverage Ratio - actual 2.48 versus minimum
permitted of 1.25; Capital Expenditures Coverage Ratio - actual 1.68 versus
minimum required of 1.0.
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 June 30, 2006, consist of approximately $2.0 million for
long-term operating leases for vehicles, office space, office equipment,
galvanizing facilities and galvanizing equipment and approximately $3.3 million
for zinc purchase commitments. The various leases for galvanizing facilities,
including option renewals, expire from 2006 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 half of 2006 and 2005 was
approximately $698,000 and $617,000, 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 June 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 denies 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
21
order denying in part and granting in part the Company's partial motion to
dismiss plaintiff's third amended complaint. The Company has 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. The Water District has
also attempted to appeal those rulings contained in the April 12, 2005 that are
adverse to the Water District. Meanwhile, litigation in the United States
District Court continues.
The Company has denied any liability with respect to this claim and intends to
vigorously defend this case. At this time, the Company has not determined the
amount of any liability that may result from this matter or whether such
liability, if any, would 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 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 during 2006. 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 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 June 30, 2006, the Company's outstanding
debt of $13,159,000, consisted of the following: Variable rate debt aggregating
$6,392,000 under the bank credit agreement, with an effective rate of 8.25%;
variable rate debt of $5,515,000 under the industrial revenue bond agreement,
with an effective rate of 4.0%; capital lease obligations of $234,000, and,
fixed rate debt consisting of $1,000,000 face value of 10% subordinated
promissory notes and a 9.5% term note of $17,000. The borrowings under all of
the Company's debt obligations at June 30, 2006 are due as follows: $744,000 in
2006; $2,526,000 in 2007; $6,173,000 in 2008 and $3,716,000 in years 2009
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 $11,900 based on June 30, 2006 outstanding borrowings. The actual
effect of changes in interest rates is dependent
22
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 June 30, 2006, the aggregate fixed price commitments
for the procurement of zinc were approximately $3.3 million (Note 6). With
respect to these zinc fixed price purchase commitments, a hypothetical decrease
of 10% in the market price of zinc from the June 30, 2006 level represented a
potential lost gross margin opportunity of approximately $330,000.
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 June 30, 2006 that materially affected, or were
reasonably likely to materially affect, internal controls over financial
reporting.
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 June 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 denies 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.
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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 has 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. The Water
District has also attempted to appeal those rulings contained in the April 12,
2005 that are adverse to the Water District. Meanwhile, litigation in the United
States District Court continues.
The Company has denied any liability with respect to this claim and intends to
vigorously defend this case. At this time, the Company has not determined the
amount of any liability that may result from this matter or whether such
liability, if any, would have a material adverse effect on the Company's
financial condition, results of operations, or liquidity.
The Internal Revenue Service is reviewing 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
concerns whether two operating leases commencing in January 2001 are conditional
sales contracts, not true leases, according to Revenue Ruling 55-540. Should the
Company be completely unsuccessful in its position that the bonds meet the
tax-exempt financing requirements, the bonds could lose their tax exempt status,
the Company could be required to redeem the bonds, which had a principal balance
of $5,515,000 at June 30, 2006, and the Company could be required to pay up to
$145,000 in additional income tax on the interest payments made to the
bondholders. Management of the Company, based upon their analysis of known facts
and circumstances and advice from legal counsel, does not believe that this
matter will have a material adverse effect on the results of operations,
financial conditions or cash flows of the Company and continues to classify
$4,763,000 of the bond liability as long-term according to the original terms of
the bond agreement. In addition, management believes the Company has sufficient
long-term borrowing capacity to repay the bonds in the unlikely event it is
required.
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 10, 2006.
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.
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Item 6. Exhibits.
(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) 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 June 30, 1996).
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 pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
99 Cautionary Statements by the Company Related to
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: July 31, 2006
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