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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 SEPTEMBER 30, 2007
Commission File No. 1-3920
NORTH AMERICAN GALVANIZING & COATINGS, INC.
(Exact name of the registrant as specified in its charter)
DELAWARE 71-0268502
(State of Incorporation) (I.R.S. Employer Identification No.)
5314 S. YALE AVENUE, SUITE 1000, TULSA, OKLAHOMA 74135
(Address of principal executive offices)
(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 September 30, 2007:
Common Stock $ .10 Par Value.....12,337,651
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NORTH AMERICAN GALVANIZING & COATINGS, INC.
AND SUBSIDIARY
INDEX TO QUARTERLY REPORT ON FORM 10-Q
PAGE
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PART I. FINANCIAL INFORMATION
Forward Looking Statements or Information 2
Item 1. Financial Statements
Report of Independent Registered Public Accounting Firm 3
Condensed Consolidated Balance Sheets as of September 30, 2007
(unaudited), and December 31, 2006 4
Condensed Consolidated Statements of Income for the three-
and nine-month periods ended September 30, 2007 and
2006 (unaudited) 5
Condensed Consolidated Statements of Cash Flows for the
nine months ended September 30, 2007 and 2006 (unaudited) 6
Notes to Condensed Consolidated Financial
Statements for the three- and nine-month periods ended
September 30, 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 Risk 22
Item 4. Controls and Procedures 23
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 Form 10-K filed on February 14, 2007 with
the Securities and Exchange Commission.
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
September 30, 2007, and the related condensed consolidated statements of income
for the three- and nine-month periods ended September 30, 2007 and 2006 and of
cash flows for the nine-month periods ended September 30, 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
October 29, 2007
3
NORTH AMERICAN GALVANIZING & COATINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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UNAUDITED
SEPTEMBER 30, DECEMBER 31,
ASSETS 2007 2006
---------- ----------
CURRENT ASSETS:
Cash $ 65 $ 1,979
Trade receivables--less allowances of $112 for 2007 and $197 for 2006 13,152 13,032
Inventories 6,175 6,755
Prepaid expenses and other assets 688 836
Deferred tax asset--net 702 784
---------- ----------
Total current assets 20,782 23,386
PROPERTY, PLANT AND EQUIPMENT--AT COST:
Land 2,168 2,167
Galvanizing plants and equipment 39,446 36,843
---------- ----------
41,614 39,010
Less--allowance for depreciation (21,498) (18,894)
Construction in progress 2,139 1,019
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Total property, plant and equipment--net 22,255 21,135
GOODWILL--Net 3,448 3,448
OTHER ASSETS 139 242
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TOTAL ASSETS $ 46,624 48,211
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term obligations $ 97 $ 778
Current portion of bonds payable -- 830
Trade accounts payable 5,895 7,444
Accrued payroll and employee benefits 1,108 1,082
Accrued taxes 1,027 762
Other accrued liabilities 1,509 3,194
---------- ----------
Total current liabilities 9,636 14,090
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DEFERRED TAX LIABILITY--Net 678 802
LONG-TERM OBLIGATIONS 2,646 3,318
BONDS PAYABLE -- 4,435
---------- ----------
Total liabilities 12,960 22,645
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COMMITMENTS AND CONTINGENCIES (NOTE 6)
STOCKHOLDERS' EQUITY (all shares for all periods adjusted for three-for-two
stock split on June 8, 2007):
Common stock--$.10 par value:
Issued--12,366,754 shares in 2007 and 12,314,887 in 2006 1,237 821
Additional paid-in capital 14,439 14,061
Retained earnings 18,143 11,078
Common shares in treasury at cost-- 29,103 in 2007 and 147,379 in 2006 (155) (394)
---------- ----------
Total stockholders' equity 33,664 25,566
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 46,624 48,211
========== ==========
See notes to condensed consolidated financial statements.
4
NORTH AMERICAN GALVANIZING & COATINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
-------------------------- --------------------------
2007 2006 2007 2006
---------- ---------- ---------- ----------
SALES $ 21,541 $ 20,155 $ 68,161 $ 53,793
COSTS AND EXPENSES:
Cost of sales 14,535 15,109 46,899 38,811
Selling, general and administrative expenses 2,193 2,119 6,998 6,206
Depreciation and amortization 876 842 2,612 2,134
---------- ---------- ---------- ----------
Total costs and expenses 17,604 18,070 56,509 47,151
---------- ---------- ---------- ----------
OPERATING INCOME 3,937 2,085 11,652 6,642
Interest expense 275 172 527 651
Interest income (15) -- (69) --
---------- ---------- ---------- ----------
INCOME BEFORE INCOME TAXES 3,677 1,913 11,194 5,991
INCOME TAX EXPENSE 1,164 809 4,129 2,462
---------- ---------- ---------- ----------
NET INCOME $ 2,513 $ 1,104 $ 7,065 $ 3,529
========== ========== ========== ==========
NET INCOME PER COMMON SHARE, all periods adjusted for three-
for-two stock split on June 8, 2007 (Note 1):
Net income
Basic $ 0.21 $ 0.09 $ 0.58 $ 0.32
Diluted $ 0.20 $ 0.09 $ 0.56 $ 0.31
See notes to condensed consolidated financial statements.
5
NORTH AMERICAN GALVANIZING & COATINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
(IN THOUSANDS)
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2007 2006
---------- ----------
OPERATING ACTIVITIES:
Net income $ 7,065 $ 3,529
Gain on disposal of assets -- 19
Depreciation 2,612 2,134
Deferred income taxes (42) (699)
Non-cash share-based compensation 441 61
Non-cash directors' fees 321 352
Changes in operating assets and liabilities:
Accounts receivable--net (120) (5,030)
Inventories and other assets 831 49
Accounts payable, accrued liabilities and other (3,354) 4,559
---------- ----------
Cash provided by operating activities 7,754 4,974
INVESTING ACTIVITIES:
Capital expenditures (3,321) (944)
Purchase of investment -- (1,008)
---------- ----------
Cash used in investing activities (3,321) (1,952)
FINANCING ACTIVITIES:
Payments on long-term obligations (12,388) (19,948)
Proceeds from long-term obligations 11,035 16,089
Payment on bonds (5,265) (544)
Payment on subordinated notes payable -- (1,000)
Tax benefits realized from stock options exercised 232 320
Proceeds from exercise of stock options 194 771
Purchase of common stock for the treasury (152) (3)
Cash paid for fractional shares pursuant to stock split effected by stock dividend (3) --
Proceeds from the exercise of stock warrants -- 57
---------- ----------
Cash used in financing activities (6,347) (4,258)
DECREASE IN CASH AND CASH EQUIVALENTS (1,914) (1,236)
CASH AND CASH EQUIVALENTS:
Beginning of year 1,979 1,367
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End of year $ 65 $ 131
========== ==========
CASH PAID DURING THE YEAR FOR:
Interest $ 444 $ 750
========== ==========
Income taxes $ 4,214 $ 1,419
========== ==========
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Acquisitions of fixed assets under capital lease obligations $ 137 $ 244
========== ==========
Acquisitions of fixed assets included in accounts payable at period end $ 411 $ --
========== ==========
See notes to condensed consolidated financial statements.
6
NORTH AMERICAN GALVANIZING & COATINGS, INC.AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2007 AND 2006
UNAUDITED
NOTE 1. BASIS OF PRESENTATION
The condensed consolidated 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 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. This examination was completed in the second
quarter of 2007 resulting in a required tax payment of $266,000, primarily due
to timing differences of deductions taken in prior year returns.
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 board of directors declared a three-for-two stock split effected by a stock
dividend for all shareholders of record on May 24, 2007, payable on June 8,
2007. All share and per share data (except par value) have been adjusted to
reflect the effect of the stock split for all periods presented. In addition,
the number of shares of common stock issuable upon the exercise of outstanding
stock options and the vesting of other stock awards, as
7
well as the number of shares of common stock reserved for issuance under our
share-based compensation plans, were proportionately increased in accordance
with the terms of those respective agreements and plans.
NOTE 2. STOCK OPTIONS
At September 30, 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 7). 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 1,875,000 shares (adjusted for three-for-two stock split) 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 $161,000 and $32,000 for the three-months
ended September 30, 2007 and 2006, respectively, and $441,000 and $61,000 for
the nine- months ended September 30, 2007 and 2006, respectively. No tax benefit
was recognized in income tax expense for the 2007 incentive stock plan
compensation cost. There was no share-based compensation cost capitalized during
2006 or 2007. Option exercises and subsequent sales of the related stock created
tax benefits of $232,000 and $320,000 for the Company, which were recognized in
stockholder's equity, in the nine-month periods ended September 30, 2007 and
2006.
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 Nine Months Ended
September 30 September 30
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Dollars in Thousands, Except per Share Amounts 2007 2006 2007 2006
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Volatility -- -- 66% 54%
Discount Rate -- -- 4.6% 4.7%
Dividend Yield -- -- -- --
Fair Value, adjusted for three-for-two stock split -- -- $ 2.36 $ 1.00
In the first nine months of 2007, the Company issued stock options for 502,500
shares at $3.47 per share, and issued stock options for 251,250 shares at $1.53
per share in the first nine-months of 2006, as adjusted to reflect the
three-for-two stock split effected in the form of a stock dividend on June 8,
2007.
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. Diluted earnings per
common share for the periods presented are based on the weighted average shares
outstanding, adjusted for the assumed exercise of stock options and warrants
using the treasury stock method. The shares and earnings per share for all
periods have been adjusted to reflect the Company's three-for-two stock split
effected in the form of a share dividend on June 8, 2007.
THREE MONTHS ENDED SEPTEMBER 30 NUMBER OF SHARES
------------------------------- --------------------------
2007 2006
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Basic 12,350,267 11,707,428
Diluted 12,861,519 12,137,058
8
NINE MONTHS ENDED SEPTEMBER 30 NUMBER OF SHARES
------------------------------- --------------------------
2007 2006
---------- ----------
Basic 12,292,268 11,041,278
Diluted 12,732,235 11,392,164
There were no options with strike prices higher than the share market value at
September 30, 2007 or September 30, 2006.
NOTE 4. LONG-TERM OBLIGATIONS
September 30 December 31
(DOLLARS IN THOUSANDS) 2007 2006
---------------------- ---------- ----------
Capital lease obligations $ 402 $ 328
Revolving credit facility 2,325 --
Term loan -- 3,751
Other 16 17
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$ 2,743 $ 4,096
Less current portion (97) (778)
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$ 2,646 $ 3,318
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On May 17, 2007, the Company entered into a new credit agreement between the
Company as borrower and Bank of America, N.A. as administrative agent, swing
line lender and letter of credit issuer. The existing credit agreement,
scheduled to expire on February 28, 2008, was cancelled, and the term loan of
$3.5 million was prepaid without any penalty.
The new credit agreement provides for a revolving credit facility in the
aggregate principal amount of $25 million with future increases of up to an
aggregate principal amount of $10 million at the discretion of the lender. The
credit facility matures on May 16, 2012, with no principal payments required
before the maturity date and no prepayment penalty. The purpose of the new
facility is to refinance a former credit agreement, term debt, and bond debt,
provide for issuance of standby letters of credit, acquisitions, and for other
general corporate purposes.
At September 30, 2007, the Company had unused borrowing capacity of $22.5
million, based on $2.3 million in borrowings outstanding under the revolving
credit facility, and $0.2 million of 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. The credit agreement provides for an applicable margin
ranging from 0.75% to 2.00% over LIBOR and commitment fees ranging from 0.10% to
0.25% depending on the Company's Funded Debt to EBITDA Ratio (as defined). The
applicable margin was 0.75% at September 30, 2007. The variable interest rate
including the applicable margin was 5.88% as of September 30, 2007.
The credit agreement requires the Company to maintain compliance with covenant
limits for leverage ratio, asset coverage ratio, and a basic fixed charge
coverage ratio. At September 30, 2007, the Company was in compliance with the
covenants. The actual financial ratios compared to the required ratios, were as
follows: Leverage Ratio - actual .16 versus maximum allowed of 3.25; Asset
Coverage Ratio - actual 15.54 vs. minimum required of 1.50; Basic Fixed Charge
Coverage Ratio - actual 6.21 versus minimum required of 1.25.
9
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 were 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 Internal Revenue Service 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 July 2, 2007 and subsequently redeemed the bonds on July 2, 2007. The
Company used proceeds from the new five-year credit facility to redeem the
bonds, as specifically contemplated in the agreement.
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 September 30, 2007 the aggregate commitments for the
procurement of zinc at fixed prices were approximately $2.4 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 zinc purchases at September 30, 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
September 30, 2007 or December 31, 2006, and did not utilize derivatives in the
nine-month period ended September 30, 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 September 30,
2007, consist of approximately $1.1 million for long-term operating leases for
vehicles, office space, office equipment, galvanizing facilities and galvanizing
equipment and approximately $2.4 million for zinc purchase commitments. The
various leases for galvanizing facilities, including option renewals, expire
from 2007 to 2017.
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
10
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 exceeds $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.
11
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 was not renewed. RSI exercised an option to
purchase the facility, and the landlord contested the Company's right to
exercise the option. RSI 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 purchased the
facility on June 29, 2007.
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 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, payable quarterly, which includes attendance at board
meetings and service on committees of the board.
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 first day of the
quarter. For the first nine months of 2006, the fees and salary deferred by the
Directors represented a total of 188,382 stock unit grants valued at $1.87 per
stock unit. In the first nine
12
months of 2007, fees and salary deferred by the Directors represented a total of
61,705 stock unit grants valued at $5.21 per stock unit. Both the 2006 and 2007
stock unit grants and average unit value of the grant were adjusted to reflect
the Company's three-for-two stock split effected in the form of a stock dividend
on June 8, 2007.
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
nine-month periods ended September 30, 2007 and 2006 were approximately $1.0
million and $1.4 million, respectively.
The amount due from Gregory Industries, Inc. included in trade receivables at
September 30, 2007 and December 31, 2006 was approximately $0.2 million and $0.3
million, 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 September 30, 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. This examination was completed in the second
quarter of 2007 resulting in a required tax payment of $266,000, primarily due
to timing differences of deductions taken in prior year returns.
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 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.
14
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- and
nine-month periods ended September 30, 2007 and 2006:
(Dollars in thousands)
THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------
2007 2006
------------------------- -------------------------
% OF % OF
AMOUNT SALES AMOUNT SALES
---------- ---------- ---------- ----------
Sales $ 21,541 100.0% $ 20,155 100.0%
Cost of sales 14,486 67.5% 15,109 75.0%
Selling, general and
administrative expenses 2,212 10.2% 2,119 10.5%
Depreciation and
amortization 876 4.1% 842 4.2%
---------- ---------- ---------- ----------
Operating income 3,967 18.3% 2,085 10.3%
Interest expense 275 1.3% 172 0.9%
Interest Income 15 0.1% -- --
---------- ---------- ---------- ----------
Income
before income taxes 3,707 17.1% 1,913 9.5%
Income tax expense 1,164 5.4% 809 4.0%
---------- ---------- ---------- ----------
Net income $ 2,543 11.7% $ 1,104 5.5%
========== ========== ========== ==========
(Dollars in thousands)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------
2007 2006
------------------------- -------------------------
% OF % OF
AMOUNT SALES AMOUNT SALES
---------- ---------- ---------- ----------
Sales $ 68,161 100.0% $ 53,793 100.0%
Cost of sales 46,850 68.8% 38,811 72.1%
Selling, general and
administrative expenses 7,017 10.3% 6,206 11.5%
Depreciation and
amortization 2,612 3.8% 2,134 4.0%
---------- ---------- ---------- ----------
Operating income 11,682 17.1% 6,642 12.3%
Interest expense 527 0.8% 651 1.2%
Interest Income 69 0.1% -- --
---------- ---------- ---------- ----------
Income
before income taxes 11,224 16.4% 5,991 11.1%
Income tax expense 4,129 6.1% 2,462 4.6%
---------- ---------- ---------- ----------
Net income $ 7,095 10.4% $ 3,529 6.6%
========== ========== ========== ==========
17
2007 COMPARED TO 2006
SALES. Sales for the three-months and nine-months ended September 30, 2007
increased 7% and 27%, respectively, over the prior year. The increase in third
quarter and first nine months' revenues was due to a higher average sales price
compared to the same periods in 2006. Sales prices have increased in response to
increases in zinc costs.
Volumes for the third quarter 2007 were 9% lower than the third quarter 2006.
Volumes for the nine months ended September 30, 2007 were 4% lower than the same
period in the prior year. Lower volumes are a result of the Company's focus to
review and accept customer orders only at adequate margin levels and the
scheduled shutdown of the Canton plant to replace the kettle and furnace during
the month of July, 2007.
COST OF GOODS SOLD. Total cost of goods sold for the three-months ended
September 30, 2007 was lower than prior year cost of goods sold for the same
period due to a decrease in volume of 9%. Variable costs per unit from year to
year were comparable, except for direct labor and plant overhead. Increases in
direct labor costs of $.3 million due to wage and incentive pay increases and
increased overtime pay were offset by reductions in other plant overhead of $.3
million.
For the first nine months of 2007, cost of goods sold increased $8.0 million
over the same period in 2006. Of the $8.0 million increase, $6.8 million was due
to an increase in zinc costs, $.9 million due to an increase in labor costs, and
$.3 million due to increases in other plant overhead costs. Year-to-date
September 2007 other overhead costs include a one-time charge of $.3 million
related to Lake River environmental site assessment costs recorded in the first
quarter of 2007.
SELLING, GENERAL AND ADMINISTRATIVE (SG&A) EXPENSES. SG&A increased $.1 million,
or 4.3%, in the third quarter of 2007 compared to the prior year, but decreased
as a percentage of revenues from 10.5% in 2006 to 10.3% in 2007. In the first
nine months of 2007, SG&A increased $.8 million, or 13.15%, compared to the same
period in the prior year, but decreased as a percentage of revenues from 11.5%
in 2006 to 10.3% in 2007. Increases in both periods were primarily due to
increases in personnel costs, primarily non-cash share-based compensation, and
legal, audit and tax expenses, including expenses related to compliance with
Sarbanes-Oxley 404, offset by a reduction in the provision for doubtful
accounts. In addition, a one-time charge to amortize the remaining deferred bond
and loan origination costs related to the IRB Bond agreement, $.2 million, was
recorded in the first quarter of 2007.
DEPRECIATION EXPENSE. Depreciation expense for the first nine months of 2007
increased $.5 million, from the same period in 2006, primarily due to 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. For the quarter ended September 30, 2007, operating income was
$3.9 million compared to $2.1 million for the third quarter of 2006. The
operating income for the nine-months ended September 30, 2007 was $11.7 million
compared to $6.6 million for the same 2006 period. The increase in operating
income is due to an increase in average selling prices.
INCOME TAXES. The Company's effective income tax rates for the third quarter of
2007 and 2006 were 31.4% and 42.2%, respectively. For the nine months ended
September 30, 2007 and 2006, the effective tax rates were 36.8% and 41.1%,
respectively. The effective tax rates differ from the federal statutory rate
primarily due to state income taxes, the section 199 domestic production
deduction, and minor adjustments to previous tax estimates.
NET INCOME. For the third quarter of 2007, the Company reported net income of
$2.5 million compared to net income of $1.1 million for the third quarter of
2006. For the nine months ended September 30, 2007, the net income was $7.1
million compared to $3.5 million for the nine months ended September 30, 2006.
The increase in net income is due to an increase in average selling prices.
18
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash flow from operations and borrowings under credit facilities
have consistently been adequate to fund its current 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 nine months of 2007 and 2006
was $7.8 million and $5.0 million, respectively. The increase of $2.8 million in
cash flow from operations in 2007 was due to increased net income.
Cash of $3.4 million used in 2007 investing activities through September 30
consisted of capital expenditures for equipment, upgrade of existing galvanizing
facilities, and purchase of the galvanizing facility in Tulsa, Oklahoma,
previously leased by RSI, as described in Note 6. Investing activities in the
first nine months of 2006 included $0.9 million in capital expenditures and $1.0
million for purchase of an investment. The Company expects base capital
expenditures for 2007 to approximate $4.0 million.
During the first nine months of 2007, total debt (current maturities and
long-term obligations and bonds payable) decreased by $6.6 million to $2.7
million. Other financing activity during the first nine months of 2007 was
proceeds from stock option exercises of $.2 million, tax benefits on stock
option exercises of $.2 million, and purchase of common stock for the treasury
of $.2 million. During the first nine months of 2006, total debt (current
maturities and long-term obligations and bonds payable) decreased $5.1 million
to $9.6 million. Other financing activities for first nine months of 2006
included proceeds from stock options exercises of $.8 million and tax benefit
realized from stock option exercises of $.3 million.
On May 17, 2007, the Company entered into a new credit agreement between the
Company as borrower and Bank of America, N.A. as administrative agent, swing
line lender and letter of credit issuer. The existing credit agreement,
scheduled to expire on February 28, 2008, was cancelled, and the term loan of
$3.5 million was prepaid without any penalty.
The new credit agreement provides for a revolving credit facility in the
aggregate principal amount of $25 million with future increases of up to an
aggregate principal amount of $10 million at the discretion of the lender. The
credit facility matures on May 16, 2012, with no principal payments required
until maturity and no prepayment penalty. The purpose of the new facility is to
refinance a former credit agreement, term debt, and bond debt, provide for
issuance of standby letters of credit, acquisitions, and for other general
corporate purposes.
At September 30, 2007, the Company had unused borrowing capacity of $22.5
million, based on $2.3 million in borrowings outstanding under the revolving
credit facility, and $.2 million of 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. The credit agreement provides for an applicable margin
ranging from .75% to 2.00% over LIBOR and commitment fees ranging from .10% to
..25% depending on the Company's Funded Debt to EBITDA Ratio (as defined). The
applicable margin was .75% at September 30, 2007. The variable interest rate
including the applicable margin was 5.88% as of September 30, 2007.
The credit agreement requires the Company to maintain compliance with covenant
limits for leverage ratio, asset coverage ratio, and a basic fixed charge
coverage ratio. At September 30, 2007, the Company was in compliance with the
covenants. The actual financial ratios compared to the required ratios, were as
follows: Leverage Ratio - actual .16 versus maximum allowed of 3.25; Asset
Coverage Ratio - actual 15.54 vs. minimum required of 1.50; Basic Fixed Charge
Coverage Ratio - actual 6.21 versus minimum required of 1.25.
19
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 July 2, 2007 and subsequently redeemed the
bonds on July 2, 2007. The Company used proceeds from the new five-year credit
facility to redeem the bonds, as specifically contemplated in the agreement.
The Company's total off-balance sheet contractual obligations at September 30,
2007, consist of approximately $1.1 million for long-term operating leases for
vehicles, office space, office equipment, galvanizing facilities and galvanizing
equipment and approximately $2.4 million for zinc purchase commitments. The
various leases for galvanizing facilities, including option renewals, expire
from 2007 to 2017. 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 nine months of 2007 and 2006 was
approximately $1.5 million and $.9 million, respectively, for the disposal and
recycling of wastes generated by the galvanizing operations. Year-to-date
September 2007 costs include a one-time charge of $.3 million related to Lake
River environmental site assessment costs recorded in the first quarter of 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 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
20
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 exceeds $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
21
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 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 September 30, 2007, the Company's
outstanding debt of $2.6 million consisted primarily of variable rate debt
aggregating $2.3 million under the bank credit agreement, with an effective rate
of 5.8%. The borrowings under all of the Company's debt obligations at September
30, 2007 are due as follows: $.1 million in years 2008 through 2011 and $2.3
million in 2012. 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 $2,300 based on September 30, 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 September 30, 2007, the aggregate fixed price
commitments for the procurement of zinc were approximately $2.4 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 September 30, 2007 level
represented a potential lost gross margin opportunity of approximately $240,000.
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.
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ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, management, including our
chief executive officer and chief financial officer, evaluated the effectiveness
of the design and operation of our disclosure controls and procedures. Based
upon, and as of the date of, the evaluation, our chief executive officer and
chief financial officer concluded that the disclosure controls and procedures
were effective, in all material respects, to ensure that information required to
be disclosed in the reports we file and submit under the Exchange Act is
recorded, processed, summarized and reported as and when required.
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 September 30, 2007 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 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
23
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 exceeds $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.
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 was not renewed. RSI exercised an option to
purchase the facility, and the landlord contested the Company's right to
exercise the option. RSI 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 purchased the
facility on June 29, 2007.
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.
24
ISSUER PURCHASES OF EQUITY SECURITIES
Total Approximate
Number of Dollar Value
Shares of Shares
Total Purchased that May Yet
Number of Average as Part of be Purchased
Period Shares Price Paid Publicly Under
(from/to) Purchased per Share Announced Plan the Plan
---------- ---------- ---------- ----------
May 1, 2007 - May 31, 2007 50 $ 16.28 133,046 $ 761,027
August 1, 2007 - August 31, 2007 28,500 5.33 161,546 609,122
---------- ---------- ---------- ----------
Total 28,550 $ 5.45 161,546 $ 609,122
========== ========== ========== ==========
In August 1998, the Board of Directors authorized $1,000,000 for a share
repurchase program for shares to be purchased in private or open market
transactions. Unless terminated earlier by resolution of the Board of Directors,
the program will expire when the Company has purchased shares with an aggregate
purchase price of no more than $1,000,000.
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 September 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 September 30, 1996).
15 Awareness Letter of Deloitte & Touche LLP.
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.
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: October 29, 2007
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