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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, 2005
COMMISSION FILE NO. 1-3920
NORTH AMERICAN GALVANIZING & COATINGS, INC.
----------------------------------------------------------
(Exact name of the registrant as specified in its charter)
DELAWARE 71-0268502
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(State of Incorporation) (I.R.S. Employer Identification No.)
2250 EAST 73RD STREET
TULSA, OKLAHOMA 74136
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(Address of principal executive offices)
Registrant's telephone number: (918) 494-0964
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 and 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES [_] NO [X]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of September 30, 2005.
Common Stock $ .10 Par Value . . . . . 6,846,848
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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 Public
Accounting Firm ................................ 3
Condensed Consolidated Balance Sheets as of
September 30, 2005 (unaudited), and December
31, 2004 ....................................... 4
Condensed Consolidated Statements of Operations
and Comprehensive Income for the three and
nine-month periods ended September 30, 2005
and 2004 (unaudited) ........................... 5
Condensed Consolidated Statements of Cash Flows
for the nine months ended September 30, 2005
and 2004 (unaudited) ........................... 6
Notes to Condensed Consolidated Interim
Financial Statements for the three and
nine-month periods ended September 30,
2005 and 2004 (unaudited) ...................... 7-14
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations ..................................... 15-23
Item 3. Quantitative and Qualitative Disclosure
About Market Risks ............................. 23
Item 4. Controls and Procedures ............................. 23-24
PART II. OTHER INFORMATION ............................................ 25-26
SIGNATURES .............................................................. 27
FORWARD LOOKING STATEMENTS OR INFORMATION
Certain statements in this Form 10-Q, including information set forth under the
caption "Management's Discussion and Analysis of Financial Condition and Results
of Operations", constitute "Forward-Looking Statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Such statements are typically
punctuated by words or phrases such as "anticipates," "estimate," "should,"
"may," "management believes," and words or phrases of similar import. The
Company cautions investors that such forward-looking statements included in this
Form 10-Q, or hereafter included in other publicly available documents filed
with the Securities and Exchange Commission, reports to the Company's
stockholders and other publicly available statements issued or released by the
Company involve significant risks, uncertainties, and other factors which could
cause the Company's actual results, performance (financial or operating) or
achievements to differ materially from the future results, performance
(financial or operating) or achievements expressed or implied by such
forward-looking statements. Factors that could cause or contribute to such
differences could include, but are not limited to, changes in demand, prices,
and the raw materials cost of zinc; changes in economic conditions of the
various markets the Company serves, as well as the other risks detailed herein
and in the Company's reports filed with the Securities and Exchange Commission.
The Company believes that the important factors set forth in the Company's
cautionary statements at Exhibit 99 to this Form 10-Q could cause such a
material difference to occur and investors are referred to Exhibit 99 for such
cautionary statements.
2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
North American Galvanizing & Coatings, Inc.
We have reviewed the accompanying condensed consolidated balance sheet of North
American Galvanizing & Coatings, Inc. and subsidiary (the "Company") as of
September 30, 2005, and the related condensed consolidated statements of
operations and comprehensive income for the three- and nine-month periods ended
September 30, 2005 and 2004 and of cash flows for the nine-month periods ended
September 30, 2005 and 2004. 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,
2004, 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 April 12, 2005, 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, 2004 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 28, 2005
3
NORTH AMERICAN GALVANIZING & COATINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
UNAUDITED
SEPTEMBER 30 December 31
(Dollars in Thousands) 2005 2004
----------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash $ 1,106 $ 634
Trade receivables, net 7,244 4,654
Inventories 6,324 5,693
Prepaid expenses and other assets 763 521
Deferred tax asset, net 343 723
------------ ------------
TOTAL CURRENT ASSETS 15,780 12,225
------------ ------------
PROPERTY, PLANT AND EQUIPMENT, AT COST
Land 2,167 1,967
Galvanizing plants and equipment 35,488 32,805
------------ ------------
37,655 34,772
Less: Accumulated depreciation (15,737) (13,861)
Construction in progress 183 220
------------ ------------
Total Property, Plant and Equipment, Net 22,101 21,131
------------ ------------
GOODWILL, NET OF ACCUMULATED AMORTIZATION 3,448 3,389
OTHER ASSETS 290 369
------------ ------------
TOTAL ASSETS $ 41,619 $ 37,114
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long-term obligations $ 716 $ 604
Current portion of bonds payable 720 692
Subordinated notes payable 991 --
Trade accounts payable 1,879 582
Accrued payroll and employee benefits 953 717
Other taxes 647 405
Other accrued liabilities 1,657 604
------------ ------------
TOTAL CURRENT LIABILITIES 7,563 3,604
------------ ------------
DEFERRED TAX LIABILITY, NET 1,020 944
LONG-TERM OBLIGATIONS 8,672 7,347
BONDS PAYABLE 5,390 5,934
SUBORDINATED NOTES PAYABLE -- 976
------------ ------------
TOTAL LIABILITIES 22,645 18,805
------------ ------------
COMMITMENTS AND CONTINGENCIES (NOTE 6)
STOCKHOLDER'S EQUITY
Common stock 821 819
Additional paid-in capital 17,321 17,252
Retained earnings 6,289 5,899
Common shares in treasury at cost (5,457) (5,661)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 18,974 18,309
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 41,619 $ 37,114
============ ============
See notes to condensed consolidated interim financial statements.
4
NORTH AMERICAN GALVANIZING & COATINGS, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Operations
and Comprehensive Income (Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
--------------------------- ---------------------------
(Dollars in Thousands Except per Share Amounts) 2005 2004 2005 2004
------------------------------------------------------------------------------------------------------------
SALES $ 12,687 $ 9,348 $ 34,768 $ 27,239
Cost of sales 9,721 6,725 26,254 19,365
Selling, general & administrative expenses 1,778 1,370 5,209 4,387
Depreciation expense 600 686 1,865 2,068
------------ ------------ ------------ ------------
TOTAL COSTS AND EXPENSES 12,099 8,781 33,328 25,820
------------ ------------ ------------ ------------
OPERATING INCOME 588 567 1,440 1,419
Interest expense, net 285 198 788 565
Other income -- -- -- (25)
------------ ------------ ------------ ------------
Income before income taxes 303 369 652 879
Income tax expense 124 140 262 334
------------ ------------ ------------ ------------
NET INCOME $ 179 $ 229 $ 390 $ 545
------------ ------------ ------------ ------------
OTHER COMPREHENSIVE INCOME (LOSS)
Unrealized holding gain on investment -- -- -- 12
Less: reclassification adjustment for realized
gain included in net income -- -- -- (18)
------------ ------------ ------------ ------------
OTHER COMPREHENSIVE INCOME (LOSS) $ -- $ -- $ -- $ (6)
------------ ------------ ------------ ------------
COMPREHENSIVE INCOME $ 179 $ 229 $ 390 $ 539
------------ ------------ ------------ ------------
NET INCOME PER COMMON SHARE
Net Income:
Basic $ 0.03 $ 0.03 $ 0.06 $ 0.08
Diluted $ 0.02 $ 0.03 $ 0.05 $ 0.07
See notes to condensed consolidated interim financial statements.
5
NORTH AMERICAN GALVANIZING & COATINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
NINE MONTHS ENDED
SEPTEMBER 30
----------------------------
(Dollars in Thousands) 2005 2004
------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 390 $ 545
Loss from disposal of fixed assets 51 14
Depreciation and amortization 1,865 2,068
Sale of investment securities -- (25)
Deferred income taxes 456 16
Non-cash directors' fees 175 54
Changes in assets and liabilities, net of purchase of assets from
Gregory Industries, Inc. (Note 2)
Accounts receivable, net (1,643) (818)
Inventories and other assets 108 (760)
Accounts payable, accrued liabilities and other 2,828 323
------------ ------------
CASH PROVIDED BY OPERATING ACTIVITIES 4,230 1,417
INVESTING ACTIVITIES
Payment for purchase of Gregory Industries' galvanizing operation (4,188) --
Proceeds from sale of assets -- 92
Capital expenditures (606) (1,129)
------------ ------------
CASH USED IN INVESTING ACTIVITIES (4,794) (1,037)
FINANCING ACTIVITIES
Purchase of treasury shares -- (45)
Proceeds from sale of treasury stock 100
Payment on bonds (516) (487)
Proceeds from long-term obligations 17,469 13,107
Payments on long-term obligations (16,017) (12,525)
------------ ------------
CASH PROVIDED BY FINANCING ACTIVITIES 1,036 50
------------ ------------
INCREASE IN CASH AND CASH EQUIVALENTS 472 430
CASH AND CASH EQUIVALENTS:
Beginning of Year 634 56
------------ ------------
End of Year $ 1,106 $ 486
============ ============
CASH PAID (RECEIVED) DURING THE YEAR FOR:
Interest $ 733 $ 558
Income taxes (net of refunds of $432 in 2005) $ (376) 288
See notes to condensed consolidated interim financial statements.
6
NORTH AMERICAN GALVANIZING & COATINGS, INC.AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2005 and 2004
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, 2004. 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
----
7
Pro-forma unaudited results of operations of the Company for the three-month
period ended September 30, 2004 and nine-month periods ended September 30, 2005
and 2004, prepared as if the purchase had taken place at the beginning of each
period, would have been as follows:
Three Months Nine Months
Ended September 30 Ended September 30
--------------------------------------------------------------------------
Dollars in Thousands 2005 2004 2005 2004
--------------------------------------------------------------------------
Sales $12,687 $11,169 $35,872 $31,936
Net Income 179 588 270 789
Earnings per share:
Basic $ .03 .09 $ .04 $ .12
Diluted $ .02 .08 $ .04 $ .11
NOTE 3. STOCK OPTIONS
The Company accounts for its stock option plans in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees",
under which no compensation cost has been recognized for stock option awards.
Had compensation cost for the Company's stock option plans been determined
according to the methodology of Statement of Financial Accounting Standards
No.123, "Accounting for Stock Based Compensation" ("SFAS No. 123"), the
Company's pro forma net earnings and basic and diluted earnings per share for
the three and nine months ended September 30, 2005 and 2004 would have been as
follows:
Three Months
Ended September 30
-------------------------------------------------------------------------------
(Dollars in Thousands, Except per Share Amounts) 2005 2004
-------------------------------------------------------------------------------
Net Income, as reported $ 179 $ 229
Deduct: Total stock-based employee
compensation expense determined under
fair value based methods, net of tax $ (24) $ (13)
-------- --------
Pro forma net income $ 155 $ 216
-------- --------
Earnings per share:
Basic - as reported $ .03 $ .03
-------- --------
Basic - pro forma $ .02 $ .03
-------- --------
Diluted - as reported $ .02 $ .03
-------- --------
Diluted - pro forma $ .02 $ .03
-------- --------
Nine Months
Ended September 30
-------------------------------------------------------------------------------
(Dollars in Thousands, Except per Share Amounts) 2005 2004
-------------------------------------------------------------------------------
Net Income, as reported $ 390 $ 545
Deduct: Total stock-based employee compensation
expense determined under fair value based methods,
net of tax $ (39) $ (20)
-------- --------
Pro forma net income $ 351 $ 525
-------- --------
Earnings per share:
Basic - as reported $ .06 $ .08
-------- --------
Basic - pro forma $ .05 $ .08
-------- --------
Diluted - as reported $ .05 $ .07
-------- --------
Diluted - pro forma $ .05 $ .07
-------- --------
8
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 Nine Months
Ended September 30 Ended September 30
-------------------------------------------------------------------------------
Dollars in Thousands 2005 2004 2005 2004
-------------------------------------------------------------------------------
Volatility 47% 43% 47% 43%
Discount Rate 4.18% 4.08% 4.19% 4.08%
Dividend Yield 0% 0% 0% 0%
Fair Value $1.25 $1.20 $1.48 $1.11
In the first nine months of 2005, the Company issued stock options for 140,000
shares at $2.33 per share. The Company issued stock options for 50,000 shares at
$1.84 per share in the first nine months of 2004.
In December 2004, the FASB issued SFAS No. 123(R), which is a revision of SFAS
No. 123. This revised statement establishes accounting standards for all
transactions in which an entity exchanges its equity instruments for goods and
services focusing primarily on accounting for transactions with employees and
carrying forward prior guidance for share-based payments for transactions with
non-employees.
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 effective date of SFAS No. 123(R) was originally to be the first reporting
period beginning after June 15, 2005, however in April 2005, the Securities and
Exchange Commission adopted a new rule amending the effective date to January 1,
2006. The Company expects to adopt SFAS No. 123(R) effective January 1, 2006.
SFAS No. 123(R) permits companies to adopt its requirements using either a
"modified prospective" method, or a "modified retrospective" method. 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 SFAS No. 123 for all unvested awards granted prior to the
effective date of SFAS No. 123(R). Under the "modified retrospective" method,
the requirements are the same as under the "modified prospective" method, but
also permits entities to restate financial statements of previous periods based
on pro forma disclosures made in accordance with SFAS No. 123. The Company plans
to adopt SFAS No. 123(R) under the modified prospective method on January 1,
2006 and currently estimates the adoption to have a similar effect on the
consolidated financial statements of the Company as reflected in the above
tabular information.
9
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.
Three Months Ended September 30 Number of Shares
------------------------------- ------------------------
2005 2004
--------- ---------
Basic 6,909,360 6,787,297
Diluted 7,626,642 7,493,574
Nine Months Ended September 30 Number of Shares
------------------------------ ------------------------
2005 2004
--------- ---------
Basic 6,857,820 6,788,540
Diluted 7,584,103 7,488,701
The options excluded from the calculation of diluted earnings per share, due to
the option price being higher than the share market value, are 295,000 and
296,500 at September 30, 2005 and 2004, respectively.
NOTE 5. LONG-TERM OBLIGATIONS
September 30 December 31
(Dollars in Thousands) 2005 2004
---------------------- --------- ---------
Revolving line of credit $ 4,784 $ 4,919
Term loan 4,585 3,013
9.5% note due 2015 19 19
--------- ---------
$ 9,388 $ 7,951
Less current portion (716) (604)
--------- ---------
$ 8,672 $ 7,347
--------- ---------
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
10
be paid down without penalty, or additional funds may be borrowed up to the
maximum line of credit. At September 30, 2005, the Company had unused borrowing
capacity of $2,816,000 under the line of credit, based on the underlying
borrowing base of accounts receivable and inventory. At September 30, 2005,
$9,369,000 was outstanding under the bank credit agreement, and $400,000 was
reserved for outstanding irrevocable letters of credit to secure payment of
current and future workers' compensation claims.
Substantially all of the Company's accounts receivable, inventories, fixed
assets and the common stock of its subsidiary are pledged as collateral under
the 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 7.0% at September 30, 2005. 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 September 30, 2005, the
Company was in compliance with the covenants. The actual financial ratios
compared to the required ratios, were as follows: Current Ratio - actual 2.09
vs. minimum required of 1.10; Debt to Tangible Net Worth - actual 1.39 vs.
maximum permitted of 2.5; Debt Service Coverage - actual 1.75 vs. minimum
permitted of 1.25; Capital Expenditures Ratio - actual 1.36 vs. 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 September 30, 2005 the aggregate commitments for the
procurement of zinc at fixed prices were approximately $6.1 million. The Company
reviews these fixed price contracts for losses using the same methodology
employed to estimate the market value of its zinc inventory. The Company had
unpriced commitments for the purchase of approximately 534 thousand pounds of
zinc at September 30, 2005.
11
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, 2005 or December 31, 2004, and did not utilize derivatives in the
nine-month period ended September 30, 2005 or the year ended December 31, 2004,
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,
2005, consist of approximately $2.5 million for long-term operating leases for
vehicles, office space, office equipment, galvanizing facilities and galvanizing
equipment and approximately $6.1 million for zinc purchase commitments. The
various leases for galvanizing facilities, including option renewals, expire
from 2005 to 2017. A lease for galvanizing equipment expires in 2007.
NAG was notified in 1997 by the Illinois Environmental Protection Agency
("IEPA") that it was a potentially responsible party ("PRP") 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. Since then approximately 30 additional PRPs have been
identified by the IEPA. A number of the PRPs (approximately 12 to 15) have
agreed to work together and with IEPA on a voluntary basis. The Company has been
and continues to participate in this volunteer group. The group has retained
consultants and legal representatives familiar with IEPA regulations. This
volunteer group, with its consultants, has cooperated with IEPA in attempting to
better define the environmental issues associated with the Sandoval Zinc site.
To that extent, this voluntary group prepared and submitted to IEPA in August
2000 a work plan. The purpose of this work plan is to attempt to define the
extent of environmental remediation that might be required, assess risks, and
review alternatives to addressing potential remediation. The IEPA has yet to
respond to this proposed work plan or suggest any other course of action, and
there has been no activity in regards to this issue during 2005. Therefore, the
Company has no basis for determining potential exposure and estimated
remediation costs at this time.
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 and other undetermined amounts 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
12
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 Comprehensive Environmental Response, Compensation and Liability
Act ("CERCLA"), 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 and March 2005, the Company filed partial motions to dismiss plaintiff's
third amended complaint, in the United States District Court, Northern District
of Illinois, Eastern Division. 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 Third Amended
complaint. 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 lease term of a galvanizing facility occupied by Reinforcing Services, Inc.
("RSI"), a subsidiary of North American Galvanizing Company, expired July 31,
2003 and has not been renewed. RSI has exercised an option to purchase the
facility, and the landlord is contesting the Company's right to exercise this
option. RSI has filed a lawsuit against the landlord seeking enforcement of the
right to exercise the option. This litigation is in the discovery stage and
management expects there will be no disruption to its galvanizing business being
conducted at the facility.
The Company will continue to have additional environmental compliance costs
associated with operations in the galvanizing business. The Company is committed
to complying with the environmental legislation and regulations affecting its
operations. Due to the uncertainties associated with future environmental
technologies, regulatory interpretations, and prospective legislative activity,
management cannot reasonably quantify the Company's potential future costs in
this area.
The Company expenses or capitalizes, where appropriate, environmental
expenditures that relate to current operations as they are incurred. Such
expenditures are expensed when they are attributable to past operations and are
not expected to contribute to current or future revenue generation. The Company
records liabilities when remediation or other environmental assessment or
clean-up efforts are probable and the cost can be reasonably estimated.
Various litigation arising in the ordinary course of business is pending against
the Company. Management believes that resolution of the Company's other
litigation and environmental matters should not materially affect the Company's
consolidated
13
financial position or liquidity. Should future developments cause the Company to
record an additional liability for environmental matters, litigation or customer
claims, the recording of such a liability could have a material impact on the
results of operations for the period involved.
NOTE 7. TREASURY STOCK
The Company issued 50,000 shares from Treasury during the first nine months of
2005. In the first quarter of 2005, a program whereby Outside Directors received
shares of Company stock issued from Treasury as payment for their quarterly
board fee was replaced with a Director Stock Unit Program (Note 8). In the first
nine months of 2004, the Company issued 32,129 shares of its common stock from
Treasury to outside Directors of the Company as payment for their quarterly
board fee in lieu of cash payments. Those shares were valued at the average
closing price of North American Galvanizing & Coatings, Inc. common stock for a
prior 30-day period, as reported by the American Stock Exchange. Such shares
were issued pursuant to the Directors' prior election and notice to the Company
to receive up to all of their 2004 quarterly board fees in the Company's stock
in lieu of cash.
NOTE 8. 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. All of the Company's Outside Directors
have elected to defer 100% of the annual board fee for 2005, and the Company's
chief executive officer and Inside Director has elected to defer a corresponding
amount of his salary in 2005. Outside Directors currently receive an annual fee
of $20,000, which includes attendance at board meetings and service on
committees of the board. In the first nine months of 2005, fees and salary
deferred by the Directors represented a total of 79,640 stock unit grants valued
at $2.20 per stock unit. The value of a stock unit grant is the average of the
closing prices for a share of the Company's stock for the 10 trading days before
the date the director fees otherwise would have been payable in cash.
NOTE 9. 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 chief executive officer, chairman of the board, and a shareholder of Gregory
Industries, Inc. Total sales to Gregory Industries, Inc. for the nine-month
period ended September 30, 2005 were approximately $1,018,000. Sales to Gregory
Industries, Inc. include revenues associated with activities performed for
Gregory Industries on an interim basis that are expected to be assumed by
Gregory Industries, Inc. on January 1, 2006.
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 nine-month period ended September 30, 2005, there were no significant
changes to the Company's critical accounting policies previously disclosed in
Form 10-K for the year ended December 31, 2004.
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. Sales for the Canton galvanizing operation for its
most recent fiscal year ended May 28, 2004 were approximately $7.0 million.
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 engineers and plant managers collaborate with steel
fabricators and design and engineering firms to 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 300,000,000
pounds of steel products for approximately 1,800 customers nationwide.
All of the Company's sales are generated for domestic customers whose end
markets are principally in the United States. The Company markets its
galvanizing and coating
15
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,
o utilities,
o petrochemical processing,
o infrastructure including buildings, airports, bridges and power generation
o industrial grating,
o wastewater treatment; fresh water storage and transportation
o pulp and paper,
o pipe and tube,
o food processing,
o agricultural (irrigation systems)
o recreation (boat trailers, marine docks, stadium scaffolds)
o bridge and pedestrian handrail
o commercial and residential lighting poles
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 process is complete. The
Company generates all of its operating cash from such revenues, and utilizes a
line of credit secured by the underlying accounts receivable and zinc inventory
to facilitate working capital needs.
Each of the Company's galvanizing plants operate in a highly competitive
environment underscored by pricing pressures, primarily from other public and
privately-owned galvanizers and alternative forms of corrosion protection, such
as paint. The Company's long-term response to these challenges has been a
sustained strategy focusing on providing a reliable quality of galvanizing to
industry ASTM specifications and rapid turn-around time on every project, large
and small. Key to the success of this
16
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 control system involving sales
order entry, facility maintenance and operating procedures, quality assurance,
purchasing and credit and accounting that enable the plant to focus on providing
galvanizing and coating services in the most cost-effective manner.
The principal raw materials essential to the Company's galvanizing and coating
operations are zinc and various chemicals which are normally available for
purchase in the open market.
KEY INDICATORS
Key industries which historically have provided the Company some indication of
the potential demand for galvanizing in the near-term, (i.e., primarily within a
year) include highway and transportation, power transmission and distribution,
telecommunications and the level of quoting activity for regional metal
fabricators. In general, growth in the commercial/industrial sectors of the
economy generates new construction and capital spending which ultimately impacts
the demand for galvanizing.
Key operating measures utilized by the Company include new orders, zinc
inventory, tons of steel galvanized, revenue, pounds and labor costs per hour,
zinc usage related to tonnage galvanized, and lost-time safety performance.
These measures are reported and analyzed on various cycles, including daily,
weekly and monthly.
The Company utilizes a number of key financial measures to evaluate the
operations at each of its galvanizing plants, to identify trends and variables
impacting operating productivity and current and future business results, which
include: sales, gross profit, fixed and variable costs, selling and general
administrative expenses, operating cash flows, capital expenditures, interest
expense, and a number of ratios such as profit from operations and accounts
receivable turnover. These measures are reviewed by the Company's operating and
executive management monthly, or more frequently, and compared to prior periods,
the current business plan and to standard performance criteria, as applicable.
KEY DEVELOPMENTS
In the last three years, the Company reported a number of developments
supporting its strategic program to reposition its galvanizing business in the
national market.
In February 2005, the Company expanded galvanizing operations into the northeast
region of the United States with the purchase of the assets of a galvanizing
facility located in Canton, Ohio. 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
17
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
small plant at the same location. This large facility is providing NAG a
strategic basis 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 installation of a state-of-the-art Spinner line to galvanize
small products, including bolts and threaded material.
In the third quarter of 2002, the Company announced the introduction of
INFRASHIELDSM Coating, a specialty polymer coating system that is designed to be
applied over hot dip galvanized material slated for harsh operating conditions.
The INFRASHIELDSM coating technology results in superior corrosion protection by
combining cathodic protection with a non-conductive coating.
RESULTS OF OPERATIONS
The following table shows the Company's results of operations for the three and
nine months ended September 30, 2005 and 2004:
Three Months Ended September 30
2005 2004
------------------------ ------------------------
(Dollars in Thousands) Amount % of Sales Amount % of Sales
--------------------- ---------- ---------- ---------- ----------
Sales $ 12,687 100.0% $ 9,348 100.0%
Cost of sales 9,721 76.6% 6,725 71.9%
---------- ---------- ---------- ----------
Gross profit 2,966 23.4% 2,623 28.1%
Selling, general & administrative
expenses 1,778 14.0% 1,370 14.7%
Depreciation and amortization 600 4.7% 686 7.3%
---------- ---------- ---------- ----------
Operating income 588 4.6% 567 6.1%
Interest expense, net 285 2.2% 198 2.2%
Other -- -- -- --%
---------- ---------- ---------- ----------
Income before income taxes 303 2.4% 369 3.9%
Income tax expense 124 1.0% 140 1.5%
---------- ---------- ---------- ----------
Net Income $ 179 1.4% $ 229 2.4%
========== ========== ========== ==========
18
Nine Months Ended September 30
2005 2004
------------------------ ------------------------
(Dollars in Thousands) Amount % of Sales Amount % of Sales
--------------------- ---------- ---------- ---------- ----------
Sales $ 34,768 100.0% $ 27,239 100.0%
Cost of sales 26,254 75.5% 19,365 71.1%
---------- ---------- ---------- ----------
Gross profit 8,514 24.5% 7,874 28.9%
Selling, general & administrative
expenses 5,209 15.0% 4,387 16.1%
Depreciation and amortization 1,865 5.4% 2,068 7.6%
---------- ---------- ---------- ----------
Operating income 1,440 4.1% 1,419 5.2%
Interest expense, net 788 2.3% 565 2.1%
Other -- -- (25) (0.1)%
---------- ---------- ---------- ----------
Income before income taxes 652 1.9% 879 3.2%
Income tax expense 262 .8% 334 1.2%
---------- ---------- ---------- ----------
Net Income $ 390 1.1% $ 545 2.0%
========== ========== ========== ==========
2005 COMPARED TO 2004
Sales. Sales for the three-months and nine-months ended September 30, 2005
increased 36% and 28%, respectively, over the prior year due primarily to
contribution from the Canton, Ohio galvanizing facility that was purchased
February 28, 2005. Same plant revenues for the third quarter and first nine
months improved 13% and 8%, respectively, over the same periods in 2004. North
American Galvanizing's existing plants started the year with a period of slow
demand in the first two months. A general increase in demand from fabricators
led to a positive trend in existing plant revenues continuing into the second
and third quarters of 2005.
In the three-months and nine-months ended September 30, 2005, average selling
prices for galvanizing and related coating services remained relatively even
with the average selling prices in the same periods for 2004. General price
increases were communicated to customers during the third quarter. Although
prices at the end of the third quarter were on average 5% higher than prices at
the beginning of the quarter, the full impact of the price increases will not be
reflected in results until the fourth quarter of 2005.
Gross Profit. The gross profit percentage decreased 4.7% and 4.4%, for the
three-months and nine-months ended September 30, 2005 and 2004, respectively.
Higher zinc and natural gas costs in 2005 were responsible for most of the
decrease in gross profit percentage. The impact of year over year higher costs
on the third quarter was a decrease in margin of 3.1% and on the nine-month
period ended September 30, a decrease in margin of 2.9%. Due to higher material
and energy costs, customer pricing was increased during the quarter. The full
impact of increases in average selling price will not be reflected in gross
profit until the fourth quarter.
19
The remaining decrease in gross profit as a percent of sales was due to
increased costs in the Canton, Ohio galvanizing facility compared to existing
plants. The primary difference in costs is higher labor costs at the Ohio plant.
As part of the transition program started with the February 28, 2005 purchase,
management is focused on improving labor efficiency, measured by
pounds-per-man-hour and cost-per-man-hour, at this facility.
Depreciation Expense. Depreciation expense for the third quarter of 2005
decreased $86,000, or 12.5%, to $600,000 compared to $686,000 for the third
quarter of 2004. Depreciation expense for the first nine months of 2005
decreased $203,000, or 9.8% to $1,865,000. The decrease for 2005 relates
primarily to assets becoming fully depreciated, partially offset by increased
depreciation expense for the Canton, Ohio galvanizing plant and equipment.
Selling, General and Administrative (SG&A) Expenses. SG&A increased $408,000, or
29.8%, in the third quarter of 2005 to $1,778,000 compared to $1,370,000 in the
third quarter of 2004. For the first nine months, SG&A increased $822,000, or
18.7%, to $5,209,000 compared to $4,387,000 in the first nine months of 2004.
Forty-four percent of the $408,000 increase for third quarter 2005 is due to
selling, general and administrative costs related to the Canton, Ohio
galvanizing facility acquired in early 2005, forty percent due to legal fees
related to the Lake River lawsuit, and sixteen percent due to higher group
health costs for administrative personnel.
Forty-six percent of the $822,000 increase for the nine months ended September
30, 2005 is due to selling, general and administrative costs related to the
Canton, Ohio galvanizing facility, twenty-one percent due to legal fees related
to the Lake River lawsuit, sixteen percent due to audit and tax fees and
professional fees related to compliance with Sarbanes Oxley 404 requirements,
twelve percent due to increased Board of Director fees, and five percent due to
other increases.
Interest Expense. Interest expense increased to $285,000 and $788,000 in the
third quarter and first nine months of 2005, respectively, from $198,000 and
$565,000 in 2004, primarily due to higher interest rates on variable-rate debt
and higher debt related to the purchase of a galvanizing facility in the first
quarter of 2005.
Income Taxes. The Company's effective income tax rates for the third quarter of
2005 and 2004 were 40.9% and 37.9%, respectively. For the nine months ended
September 30, 2005 and 2004, the effective tax rates were 40.1% and 38.0%,
respectively. The effective tax rates differ from the federal statutory rate
primarily due to state income taxes and minor adjustments to previous tax
estimates based on actual tax returns filed.
Net Income. For the third quarter of 2005, the Company reported net income of
$179,000 compared to net income of $229,000 for the third quarter of 2004. For
the nine months ended September 30, 2005, the net income was $390,000, compared
to $545,000 for the nine months ended September 30, 2004. The decrease in net
income is primarily a result of the increase in raw material and energy costs
from the first nine months of 2004 to the first nine months of 2005.
20
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 capital spending requirements. During the nine-month periods ended September
30, 2005 and 2004, 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 2005 and 2004
was $4,230,000 and $1,417,000 respectively. The increase of $2,813,000 in 2005
cash flow from operations was due primarily to changes in working capital and
cash refunds from utilization of tax net operating loss carrybacks.
Cash of $4,794,000 used in 2005 investing activities through September 30
consisted of $4,188,000 to acquire certain assets of Gregory Industries' Inc.
and capital expenditures of $606,000 for equipment to maintain galvanizing
facilities. Capital expenditures of $1,129,000 for the comparable nine-month
period of 2004 were for equipment to maintain galvanizing facilities, offset by
proceeds of $92,000 from the sale of investment securities. For the remainder of
2005, expected capital expenditures of approximately $790,000 are budgeted for
the Company's existing galvanizing facilities.
Total debt (current and long-term obligations) increased $936,000 to $16,489,000
in the nine months ended September 30, 2005. Financing activities for this
period of 2005 included proceeds from the sale of treasury stock of $100,000,
payments of $516,000 to a bond sinking fund, proceeds of $17,469,000 from a bank
line of credit and term loan, and payments of $16,017,000 on the bank line of
credit and term loans.
In February 2005, the Company amended a three-year bank credit agreement that
was scheduled to expire in December 2007 and extended its maturity to February
28, 2008. Subject to borrowing base limitations, the amended agreement provides
(i) an $8,000,000 maximum revolving credit facility for working capital and
general corporate purposes, and (ii) a $5,001,000 term loan.
At September 30, 2005, $9,369,000 was outstanding under the bank credit
agreement, and $400,000 was reserved for outstanding irrevocable letters of
credit for workers' compensation insurance coverage. The Company's commitment to
repay the remaining balance of $6,110,000 of tax-exempt adjustable rate
industrial revenue bonds issued in 2000 is fully secured by an irrevocable
letter of credit issued by Bank One Oklahoma, N.A., in favor of Bank One Trust
Company. At September 30, 2005, the Company had $2,816,000 available borrowing
capacity, net of outstanding letters of credit, under its revolving line of
credit based on the borrowing base calculated under the agreement. The Company
believes that its ability to continue to generate cash from operations and its
bank credit facilities will provide adequate capital resources and liquidity to
support operations and capital expenditures plans for 2005.
21
The Company has various commitments primarily related to long-term debt,
industrial revenue bonds, operating lease commitments and zinc purchase
commitments. The Company's off-balance sheet contractual obligations at
September 30, 2005, consist of $1,729,000 for long-term operating leases for
office space, galvanizing facilities and galvanizing equipment, $743,000 for
vehicle and office equipment operating leases and approximately $6.1 million for
zinc purchase commitments. The various leases for galvanizing facilities,
including option renewals, expire from 2005 to 2017. A lease for galvanizing
equipment expires in 2007. The vehicle and office equipment leases expire on
various dates through 2010. NAG periodically enters into fixed price purchase
commitments with domestic and foreign zinc producers to purchase a portion of
its requirements for its hot dip galvanizing operations; commitments for the
future delivery of zinc are typically up to one year.
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 2005 and 2004 was
approximately $953,000 and $703,000, respectively, for the disposal and
recycling of wastes generated by the galvanizing operations.
NAG was notified in 1997 by the Illinois Environmental Protection Agency
("IEPA") that it was a potentially responsible party ("PRP") 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. Since then approximately 30 additional PRPs have been
identified by the IEPA. A number of the PRPs (approximately 12 to 15) have
agreed to work together and with IEPA on a voluntary basis. The Company has been
and continues to participate in this volunteer group. The group has retained
consultants and legal representatives familiar with IEPA regulations. This
volunteer group, with its consultants, has cooperated with IEPA in attempting to
better define the environmental issues associated with the Sandoval Zinc site.
To that extent, this voluntary group prepared and submitted to IEPA in August
2000 a work plan. The purpose of this work plan is to attempt to define the
extent of environmental remediation that might be required, assess risks, and
review alternatives to addressing potential remediation. The IEPA has yet to
respond to this proposed work plan or suggest any other course of action, and
there has been no activity in regards to this issue during 2005. 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 addressing environmental
issues as they arise. Because of the frequent changes in environmental
technology, laws and regulations management cannot reasonably quantify the
Company's potential future costs in this area.
22
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, 2005, the Company's
outstanding debt of $16,489,000, net of an $8,700 discount, consisted of the
following: Variable rate debt aggregating $9,369,000 under the bank credit
agreement, with an effective rate of 7.0%; variable rate debt of $6,110,000
under the industrial revenue bond agreement, with an effective rate of 3.5%;
and, fixed rate debt consisting of $1,000,000 face value of 10% subordinated
promissory notes and a 9.5% term note of $19,000. The borrowings under all of
the Company's debt obligations at September 30, 2005 are due as follows:
$1,076,000 in 2005; $2,445,000 in 2006; $1,481,000 in 2007 and $11,487,000 in
years 2008 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 $15,500 based on September 30, 2005 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, 2005, the aggregate fixed price
commitments for the procurement of zinc were approximately $6.1 million. With
respect to these zinc fixed price purchase commitments, a hypothetical decrease
of 10% in the market price of zinc from the September 30, 2005 level represented
a potential lost gross margin opportunity of approximately $610,000.
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 (Note 6)
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.
23
During the nine-months ended September 30, 2005, the Company purchased the
assets of a galvanizing business located in Canton, Ohio and undertook a review
and evaluation of that operation's internal controls over financial reporting,
including the implementation of a number of controls consistent with its
established galvanizing operations. The Company will continue to integrate this
acquired business into its internal control over financial reporting.
There have been no other significant change in our internal controls over
financial reporting that occurred during our last fiscal quarter that has
materially affected, or is reasonably likely to materially affect, our internal
controls over financial reporting. There were no significant deficiencies or
material weaknesses identified in the evaluation, and therefore, no corrective
actions were taken.
24
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 and other undetermined amounts 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
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 Comprehensive Environmental Response, Compensation and Liability
Act ("CERCLA"), 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 and March 2005, the Company filed partial motions to dismiss plaintiff's
third amended complaint, in the United States District Court, Northern District
of Illinois, Eastern Division. 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 Third Amended
complaint. 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 lease term of a galvanizing facility occupied by Reinforcing Services, Inc.
("RSI"), a subsidiary of North American Galvanizing Company, expired July 31,
2003 and has not been renewed. RSI has exercised an option to purchase the
facility, and the landlord is contesting the Company's right to exercise this
option. RSI has filed a lawsuit against the landlord seeking enforcement of the
right to exercise the option. This litigation is in the discovery stage and
management expects there will be no disruption to its galvanizing business being
conducted at the facility.
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Item 2. Changes in Securities and Use of Proceeds - Not applicable.
Item 3. Defaults Upon Senior Securities - Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders - Not applicable.
Item 5. Other Information - Not applicable.
Item 6. Exhibits.
(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 September 30, 1996).
10.5 Director Stock Unit Program.
10.6 Trust under the North American Galvanizing & Coatings,
Inc. Director Stock Unit Program.
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 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.
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized:
NORTH AMERICAN GALVANIZING & COATINGS, INC.
-------------------------------------------
(Registrant)
/s/ Beth B. Hood
-------------------------
Vice President and
Chief Financial Officer
(Principal Financial Officer)
Date: October 28, 2005
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