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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarterly Period Ended June 30, 2004
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Commission file number #0-10786
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Insituform Technologies, Inc.
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(Exact name of registrant as specified in its charter)
Delaware 13-3032158
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
702 Spirit 40 Park Drive, Chesterfield, Missouri 63005
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(Address of Principal Executive Offices)
(636) 530-8000
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(Registrant's telephone number including area code)
N/A
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 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 X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at August 6, 2004
- ------------------------------------------ -----------------------------------
Class A Common Stock, $.01 par value 26,745,235 Shares
INDEX
Page No.
--------
Part I Financial Information:
Item 1. Financial Statements (unaudited):
Consolidated Statements of Income.................................................3
Consolidated Balance Sheets.......................................................4
Consolidated Statements of Cash Flows.............................................5
Notes to Consolidated Financial Statements........................................6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..............................................13
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................22
Item 4. Controls and Procedures..........................................................22
Part II Other Information:
Item 1. Legal Proceedings................................................................24
Item 4. Submission of Matters to a Vote of Security Holders..............................24
Item 6. Exhibits and Reports on Form 8-K.................................................24
Signatures...................................................................................................25
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INSITUFORM TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2004 2003 2004 2003
----------------------- ------------------------
REVENUES $ 142,434 $ 124,778 $ 270,348 $ 248,126
COST OF REVENUES 111,870 95,511 214,417 190,590
----------------------- ----------------------
GROSS PROFIT 30,564 29,267 55,931 57,536
SELLING, GENERAL AND ADMINISTRATIVE 22,974 18,982 44,966 36,065
----------------------- ----------------------
OPERATING INCOME 7,590 10,285 10,965 21,471
OTHER (EXPENSE) INCOME:
Interest expense (2,627) (2,175) (4,795) (3,372)
Other 451 (189) 287 242
----------------------- ----------------------
TOTAL OTHER EXPENSE (2,176) (2,364) (4,508) (3,130)
----------------------- ----------------------
INCOME BEFORE TAXES ON INCOME 5,414 7,921 6,457 18,341
TAXES ON INCOME 2,238 3,089 2,663 7,153
----------------------- ----------------------
INCOME BEFORE MINORITY INTERESTS, EQUITY IN EARNINGS
AND DISCONTINUED OPERATIONS 3,176 4,832 3,794 11,188
MINORITY INTERESTS (45) (30) (101) (60)
EQUITY IN EARNINGS OF AFFILIATED COMPANIES 25 75 (35) 100
----------------------- ----------------------
INCOME FROM CONTINUING OPERATIONS 3,156 4,877 3,658 11,228
LOSS FROM DISCONTINUED OPERATIONS -- (292) -- (16)
----------------------- ----------------------
NET INCOME $ 3,156 $ 4,585 $ 3,658 $ 11,212
======================= ======================
EARNINGS PER SHARE OF COMMON STOCK AND COMMON
STOCK EQUIVALENTS:
Basic:
Income from continuing operations $ 0.12 $ 0.18 $ 0.14 $ 0.42
Discontinued operations -- (0.01) -- --
Net income 0.12 0.17 0.14 0.42
Diluted:
Income from continuing operations $ 0.12 $ 0.18 $ 0.14 $ 0.42
Discontinued operations -- (0.01) -- --
Net income 0.12 0.17 0.14 0.42
See accompanying notes to consolidated financial statements.
3
INSITUFORM TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
JUNE 30, 2004 DECEMBER 31, 2003
-------------------------------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 89,828 $ 93,865
Restricted cash 1,343 6,126
Receivables, net 88,491 90,814
Retainage 25,135 24,902
Costs and estimated earnings in excess of billings 38,400 27,853
Inventories 15,127 12,935
Prepaid expenses and other assets 8,722 19,515
Assets related to discontinued operations -- 1,263
-----------------------------------
TOTAL CURRENT ASSETS 267,046 277,273
-----------------------------------
PROPERTY, PLANT AND EQUIPMENT, less accumulated depreciation 83,696 75,667
-----------------------------------
OTHER ASSETS
Goodwill 131,577 131,613
Other assets 23,546 23,807
-----------------------------------
TOTAL OTHER ASSETS 155,123 155,420
-----------------------------------
TOTAL ASSETS $505,865 $ 508,360
-----------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long-term debt and line of credit $ 16,859 $ 16,938
Accounts payable and accrued expenses 88,880 82,670
Billings in excess of costs and estimated earnings 8,663 8,495
Liabilities related to discontinued operations -- 1,770
------------------------------
TOTAL CURRENT LIABILITIES 114,402 109,873
------------------------------
LONG-TERM DEBT, less current maturities 98,510 114,323
OTHER LIABILITIES 3,361 3,530
------------------------------
TOTAL LIABILITIES 216,273 227,726
------------------------------
MINORITY INTERESTS 1,578 1,465
------------------------------
COMMITMENTS AND CONTINGENCIES (NOTE 9)
STOCKHOLDERS' EQUITY
Preferred stock, undesignated, $.10 par -- shares authorized
1,400,000; none outstanding -- --
Series A Junior Participating Preferred stock, $.10 par -- shares
authorized 600,000; none outstanding -- --
Common stock, $.01 par -- shares authorized 60,000,000;
shares outstanding 26,742,735 and 26,458,205 291 288
Unearned restricted stock compensation (679) (412)
Additional paid-in capital 137,015 133,794
Retained earnings 201,986 198,328
Treasury stock -- 2,357,464 shares (51,596) (51,596)
Accumulated other comprehensive income (loss) 997 (1,233)
------------------------------
TOTAL STOCKHOLDERS' EQUITY 288,014 279,169
------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $505,865 $ 508,360
==============================
See accompanying notes to consolidated financial statements.
4
INSITUFORM TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
FOR THE SIX MONTHS
ENDED JUNE 30,
2004 2003
----------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME $ 3,658 $ 11,212
Loss from discontinued operations -- 16
----------------------
INCOME FROM CONTINUING OPERATIONS 3,658 11,228
ADJUSTMENTS TO RECONCILE TO NET CASH PROVIDED BY OPERATING ACTIVITIES:
Depreciation 8,164 7,247
Amortization 1,190 653
Deferred income taxes 35 (20)
Write-off of debt issuance costs 226 --
Other 3,256 1,510
CHANGES IN OPERATING ASSETS AND LIABILITIES, NET OF PURCHASED BUSINESSES:
Changes in restricted cash related to operating activities 181 672
Receivables, including costs and estimated earnings in excess of billings (7,612) 6,690
Inventories (2,192) (63)
Prepaid expenses and other assets 11,077 341
Accounts payable and accrued expenses 4,608 1,574
----------------------
NET CASH PROVIDED BY CONTINUING OPERATIONS 22,591 29,832
NET CASH USED BY DISCONTINUED OPERATIONS -- (1,299)
----------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 22,591 28,533
----------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (16,598) (5,734)
Proceeds from sale of fixed assets 473 349
Investment in joint venture (844) --
Purchase of business, net of cash acquired -- (300)
Other investing activities -- 1,089
----------------------
NET CASH USED IN INVESTING ACTIVITIES (16,969) (4,596)
----------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock and exercise of stock options 2,913 185
Purchases of treasury stock -- (1,417)
Principal payments on long-term debt (15,813) (19,271)
Issuance of long-term debt -- 65,000
Decrease in line of credit -- (25,778)
Deferred financing charges (633) (692)
Changes in restricted cash related to financing activities 4,602 --
----------------------
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES (8,931) 18,027
----------------------
Effect of exchange rate changes on cash (728) 874
----------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS FOR THE PERIOD (4,037) 42,838
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 93,865 71,401
----------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 89,828 $ 114,239
----------------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
CASH PAID (RECEIVED) FOR:
Interest $ 4,409 $ 3,450
Income taxes, net (7,259) 5,329
NONCASH INVESTING AND FINANCING ACTIVITIES:
Note payable recovered in settlement $ -- $ 5,350
Accrued interest recovered in settlement -- 557
Treasury stock recovered in settlement -- 254
See accompanying notes to consolidated financial statements.
5
INSITUFORM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
JUNE 30, 2004
1. GENERAL
In the opinion of the Company's management, the accompanying consolidated
financial statements reflect all adjustments (consisting of only normal
recurring adjustments) necessary to present fairly the Company's unaudited
consolidated balance sheets as of June 30, 2004 and December 31, 2003, the
unaudited consolidated statements of income for the three and six months
ended June 30, 2004 and 2003 and the unaudited consolidated statements of
cash flows for the six months ended June 30, 2004 and 2003. The financial
statements have been prepared in accordance with the requirements of Form
10-Q and consequently do not include all the disclosures normally made in
an Annual Report on Form 10-K. Accordingly, the consolidated financial
statements included herein should be reviewed in conjunction with the
financial statements and the footnotes thereto included in the Company's
2003 Annual Report on Form 10-K.
The results of operations for the three and six months ended June 30, 2004
and 2003 are not necessarily indicative of the results to be expected for
the full year.
Beginning in the quarter ended June 30, 2004 and for all periods presented
in this Report, restricted cash is presented separately on the consolidated
balance sheets and changes in restricted cash are presented on the
consolidated statements of cash flows according to the purpose for which
the restricted cash is held (i.e., operating, investing or financing
activity).
2. STOCK-BASED COMPENSATION
At June 30, 2004, the Company had two plans under which stock-based awards
may be granted, including stock appreciation rights, restricted shares of
common stock, performance awards, stock options and stock units. The
Company applies the recognition and measurement principles of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations in accounting for those plans. No
compensation expense from stock options was reflected in the net income for
the three or six months ended June 30, 2004 and 2003, as all options were
granted at an exercise price equal to the market value of the underlying
common stock on the date of the grant. Stock-based compensation expense
related to grants of restricted stock was $9,000 and $43,000 for the three
and six months ended June 30, 2004, respectively. Stock-based compensation
expense related to grants of restricted stock was $33,000 for the three and
six months ended June 30, 2003. There were no grants of restricted stock
prior to the second quarter of 2003. The following table illustrates the
effect on net income and earnings per share if the Company had applied the
fair value recognition provisions of Statement of Financial Accounting
Standards No. 123 ("SFAS No. 123"), "Accounting for Stock-Based
Compensation," to stock-based compensation (in thousands, except share
data):
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2004 2003 2004 2003
--------------------------------------------------------
Net income -- as reported $ 3,156 $ 4,585 $ 3,658 $11,212
Add: Total stock-based compensation
expense included in net income, net of
related tax benefits 5 20 25 20
Deduct: Total stock-based compensation
expense determined under fair value
method for all awards, net of related
tax effects (195) (1,000) (546) (2,469)
--------------------------------------------------------
Pro forma net income $ 2,966 $ 3,605 $ 3,137 $ 8,763
========================================================
Basic earnings per share:
As reported $ 0.12 $ 0.17 $ 0.14 $ 0.42
Pro forma 0.11 0.14 0.12 0.33
Diluted earnings per share:
As reported 0.12 0.17 0.14 0.42
Pro forma 0.11 0.14 0.12 0.33
For SFAS No. 123 disclosure purposes, the weighted average fair value of
stock options is required to be based on a theoretical option-pricing model
such as the Black-Scholes method. In actuality, because the Company's
employee stock options are not traded on an exchange and are subject to
vesting periods, the disclosed fair value represents only an
6
approximation of option value based solely on historical performance.
Beginning in 2000, the Company decided to increase the alignment of key
employee goals and shareholder objectives by increasing the relative value
of variable compensation.
For SFAS No. 148 ("Accounting for Stock-Based Compensation - Transition and
Disclosure") disclosure purposes, the stock-based compensation expense
recorded in the determination of reported net income is disclosed in the
table above. The pro forma stock-based compensation expense includes the
recorded expense and expense related to stock options that was determined
using the fair value method.
On July 28, 2004, the Company granted an aggregate of 28,100 deferred stock
units to members of the Board of Directors, excluding the Company's
president and chief executive officer. Each deferred stock unit represents
the Company's obligation to transfer one share of common stock to the
director in the future, and is fully vested at grant. Following termination
of the director's service on the Company's board due to death or a change
in control, or six months after termination of the director's service for
any other reason, shares of the Company's common stock equal to the number
of deferred stock units reflected on the director's account, will be
distributed. A director may, while serving on the Company's board, elect to
defer the distribution date in annual installments over a period up to five
years, beginning in the year following termination of service on the board.
The Company will record $0.4 million in compensation expense in the third
quarter of 2004 related to this grant.
On May 25, 2004, the Company granted 27,000 shares of restricted stock to
certain key employees, other than executive officers. The grant date fair
value of these shares was $0.4 million.
On May 27, 2003, the Company granted 57,300 shares of restricted stock to
executives and key employees. The grant date fair value of these shares was
$0.9 million. At June 30, 2004, 8,600 of these shares remained outstanding,
as 48,700 shares were forfeited through the departure of certain members of
senior management and through the failure to meet certain performance
goals.
Each of the restricted stock grants is subject to a three-year service
term before vesting. The restricted shares granted to executive officers on
May 27, 2003 also had restrictions providing that certain company
performance goals were met as of March 31, 2004. These goals were not met
and the shares were forfeited. The value of all restricted stock grants was
added to additional paid-in capital at the grant dates, and an equal amount
was established in unearned restricted stock compensation. All restricted
shares are expensed as compensation through the service term.
3. BUSINESS ACQUISITIONS
In November 2003, the Company acquired the remaining interest in Ka-Te
Insituform AG ("Ka-Te Insituform") for $2.2 million. Net of related party
debt and shared accrued employee liabilities, the cash paid by the Company
was $0.8 million.
In September 2003, the Company acquired the business and certain assets of
Insituform East, Inc. ("East") for $5.5 million. The Company subsequently
exercised an option to purchase additional assets from East for $0.6
million.
In June 2003, the Company completed the acquisition of the business of
Sewer Services, Ltd. ("Sewer Services") for $0.4 million.
On a combined basis, these acquisitions added $7.2 million and $13.7
million in revenue for the three and six months ended June 30, 2004,
respectively. Operating income was increased by $0.1 million in the three
months ended June 30, 2004, while operating income decreased by $0.4
million in the six months ended June 30, 2004 as a result of these
acquisitions. Operating expenses included $0.3 million and $0.5 million of
amortization of intangibles for the three and six months ended June 30,
2004, respectively, as a result of the East acquisition.
Pro forma information for these acquisitions has not been provided given
their relative immateriality on an individual and aggregate basis.
4. DISCONTINUED OPERATIONS
During the fourth quarter of 2001, the Company made the decision to sell
certain operations acquired with Kinsel Industries, Inc. ("Kinsel"), which
was acquired in February 2001. Accordingly, the Company classified these
operations as discontinued as they were not consistent with the Company's
operating strategy of providing trenchless rehabilitation and tunneling
services. The Company has completed the disposition of all material assets
classified as discontinued pursuant to the acquisition of Kinsel. At
December 31, 2003, substantially all discontinued operations had been
completed, and the Company no longer reports discontinued operations
activity separately in 2004.
7
The Company negotiated settlements, without litigation, during the first
quarter of 2003 between the Company and the former Kinsel owners, and the
Company and the purchasers of the wastewater treatment plant operations
acquired from Kinsel. The Company made various claims against the former
shareholders of Kinsel, arising out of the February 2001 acquisition of
Kinsel and a related company, Tracks of Texas, Inc. Those claims were
settled in March 2003 without litigation. Under the terms of the
settlement, 18,891 shares of Company common stock valued at $254,084 based
on the settlement date closing stock price of $13.45 per share, and all of
the promissory notes, totaling $5,350,000 in principal (together with all
accrued and unpaid interest), issued to former Kinsel shareholders in
connection with the acquisition, were returned to the Company from the
claim collateral escrow account established at the time of acquisition. The
remaining 56,672 shares of Company common stock held in the escrow account
were distributed to the former Kinsel shareholders. The settlement of the
escrow account primarily related to matters associated with Kinsel
operations that have been sold and were presented as discontinued
operations through December 31, 2003. In January 2003, the Company received
notice of multiple claims, totaling more than $3.5 million, from the buyer
of the former Kinsel wastewater treatment division. The claims arose out of
the January 2002 sale of the Kinsel wastewater treatment division and
alleged the valuation of the assets sold was overstated. These settlements
resulted in a $1.0 million pre-tax non-operating gain in the results of
continuing operations ($0.6 million after-tax), and a net pre-tax $1.1
million gain in discontinued operations ($0.7 million after-tax).
5. COMPREHENSIVE INCOME
For the quarters ended June 30, 2004 and 2003, comprehensive income was
$4.4 million and $7.3 million, respectively, with comprehensive income of
$5.9 million and $13.0 million for the six months ended June 30, 2004 and
2003, respectively. The Company's adjustment to net income to calculate
comprehensive income consists solely of cumulative foreign currency
translation adjustments of $1.2 million and $2.7 million for the quarters
ended June 30, 2004 and 2003, respectively, and $2.2 million and $1.8
million for the six months ended June 30, 2004 and 2003, respectively.
6. SHARE INFORMATION
Earnings per share have been calculated using the following share
information:
THREE MONTHS ENDED JUNE 30,
2004 2003
-------------------------------
Weighted average number of common shares
used for basic EPS 26,685,340 26,444,923
Effect of dilutive stock options and restricted stock 97,065 102,815
------------------------------
Weighted average number of common shares
and dilutive potential common stock used in dilutive EPS 26,782,405 26,547,738
===============================
SIX MONTHS ENDED JUNE 30,
2004 2003
-------------------------------
Weighted average number of common shares
used for basic EPS 26,586,563 26,487,028
Effect of dilutive stock options and restricted stock 131,678 86,665
-------------------------------
Weighted average number of common shares
and dilutive potential common stock used in dilutive EPS 26,718,241 26,573,693
===============================
7. SEGMENT REPORTING
The Company has three principal operating segments: rehabilitation,
tunneling, and TiteLiner(R), the Company's corrosion and abrasion segment
("TiteLiner"). The segments were determined based upon the types of
products sold by each segment and each is regularly reviewed and evaluated
separately.
The following disaggregated financial results have been prepared using a
management approach, which is consistent with the basis and manner with
which management internally disaggregates financial information for the
purpose of assisting in making internal operating decisions. The Company
evaluates performance based on stand-alone operating income.
8
Financial information by segment is as follows (in thousands):
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2004 2003 2004 2003
----------------------------------------------------------
REVENUES
Rehabilitation $ 104,625 $ 93,883 $ 200,254 $ 186,250
Tunneling 31,145 26,385 57,195 51,970
TiteLiner 6,664 4,510 12,899 9,906
----------------------------------------------------------
TOTAL REVENUES $ 142,434 $ 124,778 $ 270,348 $ 248,126
==========================================================
GROSS PROFIT
Rehabilitation $ 24,757 $ 25,004 $ 45,062 $ 48,472
Tunneling 3,437 2,773 6,383 5,934
TiteLiner 2,370 1,490 4,486 3,130
----------------------------------------------------------
TOTAL GROSS PROFIT $ 30,564 $ 29,267 $ 55,931 $ 57,536
==========================================================
OPERATING INCOME
Rehabilitation $ 5,364 $ 8,589 $ 7,091 $ 17,403
Tunneling 835 976 1,331 2,417
TiteLiner 1,391 720 2,543 1,651
----------------------------------------------------------
TOTAL OPERATING INCOME $ 7,590 $ 10,285 $ 10,965 $ 21,471
==========================================================
8. ACQUIRED INTANGIBLE ASSETS AND GOODWILL
Acquired intangible assets include patents, license agreements, non-compete
agreements, purchased backlog and customer relationships. Intangible assets
at June 30, 2004 and amortization expense were as follows ($ in thousands):
AS OF JUNE 30, 2004
GROSS CARRYING ACCUMULATED
AMOUNT AMORTIZATION
------------------------------
Amortized intangible assets:
Patents and trademarks $ 13,943 $ (12,458)
License agreements 4,803 (2,227)
Non-compete agreements 3,244 (1,496)
Purchased backlog 582 (582)
Customer relationships 1,797 (90)
--------------------------
Total $ 24,369 $ (16,853)
--------------------------
Aggregate amortization expense:
For quarter ended June 30, 2004 $ 584
For six months ended June 30, 2004 1,190
Estimated amortization expense:
For year ending December 31, 2004 $ 1,580
For year ending December 31, 2005 850
For year ending December 31, 2006 845
For year ending December 31, 2007 452
For year ending December 31, 2008 438
9. COMMITMENTS AND CONTINGENCIES
Litigation
In the third quarter of 2002, a Company crew had an accident on an
Insituform CIPP Process project in Des Moines, Iowa. Two workers died and
five workers were injured in the accident. The Company fully cooperated
with Iowa's state OSHA in the investigation of the accident. Iowa OSHA
issued a Citation and Notification of Penalty in connection with the
accident, including several willful citations. Iowa OSHA proposed penalties
of $808,250. The Company challenged Iowa OSHA's findings, and in the fourth
quarter of 2003, an administrative law judge found in favor of Iowa OSHA on
some citations, found in favor of the Company on some citations and
combined a number of citations for purposes of assessing penalties. The
administrative law judge reduced the penalties to $158,000. In the second
quarter of 2004, the Iowa
9
Employment Appeal Board reinstated many of the original penalties, ordering
total penalties in the amount of $733,750. The Company is vigorously
opposing the citations, and has filed a notice of appeal with the Iowa
state district court.
In July 2004, three separate civil actions were filed in the Iowa District
Court for Polk County with respect to the Des Moines accident. The first
Complaint, filed by family members and the Estate of Brian Burford on July
7, 2004, names the Company, Insituform Technologies USA, Inc., a wholly
owned subsidiary of the Company ("Insituform USA"), the City of Des Moines
and 15 current or former employees of the Company as defendants. The two
other actions, filed on July 6, 2004 by (1) family members and the Estate
of Daniel Grasshoff and (2) Michael Walkenhorst, James E. Johnson and Linda
Johnson, name the City of Des Moines and the 15 current or former employees
of the Company as defendants, but do not name the Company or Insituform USA
as defendants. The Complaints filed with respect to Burford and Grasshoff
allege wrongful death, negligence, gross negligence and civil conspiracy.
The Complaint filed with respect to Walkenhorst and Johnson alleges gross
negligence and civil conspiracy. The Company believes that the allegations
in the Complaints are without merit and that the workers' compensation
statutes provide the exclusive remedy to the plaintiffs for the deaths and
injuries that occurred as a result of the Des Moines accident. The Company
intends to vigorously defend the actions. Each Complaint seeks unspecified
damages, including punitive damages.
In December 2003, Environmental Infrastructure Group, L.P. ("EIG") filed
suit in the District Court of Harris County, Texas, against several
defendants, including Kinsel Industries, Inc., a wholly-owned subsidiary of
the Company ("Kinsel"), seeking unspecified damages. The suit alleges,
among other things, that Kinsel failed to pay EIG monies due under a
subcontractor agreement (the "Subcontract"). In February 2004, Kinsel filed
an answer, generally denying all claims, and also filed a counter-claim
against EIG based upon EIG's failure to perform its work required under the
Subcontract. In June 2004, EIG amended its complaint to add the Company as
an additional defendant and to include a claim for lost opportunity
damages. The parties currently are conducting discovery in this matter. The
Company believes that the factual allegations and legal claims made against
it and Kinsel are without merit and intends to vigorously defend them.
Boston Installation
In August 2003, the Company began an Insituform CIPP Process installation
in Boston. The $1 million project required the Company to line 5,400 feet
of a 109-year-old 36- to 41-inch diameter unusually-shaped hand-laid rough
brick pipe. Many aspects of this project were atypical of the Company's
normal Insituform CIPP Process installations. Following installation, the
owner rejected approximately 4,500 feet of the liner and all proposed
repair methods. All rejected liner was removed and re-installed, and the
Company recorded a loss of $5.1 million on this project in the year ended
December 31, 2003. The lines are now back in service and the contract is
now in a warranty period. The Company will be required to inspect the lines
in early 2005 to determine if any problems exist. The Company believes that
it is adequately reserved for potential warranty costs.
The Company has a "Contractor Rework" special endorsement to its primary
comprehensive general liability insurance policy. The Company has filed a
claim with its primary insurance carrier relative to rework of the Boston
project, who has informally advised the Company that it will indemnify the
Company under the special endorsement. The primary coverage is $1 million,
less a $250,000 deductible, which has been accrued on the Company's books.
The Company has excess comprehensive general liability insurance coverage.
The excess insurance coverage is in an amount far greater than the
estimated costs associated with the liner removal and re-installation. The
Company believes the "Contractor Rework" special endorsement applies to the
excess insurance coverage, it has already incurred costs in excess of the
primary coverage and it has put its excess carrier on notice. The excess
insurance carrier denied coverage in writing without referencing the
"Contractor Rework" special endorsement, and subsequently indicated that it
does not believe that the "Contractor Rework" special endorsement applies
to the excess insurance coverage.
On March 10, 2004, the Company filed a lawsuit in Massachusetts against its
excess insurance carrier for its failure to acknowledge coverage and to
indemnify the Company for the entire loss in excess of the primary
coverage. The excess insurance carrier has filed an answer in response.
Because of the uncertainties in litigation and although the Company is
vigorously pursuing a full recovery of the loss, the Company did not
recognize any of the potential excess carrier insurance recovery at June
30, 2004.
Other Litigation
The Company is involved in certain litigation incidental to the conduct of
its business and affairs. Management, after consultation with legal
counsel, does not believe that the outcome of any such litigation will have
a material adverse effect on the consolidated financial condition, results
of operations or liquidity of the Company.
10
Guarantees
The Company has entered into several contractual joint ventures to develop
joint bids on contracts for its rehabilitation businesses, and for
tunneling operations. In these cases, the Company could be required to
complete the joint venture partner's portion of the contract if the partner
is unable to complete its portion. The Company is liable for any amounts
for which the Company itself could not complete the work and for which a
third party contractor could not be located to complete the work for the
amount awarded in the contract. While the Company would be liable for
additional costs, these costs would be offset by any related revenues due
under that portion of the contract. The Company has not experienced
material adverse results from such arrangements. Based on these facts,
while there can be no assurances, the Company currently does not anticipate
any future material adverse impact on its consolidated financial position,
results of operations or cash flows.
The Company also has many contracts that require the Company to indemnify
the other party against loss from claims of patent or trademark
infringement. The Company also indemnifies its bonding agents against
losses from third party claims of customers and subcontractors. The Company
has not experienced material losses under these provisions and, while there
can be no assurances, currently does not anticipate any future material
adverse impact on its consolidated financial position, results of
operations or cash flows.
The Company regularly reviews its exposure under all its engagements,
including performance guarantees by contractual joint ventures and
indemnification of its bonding agents and licensees. As a result of the
most recent review, the Company has determined that the risk of material
loss is remote under these arrangements and has not recorded a liability
for these risks at June 30, 2004 on its consolidated balance sheet.
10. FINANCINGS
Amended Credit Facility
Effective March 12, 2004, the Company entered into an amended and restated
bank revolving credit facility (the "Amended Credit Facility") that
replaced its existing $75 million bank credit facility (the "Old Credit
Facility"). The Amended Credit Facility provides a borrowing capacity of
$25 million, any portion of which may be used for the issuance of standby
letters of credit. The Company believed that the covenants contained in the
Old Credit Facility unduly limited the Company in the operation of its
business. In light of the Company being out of compliance with certain debt
covenants at December 31, 2003 and based on the determination that it did
not anticipate using more than $25 million of its bank credit facility in
the foreseeable future (primarily for standby letters of credit), the
Company decided to amend the Old Credit Facility with the Amended Credit
Facility. The Amended Credit Facility, which subjects the Company to less
restrictive covenants, brought the Company back into compliance with its
financial covenants as of December 31, 2003. The Amended Credit Facility
matures on September 12, 2005.
Under the Amended Credit Facility, the Company paid a $25,000 closing fee
and will pay a commitment fee equal to 0.4% per annum on the unborrowed
balance at the end of each fiscal quarter. The Company also will pay a
letter of credit fee of 2.25% per annum on the aggregate stated amount for
each letter of credit that is issued and outstanding at the end of each
fiscal quarter. Any loan under the Amended Credit Facility will bear
interest at the rate equal to the Bank of America prime rate (4.0% per
annum as of June 30, 2004). The Amended Credit Facility contains
cross-default provisions to the Company's amended Senior Notes as
summarized below.
Non-interest bearing letters of credit utilized as collateral for insurance
under the Old Credit Facility were transferred to the Amended Credit
Facility. In March 2004, the Company issued $4.6 million in additional
letters of credit under the Amended Credit Facility relating to collateral
for the benefit of its insurance carrier. As a result, the insurance
collateral agreement was canceled since it was no longer necessary and the
related amounts of restricted cash ($4.6 million) posted as insurance
collateral were released. At June 30, 2004, $9.2 million in letters of
credit were issued and outstanding. There were no other outstanding
borrowings under the Amended Credit Facility at June 30, 2004, resulting in
$15.8 million of available borrowing capacity under the Amended Credit
Facility, at that date.
In connection with the Company's annual renewal of its insurance program
effective July 1, 2004, the Company posted an additional $2.7 million in
letters of credit for the benefit of its insurance carrier, bringing total
letters of credit outstanding in July 2004 to $12.0 million and reducing
available borrowing capacity under the Amended Credit Facility to $13.0
million.
11
Senior Notes
On March 12, 2004, the Company, with the requisite approval of the holders
of the Company's Senior Notes, Series A, due February 14, 2007, and the
Company's Senior Notes, Series 2003-A, due April 24, 2013, amended certain
of the terms and conditions of the Senior Notes. In connection with the
amendment, the Company paid the noteholders an amendment fee of 0.25% of
the outstanding principal balance of each series of Senior Notes, or $0.3
million. In addition, the interest rate on each series of Senior Notes
increased by 0.75% per annum at closing, reducing by 0.25% per annum
beginning on April 1, 2005 and by an additional 0.5% per annum beginning on
April 1, 2006.
At June 30, 2004, the Senior Notes, Series A, bore interest, payable
semi-annually, at 8.63% per annum. The outstanding principal amount under
the Senior Notes, Series A, at such date was $47.1 million. Each year
through maturity the Company is required to make principal payments under
the Senior Notes, Series A, of $15.7 million, plus interest. Upon specified
change in control events, each holder of the Senior Notes, Series A, has
the right to require the Company to purchase its notes, without premium.
At June 30, 2004, the Senior Notes, Series 2003-A, bore interest, payable
semi-annually, at a rate of 6.04% per annum. The outstanding principal
amount under the Senior Notes, Series 2003-A, at such date was $65.0
million. The principal amount of the Senior Notes, Series 2003-A, is due in
a single payment on April 24, 2013. Upon specified change in control
events, each holder of the Senior Notes, Series 2003-A, has the right to
require the Company to purchase its notes, without premium. The proceeds of
the Senior Notes, Series 2003-A, were used by the Company to pay off
balances on the Old Credit Facility and to provide liquidity to the Company
for general corporate purposes.
The amended note purchase agreements of the Senior Notes, Series A, and the
Senior Notes, Series 2003-A, and the Amended Credit Facility obligate the
Company to comply with certain amended financial ratios and restrictive
covenants through the end of the first quarter of 2005. These covenants,
among other things, place limitations on operations, stock repurchases,
dividends, capital expenditures, acquisitions and sales of assets by the
Company and/or its subsidiaries and limit the ability of the Company and
its subsidiaries to incur further indebtedness. On April 1, 2005, the
financial covenants will revert to the original covenants which were in
place with respect to the two senior note facilities prior to the March 12,
2004 amendments.
At December 31, 2003, the Company was not in compliance with certain of the
debt covenants under the note purchase agreements, but with the March 12,
2004 amendments, the Company was brought back into compliance with such
covenants as of such date. At June 30, 2004, the Company was in compliance
with all debt covenants, and expects to be in compliance through the second
quarter of 2005, at a minimum.
In connection with the refinancing/amendments of its debt agreements as
described above, the Company recorded a charge to interest expense in the
first quarter of 2004 of approximately $0.3 million relative to costs
incurred for the refinancing/amendments, including the write-off of a
portion of deferred financing fees.
The Company's Euro Note, due July 7, 2006, bears interest, payable
quarterly in January, April, July, and October of each year, at the rate
per annum of 5.5%. Each year until maturity, the Company will be required
to make principal payments of $1.0 million for which currency fluctuations
will have an effect on the U.S. dollar payment amount. On June 30, 2004,
the principal amount of the Euro Note outstanding was 2.4 million Euros, or
approximately $3.0 million.
11. NEW ACCOUNTING PRONOUNCEMENTS
In January 2003 (as revised December 2003), the FASB issued Interpretation
No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). FIN 46
clarifies the application of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," for certain entities in which equity
investors do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance
its activities without additional subordinated financial support from other
parties. FIN 46 requires that variable interest entities, as defined,
should be consolidated by the primary beneficiary, which is defined as the
entity that is expected to absorb the majority of the expected losses,
receive the majority of the gains or both. FIN 46 requires that companies
disclose certain information about a variable interest entity created prior
to February 1, 2003. FIN 46 was effective for the Company on January 1,
2004. The adoption of FIN 46 did not have a material impact on the
Company's consolidated financial position or results of operations.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following is management's discussion and analysis of certain significant
factors that have affected the Company's financial condition and results of
operations during the periods included in the accompanying consolidated
financial statements. See the discussion of the Company's critical accounting
policies in its Annual Report on Form 10-K for the year ended December 31, 2003;
there have been no changes to these policies during the quarter and six months
ended June 30, 2004.
EXECUTIVE SUMMARY
The Company is a worldwide corporation specializing in trenchless technologies
to rehabilitate, replace, maintain and install underground pipes. The Company
has three principal operating segments: rehabilitation, tunneling and Tite
Liner(R) ("Tite Liner"). These segments have been determined based on the types
of products sold, and each is reviewed and evaluated separately. While the
Company uses a variety of trenchless technologies, the Insituform
cured-in-place-pipe process (the "Insituform CIPP Process") contributed 70.6% of
the Company's revenues in the first half of 2004. This percentage has been
trending downward slightly over the last few years as the Company has pursued
diversification from the addition of complementary businesses, technologies and
techniques. The tunneling segment has grown through organic growth and with the
acquisition of Elmore Pipe Jacking, Inc. in 2002. Tunneling revenues grew from
$49.0 million in 2001 to $100.0 million in 2003.
Revenues are generated by the Company and its subsidiaries operating principally
in the United States, Canada, the United Kingdom, the Netherlands, France,
Belgium, Spain, Switzerland, and Chile, and include product sales and royalties
from several joint ventures in Europe, and unaffiliated licensees and
sub-licensees throughout the world. The United States remains the Company's
single largest market, representing 82.2% of total revenue in the first half of
2004. See Note 7 to the Consolidated Financial Statements for additional segment
information and disclosures.
The Company has identified several initiatives that management believes will
reposition the Company to maintain its prominent status in its industry. In
order to accomplish these initiatives, the Company will continue to
strategically invest money over the next 18 months. These initiatives are
designed to accomplish cost reduction, product innovation, and business growth
for the long term. Specifically, the Company will spend money on enhancing
quality control and safety programs, training, logistics management and sales
programs, which should impact all aspects of the business. In addition, there
will be strategic investments in the areas of product innovation, particularly
seeking methods to drive costs out of the business so as to gain
competitiveness. Some of the initiatives are already in the implementation
phase, and the Company will continue to make planned investments to accomplish
its goals. All of these investments are tempered by the fact that the Company's
debt covenants place temporary restrictions on the use of cash. The Company
expects the implementation of these initiatives to start benefiting its
financial results in 2005.
UPDATE OF FOURTH QUARTER AND YEAR-END 2003 ISSUES
As discussed in the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 2003 (the "2003 Annual Report"), there were a number of
operational issues requiring adjustment to the Company's financial statements in
2003. The following is a brief discussion on some of the major issues discussed
in the 2003 Annual Report.
BOSTON INSITUFORM CIPP PROCESS PROJECT
See discussion in Note 9 to the Consolidated Financial Statements for an update.
CASUALTY INSURANCE AND HEALTHCARE RESERVES
In the fourth quarter of 2003, the Company recorded an additional $3.0 million
to its casualty insurance reserve and $0.7 million to its healthcare benefits
reserve. The Company obtains actuarial estimates of its liabilities on a
quarterly basis and adjusts its reserves accordingly. During the second quarter
of 2004, the casualty insurance reserve was increased by $0.5 million and the
healthcare benefits reserve was increased by $0.3 million to $10.5 million and
$2.4 million, respectively. During the first six months of 2004, the casualty
insurance reserve was increased $1.3 million and the healthcare benefits reserve
was increased $0.7 million. The Company believes that reserve increases will
continue through the remainder of 2004.
13
RESERVE FOR POTENTIALLY UNCOLLECTIBLE ACCOUNTS AND CLAIMS
The Company recorded bad debt expense in the fourth quarter of 2003 of $0.6
million. The Company recorded $0.2 million and $0.7 million in bad debt expense
in the first six months of 2004 and 2003, respectively. Also, at December 31,
2003, the Company reserved $0.8 million against several previously recorded
customer claims in the tunneling segment for which collection at originally
expected amounts was no longer considered probable. Management determined that
there was no need to increase these reserves in the first half of 2004.
WRITE-DOWNS AND RESERVES AGAINST CERTAIN ASSETS, DISCONTINUED OPERATIONS AND
OTHER
The Company wrote down certain assets by $1.1 million during the fourth quarter
of 2003. The Company expects to perform physical counts of its fixed assets,
with individual original cost below $50,000, in the second half of 2004. In the
first half of 2004, the physical inventory of such items had not started, and no
additional write-offs were recorded.
In the fourth quarter of 2003, the Company recorded a $1.5 million reserve via a
charge to continuing operations against certain assets related to prior
discontinued operations. In the second quarter of 2004, the Company added $0.2
million to this reserve, reflecting management's judgment as to the ultimate
collectibility and realizability of these assets. While the Company believes it
has appropriately reserved at June 30, 2004 against assets recoverable from its
former discontinued operations, it is not possible to determine at this time
whether further deterioration in the recoverability of these assets which had a
net carrying value of $0.7 million at June 30, 2004, will require additional
provisions at a future date.
At December 31, 2003, the Company established a valuation allowance of $0.8
million for deferred tax assets related to net operating loss carryforwards in
France and Belgium. The Company's total long-lived assets in France and Belgium,
which consist of property, plant and equipment, were $1.3 million at June 30,
2004. Of this amount, $1.2 million is in France. French operations had losses in
2002 and 2003 primarily due to poor market conditions. New management has been
put in place, and French operations have generated a slight profit in the second
quarter of 2004. The losses that France experienced in 2003 and 2002 are not
expected to continue indefinitely into the future. It is expected that France
will experience positive operating results and cash flows going forward, and as
such, the ability to recover the carrying value of the French assets is
expected. The Company will continue to monitor the recoverability of these
assets and the need for a valuation allowance on deferred tax assets. The
working capital in both countries which aggregated $1.5 million at June 30,
2004, is also considered to be appropriately stated at net realizable value.
The Company's fifty-percent owned Italian joint venture, which is accounted for
under the equity method, has incurred losses over the last three years. In
connection with certain 2004 restructuring initiatives approved by the Company
and its joint venture partner, including transferring management
responsibilities for the Italian joint venture to management of the Company's
profitable German joint venture, the Company increased its investment in the
joint venture by $0.8 million in the first half of 2004. The carrying value of
the Company's equity investment in the Italian joint venture approximated $0.1
million at June 30, 2004. The Italian joint venture's losses have been reduced
in 2004, and the Company will closely monitor the viability of this joint
venture going forward.
RESULTS OF OPERATIONS - Three and Six Months Ended June 30, 2004 and 2003
The following table highlights the results for each of the segments and periods
presented (in thousands):
THREE MONTHS ENDED THREE MONTHS ENDED
JUNE 30, 2004 JUNE 30, 2003
REHABILITATION TUNNELING TITE LINER TOTAL REHABILITATION TUNNELING TITE LINER TOTAL
---------------------------------------------------------------------------------------------
Revenues $104,625 $31,145 $ 6,664 $142,434 $93,883 $26,385 $4,510 $124,778
Gross profit 24,757 3,437 2,370 30,564 25,004 2,773 1,490 29,267
Gross profit margin 23.7% 11.0% 35.6% 21.5% 26.6% 10.5% 33.0% 23.5%
Operating expenses 19,393 2,602 979 22,974 16,415 1,797 770 18,982
Operating income 5,364 835 1,391 7,590 8,589 976 720 10,285
Operating income percentage 5.1% 2.7% 20.9% 5.3% 9.1% 3.7% 16.0% 8.2%
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2004 JUNE 30, 2003
REHABILITATION TUNNELING TITE LINER TOTAL REHABILITATION TUNNELING TITE LINER TOTAL
--------------------------------------------------------------------------------------------
Revenues $200,254 $57,195 $12,899 $270,348 $186,250 $51,970 $9,906 $248,126
Gross profit 45,062 6,383 4,486 55,931 48,472 5,934 3,130 57,536
Gross profit margin 22.5% 11.2% 34.8% 20.7% 26.0% 11.4% 31.6% 23.2%
Operating expenses 37,971 5,052 1,943 44,966 31,069 3,517 1,479 36,065
Operating income 7,091 1,331 2,543 10,965 17,403 2,417 1,651 21,471
Operating income percentage 3.5% 2.3% 19.7% 4.1% 9.3% 4.7% 16.7% 8.7%
14
The following table summarizes the increase (decrease) in operating income for
each of the segments and periods presented ($ in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2004 JUNE 30, 2004
VS. 2003 VS. 2003
------------------------------------------------------
Rehabilitation $ (3,225) (37.5%) $ (10,312) (59.3%)
Tunneling (141) (14.4%) (1,086) (44.9%)
TiteLiner 671 93.2% 892 54.0%
------------------------------------------------------
TOTAL $ (2,695) (26.2%) $ (10,506) (48.9%)
OVERVIEW
Revenues increased $17.7 million, or 14.2%, to $142.4 million in the second
quarter of 2004 compared to $124.8 million in the second quarter of 2003. In the
first six months of 2004, revenues increased $22.2 million, or 9.0%, to $270.3
million compared to $248.1 million in the first six months of 2003. Revenues in
2004 reflect the impact of acquisitions made after the second quarter of 2003,
as well as growth in three domestic rehabilitation regions, Europe, the Tite
Liner segment and tunneling.
Gross profit increased $1.3 million, or 4.4%, to $30.6 million for the second
quarter of 2004 compared to $29.3 million in the same quarter of 2003.
Year-to-date, gross profit declined $1.6 million, or 2.8%, to $55.9 million from
$57.5 million in the first six months of 2003. Gross profit margin decreased to
21.5% in the second quarter of 2004 compared to 23.5% in the second quarter of
2003. Gross profit in the first six months decreased to 20.7% in 2004 compared
to 23.2% in the first six months of 2003. Gross profit declines in three
domestic rehabilitation regions drove this trend. Lower volume and pricing, due
to the industry's competitive environment, as well as low-margin pipebursting
work, combined to negatively impact gross profit margins in the first half of
2004. Higher volumes of tunneling work which generated lower margins than CIPP
contributed to lower gross margin percentages.
Operating expenses increased $4.0 million, or 21.0%, to $23.0 million in the
second quarter of 2004 compared to $19.0 million in the second quarter of 2003.
Operating expenses in the first six months of 2004 increased $8.9 million, or
24.7%, to $45.0 million from $36.1 million in the first six months of 2003.
Operating expenses in 2004 include additional compensation and employee-related
costs, along with increased professional and consulting fees. These higher costs
reflect the Company's key strategic initiatives, notably investment in business
growth, sales, and logistics enhancement. Acquisitions made in 2003 added $1.2
million and $2.5 million of operating expenses in the second quarter and first
six months of 2004, respectively.
REHABILITATION SEGMENT
Revenues
Rehabilitation revenues increased $10.7 million, or 11.4%, to $104.6 million in
the second quarter of 2004 compared to $93.9 million in the second quarter of
2003. Revenues in Europe increased $5.0 million, which includes $3.3 million
added by the acquisitions of Sewer Services and the remaining 50% interest in
the Company's joint venture in Switzerland. Three North American rehabilitation
regions increased $6.6 million in the second quarter of 2004 compared to the
second quarter of 2003, offset by declines in three North American
rehabilitation regions and manufacturing totaling $0.9 million. North American
rehabilitation revenues in 2004 include the acquisition of Insituform East, Inc.
("East"), which added $3.9 million in revenues during the three months ended
June 30, 2004. The typical lag time between winning a contract and recognizing
revenue on the contract runs approximately three to six months. During the last
six months of 2003, contract backlog experienced moderate growth, which began to
impact revenues in the first and second quarters of 2004. To accommodate the
increased contract backlog, seven crews have been added for North American
Insituform CIPP Process projects since December 31, 2003. Since June 30, 2003, a
total of 11 crews have been added, which includes three crews acquired with
East.
Year-to-date rehabilitation revenues increased $14.0 million, or 7.5%, to $200.3
million compared to $186.3 million in the first six months of 2003. As with
second quarter revenues, the effect of acquisitions and growth in the same
markets impacted revenues in the first six months of 2004. Europe's revenues
increased $9.6 million in the first six months of 2004, which includes $7.2
million added by the acquisitions of Sewer Services and the remaining 50%
interest in the Company's joint venture in Switzerland. Revenues in three North
American rehabilitation regions increased by $12.9 million, which includes $6.4
million added by the acquisition of East. Offsetting declines in three North
American rehabilitation regions and manufacturing totaled $8.5 million in the
first half of 2004. As with the second quarter, backlog growth in the second
half of 2003 impacted rehabilitation revenues in the first and second quarters
of 2004. Management anticipates that consistent revenue growth will be
experienced in the last six months of 2004 due to backlog growth and the
additional crews.
15
Gross Profit
Rehabilitation gross profit in the second quarter of 2004 was relatively flat
compared to gross profit in the second quarter of 2003. However, gross profit
margin decreased to 23.7% in the second quarter of 2004 from 26.6% in the second
quarter of 2003. This is attributable to lower pricing in one North American
rehabilitation region and an increase in volume in pipebursting work, which has
experienced significantly lower margins. Pipebursting has experienced margin
erosion in the first two quarters of 2004, due to lower pricing and issues of
consistent workload reducing crew productivity. The gross profit margin from
pipebursting activities decreased from 15.9% in the second quarter of 2003 to
7.6% in the second quarter of 2004, causing a negative impact on gross profit of
$0.9 million. In addition, there were minor, isolated product performance issues
in Insituform CIPP which occurred in the second quarter of 2004, which
negatively impacted gross profit by $0.3 million.
Gross profit for the first six months of 2004 decreased $3.4 million, or 7.0%,
to $45.1 million compared to $48.5 million in the first six months of 2003.
Gross profit margin in the first six months of 2004 declined to 22.5% compared
to 26.0% in the first six months of 2003. Gross profit declines in three North
American rehabilitation regions drove this negative gross profit trend. Lower
volume and/or lower pricing due to increased competition, as well as the
previously mentioned margin erosion related to pipebursting, combined to
negatively impact gross profit and gross profit margin. The gross profit margin
from pipebursting activities decreased to 9.6% in the first six months of 2004
as compared to 17.8% in the first six months of 2003, causing a $1.6 million
decrease in gross profit. Continued pressure is expected to be seen on gross
profit margins for the balance of 2004 due to lower margin pipebursting work
still in backlog and the lower volume and pricing in several North American
rehabilitation regions.
Operating Expenses
Operating expenses increased $3.0 million, or 18.1%, to $19.4 million in the
second quarter of 2004 compared to $16.4 million in the second quarter of 2003.
Operating expenses were higher across all segments due to growth and the
implementation of strategic initiatives. As the Insituform CIPP Process is one
of the Company's core businesses, many of the costs of implementation are
charged to this segment. The largest component contributing to higher operating
expenses was employee and benefits costs. This combined with higher professional
and consulting fees, much of which is related to the implementation of key
strategic initiatives, caused the increase in operating expenses. In addition,
the Company made severance and benefit payments for certain senior management
turnover during the second quarter of 2004 of approximately $0.3 million.
Operating expenses in the first six months of 2004 increased $6.9 million, or
22.2%, to $38.0 million compared to $31.1 million in the first half of 2003. The
same factors combining to cause higher expenses in the second quarter of 2004
also caused the year-to-date increase in operating expenses. Spending on the
strategic initiatives is expected to continue through the balance of 2004 and
beyond.
TUNNELING SEGMENT
Revenues
Tunneling revenues increased $4.7 million, or 18.0%, to $31.1 million in the
second quarter of 2004 compared to $26.4 million in the second quarter of 2003.
Tunneling revenues in the first six months of 2004 increased $5.2 million, or
10.1%, to $57.2 million from $52.0 million in the first six months of 2003.
These increases resulted from increased backlog in 2004, from orders received
primarily in late 2003. Management currently anticipates that revenues will
continue to grow compared to the prior year due to the increased backlog.
Gross Profit
Tunneling gross profit in the second quarter of 2004 increased $0.6 million, or
23.9%, to $3.4 million from $2.8 million in the second quarter of 2003. The
increase in gross profit in the second quarter of 2004 was primarily a function
of increased volume. The gross profit margin increased slightly to 11.0% in the
second quarter of 2004 compared to 10.5% in the second quarter of 2003.
Gross profit in the tunneling segment increased $0.5 million, or 7.6%, to $6.4
million in the first six months of 2004 compared to $5.9 million in the first
six months of 2003. As with second quarter gross profit, the increase in gross
profit in the six-month period ended June 30, 2004 was a function of volume as
the gross profit margin remained relatively static at 11.2% in the first six
months of 2004 compared to 11.4% for the same period last year. In 2003, the
Company improved its procedures for recognizing revenue related to contract
claims, by supplementing management's discretion, allowing recognition only
after formal, written acceptance of the claim by the customer and, consistent
with prior procedures, the reasonable expectation of the receipt of cash. This
procedure has caused some delays in the recognition of revenue and
profitability, as the claim review and negotiation process often takes several
months. The tunneling segment currently is pursuing these change order claims
arising in the ordinary course of business with several customers, $2.3 million
of which are recorded on the balance sheet, but also including certain amounts
which have not yet been recognized on the balance sheet as they do not meet the
new procedure for recognizing claims. Favorable claims collection developments
in this area could result in the Company recognizing additional revenue from
these claims. Conversely, unfavorable claims collection developments could
result in some of the claims that
16
have been recognized on the balance sheet having to be reserved. Excluding
recoveries on claims, gross profit margins are expected to continue in the same
range for the balance of 2004.
Operating Expenses
Operating expenses increased $0.8 million, or 44.8%, to $2.6 million in the
second quarter of 2004 compared to $1.8 million in the second quarter of 2003.
As discussed under the rehabilitation segment, operating expenses were higher
across all segments due to the implementation of strategic initiatives. In
addition, administrative functions were added, specifically in project
management, to handle future expected growth.
Operating expenses in the first six months of 2004 increased $1.6 million, or
43.6%, to $5.1 million compared to $3.5 million in the first half of 2003. The
same factors combining to cause higher expenses in the second quarter of 2004
also were the cause of the year-to-date increase in operating expenses. Growth
and the spending on the strategic initiatives will continue through the balance
of 2004 and beyond.
TITE LINER SEGMENT
Revenues
Tite Liner revenues increased $2.2 million, or 47.8%, to $6.7 million in the
second quarter of 2004 compared to $4.5 million in the second quarter of 2003.
Revenues in the first six months of 2004 increased $3.0 million, or 30.2%, to
$12.9 million from $9.9 million in the first six months of 2003. A solid
workload in the United States and Canada fueled much of the revenue growth. In
addition, a favorable closeout of a foreign project also contributed to the
revenue growth. The Company is also pursuing a claim for additional revenue of
approximately $0.3 million on a foreign project carried out by its Tite Liner
subsidiary. The Company has not recognized this income as the amount is
uncertain as to collectibility from the client. Management anticipates that
revenue growth will return to more normal levels in the balance of 2004.
Gross Profit
Gross profit increased $0.9 million, or 59.1%, to $2.4 million in the second
quarter of 2004 compared to $1.5 million in the second quarter of 2003. The
gross profit margin improved to 35.6% in the second quarter of 2004 compared to
33.0% in the same period last year. The favorable completion of certain projects
caused the increase in gross profit and gross profit margin.
In the first six months of 2004, gross profit increased $1.4 million, or 43.3%,
to $4.5 million from $3.1 million in the first six months of 2003. The gross
profit margin improved to 34.8% in the first six months of 2004 compared to
31.6% for the same period last year. The previously mentioned completion of
certain projects as well as favorable results in the United States and Canada
have combined to positively impact gross profit and gross profit margin in the
Tite Liner segment in the first half of 2004 compared to the same period in
2003. Management anticipates that gross profit margins will return to prior-year
levels, as the major projects have been completed.
Operating Expenses
Operating expenses increased $0.2 million, or 27.2%, to $1.0 million in the
second quarter of 2004 compared to $0.8 million in the second quarter of 2003.
For the first six months of 2004, operating expenses increased $0.4 million, or
31.4%, to $1.9 million from $1.5 million in the first six months of 2003. As
discussed under the rehabilitation segment, operating expenses were higher
across all segments due to the implementation of key strategic initiatives.
Growth and the spending on the strategic initiatives will continue through the
balance of 2004.
OTHER INCOME (EXPENSE) AND TAXES
Details of interest and other income (expense) and taxes are included in the
table below ($ in thousands):
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2004 2003 2004 2003
--------------------------- -------------------------
Operating income $ 7,590 $ 10,285 $ 10,965 $ 21,471
Interest expense (2,627) (2,175) (4,795) (3,372)
Other income (expense) 451 (189) 287 242
------------------------ -----------------------
Income before taxes $ 5,414 $ 7,921 $ 6,457 $ 18,341
Taxes on income 2,238 3,089 2,663 7,153
------------------------ -----------------------
Income before minority interests
and equity earnings $ 3,176 $ 4,832 $ 3,794 $ 11,188
In the second quarter of 2004, interest expense increased $0.4 million, or
20.8%, to $2.6 million from $2.2 million in the second quarter of 2003. On April
24, 2003, the Company placed $65.0 million in Senior Notes bearing interest at
5.29%. In
17
2004, amendments were made to the Company's debt agreements, and the interest
rate was adjusted to 6.04%. As such, the notes were outstanding for the full
quarter (91 days), bearing interest at 6.04% in the second quarter of 2004
compared to being outstanding for part (67 days) of the second quarter of 2003,
bearing interest at 5.29%.
For the first six months of 2004, interest expense increased $1.4 million, or
42.2%, to $4.8 million from $3.4 million in the first six months of 2003. In
addition to the $65.0 million in Senior Notes discussed in the preceding
paragraph, approximately $0.3 million in fees were paid to the note holders as
part of the debt amendment (see Note 10 to the Consolidated Financial
Statements) and approximately $0.2 million in previously capitalized fees were
written off.
In the second quarter of 2004, other income (expense) increased by $0.6 million
from the second quarter of 2003 primarily due to slightly increased investment
income and the second quarter of 2003 was impacted by a $0.5 million increase in
reserves for equipment obsolescence.
In the second quarter of 2004, taxes on income decreased $0.9 million, or 27.5%,
to $2.2 million from $3.1 million in the second quarter of 2003. For the first
six months of 2004, taxes on income decreased $4.5 million, or 62.8%, to $2.7
million from $7.2 million in the first six months of 2003. The effective tax
rate increased to 41.2% from 39.0% due to lower pre-tax income and the fixed
provision for permanent adjustments to book income.
DISCONTINUED OPERATIONS
See Note 4 to the Consolidated Financial Statements for information on prior
year discontinued operations.
BACKLOG
Contract backlog was $369.7 million at June 30, 2004 compared to $294.0 million
at December 31, 2003. Contract backlog is management's expectation of revenues
to be generated from received, signed, uncompleted contracts whose cancellation
is not anticipated at the time of reporting. Contract backlog excludes any term
contracts for which there is not specific and determinable work released and
projects where the Company has been advised that it is the low bidder, but not
formally awarded the contract.
LIQUIDITY AND CAPITAL RESOURCES
CASH AND EQUIVALENTS
($ in thousands) JUNE 30, 2004 DECEMBER 31, 2003
-----------------------------------
Cash and equivalents $89,828 $ 93,865
---------------------------
Restricted cash -- in escrow 1,343 1,524
Restricted cash -- held as collateral - 4,602
---------------------------
Total restricted cash $ 1,343 $ 6,126
===========================
Cash and cash equivalents in the prior period have been re-cast to conform to
current presentation. See Note 1 to the Consolidated Financial Statements for
further discussion. Restricted cash held in escrow was $1.3 million at June 30,
2004 and $1.5 million at December 31, 2003. Restricted cash held as collateral
was $4.6 million at December 31, 2003. Restricted cash held in escrow relates to
deposits made as escrow for release of retention on specific projects performed
for municipalities and state agencies. Restricted cash held as collateral
relates to deposits posted as collateral for casualty insurance policies. In the
first quarter of 2004, the Company issued letters of credit to satisfy this
requirement and the restricted cash of $4.6 million was released.
CASH FLOWS FROM OPERATIONS
Cash flows from operating activities was the largest component of the Company's
overall cash flow for the six months ended June 30, 2004. Working capital
changes provided $5.9 million of operating cash flow for the six-month period
ended June 30, 2004 compared to $8.5 million in the first six months of 2003.
The most significant source of cash reflected in working capital changes was the
receipt of $9.1 million in tax refunds in the first quarter of 2004. Changes in
receivables, including costs and estimated earnings in excess of billings, used
$7.6 million. However, a focus on cash collections and receivables management
has had a positive impact on cash flow. Receivables increased due to revenue
growth, but that increase was partially offset by improved cash collections and
lower days' sales outstanding (DSO). Depreciation increased to $8.2 million in
the first six months of 2004 compared to $7.2 million in the first six months of
2003 due to higher capital expenditures in the first six months of 2004.
Amortization
18
increased to $1.2 million in the first six months of 2004 from $0.7 million in
the first six months of 2003 primarily due to the amortization of intangible
assets acquired with East, which was approximately $0.5 million in the first six
months of 2004.
CASH FLOWS FROM INVESTING ACTIVITIES
Cash flows from investing activities is composed of capital expenditures and an
additional investment in the Company's fifty-percent owned Italian joint venture
offset by cash received from disposals. In the first six months of 2004, the
Company used $16.6 million in cash on capital expenditures compared to $5.7
million in the first six months of 2003. Major components of capital
expenditures include approximately $4.4 million for various components of
tunneling equipment and $3.6 million for expansion and equipment at the
Company's Batesville, Mississippi, manufacturing facility. Other significant
expenditures include trucks and equipment for the North American Insituform CIPP
Process business related to crew expansion and replacement of older equipment
and equipment for a new operational facility in Europe. Capital expenditures
will continue at a higher level for the remainder of 2004 as the Company
continues to replace field equipment and to expand crew capacity.
CASH FLOWS FROM FINANCING ACTIVITIES
The largest component of cash flows from financing activities in 2004 was the
normal debt principal amortization of $15.7 million of the Senior Notes in the
first quarter of 2004. Total debt repayments in the first six months were $15.8
million. In the first six months of 2003, debt repayments and a decrease in the
Company's line of credit used $45.0 million, but was offset by the placement of
$65.0 million in Senior Notes in the second quarter of 2003. The release of the
restricted cash held as collateral deposits on casualty insurance policies
provided $4.6 million of cash from financing activities. In the first six months
of 2004, the Company received $2.9 million in cash from the exercise of stock
options, mostly by former senior executives of the Company in the first quarter
of 2004. There were no purchases of treasury stock in the first six months of
2004. In the first six months of 2003, $0.2 million was received from stock
option exercises, and $1.4 million was used in purchases of treasury stock.
MATERIAL CHANGES IN FINANCIAL CONDITION
Costs and estimated earnings in excess of billings ("unbilled receivables") were
$38.4 million at June 30, 2004 compared to $27.9 million at December 31, 2003.
Unbilled receivables arise when work on projects begins, incurring costs before
billings can be issued. Revenue growth in the first half of 2004 contributed to
the increase in unbilled receivables.
Prepaid expenses and other assets decreased $10.8 million to $8.7 million at
June 30, 2004 compared to $19.5 million at December 31, 2003 primarily due to
the receipt of $9.1 million in tax refunds during the first quarter of 2004.
FINANCINGS
See discussion in Note 10 to the Consolidated Financial Statements regarding the
Company's financings.
At December 31, 2003, the Company was out of compliance with certain covenants
under the following facilities: the Senior Notes, Series A, the Senior Notes,
Series 2003-A, the Old Credit Facility and an insurance collateral agreement. On
March 12, 2004, the covenants under the two senior note facilities were amended.
The amendments included revisions to the covenants applicable at December 31,
2003, thereby bringing the Company back into compliance as of such date. The Old
Credit Facility also was amended on March 12, 2004, and its covenants now
incorporate by reference those under the two series of amended Senior Notes. In
addition, the insurance collateral agreement was terminated as a result of
posting letters of credit in lieu of the cash collateral. The covenants under
the Old Credit Facility and the insurance collateral agreement are not
considered to be relevant for discussion as such agreements no longer exist, and
the Company is currently in compliance with the amended covenants under the
amended March 12, 2004 debt facilities. The Company now has two sets of debt
covenants: one set for the amended Senior Notes, Series A, and one set for the
amended Senior Notes, Series 2003-A. The covenants that were out of compliance
at December 31, 2003, prior to amendment, under each Senior Note facility are
presented below:
DECEMBER 31, 2003
-------------------------------------------
DESCRIPTION OF COVENANT ORIGINAL COVENANT ACTUAL RATIO AMENDED COVENANT
----------------------------------------------------------------------------------------------------------------------
$110 MILLION 7.88% SENIOR NOTES,
SERIES A, DUE FEBRUARY 14, 2007
Fixed charge coverage ratio(1) No less than 2.5 to 1.0 2.00 No less than 1.25 to 1.0
$65 MILLION 5.29% SENIOR NOTES,
SERIES 2003-A, DUE APRIL 24, 2013
Ratio of consolidated indebtedness to EBITDA(1) No greater than 3.25 to 1.0 3.68 No greater than 3.75 to 1.0
Fixed charge coverage ratio(1) No less than 2.0 to 1.0 1.96 No less than 1.25 to 1.0
19
Under the amended debt facilities, the Company is obligated to comply with the
amended covenants through the end of the first quarter of 2005. On April 1,
2005, the covenants will revert to the original covenants in place with respect
to the two senior note facilities prior to the March 12, 2004 amendments. The
Company is in the process of completing its budget for 2005 and accordingly does
not have a final forecast of its profitability for that period. However, based
on preliminary assessments of forecasted 2005 results and the Company's
improving current performance, the Company believes that it will remain in
compliance with its covenants under its debt facilities through the second
quarter of 2005. Given that the Company is currently in compliance with debt
covenants and believes that a covenant violation in the next 12 months is not
probable, it has recorded its outstanding debt as long-term at June 30, 2004,
except for the current maturity portion. Details of the existing covenants are
set forth below:
DESCRIPTION OF COVENANT FISCAL QUARTER AMENDED COVENANT(2) ACTUAL RATIO(2)
-----------------------------------------------------------------------------------------------------------------------
$110 MILLION 7.88% SENIOR NOTES,
SERIES A, DUE FEBRUARY 14, 2007
Fixed charge coverage ratio(1) First quarter 2004 No less than 1.25 to 1.0 1.64
Second quarter 2004 No less than 1.20 to 1.0 1.56
Third quarter 2004 No less than 1.20 to 1.0 n/a
Fourth quarter 2004 No less than 1.70 to 1.0 n/a
First quarter 2005 No less than 1.70 to 1.0 n/a
Second quarter 2005 No less than 2.50 to 1.0 n/a
$65 MILLION 5.29% SENIOR NOTES,
SERIES 2003-A, DUE APRIL 24, 2013
Ratio of consolidated indebtedness to EBITDA(1) First quarter 2004 No greater than 5.00 to 1.0 4.13
Second quarter 2004 No greater than 6.25 to 1.0 4.39
Third quarter 2004 No greater than 6.25 to 1.0 n/a
Fourth quarter 2004 No greater than 4.00 to 1.0 n/a
First quarter 2005 No greater than 4.00 to 1.0 n/a
Second quarter 2005 No greater than 3.25 to 1.0 n/a
Fixed charge coverage ratio(1) First quarter 2004 No less than 1.25 to 1.0 1.59
Second quarter 2004 No less than 1.20 to 1.0 1.53
Third quarter 2004 No less than 1.20 to 1.0 n/a
Fourth quarter 2004 No less than 1.70 to 1.0 n/a
First quarter 2005 No less than 1.70 to 1.0 n/a
Second quarter 2005 No less than 2.00 to 1.0 n/a
(1)The ratios are calculated as defined in the Note Purchase Agreements,
which have been incorporated into the Company's Form 10-K for the fiscal
year ended December 31, 2003 as Exhibits 10.2 and 10.3.
(2)The ratios for each quarter are based on rolling four-quarter
calculations of profitability. The significant loss experienced by the
Company in the fourth quarter of 2003 will have a negative impact on the
ratios through the third quarter of 2004.
The Company believes it has adequate resources and liquidity to fund future cash
requirements and debt repayments with cash generated from operations, existing
cash balances, additional short- and long-term borrowings and the sale of
assets, for the next 12 months.
DISCLOSURE OF FINANCIAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The Company has entered into various financial obligations and commitments in
the course of its ongoing operations and financing strategies. Financial
obligations are considered to represent known future cash payments that the
Company is required to make under existing contractual arrangements, such as
debt and lease agreements. These obligations may result from both general
financing activities or from commercial arrangements that are directly supported
by related revenue-producing activities. Commercial commitments represent
contingent obligations of the Company, which become payable only if certain
pre-defined events were to occur, such as funding financial guarantees. See Note
9 to the Consolidated Financial Statements for further discussion.
The Company has entered into several contractual joint ventures to develop joint
bids on contracts for its rehabilitation businesses, and for tunneling
operations. In these cases, the Company could be required to complete the joint
venture partner's portion of the contract if the partner is unable to complete
its portion. The Company is liable for any amounts for which the Company itself
could not complete the work and for which a third party contractor could not be
located to complete the work for the amount awarded in the contract. While the
Company would be liable for additional costs, these costs would be offset by any
related revenues due under that portion of the contract. The Company has not
experienced material adverse results from such arrangements. Based on these
facts, the Company currently does not anticipate any future material adverse
impact on its consolidated financial position, results of operations or cash
flows.
20
The Company also has many contracts that require the Company to indemnify the
other party against loss from claims of patent or trademark infringement. The
Company also indemnifies its bonding agents against losses from third party
claims of customers and subcontractors. The Company has not experienced material
losses under these provisions and currently does not anticipate any future
material adverse impact on its consolidated financial position, results of
operations or cash flows.
The Company regularly reviews its exposure under all its engagements, including
performance guarantees by contractual joint ventures and indemnification of its
bonding agents and licensees. As a result of the most recent review, the Company
has determined that the risk of material loss is remote under these arrangements
and has not recorded a liability for these risks at June 30, 2004 on its
consolidated balance sheet.
The following table provides a summary of the Company's financial obligations
and commercial commitments as of June 30, 2004 ($ in thousands). This table
includes cash obligations related to principal outstanding under existing debt
agreements and operating leases.
PAYMENTS DUE BY PERIOD
CASH OBLIGATIONS(1) TOTAL 2004 2005 2006 2007 2008 THEREAFTER
- ----------------------------------------------------------------------------------------------------------------------
Long-term debt $115,369 $1,075 $16,802 $16,782 $15,710 $ - $65,000
Line of credit - - - - - - -
facility(2)
Operating leases 32,670 5,993 7,647 5,750 4,673 3,666 4,941
-------------------------------------------------------------------------------------------
Total contractual cash
obligations $148,039 $7,068 $24,449 $22,532 $20,383 $3,666 $69,941
===========================================================================================
(1)Cash obligations are not discounted and do not include related interest. See
Notes 9 and 10 to the Consolidated Financial Statements regarding commitments
and contingencies and financings, respectively.
(2)As of June 30, 2004, there was no borrowing balance on the credit facility
and therefore there was no applicable interest rate as the rates are determined
on the borrowing date. The available balance was $15.8 million, and the
commitment fee was 0.40% per annum. The remaining $9.2 million was used for
non-interest bearing letters of credit, all of which were collateral for
insurance. The Company generally used the credit facility for short-term
borrowings and disclosed amounts outstanding as a current liability. See Note 10
to the Consolidated Financial Statements regarding refinancing of the line of
credit facility.
NEW ACCOUNTING PRONOUNCEMENTS
See Note 11 to the Consolidated Financial Statements for discussion of new
accounting pronouncements and their impact on the Company.
MARKET RISK
The Company is exposed to the effect of interest rate changes and foreign
currency fluctuations. Due to the relative immateriality of potential impacts
from changes in these rates, the Company does not use derivative contracts to
manage these risks.
INTEREST RATE RISK
The fair value of the Company's cash and short-term investment portfolio at June
30, 2004 approximated carrying value. Given the short-term nature of these
instruments, market risk, as measured by the change in fair value resulting from
a hypothetical 10% change in interest rates, is not material.
The Company's objectives in managing exposure to interest rate changes are to
limit the impact of interest rate changes on earnings and cash flows and to
lower overall borrowing costs. To achieve these objectives, the Company
typically borrows under fixed rate agreements. The fair value of the Company's
long-term debt, including current maturities, approximated its carrying value at
June 30, 2004. Market risk was estimated to be $3.1 million as the potential
increase in fair value resulting from a hypothetical 10% decrease in the
Company's debt specific borrowing rates at June 30, 2004.
FOREIGN EXCHANGE RISK
The Company operates subsidiaries and is associated with licensees and
affiliates operating solely in countries outside of the United States, and in
currencies other than the U.S. dollar. Consequently, these operations are
inherently exposed to risks associated with fluctuation in the value of the
local currencies of these countries compared to the U.S. dollar. At June 30,
2004, approximately $3.1 million of financial instruments, primarily long-term
debt, were denominated in Euros. The effect of a hypothetical change of 10% in
year-end exchange rates would be immaterial.
21
OFF-BALANCE SHEET ARRANGEMENTS
The Company uses various structures for the financing of operating equipment,
including borrowing, operating and capital leases, and sale-leaseback
arrangements. All debt, including the discounted value of future minimum lease
payments under capital lease arrangements, is presented in the balance sheet.
The Company's future commitments under operating lease arrangements were $32.7
million at June 30, 2004. The Company also has exposure under performance
guarantees by contractual joint ventures and indemnification of its bonding
agents. However, the Company has not experienced any material adverse effects to
its consolidated financial position, results of operations or cash flows
relative to these arrangements and believes the exposure to any losses in the
future is immaterial. All foreign joint ventures are accounted for using the
equity method. The Company has no other off-balance sheet financing arrangements
or commitments. See Note 9 in the Notes to Consolidated Financial Statements
regarding commitments and contingencies.
FORWARD-LOOKING INFORMATION
This quarterly report contains various forward-looking statements that are based
on information currently available to management and on management's beliefs and
assumptions. When used in this document, the words "anticipate," "estimate,"
"believes," "plans," and similar expressions are intended to identify
forward-looking statements, but are not the exclusive means of identifying such
statements. Such statements are subject to risks and uncertainties. The
Company's actual results may vary materially from those anticipated, estimated
or projected due to a number of factors, such as the competitive environment for
the Company's products and services, the geographical distribution and mix of
the Company's work, the timely award or cancellation of projects, political
circumstances impeding the progress of work, and other factors set forth in
reports and other documents filed by the Company with the Securities and
Exchange Commission from time to time. The results the Company anticipates to
achieve from its strategic initiatives, which results include, among other
things, cost reduction, product innovation, business growth for the long term,
the Company's ability to drive costs out of the business and the Company's
ability to gain competitiveness may be other than expected. The Company does not
assume a duty to update forward-looking statements. Please use caution and do
not place reliance on forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information concerning this item, see "Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations - Market Risk," which
information is incorporated herein by reference.
ITEM 4. CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Chief Financial Officer carried out an
evaluation of the effectiveness of the Company's disclosure controls and
procedures (as defined in Securities Exchange Act Rules 13a-15(e) and
15(d)-15(e)) as of the end of the period covered by this report. Based on their
evaluation, the Chief Executive Officer and the Chief Financial Officer have
concluded that the Company's disclosure controls and procedures were effective
at the reasonable assurance level.
There were changes in the Company's internal controls over financial reporting
that occurred during the Company's fiscal quarter and six months ended June 30,
2004 that have materially affected, or are reasonably likely to materially
affect, the Company's internal control over financial reporting. Specifically,
and as previously described in the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 2003, the Company took the following steps during
the first half of 2004 to enhance its internal controls over financial
reporting:
o appointing a Corporate Controller;
o instituting enhanced detailed senior and regional management reviews of
financial accounts of regional operations;
o enhancing regional management's and controllers' ownership and
accountability over financial accounts and reporting;
o enhancing detailed reviews of collectibility of accounts receivable;
o enhancing detailed reviews of fixed asset accounts and reconciliations
to the Company's general ledger;
o increasing supervisory and management reviews of procedures,
reconciliation activities and financial reporting; and
o improving information technology system integrity management and
enhancement of systems controls.
22
The Company also evaluated and implemented, and will continue to evaluate and
implement, other improvements to the system of internal controls, as it prepares
for management's report on internal controls required under Section 404 of the
Sarbanes-Oxley Act.
23
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the third quarter of 2002, a Company crew had an accident on an Insituform
CIPP Process project in Des Moines, Iowa. Two workers died and five workers were
injured in the accident. The Company fully cooperated with Iowa's state OSHA in
the investigation of the accident. Iowa OSHA issued a Citation and Notification
of Penalty in connection with the accident, including several willful citations.
Iowa OSHA proposed penalties of $808,250. The Company challenged Iowa OSHA's
findings, and in the fourth quarter of 2003, an administrative law judge found
in favor of Iowa OSHA on some citations, found in favor of the Company on some
citations and combined a number of citations for purposes of assessing
penalties. The administrative law judge reduced the penalties to $158,000. In
the second quarter of 2004, the Iowa Employment Appeal Board reinstated many of
the original penalties, ordering total penalties in the amount of $733,750. The
Company is vigorously opposing the citations, and has filed a notice of appeal
with the Iowa state district court.
In July 2004, three separate civil actions were filed in the Iowa District Court
for Polk County with respect to the Des Moines accident. The first Complaint,
filed by family members and the Estate of Brian Burford on July 7, 2004, names
the Company, Insituform Technologies USA, Inc., a wholly-owned subsidiary of the
Company ("Insituform USA"), the City of Des Moines and 15 current or former
employees of the Company as defendants. The two other actions, filed on July 6,
2004 by (1) family members and the Estate of Daniel Grasshoff and (2) Michael
Walkenhorst, James E. Johnson and Linda Johnson, name the City of Des Moines and
the 15 current or former employees of the Company as defendants, but do not name
the Company or Insituform USA as defendants. The Complaints filed with respect
to Burford and Grasshoff allege wrongful death, negligence, gross negligence and
civil conspiracy. The Complaint filed with respect to Walkenhorst and Johnson
alleges gross negligence and civil conspiracy. The Company believes that the
allegations in the Complaints are without merit and that the workers'
compensation statutes provide the exclusive remedy to the plaintiffs for the
deaths and injuries that occurred as a result of the Des Moines accident. The
Company intends to vigorously defend the actions. Each Complaint seeks
unspecified damages, including punitive damages.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Company's Annual Meeting of Stockholders held on April 28, 2004,
stockholders elected the following persons as directors of the Company:
WITHHOLD
FOR AUTHORITY
--- ---------
Robert W. Affholder 25,497,471 117,597
Paul A. Biddelman 24,059,900 1,555,168
Stephen P. Cortinovis 25,500,787 114,281
John P. Dubinsky 25,500,291 114,777
Juanita H. Hinshaw 24,100,385 1,514,683
Thomas N. Kalishman 25,148,370 466,698
Thomas S. Rooney, Jr. 25,500,353 114,715
Sheldon Weinig 24,099,862 1,515,206
Alfred L. Woods 24,374,893 1,240,175
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The exhibits filed as part of this Quarterly Report on Form 10-Q
are listed on the annexed Index to Exhibits.
(b) On May 6, 2004, the Company filed a Current Report on Form 8-K,
under Items 7 and 12, to provide the Company's press release,
dated April 29, 2004, announcing its financial results for the
fiscal quarter ended March 31, 2004, and to provide a transcript
of the Company's April 30, 2004, conference call held to
announce and discuss its financial results for the fiscal
quarter ended March 31, 2004.
In addition, on August 5, 2004, the Company filed a Current
Report on Form 8-K, under Items 7 and 12, to provide the
Company's earnings release, dated July 29, 2004, announcing its
financial results for the fiscal quarter ended June 30, 2004,
and to provide a transcript of the Company's July 30, 2004,
conference call held to announce and discuss its financial
results for the fiscal quarter ended June 30, 2004.
24
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.
INSITUFORM TECHNOLOGIES, INC.
August 9, 2004 /s/ Christian G. Farman
-------------------------------------------
Christian G. Farman
Vice President - Chief Financial Officer
Principal Financial and Accounting Officer
25
INDEX TO EXHIBITS
10.1 Executive Separation Agreement and Release effective as of June 18,
2004 by and between the Company and Thomas A. A. Cook. (1)
31.1 Certification of Thomas S. Rooney, Jr. pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Christian G. Farman pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Thomas S. Rooney, Jr. pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 Certification of Christian G. Farman pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
- -----------------------------------
(1) Management contract or compensatory plan or arrangement.
26