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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 March 31, 2005
Commission file number 0-10786
Insituform Technologies, Inc.
- --------------------------------------------------------------------------------
(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 63005-1195
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(Address of Principal Executive Offices)
(636) 530-8000
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(Registrant's telephone number, including area code)
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 April 30, 2005
- ------------------------------------ -----------------------------
Class A Common Stock, $.01 par value 26,809,055 Shares
INDEX
Page No.
Part I Financial Information:
Item 1. Financial Statements (unaudited):
Consolidated Statements of Income for the Three Months Ended March 31, 2005 and 2004........... 3
Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004......................... 4
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2005 and 2004....... 5
Notes to Consolidated Financial Statements as of March 31, 2005................................ 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................................................ 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk..................................... 20
Item 4. Controls and Procedures........................................................................ 21
Part II Other Information:
Item 1. Legal Proceedings.............................................................................. 22
Item 4. Submission of Matters to a Vote of Security Holders............................................ 22
Item 6. Exhibits....................................................................................... 23
Signatures......................................................................................................... 24
Index to Exhibits.................................................................................................. 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
ENDED MARCH 31,
------------------------
2005 2004
---------- ----------
REVENUES $ 136,277 $ 127,914
COST OF REVENUES 110,178 102,547
---------- ----------
GROSS PROFIT 26,099 25,367
OPERATING EXPENSES 23,458 21,992
---------- ----------
OPERATING INCOME 2,641 3,375
OTHER (EXPENSE) INCOME:
Interest expense (1,876) (2,168)
Other 45 (164)
---------- ----------
TOTAL OTHER EXPENSE (1,831) (2,332)
---------- ----------
INCOME BEFORE TAXES ON INCOME 810 1,043
TAXES ON INCOME 283 425
---------- ----------
INCOME BEFORE MINORITY INTERESTS AND EQUITY IN EARNINGS 527 618
MINORITY INTERESTS (40) (56)
EQUITY IN LOSSES OF AFFILIATED COMPANIES (87) (60)
---------- ----------
NET INCOME $ 400 $ 502
========== ==========
BASIC EARNINGS PER SHARE $ 0.01 $ 0.02
========== ==========
DILUTED EARNINGS PER SHARE $ 0.01 $ 0.02
========== ==========
See accompanying notes to consolidated financial statements.
3
INSITUFORM TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
MARCH 31, 2005 DECEMBER 31, 2004
-------------- -----------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 55,497 $ 93,246
Restricted cash 1,801 1,705
Receivables, net 93,251 78,665
Retainage 26,078 25,655
Costs and estimated earnings in excess of billings 33,929 34,789
Inventories 16,096 13,339
Prepaid expenses and other assets 24,203 21,469
-------- ---------
TOTAL CURRENT ASSETS 250,855 268,868
-------- ---------
PROPERTY, PLANT AND EQUIPMENT, less accumulated depreciation 94,409 90,846
-------- ---------
OTHER ASSETS
Goodwill 131,533 131,540
Other assets 17,585 17,567
-------- ---------
TOTAL OTHER ASSETS 149,118 149,107
-------- ---------
TOTAL ASSETS $494,382 $ 508,821
======== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long-term debt $ 15,778 $ 15,778
Accounts payable and accrued expenses 86,620 85,398
Billings in excess of costs and estimated earnings 12,737 12,809
-------- ---------
TOTAL CURRENT LIABILITIES 115,135 113,985
-------- ---------
LONG-TERM DEBT, less current maturities 80,767 96,505
OTHER LIABILITIES 6,684 6,848
-------- ---------
TOTAL LIABILITIES 202,586 217,338
-------- ---------
MINORITY INTERESTS 1,681 1,647
-------- ---------
COMMITMENTS AND CONTINGENCIES (NOTE 7) - -
STOCKHOLDERS' EQUITY
Preferred stock, undesignated, $.10 par - shares authorized
2,000,000; none outstanding - -
Common stock, $.01 par - shares authorized 60,000,000;
shares issued 29,103,419 and 29,100,419;
shares outstanding 26,808,355 and 26,816,555 291 291
Unearned restricted stock (1,092) (1,226)
Additional paid-in capital 138,583 138,695
Retained earnings 199,325 198,925
Treasury stock - 2,357,464 shares (51,596) (51,596)
Accumulated other comprehensive income 4,604 4,747
-------- ---------
TOTAL STOCKHOLDERS' EQUITY 290,115 289,836
-------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $494,382 $ 508,821
======== =========
See accompanying notes to consolidated financial statements.
4
INSITUFORM TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
FOR THE THREE MONTHS
ENDED MARCH 31,
----------------------
2005 2004
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME $ 400 $ 502
ADJUSTMENTS TO RECONCILE TO NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES:
Depreciation 4,573 4,098
Amortization 423 606
Deferred income taxes 4 (62)
Write-off of debt issuance costs - 226
Other 168 859
Change in restricted cash related to operating activities (96) 210
CHANGES IN OPERATING ASSETS AND LIABILITIES, NET OF PURCHASED BUSINESSES:
Receivables, including costs and estimated earnings in excess of billings (15,067) (1,347)
Inventories (2,824) (1,492)
Prepaid expenses and other assets 159 10,090
Accounts payable and accrued expenses (741) 2,452
-------- --------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (13,001) 16,142
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (7,631) (7,696)
Proceeds from sale of fixed assets 33 243
-------- --------
NET CASH USED IN INVESTING ACTIVITIES (7,598) (7,453)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 26 2,770
Principal payments on long-term debt (15,738) (15,715)
Deferred financing charges paid (260) (633)
Change in restricted cash related to financing activities - 4,602
-------- --------
NET CASH USED IN FINANCING ACTIVITIES (15,972) (8,976)
-------- --------
Effect of exchange rate changes on cash (1,178) (127)
-------- --------
NET DECREASE IN CASH AND CASH EQUIVALENTS FOR THE PERIOD (37,749) (414)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 93,246 93,865
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 55,497 $ 93,451
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
CASH PAID (RECEIVED) FOR:
Interest $ 2,037 $ 2,495
Income taxes, net 583 (7,929)
See accompanying notes to consolidated financial statements.
5
INSITUFORM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
MARCH 31, 2005
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 March 31, 2005 and December 31, 2004 and
the unaudited consolidated statements of income and cash flows for the
three months ended March 31, 2005 and 2004. 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 read in conjunction with the financial
statements and the footnotes included in the Company's 2004 Annual Report
on Form 10-K.
The results of operations for the three months ended March 31, 2005 are
not necessarily indicative of the results to be expected for the full
year.
For all periods presented in this Form 10-Q, 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. EQUITY-BASED COMPENSATION
At March 31, 2005, the Company had two active equity-based compensation
plans under which equity-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 stock options.
Stock Options
All stock options granted in prior periods had an exercise price equal to
the market value of the underlying common stock on the date of grant. As a
result, no compensation expense was required to be recorded.
Restricted Stock
Restricted shares of the Company's Class A common stock are awarded from
time to time to the executive officers and certain key employees of the
Company subject to a three-year service restriction and may not be sold or
transferred during the restricted period. Restricted stock compensation is
recorded based on the stock price on the date of grant and charged to
expense ratably through the restriction period. The expense recorded each
month for shares of restricted stock awarded to executive officers, which
are subject to the Company's achievement of certain pre-established
performance goals in addition to the service restrictions described above,
must be adjusted according to the fluctuation of the Company's stock
price. Forfeitures cause the reversal of all previous expense recorded as
a reduction of current period expense. There were 62,400 and 28,400
restricted shares outstanding at March 31, 2005 and 2004, respectively.
There were no grants of restricted stock during the first quarter of 2005
or 2004, and there were forfeitures of 11,200 shares in the first quarter
of 2005 and none in the first quarter of 2004. On May 5, 2005, the Company
granted 55,000 shares of restricted stock to executive officers and
certain key employees.
6
Expense associated with grants of restricted stock and the effect of
related forfeitures is presented below (in thousands):
THREE MONTHS ENDED
MARCH 31,
------------------
2005 2004
------ ------
Restricted stock expense $ 55 $ 34
Forfeitures (61) -
------ ------
Restricted stock (benefit)/expense (6) 34
Tax (benefit)/expense 2 (14)
------ ------
Net (benefit)/expense $ (4) $ 20
====== ======
Deferred Stock Units
Deferred stock units are generally awarded to key executives and directors
of the Company and represent the Company's obligation to transfer one
share of the Company's common stock to the grantee at a future date and
generally are fully vested on the date of grant. The expense related to
the issuance of deferred stock units is recorded in full on the date of
grant. There were 4,182 deferred stock units awarded in the first quarter
of 2005, resulting in $58,000 of related expense, net of tax. There were
no grants of deferred stock units in the first quarter of 2004.
On April 27, 2005, the Company granted, in aggregate, 24,900 deferred
stock units to its non-employee directors. The Company will record $0.4
million ($0.3 million, net of tax) of compensation expense for this grant
in the second quarter of 2005.
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 123"),
"Accounting for Stock-Based Compensation" to equity-based compensation
(dollars in thousands, except per share data):
THREE MONTHS ENDED
MARCH 31,
-----------------------
2005 2004
-------- --------
Net income - as reported $ 400 $ 502
Add: Total equity-based compensation expense
included in net income, net of related tax benefits 54 20
Deduct: Total equity-based compensation expense
determined under fair value method for all awards,
net of related tax effects (387) (351)
-------- --------
Pro forma net income $ 67 $ 171
======== ========
Basic earnings per share:
As reported $ 0.01 $ 0.02
Pro forma 0.00 0.01
Diluted earnings per share:
As reported 0.01 0.02
Pro forma 0.00 0.01
For SFAS 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 stock
options are not traded on an exchange and are subject to vesting periods,
the disclosed fair value represents only an approximation of option value
based solely on historical performance.
7
For SFAS 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.
3. COMPREHENSIVE INCOME
For the quarters ended March 31, 2005 and 2004, comprehensive income was
$0.3 million and $1.5 million, respectively. The Company's adjustment to
net income to calculate comprehensive income consisted solely of
cumulative foreign currency translation adjustments of $(0.1) million and
$1.0 million for the quarters ended March 31, 2005 and 2004, respectively.
4. SHARE INFORMATION
Earnings per share have been calculated using the following share
information:
THREE MONTHS ENDED MARCH 31,
----------------------------
2005 2004
----------- ------------
Weighted average number of common shares
used for basic EPS 26,744,588 26,487,787
Effect of dilutive stock options, stock appreciations rights,
restricted stock and deferred stock units (Note 2) 173,223 158,013
---------- ----------
Weighted average number of common shares
and dilutive potential common stock used in dilutive EPS 26,917,811 26,645,800
========== ==========
5. SEGMENT REPORTING
The Company has principally three operating segments: rehabilitation;
tunneling; and Tite Liner(R), the Company's corrosion and abrasion segment
("Tite Liner"). The segments were determined based upon the types of
products and services 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 making internal operating decisions. The Company evaluates
performance based on stand-alone operating income.
Financial information by segment is as follows (in thousands):
THREE MONTHS ENDED MARCH 31,
----------------------------
2005 2004
-------- ---------
Revenues:
Rehabilitation $105,228 $ 95,629
Tunneling 23,949 26,050
Tite Liner(R) 7,100 6,235
-------- --------
Total revenues $136,277 $127,914
======== ========
Gross profit:
Rehabilitation $ 23,807 $ 20,305
Tunneling 265 2,946
Tite Liner(R) 2,027 2,116
-------- --------
Total gross profit $ 26,099 $ 25,367
======== ========
Operating income (loss):
Rehabilitation $ 5,122 $ 1,727
Tunneling (3,399) 496
Tite Liner(R) 918 1,152
-------- --------
Total operating income $ 2,641 $ 3,375
======== ========
The tunneling segment's results include the continuation of projects that
encountered unfavorable gross margin developments in the fourth quarter of
2004, along with production delays and productivity issues that occurred
in the first quarter of 2005.
8
The following summarizes revenues, gross profit and operating income by
geographic region ($ in thousands):
THREE MONTHS ENDED
MARCH 31,
2005 2004
--------- ---------
Revenues:
United States $ 109,032 $ 104,438
Canada 6,524 5,858
Europe 20,328 17,479
Other Foreign 393 139
--------- ---------
Total Revenues $ 136,277 $ 127,914
========= =========
Gross Profit:
United States $ 19,055 $ 19,380
Canada 2,033 1,837
Europe 4,904 4,114
Other Foreign 107 36
--------- ---------
Total Gross Profit $ 26,099 $ 25,367
========= =========
Operating income (loss):
United States $ 1,610 $ 2,626
Canada 936 763
Europe 166 30
Other Foreign (71) (44)
--------- ---------
Total Operating Income $ 2,641 $ 3,375
========= =========
6. ACQUIRED INTANGIBLE ASSETS
Acquired intangible assets include patents, license agreements,
non-compete agreements, and customer relationships.
9
Intangible assets at March 31, 2005 and December 31, 2004 were as follows
(in thousands):
AS OF MARCH 31, 2005
--------------------------------------------------
GROSS CARRYING ACCUMULATED NET CARRYING
AMOUNT AMORTIZATION AMOUNT
-------------- ------------ ------------
Amortized intangible assets:
Patents and trademarks $ 13,943 $ (12,744) $ 1,199
License agreements 4,803 (2,400) 2,403
Non-compete agreements 4,737 (3,438) 1,299
Customer relationships 1,797 (181) 1,616
-------- --------- --------
Total $ 25,280 $ (18,763) $ 6,517
======== ========= ========
AS OF DECEMBER 31, 2004
--------------------------------------------------
GROSS CARRYING ACCUMULATED NET CARRYING
AMOUNT AMORTIZATION AMOUNT
-------------- ------------ ------------
Amortized intangible assets:
Patents and trademarks $ 13,943 $ (12,646) $ 1,297
License agreements 4,803 (2,340) 2,463
Non-compete agreements 4,737 (3,287) 1,450
Customer relationships 1,797 (151) 1,646
-------- --------- --------
Total $ 25,280 $ (18,424) $ 6,856
======== ========= ========
Amortization expense for the three months ended March 31, 2005 and 2004
and estimated amortization expense for the next five years are as follows
($ in thousands):
FOR THE THREE MONTHS
ENDED MARCH 31,
-----------------------
2005 2004
-------- -------
Aggregate amortization expense $ 423 $ 606
Estimated amortization expense:
For year ending December 31, 2005 $ 1,371
For year ending December 31, 2006 1,127
For year ending December 31, 2007 700
For year ending December 31, 2008 440
For year ending December 31, 2009 332
7. COMMITMENTS AND CONTINGENCIES
Litigation
In the third quarter of 2002, an accident on an Insituform CIPP Process
project in Des Moines, Iowa resulted in the death of two workers and the
injury of five workers. 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 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 appealed the decision of the Employment Appeal Board to the
Iowa District Court for Polk County, which, in the first quarter of 2005,
reduced the penalties back to $158,000. We continue to vigorously oppose
the citations and, in connection therewith, filed a notice of appeal with
the Iowa Supreme Court in April 2005.
In July 2004, three separate civil actions were filed in the Iowa district
court of 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, named the Company, Insituform Technologies USA, Inc. (a wholly
owned subsidiary of the Company), 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,
named the City of Des Moines and the 15 current or former employees of the
Company as defendants, but did not name the Company or Insituform
Technologies USA, Inc. as defendants. The complaints filed
10
with respect to Messrs. Burford and Grasshoff alleged wrongful death,
negligence, gross negligence and civil conspiracy. The complaint filed
with respect to Messrs. Walkenhorst and Johnson alleged gross negligence
and civil conspiracy. The Company believes that the allegations in each of
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 sought
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, seeking unspecified damages. The suit alleges, among other
things, that Kinsel failed to pay EIG monies due under a subcontractor
agreement. 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 work required of it under the subcontract. In June
2004, EIG amended its complaint to add the Company as an additional
defendant and included a claim for lost opportunity damages. In December
2004, the Company and Kinsel filed Third-Party Petitions against the City
of Pasadena, Texas, on the one hand, and Greystar-EIG, LP, Grey General
Partner, LLC and Environmental Infrastructure Management, LLC
(collectively, the "Greystar Entities"), on the other hand. The original
petition filed by EIG against Kinsel seeks damages for funds that EIG
claims should have been paid to EIG on the new 14.0 MGD Vince Bayou
Wastewater Treatment Plant built for the City of Pasadena. Kinsel's
Third-Party Petition against the City of Pasadena seeks approximately $1.4
million in damages to the extent EIG's claims against Kinsel have merit
and were appropriately requested. The Third-Party Petition against the
Greystar Entities seeks damages based upon fraudulent conveyance, alter
ego and single business enterprise (the Greystar Entities are the
successors-in-interest to all or substantially all of the assets of EIG,
now believed to be defunct). Following the filing of the Third-Party
Petitions, the City of Pasadena filed a Motion to Dismiss based upon lack
of jurisdiction claiming they are protected by sovereign immunity. The
trial court denied the City's Motion and the suit has been stayed pending
appeal of the City of Pasadena's motion, presently pending in the Corpus
Christi Court of Appeals. 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. During the first quarter of
2005, the Company, in accordance with its agreement with the client,
inspected the lines. During the course of such inspection, it was
determined that one segment of the liner had failed (the segment that
failed was the segment that was not removed and reinstalled in early
2004). The Company currently is working with the client and the client's
engineer to formulate a plan for the repair of the failed segment. As of
March 31, 2005, the Company had adequately reserved for any potential
replacement costs in connection with such failure, when taking into
account existing insurance coverage.
The Company has a "Contractor Rework" special endorsement to its primary
comprehensive general liability insurance policy. The Company filed a
claim with its primary insurance carrier relative to rework of the Boston
project. The carrier has paid the Company the primary coverage of $1
million, less a $250,000 deductible, in satisfaction of its obligations
under the policy.
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.
In March 2004, the Company filed a lawsuit in Massachusetts against its
excess insurance carrier for such carrier's failure to acknowledge
coverage and to indemnify the Company for the entire loss in excess of the
primary coverage. The excess insurance carrier filed an answer in
response. In March 2005, the Court granted the Company's motion for
summary judgment, concluding that the Company's policy with its excess
insurance carrier provided coverage for costs associated with the rework
of the Boston project in excess of the primary comprehensive general
liability insurance policy. The excess insurance carrier has filed a
motion for reconsideration of the Court's order, and the Company has filed
a motion opposing the excess insurance carrier's motion for
reconsideration.
The Company believes that any costs incurred by the Company in connection
with the repair/replacement of the entire 5,400-foot liner will be subject
to the excess insurance carrier coverage. As of March 31, 2005, the
Company had not recognized any of the potential excess carrier insurance
recovery.
Other Litigation
The Company is involved in certain other 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 other
litigation will have a material adverse effect on its consolidated
financial condition, results of operations or cash flows.
11
Guarantees
The Company has entered into several contractual joint ventures in order
to develop joint bids on contracts for its installation business 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 were unable to complete its portion. The Company would be 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 surety against losses from
third party claims of 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 surety. 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
March 31, 2005 on its consolidated balance sheet.
8. FINANCINGS
On March 16, 2005, the Series A Senior Note holders and the Series 2003-A
Senior Note holders amended the debt covenants under the Series A and the
Series 2003-A Senior Notes. The bank also agreed to incorporate the
amended debt covenants of the Series A Senior Notes and the Series 2003-A
Senior Notes into the credit facility. The Company expects to maintain
covenant compliance with respect to the amended covenants throughout 2005
and beyond.
Effective March 16, 2005, the Company agreed to increase the interest rate
on the Series A Senior Notes from 7.88% per annum to 8.88% per annum and
to increase the interest rate on the Series 2003-A Senior Notes from 5.29%
per annum to 6.54% per annum, to obtain the less restrictive financial
covenants and waivers of defaults that existed prior to that date. The
Company also paid its creditors approximately $260,000 in fees to obtain
the waivers and amendments. The table below sets forth the new covenants,
which were effective on March 16, 2005:
12
DESCRIPTION OF COVENANT FISCAL QUARTER AMENDED COVENANT(2, 3) ACTUAL RATIO(2)
- ------------------------------------- ----------------------- ----------------------------- --------------
$110 MILLION 8.88% SENIOR NOTES,
SERIES A, DUE FEBRUARY 14, 2007 AND
$65 MILLION 6.54% SENIOR NOTES,
SERIES 2003-A, DUE APRIL 24, 2013
Fixed charge coverage ratio(1) First quarter 2005 No less than 1.25 to 1.0 1.64
Second quarter 2005 No less than 1.25 to 1.0 n/a
Third quarter 2005 No less than 1.50 to 1.0 n/a
Fourth quarter 2005 No less than 1.75 to 1.0 n/a
First quarter 2006 No less than 2.00 to 1.0 n/a
Ratio of consolidated indebtedness to First quarter 2005 No greater than 4.25 to 1.0 3.50
EBITDA(1) Second quarter 2005 No greater than 4.00 to 1.0 n/a
Third quarter 2005 No greater than 4.00 to 1.0 n/a
Fourth quarter 2005 No greater than 3.00 to 1.0 n/a
First quarter 2006 No greater than 3.00 to 1.0 n/a
Consolidated net worth(1) First quarter 2005 and No less than $260.2 million(4) $290.1
each quarter thereafter
Consolidated indebtedness to First quarter 2005 and No greater than 0.45 to 1.0 0.29
consolidated capitalization(1) each quarter thereafter
- ----------
(1) The ratios are calculated as defined in the Note Purchase
Agreements, as amended, which have been incorporated into the
Company's Annual Report on Form 10-K for the year ended December 31,
2004 as exhibits 10.2 and 10.3.
(2) The ratios for each quarter are based on rolling four-quarter
calculations of profitability. The loss in the fourth quarter of
2004 will have a negative impact on the ratios through the third
quarter of 2005.
(3) The line of credit facility with Bank of America has incorporated
the amended covenants for the Series A Senior Notes and the Series
2003-A Senior Notes into the line of credit agreement. In addition,
the bank requires that the Company maintain a minimum cash balance
of $50 million on a consolidated basis at all times.
(4) Minimum consolidated net worth is $260.0 million plus 50% of net
income after December 31, 2004 on a cumulative basis.
9. NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123 (R), "Share-Based Payment."
This Statement revises the measurement, valuation and recognition of
financial accounting and reporting standards for stock-based employee
compensation plans contained in SFAS No. 123, "Accounting for Stock-Based
Compensation." The new rules require companies to expense the value of
employee stock options and similar share-based compensation awards based
on fair value recognition provisions. The new principles become effective
for the Company in the first quarter of 2006. The adoption of SFAS 123 (R)
by the Company on January 1, 2006 will cause the Company to expense the
fair value of its employee stock options, the impact of which is currently
disclosed in its financial statements on a pro-forma basis. While an
assessment of the effects of SFAS 123(R) has not been completed, the
Company disclosed after tax equity-based compensation expense of $2.1
million in 2004 and $3.3 million in 2003, on a pro-forma basis.
13
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 our financial condition, results of operations and
cash flows during the periods included in the accompanying unaudited
consolidated financial statements. This discussion should be read in conjunction
with the consolidated financial statements and notes included in our Annual
Report on Form 10-K for the year ended December 31, 2004 ("2004 Annual Report").
See discussion of our critical accounting policies in our 2004 Annual Report;
there have been no changes to these policies during the first quarter of 2005.
FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains various forward-looking statements
(as such term is defined in the Private Securities Litigation Reform Act of
1995) that are based on information currently available to the management of
Insituform Technologies, Inc. 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. Our actual results may vary materially from
those anticipated, estimated or projected due to a number of factors, such as
the competitive environment for our products and services, the availability of
raw materials used in the Insituform(R) cured-in-place-pipe ("CIPP") process,
increased competition upon expiration of our patents or the inadequacy of one or
more of our CIPP process patents to protect our operations, the geographical
distribution and mix of our work, our ability to attract business at acceptable
margins, foreseeable and unforeseeable issues in projects that make it difficult
or impossible to meet projected margins, the timely award or cancellation of
projects, political circumstances impeding the progress of work, our ability to
remain in compliance with the financial covenants included in our financing
documents, the regulatory environment, the outcome of our pending litigation and
other factors set forth in reports and other documents filed by us with the
Securities and Exchange Commission from time to time. We do not assume a duty to
update forward-looking statements. Please use caution and do not place reliance
on forward-looking statements.
EXECUTIVE SUMMARY
Insituform Technologies is a worldwide company specializing in trenchless
technologies to rehabilitate, replace, maintain and install underground pipes.
We have three principal operating segments: rehabilitation, tunneling and Tite
Liner(R). These segments have been determined based on the types
of products sold, and each is reviewed and evaluated separately. While we use a
variety of trenchless technologies, the CIPP process contributed 69.4% of our
revenues in the first quarter of 2005.
Revenues are generated 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 our single largest market, representing approximately 80.0% of total
revenue in the first quarter of 2005. See Note 5 to the consolidated financial
statements for additional segment information and disclosures.
RESULTS OF OPERATIONS - Three Months Ended March 31, 2005 and 2004
Key financial data for the first quarter of 2005 compared to the first quarter
of 2004 is as follows (dollars in thousands):
THREE MONTHS ENDED MARCH 31, 2005
---------------------------------------------------------------------------
GROSS OPERATING
GROSS PROFIT OPERATING OPERATING INCOME (LOSS)
SEGMENT REVENUES PROFIT MARGIN EXPENSE INCOME/(LOSS) PERCENTAGE
--------- ------- ------ --------- ------------ ------------
Rehabilitation $ 105,228 $23,807 22.6% $ 18,685 $ 5,122 4.9%
Tunneling 23,949 265 1.1 3,664 (3,399) (14.2)
Tite Liner(R) 7,100 2,027 28.5 1,109 918 12.9
--------- ------- ---- -------- ------- -----
TOTAL $ 136,277 $26,099 19.2% $ 23,458 $ 2,641 1.9%
========= ======= ==== ======== ======= =====
14
THREE MONTHS ENDED MARCH 31, 2004
GROSS OPERATING
GROSS PROFIT OPERATING OPERATING INCOME
SEGMENT REVENUES PROFIT MARGIN EXPENSE INCOME PERCENTAGE
--------- ------- ------ --------- --------- ----------
Rehabilitation $ 95,629 $20,305 21.2% $ 18,578 $ 1,727 1.8%
Tunneling 26,050 2,946 11.3 2,450 496 1.9
Tite Liner 6,235 2,116 33.9 964 1,152 18.5
--------- ------- ---- -------- ------- ----
TOTAL $ 127,914 $25,367 19.8% $ 21,992 $ 3,375 2.6%
========= ======= ==== ======== ======= ====
The following table summarizes the increases (decreases) in key financial data
for the three months ended March 31, 2005 as compared with the same period
in 2004 ($ in thousands):
THREE MONTHS ENDED
MARCH 31, 2005 VS. 2004
--------------------------
TOTAL PERCENTAGE
INCREASE INCREASE
(DECREASE) (DECREASE)
---------- ----------
ALL SEGMENTS
Revenues $ 8,363 6.5%
Gross profit 732 2.9
Operating expenses 1,466 6.7
Operating income (734) (21.7)
REHABILITATION
Revenues 9,599 10.0
Gross profit 3,502 17.2
Operating expenses 107 0.6
Operating income 3,395 196.6
TUNNELING
Revenues (2,101) (8.1)
Gross profit (2,681) (91.0)
Operating expenses 1,214 49.6
Operating income (3,895) (785.3)
TITE LINER
Revenues 865 13.9
Gross profit (89) (4.2)
Operating expenses 145 15.0
Operating income (234) (20.3)
INTEREST EXPENSE
AND TAXES
Interest expense (292) (13.5)
Taxes on income (142) (33.4)
15
OVERVIEW
Lower earnings in the first quarter of 2005 compared to 2004 are primarily due
to the challenges experienced in our tunneling business. Unfavorable gross
margin adjustments made on a number of projects in the fourth quarter of 2004
continued to impact tunneling's performance in the first quarter of 2005.
Partially offsetting tunneling's unfavorable results is improvement in the
rehabilitation segment. Rehabilitation gross margin percentages improved to
22.6% in the first quarter of 2005 compared to 21.2% in the first quarter of
2004. TiteLiner(R) experienced a marginal decrease in gross profit, but overall,
remained sound with a 28.5% gross profit margin in the first quarter of 2005.
REHABILITATION SEGMENT
Revenues
Revenue growth in most North American and European regions added $11.3 million
in the first quarter of 2005 compared to the first quarter of 2004. North
American revenues increased primarily due to higher backlog levels achieved in
late 2004 and crew expansion to accommodate higher backlog. In addition, in the
first quarter of last year, a number of crews were diverted to perform
remediation work on a project in Boston, Massachusetts, causing revenues to be
lower in that period. European revenues were particularly driven by revenues in
the United Kingdom and the Netherlands, which benefited from solid backlog
obtained in late 2004. These increases were partially offset by $1.8 million of
decreases primarily due to severe weather in certain North American and European
regions.
Gross Profit
Rehabilitation gross profit increased in the first quarter of 2005 compared to
the first quarter of 2004 due primarily to higher revenues, stronger performance
in several North American and European regions, greater efficiencies in the
manufacturing operations, and reduced volume in lower-margin pipebursting. Gross
profit percentages also improved to 22.6% in the first quarter of 2005 compared
to 21.2% in the first quarter of 2004. Offsetting gross margin improvement were
the effects of significant increases in commodity prices, particularly resin, in
the first quarter of 2005 compared to the same period last year. Certain North
American and European regions added $6.3 million in gross profit in the first
quarter of 2005 compared to the first quarter of 2004. Gross profit in a few
other North American and European regions fell by $2.7 million primarily due to
poor weather conditions. Manufacturing operations experienced significant
improvement in margins due to efficiencies gained through facility
modifications, upgrades and expansion that were undertaken in 2003 and 2004.
European gross profit improvement was due to strong performance in the United
Kingdom, France and the Netherlands. Due to higher backlog levels obtained in
late 2004, there were no idle crews in these European regions, resulting in
greater crew efficiency.
Gross margins in the rehabilitation business are expected to continue to
benefit from the efficiencies gained in the manufacturing operation and the
logistical enhancements to our distribution activities.
Operating Expenses
Rehabilitation operating expenses were relatively stable in the first quarter of
2005 compared to 2004. However, operating expenses as a percentage of revenue
declined to 17.8% in the first quarter of 2005 compared to 19.4% in the first
quarter of 2004.
Operating expenses are expected to be only marginally higher in 2005 compared to
2004. However, operating expenses as a percentage of revenue are expected to
decrease in 2005 compared to 2004, as demonstrated in the first quarter of 2005.
TUNNELING SEGMENT
Given the challenges in the tunneling division, we currently anticipate modest
operating losses in the operation through the end of 2005 as the segment
continues to work its lower-margin projects towards completion. Management
continues to focus on tunneling to return the operation to profitability.
Specifically, management is focusing on the following issues:
- Conservative and selective bidding
- Strategic and planned reduction of expensive excess tunneling
equipment
- Reduction in unproductive overhead
- Claims management
- Rigorous cost control and production monitoring systems
16
Management believes that these steps are important to return the operation to
its historic levels of profitability.
Revenues
Tunneling revenues declined in the first quarter of 2005 compared to the first
quarter of 2004 due to backlog depletion during the quarter. In the first
quarter of 2005, we were engaged in a thorough review of tunneling and did not
aggressively bid projects. The Company has also been more selective in bidding
work in order to win margins acceptable to the Company.
Gross Profit
Tunneling's gross profit and gross profit margin decreased significantly due to
continuation of projects that encountered unfavorable gross margin developments
in the fourth quarter of 2004. In addition, production delays and productivity
issues also unfavorably influenced gross profit. Partially offsetting the
unfavorable experience was the recognition of $0.7 million in contract claims
receivable, which related to additional costs incurred on past work due to
unanticipated site conditions or costs.
Operating Expenses
Operating expenses were higher in the first quarter of 2005 compared to the
first quarter of 2004 due to increased headcount, particularly staff to improve
cost control and project management. Corporate expenses allocated to the
tunneling business increased due to additional senior management time spent on
tunneling matters, additional technology costs related to systems initiatives,
legal and professional costs related to claims and additional audit costs.
TITE LINER(R) SEGMENT
Revenues
Tite Liner(R) revenues were higher in the first quarter of 2005 compared to the
first quarter of 2004 due to growth in all regions. In the first quarter of 2005
compared to the same period in 2004, revenues in U.S. and Canadian operations
increased $0.7 million, while revenues in South America increased $0.2 million.
Gross Profit
Gross profit experienced a marginal decline in the first quarter of 2005
compared to the first quarter of 2004 due to the favorable closeout of a foreign
project in the first quarter of 2004, which provided a benefit to that period's
gross profit. Gross profit percentages were 28.5% and 33.9% in the first quarter
of 2005 and 2004, respectively.
Operating Expenses
First quarter 2005 and 2004 comparative operating expenses were relatively
stable. Operating expenses as a percentage of revenue were also flat at 15.6%
and 15.5% in the first quarter of 2005 and 2004, respectively.
INTEREST EXPENSE
Interest expense declined approximately $0.3 million in the first quarter of
2005 compared to the first quarter of 2004 due to the following factors:
IMPACT IN
2005
---------
Debt principal amortization - Series A Notes $ (300)
Increased rates due to debt amendments on March 12, 2004 200
Deferred fee writeoffs due to debt amendments in 2004 (226)
Euro note interest in 2004 (60)
Lower interest income 78
Other 16
-------
Total $ (292)
=======
TAXES ON INCOME
Taxes on income decreased in the first quarter of 2005 compared to the first
quarter of 2004 due to an effective tax rate of 34.9% on lower pre-tax income in
the first quarter of 2005 compared to 40.8% in the first quarter of 2004. The
utilization of net operating loss carryforwards by certain foreign operations
has primarily caused the lower effective tax rate in the first quarter of 2005
compared to the same period in 2004.
17
CONTRACT BACKLOG
MARCH 31, DECEMBER 31,
BACKLOG 2005 2004
- ------- --------- ------------
(in millions)
Rehabilitation 181.4 190.4
Tunneling 99.5 129.3
Tite Liner(R) 13.2 8.6
----- -----
Total 294.1 328.3
===== =====
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 contract amounts for
which there is not specific and determinable work released and projects where we
have been advised that we are the low bidder, but not formally awarded the
contract.
Contract backlog in rehabilitation declined slightly due principally to
increased revenue at the end of the first quarter of 2005 and due to the timing
of awards. Contract backlog in tunneling decreased primarily due to a more
selective bidding process.
LIQUIDITY AND CAPITAL RESOURCES
CASH AND EQUIVALENTS
MARCH 31, 2005 DECEMBER 31, 2004
-------------- -----------------
(in millions)
Cash and cash equivalents $ 55.5 $ 93.2
Cash restricted - in escrow 1.8 1.7
-------- -------
Total $ 57.3 $ 94.9
======== =======
Cash Flows from Operating Activities
Cash used in operating activities in the first quarter of 2005 includes
increases in working capital, including accounts receivable and inventories.
Stronger activity late in the first quarter of 2005 caused significant billings,
increasing accounts receivable. Accounts receivable increased $14.6 million over
the balance at December 31, 2004. Inventories, primarily CIPP tube inventories,
increased $2.8 million as the manufacturing operations produced record volume of
tube late in the quarter to accommodate anticipated activity beginning in the
second quarter of 2005. Depreciation increased marginally in the first quarter
of 2005 due to the higher level of fixed assets compared to the same period last
year, but amortization declined due to certain intangible assets acquired with
Insituform East, Inc. becoming fully amortized during 2004. Cash provided by
operating activities in the first quarter of 2004 was due primarily to the $9.1
million received in tax refunds in that period.
Strong billing activity in March, resulting in a significant increase in working
capital at March 31, 2005, should result in increased collections in the second
and third quarters of 2005. In addition, increased manufacturing activity late
in the first quarter was undertaken in anticipation of increased CIPP production
beginning in the second quarter of 2005.
Cash Flows from Investing Activities
Investing activities in the first quarter of 2005 were composed primarily of
$7.6 million of capital expenditures compared to $7.7 million of capital
expenditures in the first quarter of 2004. Capital expenditures include
investments in equipment for our developing steam-inversion process, replacement
of older equipment, and other new equipment to accommodate our revenue growth
and crew expansion. This trend is expected to continue through the end of 2005.
Cash Flows from Financing Activities
Cash flows used in the first quarter of 2005 by financing activities were
primarily comprised of a normal debt amortization payment of $15.7 million and
$0.3 million of capitalized financing fees. In the first quarter of 2004, our
normal debt amortization payment of $15.7 million was partially offset by $2.7
million received from the exercise of stock options, primarily by former
executives, and the release of $4.6 million of restricted cash held as
collateral for certain debt agreements at December 31, 2003.
18
MATERIAL CHANGES IN FINANCIAL CONDITION
In addition to cash, described in the previous paragraphs, the following balance
sheet accounts experienced significant changes in the first quarter of 2005:
Accounts Receivable
Accounts receivable increased $14.6 million at March 31, 2005 compared to
December 31, 2004 due to increased activity late in the quarter, leading to
strong billings in March 2005. Receivables over sixty days old, however,
decreased, reflecting our focus on cash collections.
Inventories
Inventories increased $2.8 million at March 31, 2005 compared to December 31,
2004 due to buildup of CIPP tube inventories. Our manufacturing facility in
Batesville, Mississippi experienced record production of tube in March to
accommodate anticipated stronger activity beginning in the second quarter of
2005.
Long-term Debt
Long-term debt decreased $15.7 million at March 31, 2005 compared to December
31, 2004 due to the scheduled amortization payment on our Series A Senior Notes
during the first quarter of 2005.
FINANCINGS
See discussion in Note 8 to the consolidated financial statements contained in
this report regarding our financings and debt covenant compliance.
We believe we have 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 borrowing and the sale of assets,
for the next 12 months.
DISCLOSURE OF FINANCIAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
We have entered into various financial obligations and commitments in the course
of our ongoing operations and financing strategies. Financial obligations are
considered to represent known future cash payments that we are 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 our
company, which become payable only if certain pre-defined events were to occur,
such as funding financial guarantees. See Note 7 to the consolidated financial
statements contained in this report for further discussion.
The following table provides a summary of our financial obligations and
commercial commitments as of March 31, 2005 (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)(3) TOTAL 2005 2006 2007 2008 2009 THEREAFTER
- ---------------------- ----- ---- ---- ---- ---- ---- ----------
Long-term debt $ 96,545 $ 40 $15,795 $15,710 $ - $ - $65,000
Interest on long-term
debt 40,158 5,484 6,344 4,949 4,251 4,251 14,879
Line of credit
facility(2) - - - - - - -
Operating leases 41,126 10,591 9,855 8,257 7,036 3,456 1,931
-------- ------- ------- ------- -------- ------ -------
Total contractual cash
obligations $177,829 $16,115 $31,994 $28,916 $ 11,287 $7,707 $81,810
======== ======= ======= ======= ======== ====== =======
- ----------
(1) Cash obligations are not discounted. See Notes 7 and 8 to the consolidated
financial statements regarding commitments and contingencies and
financings, respectively.
19
(2) As of March 31, 2005, there was no borrowing balance on the $25.0 million
credit facility and, therefore, there was no applicable interest rate as
the rates are determined on the borrowing date. The available balance was
$13.0 million, and the commitment fee was 0.40%. The remaining $12.0
million was used for non-interest bearing letters of credit, all of which
were collateral for insurance. We generally use the credit facility for
short-term borrowings and disclose amounts outstanding as a current
liability.
(3) A resin supply contract with one of our vendors is excluded from this
table. See "Market Risk - Commodity Risk" under Item 3 of this report for
further discussion.
OFF-BALANCE SHEET ARRANGEMENTS
We use 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. Our future
commitments under operating lease arrangements were $41.1 million at March 31,
2005. We also have exposure under performance guarantees by contractual joint
ventures and indemnification of the surety. However, we have never experienced
any material adverse effects to our consolidated financial position, results of
operations or cash flows relative to these arrangements. All foreign joint
ventures are accounted for using the equity method. We have no other off-balance
sheet financing arrangements or commitments. See Note 7 to consolidated
financial statements regarding commitments and contingencies.
NEW ACCOUNTING PRONOUNCEMENTS
For discussion of new accounting pronouncements see Note 9 to the consolidated
financial statements contained in this report.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
We are exposed to the effect of interest rate changes, foreign currency and
commodity price fluctuations. Due to the immateriality of potential impacts from
changes in these rates, we do 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
March 31, 2005 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.
Our 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, we maintain fixed rate debt. The
fair value of our long-term debt, including current maturities and the amount
outstanding on the line of credit facility, approximated its carrying value at
March 31, 2005. Market risk was estimated to be $1.3 million as the potential
increase in fair value resulting from a hypothetical 10% decrease in our debt
specific borrowing rates at March 31, 2005.
FOREIGN EXCHANGE RISK
We operate subsidiaries, and are 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. Exchange rate
fluctuations do impact our cash balances denominated in foreign currencies. For
the first quarter of 2005, there was an unfavorable unrealized impact of $1.2
million on our cash balances of approximately $39.9 million which are primarily
denominated in Canadian dollars and Western European currencies.
20
COMMODITY RISK
We have exposure to the effect of changes in commodity pricing related to a
variety of raw materials and activities that we purchase and utilize in our
operating activities, including resin, fiber, pipe and fuel. During 2004 and the
first quarter of 2005, we experienced increases in costs related to unfavorable
changes in commodity prices. We manage this risk by entering into agreements
with suppliers, when possible, to reduce the effects of fluctuations in the
underlying commodity markets.
We entered into a resin supply contract effective March 29, 2005, for the
purchase and sale of certain resins we use in our North American operations. The
contract provides for the exclusive sale of these commodities by the vendor to
us or to third parties that we designate. The contract has an initial term from
March 29, 2005 until December 31, 2007, which term shall renew for succeeding
12-month periods until the contract is terminated by either party upon 180-days'
prior written notice to the other party.
ITEM 4. CONTROLS AND PROCEDURES
Our Company's management, with the participation of the chief executive officer
and chief financial officer, has conducted an evaluation of the effectiveness of
our disclosure controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)) as of March 31, 2005. Based on this evaluation, the
chief executive officer and chief financial officer have concluded that our
disclosure controls were effective at March 31, 2005.
We maintain internal controls and procedures designed to ensure that we are able
to collect the information subject to required disclosure in reports we file
with the United States Securities and Exchange Commission, and to process,
summarize and disclose this information within the time specified by the rules
set forth by the Securities and Exchange Commission.
There were changes in our internal control over financial reporting that
occurred during the quarter ended March 31, 2005 that materially affected, or
are reasonably likely to affect, the Company's internal control over financial
reporting.
During the first quarter of 2005, enhancements of internal control took place,
specifically in the tunneling segment, as follows:
- enhanced monthly project status review procedures and reporting;
- increased supervisory and management reviews of project risks and
controls; and
- improved procedures concerning bid selection and risk mitigation
processes.
21
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the third quarter of 2002, an accident on an Insituform CIPP Process project
in Des Moines, Iowa resulted in the death of two workers and the injury of five
workers. We 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. We challenged Iowa OSHA's findings, and in the fourth
quarter of 2003, an 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.
We appealed the decision of the Employment Appeal Board to the Iowa District
Court for Polk County, which, in the first quarter of 2005, reduced the
penalties back to $158,000. We continue to vigorously oppose the citations and,
in connection therewith, filed a notice of appeal with the Iowa Supreme Court in
April 2005.
In July 2004, three separate civil actions were filed in the Iowa district court
of 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, named
Insituform Technologies, Inc., Insituform Technologies USA, Inc. (a wholly owned
subsidiary of our company), the City of Des Moines and 15 current or former
employees of our 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, named the City of Des Moines
and the 15 current or former employees of our company as defendants, but did not
name Insituform Technologies, Inc. or Insituform Technologies USA, Inc. as
defendants. The complaints filed with respect to Messrs. Burford and Grasshoff
alleged wrongful death, negligence, gross negligence and civil conspiracy. The
complaint filed with respect to Messrs. Walkenhorst and Johnson alleged gross
negligence and civil conspiracy. We believe that the allegations in each of 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. We intend to vigorously defend the
actions. Each complaint seeks unspecified damages, including punitive damages.
We are involved in certain other litigation incidental to the conduct of our
business and affairs. Management, after consultation with legal counsel, does
not believe that the outcome of any such other litigation will have a material
adverse effect on our consolidated financial condition, results of operations or
cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At our Annual Meeting of Stockholders held on Wednesday, April 27, 2005, the
following matters were voted upon:
1. Election of eight directors, each to serve a one-year term or until his or
her successor has been elected and qualified:
NAME FOR WITHHELD
- --------------------- ---------- --------
Paul A. Biddelman 23,522,005 591,006
Stephen P. Cortinovis 23,750,103 362,908
John P. Dubinsky 23,750,993 362,018
Juanita H. Hinshaw 23,749,950 363,061
Alfred T. McNeill 23,751,362 361,649
Thomas S. Rooney, Jr. 23,520,064 592,947
Sheldon Weinig 23,520,901 592,110
Alfred L. Woods 23,749,909 363,102
2. Approval of the Amendment to the Restated Certificate of Incorporation:
FOR AGAINST ABSTAIN
- ---------- ------- -------
23,217,697 854,988 40,326
22
3. Ratification of the appointment of PricewaterhouseCoopers LLP as
independent auditors for the fiscal year ending December 31, 2005:
FOR AGAINST ABSTAIN
- ---------- ------- -------
23,366,223 734,905 11,883
ITEM 6. EXHIBITS
The exhibits required to be filed as part of this Quarterly Report on Form 10-Q
are listed on the Index to Exhibits attached hereto.
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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.
May 10, 2005 /s/ Christian G. Farman
-------------------------------------------------
Christian G. Farman
Senior Vice President and Chief Financial Officer
Principal Financial and Accounting Officer
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INDEX TO EXHIBITS
3.1(a) Restated Certificate of Incorporation, as amended, of the Company
(incorporated by reference to Exhibit 3.1 to the quarterly report on
Form 10-Q for the quarter ended June 30, 2000), and Certificate of
Designation, Preferences and Rights of Series A Junior Participating
Preferred Stock (incorporated by reference to Exhibit 3.1 to the
annual report on Form 10-K for the year ended December 31, 2001).
3.1(b) Certificate of Amendment of Restated Certificate of Incorporation,
as amended, of the Company, dated April 27, 2005, filed herewith.
31.1 Certification of Thomas S. Rooney, Jr. pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002, filed herewith.
31.2 Certification of Christian G. Farman pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002, filed herewith.
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, filed herewith.
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, filed herewith.
25