UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period From ____________TO _____________
COMMISSION FILE NUMBER 001-10651
-----------
MAVERICK TUBE CORPORATION
16401 Swingley Ridge Road
Seventh Floor
Chesterfield, Missouri 63017
(636) 733-1600
State or other jurisdiction of incorporation or organization - Delaware
I.R.S. Employee Identification No. - 43-1455766
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 XX No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes XX No --
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $0.01 Par Value - 42,500,905 shares as of August 3, 2004
- --------------------------------------------------------------------------------
MAVERICK TUBE CORPORATION AND SUBSIDIARIES
INDEX
- --------------------------------------------------------------------------------
PAGE NO.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited) 3
Condensed Consolidated Balance Sheets - June 30, 2004
and December 31, 2003 3
Condensed Consolidated Statements of Income - Three
and Six Months Ended June 30, 2004 and 2003 4
Condensed Consolidated Statements of Cash Flows - Six
Months Ended June 30, 2004 and 2003 5
Notes to Condensed Consolidated Financial Statements 7
Report of Independent Registered Public Accounting Firm 15
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk 29
Item 4. Controls and Procedures 30
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 31
Item 6. Exhibits and Reports on Form 8-K 32
SIGNATURES 33
EXHIBIT INDEX 34
2
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MAVERICK TUBE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
- --------------------------------------------------------------------------------
June 30, December 31,
2004 2003
(Unaudited)
-------------------------
ASSETS
Current assets:
Cash and cash equivalents.......................... $37,456 $29,202
Accounts receivable, less allowances of $7,620
and $5,414 on June 30, 2004 and December 31,
2003, respectively.............................. 163,298 117,115
Inventories........................................ 268,892 184,025
Deferred income taxes.............................. 6,363 5,534
Income taxes refundable............................ 1,739 590
Prepaid expenses and other current assets.......... 7,066 6,267
-------------------------
Total current assets................................... 484,814 342,733
Property, plant and equipment, net of accumulated
depreciation of $162,095 and $151,331 on June 30,
2004 and December 31, 2003, respectively........... 195,721 189,434
Goodwill............................................... 85,984 82,982
Other acquired intangibles, net of accumulated
amortization....................................... 34,915 35,304
Note receivable........................................ - 9,500
Other assets........................................... 14,149 10,773
-------------------------
$815,583 $670,726
=========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................... $58,412 $47,557
Accrued expenses and other liabilities............. 40,098 34,391
Deferred revenue................................... 6,270 3,386
Income taxes payable............................... 33,972 203
Current maturities of long-term debt............... 3,407 3,533
-------------------------
Total current liabilities.............................. 142,159 89,070
Long-term debt, less current maturities................ 3,208 4,209
Convertible senior subordinated notes.................. 120,000 120,000
Revolving credit facility.............................. 50,000 50,213
Other liabilities...................................... 15,699 16,436
Deferred income taxes.................................. 9,307 6,000
STOCKHOLDERS' EQUITY
Preferred stock, $0.01 par value per share; 5,000,000
authorized shares; 1 share issued and outstanding.. - -
Common stock, $0.01 par value per share; 80,000,000
authorized shares; 42,455,477 and 42,001,662
shares issued and outstanding at June 30, 2004
and December 31, 2003, respectively................ 425 420
Additional paid-in capital............................. 234,365 227,048
Unamortized value of restricted stock.................. (1,824) -
Retained earnings...................................... 248,930 162,192
Accumulated other comprehensive loss................... (6,686) (4,862)
-------------------------
475,210 384,798
-------------------------
$815,583 $670,726
=========================
See accompanying notes to condensed consolidated financial statements.
3
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MAVERICK TUBE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
- --------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
-------------------------------------------------
Net sales...................... $348,088 $194,925 $659,386 $414,363
Cost of goods sold............. 228,824 179,279 469,582 383,808
-------------------------------------------------
Gross profit................... 119,264 15,646 189,804 30,555
Selling, general and
administrative............... 22,602 11,785 42,243 24,098
-------------------------------------------------
Income from operations......... 96,662 3,861 147,561 6,457
Interest expense............... 2,677 2,207 5,295 4,442
------------------------------------------------
Income before income taxes..... 93,985 1,654 142,266 2,015
Provision for income taxes..... 35,988 591 53,944 710
-------------------------------------------------
Income before cumulative
effect of an accounting
change....................... 57,997 1,063 88,322 1,305
Cumulative effect of an
accounting change (net of
benefit for income taxes of
$951)........................ - - (1,584) -
-------------------------------------------------
Net income..................... $57,997 $1,063 $86,738 $1,305
=================================================
Basic earnings per share
Income before cumulative
effect of an accounting
change..................... $1.37 $0.03 $2.09 $0.03
Cumulative effect of an
accounting change.......... - - (0.04) -
-------------------------------------------------
Net income................... $1.37 $0.03 $2.06 $0.03
=================================================
Diluted earnings per share
Income before cumulative
effect of an accounting
change..................... $1.36 $0.03 $2.08 $0.03
Cumulative effect of an
accounting................. - - (0.04) -
-------------------------------------------------
Net income................... $1.36 $0.03 $2.04 $0.03
=================================================
See accompanying notes to condensed consolidated financial statements.
4
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MAVERICK TUBE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
- --------------------------------------------------------------------------------
Six Months Ended
June 30,
2004 2003
-------------------------
OPERATING ACTIVITIES
Net income............................................. $86,738 $1,305
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Cumulative effect of an accounting change.............. 1,584 -
Depreciation and amortization.......................... 13,109 11,020
Deferred income taxes.................................. 1,718 340
Provision for losses on accounts receivable............ 601 (701)
Gain on sale of equipment.............................. (23) (5)
Changes in operating assets and liabilities,
net of effect of acquisitions:
Accounts receivable................................. (42,630) (16,295)
Inventories......................................... (70,833) 31,321
Prepaid expenses and other current assets........... (127) 1,707
Other assets........................................ (2,536) 450
Accounts payable.................................... 6,563 (45,940)
Accrued expenses and other liabilities.............. 39,233 (1,321)
Deferred revenue.................................... 2,884 6,119
-------------------------
Cash provided (used) by operating activities........... 36,281 (12,000)
INVESTING ACTIVITIES
Cash paid for acquisitions, net of cash received....... (21,633) (3,964)
Expenditures for property, plant and equipment......... (11,659) (8,006)
Proceeds from disposal of equipment.................... 5,589 -
Other.................................................. (34) -
-------------------------
Cash used by investing activities...................... (27,737) (11,970)
FINANCING ACTIVITIES
Net (repayments) borrowings on revolving credit
facility............................................. - (75,860)
Proceeds from convertible senior subordinated notes.... - 120,000
Principal payments on long-term borrowings and notes... (3,423) (1,316)
Deferred debt costs.................................... (348) (4,232)
Proceeds from sale of common stock..................... - 250
Principal payments on long-term note receivable........ 313 1,617
Proceeds from exercise of stock options................ 4,084 -
-------------------------
Cash provided by financing activities.................. 626 40,459
Effect of exchange rate changes on cash................ (916) 649
-------------------------
Increase in cash and cash equivalents.................. 8,254 17,138
Cash and cash equivalents at beginning of period....... 29,202 2,551
-------------------------
Cash and cash equivalents at end of period............. $37,456 $19,689
=========================
5
Supplemental disclosures of cash flow information:
Noncash investing and financing activities:
Net assets consolidated from a cumulative effect
of an accounting change.......................... $11,492 $-
Stock issued for acquisitions...................... $- $12,104
Debt issued for acquisitions....................... $- $5,000
See accompanying notes to condensed consolidated financial statements.
6
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MAVERICK TUBE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
- --------------------------------------------------------------------------------
(1) BASIS OF PRESENTATION
- --------------------------------------------------------------------------------
The unaudited, condensed, consolidated financial statements include the accounts
of Maverick Tube Corporation and its direct and indirect wholly-owned
subsidiaries, collectively referred to as the "Company." All significant
intercompany accounts and transactions have been eliminated. The accompanying
condensed, consolidated financial statements include the financial statements of
Maverick Tube L.P. ("Maverick"), Prudential Steel Ltd. ("Prudential"), Precision
Tube Holding Corporation ("Precision"), Maverick C&P, Inc. doing business as
"Republic Conduit", SeaCAT Corporation ("SeaCAT") since its acquisition on
February 28, 2003 and Pennsylvania Cold Drawn, LLC ("PCD") since its
consolidation on March 31, 2004.
The accompanying unaudited, condensed, consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and notes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring items) considered necessary for a
fair presentation have been included. Operating results for the six months ended
June 30, 2004 are not necessarily indicative of the results that may be expected
for the year ended December 31, 2004. For further information, refer to the
consolidated financial statements and notes thereto included in the Company's
Annual Report in the 2003 Form 10-K.
(2) RECENT ACCOUNTING PRONOUNCMENTS
- --------------------------------------------------------------------------------
In January 2003, the Financial Accounting Standards Board issued Interpretation
No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51," which was revised in December 2003. FIN 46
requires an investor who receives the majority of the expected losses, the
expected residual returns, or both ("primary beneficiary") of a variable
interest entity ("VIE") to consolidate the assets, liabilities and results of
operations of the entity. A VIE is an entity in which the equity investors do
not have a controlling interest or the equity investment at risk is insufficient
to finance the entity's activities without receiving additional subordinated
financial support from other parties.
On March 29, 2002, pursuant to an asset purchase agreement dated March 21, 2002,
the Company completed the sale of the Cold Drawn Tubular Business ("DOM")
business to PCD for $8,115,000, consisting of $1,238,000 cash and the buyer's
nine-year secured promissory note for $6,877,000. In November 2003, the Company
restructured the buyer's promissory note in exchange for the release of its
guarantee of certain payment obligations and obtained additional security
including the buyer's personal guarantee and increased the outstanding note
obligation. As of June 30, 2004, the Company holds three PCD notes receivable
totaling $10,097,000 and accounts receivable of $2,830,000.
During the first quarter of 2004, the Company adopted the provisions of FIN 46
with respect to PCD, which is a VIE as defined under FIN 46. As the Company was
deemed the primary beneficiary, it was required to consolidate PCD as of March
31, 2004. As a result, the Company recognized a non-cash charge of $1,584,000
(net of benefit for income taxes of $951,000), reflecting the cumulative losses
of PCD from the time of the sale on March 29, 2002, as a cumulative effect of an
accounting change in the accompanying Condensed Consolidated Statements of
Income. The third party creditors of PCD have no recourse to the general credit
of the Company.
7
The unaudited pro forma amounts below reflect the retroactive application of FIN
46 as if the Company had adopted the standard on January 1, 2003 and the
corresponding elimination of the cumulative effect of an accounting change (in
thousands, except per share amounts):
Three Months Ended Six Months Ended
June 30, June 30,
2003 2004 2003
-------------------------------------
Net income (loss) (pro forma).............. $460 $88,234 ($171)
Basic earnings per share (pro forma)....... $0.01 $2.09 $0.00
Diluted earnings per share (pro forma)..... $0.01 $2.07 $0.00
The above pro forma results include adjustments to give effect of intercompany
transactions and are not necessarily indicative of the operating results that
would have occurred nor are they necessarily indicative of future operating
results.
(3) BUSINESS ACQUISITIONS
- --------------------------------------------------------------------------------
Texas Arai
On April 23, 2004, Maverick acquired the assets and certain liabilities of Texas
Arai, a subsidiary of Grant Prideco, Inc., a publicly held, Houston based,
oilfield service manufacturer, for a purchase price of $20,033,000 cash (subject
to finalization of the working capital adjustment). The acquisition was
accounted for as a purchase business combination, and the financial statements
of Texas Arai have been consolidated from the acquisition date. The cost to
acquire Texas Arai has been preliminarily allocated to the assets acquired and
liabilities assumed according to their estimated fair values as described below.
The finalization of the working capital adjustment is subject to adjustment
between Maverick and Grant Prideco, Inc. Texas Arai is the largest North
American provider of American Petroleum Institute and premium-grade couplings
used to connect tubing and casing in oil and gas wells.
Following is a summary of the net assets and liabilities acquired during 2004
(in thousands):
Texas Arai
-------------
Purchase price (including transaction costs)....................... $20,033
Assets acquired:
Cash............................................................. 1
Accounts receivable.............................................. 4,290
Inventory........................................................ 13,989
Property, plant and equipment.................................... 4,712
Other assets..................................................... 176
-------------
23,168
Liabilities acquired:
Accounts payable................................................. (2,632)
Other accruals................................................... (503)
-------------
(3,135)
Net assets acquired................................................ 20,033
-------------
Goodwill........................................................... $-
=============
8
(4) INVENTORIES
- --------------------------------------------------------------------------------
Inventories at June 30, 2004 and December 31, 2003 consist of the following (in
thousands):
June 30, December 31,
2004 2003
-------------------------
Finished goods......................................... $143,964 $98,575
Work-in-process........................................ 21,907 10,252
Raw materials.......................................... 91,391 63,023
Storeroom parts........................................ 11,630 12,175
-------------------------
$268,892 $184,025
=========================
Inventories are principally valued at the lower of average cost or market.
(5) SENIOR CREDIT FACILITY
- --------------------------------------------------------------------------------
The Company has a senior credit facility providing for an $185,000,000 revolving
line of credit. In addition, the Company has letters of credit outstanding under
this agreement of $1,788,000 at June 30, 2004. Interest is payable monthly at
the LIBOR rate adjusted by an interest margin, depending upon certain financial
measurements. Under the senior credit facility, the Company can borrow an amount
based on a percentage of eligible accounts receivable, eligible inventory and
property, plant and equipment, reduced by outstanding letters of credit. The
additional available borrowings under the senior credit facility were
approximately $122,000,000 and the applicable interest rate was 3.4% per annum
as of June 30, 2004. The senior credit facility includes restrictive covenants
relating to maintaining a minimum fixed charge coverage ratio if availability
falls below $30,000,000. Also, if availability falls below $50,000,000, the debt
will be classified as current. The senior credit facility also limits capital
expenditures to $30,000,000 per year and limits the Company's ability to pay
dividends, create liens, sell assets or enter into transactions with affiliates
without the consent of the lenders.
(6) CONVERTIBLE SENIOR SUBORDINATED NOTES
- --------------------------------------------------------------------------------
In June 2003, the Company issued $120,000,000 of contingent convertible senior
subordinated notes (the "Convertible Notes") due June 15, 2033. The Company pays
interest semi-annually on the Convertible Notes at the rate of 4.0% per annum.
Beginning with the six-month interest period commencing on June 15, 2008, the
Company will pay contingent interest during a six-month interest period if the
average trading price of the Convertible Notes equals or exceeds 130.0% of the
principal amount of the Convertible Notes during a specified period prior to
such six-month interest period. The embedded derivative related to this
contingent interest feature is required to be valued separately from the
Convertible Note; however, the fair value of this derivative is not material at
June 30, 2004.
The Convertible Notes are general unsecured obligations of the Company and are
subordinated to the Company's present and any future senior indebtedness. Also,
the Convertible Notes are convertible under certain limited circumstances into
shares of the Company's common stock at an initial conversion rate of 34.2583
shares of the Company's common stock per $1,000 principal amount of the
Convertible Notes, representing a conversion price of $29.19 per common share.
The Company has the right to redeem the Convertible Notes after June 15, 2008 at
a redemption price equal to par plus accrued interest, if any. From June 15,
2008 to June 15, 2011, the Company may redeem the Convertible Notes only if the
closing price of the Company's common stock has exceeded 130.0% of the
conversion price then in effect over 20 trading days out of a period of 30
consecutive trading days. After June 15, 2011, the Company may redeem the
Convertible Notes at any time. Holders of the Convertible Notes have the right
to require the Company to repurchase all or some of their Convertible Notes on
June
9
15, 2011, 2013, 2018, 2023 and 2028 at a price equal to par plus accrued
interest, if any, payable in cash. Holders of the Convertible Notes also have
the right to require the Company to purchase all or some of their Convertible
Notes at a price equal to par plus accrued interest, if any, if certain change
of control events occur prior to June 15, 2011.
(7) DERIVATIVES, FINANCIAL INSTRUMENTS AND RISK MANAGEMENT
- --------------------------------------------------------------------------------
Derivative Instruments and Hedging Activities
- ---------------------------------------------
Certain activities of the Company expose it to market risks, including the
effects of changes in foreign currency exchange rates and interest rates. The
financial exposures are monitored and managed by the Company as an integral part
of its overall risk management program. The Company's risk management program
seeks to reduce the potentially adverse effects that the volatility of the
markets may have on its operating results.
The Company maintains an interest rate risk management strategy that may, from
time to time, use derivative instruments to minimize significant, unanticipated
earnings fluctuations caused by interest rate volatility.
The Company maintains a foreign currency risk management strategy that uses
derivative instruments to protect its interests from unanticipated fluctuations
in earnings and cash flows caused by volatility in currency exchange rates. The
Company does not hold or issue financial instruments for trading purposes, nor
does it hold or issue leveraged derivative instruments.
The Company generally uses cash flow hedging strategies to reduce the
potentially adverse effects that market volatility may have on its operating
results. Cash flow hedges are hedges of forecasted transactions or of the
variability of cash flows to be received or paid related to a recognized asset
or liability. The Company enters into foreign exchange forward contracts
generally expiring within six months with the objective of converting U.S.
denominated debt held by the Company's Canadian subsidiary, Prudential into its
functional currency. These contracts protect against the risk that the eventual
cash flows resulting from such transactions will be adversely affected by
changes in exchange rates. The Company also uses interest rate swaps to convert
a portion of its variable rate revolving credit facility to fixed rates, which
generally expire in nine months.
Accounting for Derivatives and Hedging Activities
- -------------------------------------------------
The Company formally documents at inception all relationships between hedging
instruments and hedged items, as well as its risk management objective and
strategy for undertaking various hedged items. The Company also formally
assesses, both at the hedge's inception and on an ongoing basis, whether the
derivatives used in hedging transactions are highly effective in offsetting
changes in fair value or cash flows of the hedged items. Changes in the fair
value of a derivative that is highly effective as, and that is designated and
qualifies as, a cash flow hedge are recorded in other comprehensive earnings,
until the underlying transactions occur. When it is determined a derivative is
not highly effective as a hedge or it has ceased to be a highly effective hedge,
the Company discontinues hedge accounting prospectively.
10
The following table summarizes the notional transaction amounts and fair values
for the Company's outstanding derivatives, by risk category and instrument type,
at June 30, 2004 (in thousands).
Notional Fair Value
Qualifying Cash Flow Hedges Amount Asset/(Liability) Description
- --------------------------------------------------------------------------------
Interest rate swaps $50,000 $(75) Effectively converts
(floating to the interest rate on
fixed rate swaps) an equivalent amount
of variable rate
borrowings to a
fixed rate
Foreign currency hedges $30,000 $125 Effectively hedges the
(floating to variability in
fixed exchange rates) forecasted cash flows
due to the foreign
currency risk
associated with the
settlement of
nonfunctional
currency denominated
debt
The ineffective portion of these hedges was immaterial as of June 30, 2004 and
the Company expects these hedges to remain highly effective.
(8) DEFINED BENEFIT PLANS
- --------------------------------------------------------------------------------
Prudential sponsors two pension plans and a postretirement benefit plan for
substantially all of its Canadian employees and a supplemental executive
retirement plan ("SERP") for certain former key Prudential executives. Expected
contributions for the year ended December 31, 2004 (in thousands) are as
follows:
Pension
Benefits Postretirement
and SERP Benefit Plan
---------------------------------
Contributions required by funding
regulations or laws.......................... $1,231 $-
Additional discretionary contributions......... 826 53
---------------------------------
$2,057 $53
=================================
Benefit costs consist of the following for the three and six months ended June
30, 2004 and 2003 (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
-------------------------------------------------
Pension benefit costs:
Service cost................... $374 $377 $765 $754
Interest cost.................. 689 634 1,409 1,268
Expected return on plan assets. (611) (564) (1,250) (1,128)
Amortization of prior service
cost......................... 107 60 219 120
Amortization of transition
asset........................ (149) (158) (305) (316)
Recognized net actuarial gain.. 86 171 175 342
-------------------------------------------------
$496 $520 $1,013 $1,040
=================================================
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
-------------------------------------------------
Postretirement benefit plan
costs:
Service cost................... $15 $15 $30 $30
Interest cost.................. 29 29 60 58
Recognized net actuarial loss.. 13 14 27 28
-------------------------------------------------
$57 $58 $117 $116
=================================================
(9) SEGMENT INFORMATION
- --------------------------------------------------------------------------------
The Energy Products segment includes revenue and operating expenses associated
with those products and services of the Company sold to the energy industry,
such as oil country tubular goods ("OCTG"), line
11
pipe, coiled steel pipe, premium couplings and tolling services. The Industrial
Products segment includes revenue and operating expenses associated with those
products of the Company sold to the industrial industry, such as electrical
conduit, rigid conduit, structural shapes and rounds, standard pipe, mechanical
tubing and pipe piling.
The following table sets forth data (in thousands) for the three and six months
ended June 30, 2004 and 2003, regarding the reportable industry segments of the
Company. Intersegment sales are not material. Identifiable assets are those used
in the Company's operations in each segment.
Energy Industrial
Products Products Corporate Total
-------------------------------------------------
Three months ended June 30, 2004
- --------------------------------
Net sales...................... $192,178 $155,910 $- $348,088
Income from operations......... 41,533 55,129 - 96,662
Identifiable assets............ 516,868 223,099 75,616 815,583
Six months ended June 30, 2004
- ------------------------------
Net sales...................... $402,162 $257,224 $- $659,386
Income from operations......... 72,023 75,538 - 147,561
Identifiable assets............ 516,868 223,099 75,616 815,583
Three months ended June 30, 2003
- --------------------------------
Net sales...................... $131,196 $63,729 $- $194,925
Income (loss) from operations.. 4,144 (283) - 3,861
Identifiable assets............ 419,189 154,988 69,668 643,845
Six months ended June 30, 2003
- ------------------------------
Net sales...................... $283,609 $130,754 $- $414,363
Income (loss) from operations.. 7,423 (966) - 6,457
Identifiable assets............ 419,189 154,988 69,668 643,845
The corporate information in the above table is not considered a segment;
however, it represents the corporate assets necessary for the day-to-day
operations of the Company (that are not identifiable to the reporting segments).
(10) STOCK-BASED COMPENSATION
- --------------------------------------------------------------------------------
The Company has three employee stock option plans and three stock option plans
for eligible directors allowing for incentive and non-qualified stock options.
The Company also has an Omnibus Incentive Plan in which restricted stock has
been granted to certain employees of the Company. Effective January 1, 2003, the
Company adopted SFAS No. 148, "Accounting for Stock-Based Compensation," which
allows the Company to continue to account for stock option plans under the
intrinsic value method in accordance with Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, no
stock-based employee compensation cost is reflected in net income as all options
granted under those plans had an exercise price equal to the market value of the
underlying common stock on the date of grant. Compensation expense is recognized
in net earnings for restricted stock grants.
12
Pursuant to the disclosure requirements of SFAS No. 123, "Accounting for
Stock-Based Compensation," as amended by SFAS No. 148, pro forma net income and
earnings per share are presented in the table below as if compensation cost for
stock options was determined as of the grant date under the fair value method
(in thousands, except per share information):
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
-------------------------------------------------
Net income, as reported........ $57,997 $1,063 $86,738 $1,305
Add: total stock-based employee
compensation expense included
in reported net earnings, net
of related tax effects....... 124 - 124 -
Deduct: total stock-based
employee compensation expense
determined under fair
value-based method for all
awards, net of related
tax effects.................. (393) (557) (577) (987)
-------------------------------------------------
Pro forma net income........... $57,728 $506 $86,285 $318
=================================================
Basic earnings per share
Net income - as reported..... $1.37 $0.03 $2.06 $0.03
Net income - pro forma....... $1.36 $0.01 $2.04 $0.01
Diluted earnings per share
Net income - as reported..... $1.36 $0.03 $2.04 $0.03
Net income - pro forma....... $1.35 $0.01 $2.03 $0.01
SFAS No. 123 requires the use of option pricing models that were not developed
for use in valuing employee stock options. Further, option pricing models
require the input of highly subjective assumptions, including the options'
expected life and price volatility of the underlying stock. Thus, in the opinion
of management, existing option pricing models do not necessarily provide a
reliable measure of the fair value of employee stock options.
The pro forma compensation expense associated with the fair value of the options
calculated for the six months ended June 30, 2004 and 2003 is not necessarily
representative of the potential effects on reported net income (loss) in future
periods. The fair value of each option grant is estimated on the date of the
grant by use of the Black-Scholes option pricing model.
(11) CAPITAL STOCK
- --------------------------------------------------------------------------------
On June 11, 2000, the Company and Prudential entered into a Business Combination
Agreement providing for the combination of Prudential with the Company. Under
the terms of the transaction, Prudential stockholders received 0.52 of an
exchangeable share, issued by Maverick Tube (Canada) Inc., a wholly-owned
Canadian subsidiary of the Company, for each Prudential common share.
Consequently, Prudential stockholders received a total of 15,813,088
exchangeable shares that began trading on The Toronto Stock Exchange on
September 27, 2000. These shares have the same voting rights, dividend and
distribution entitlements, and other attributes as shares of the Company's
common stock and are exchangeable, at each stockholder's option, for the
Company's common stock on a one-for-one basis. The transaction was accounted for
as a pooling of interests.
In conjunction with the Prudential transaction, the Company's Board of Directors
designated one share of the Company's authorized preferred stock as Special
Voting Stock. The Special Voting Stock is entitled to a number of votes equal to
the number of outstanding exchangeable shares of Maverick Tube (Canada) Inc., on
all matters presented to the common stockholders of the Company. The one share
of Special Voting Stock is issued to CIBC Mellon Trust Company, as trustee
pursuant to the Voting and Exchange Trust Agreement among the Company, Maverick
Tube (Canada) Inc. and CIBC Mellon Trust Company, for the benefit of the holders
of the exchangeable shares of Maverick Tube (Canada) Inc. For financial
13
statement purposes, the exchangeable shares that have not been exchanged for
shares of the Company's common stock have been treated as if they had been
exchanged and are included in the Company's outstanding shares of common stock.
As long as any exchangeable shares of Maverick Tube (Canada) Inc. are
outstanding, the Special Voting Stock may not be redeemed, the number of shares
comprising the Special Voting Stock shall not be increased or decreased and no
other term of the Special Voting Stock shall be amended, except upon the
unanimous approval of all common stockholders of the Company. If the Special
Voting Stock is purchased or otherwise acquired by the Company, it shall be
deemed retired and cancelled. Thereafter, it will become an authorized but
unissued and undesignated preferred share of the Company.
(12) EARNINGS PER COMMON SHARE
- --------------------------------------------------------------------------------
Basic earnings per share exclude any dilutive effects of restricted stock, stock
options and the effect of the conversion of the Convertible Notes, but include
the exchangeable shares (as further described in Note 11) from the business
combination with Prudential on an as-if exchanged basis. Diluted earnings per
share include the exchangeable shares on an as-if exchanged basis and the net
effect of unvested restricted stock and stock options, but exclude the effect of
the conversion of the Convertible Notes.
The reconciliation for diluted earnings per share for each of the three and six
months ended June 30, 2004 and 2003, is as follows (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
-------------------------------------------------
Average shares outstanding..... 42,346 41,855 42,205 41,533
Dilutive effect of unvested
restricted stock and
outstanding stock options.... 354 430 324 392
-------------------------------------------------
Average shares deemed
outstanding.................. 42,700 42,285 42,529 41,925
=================================================
Income before cumulative effect
of an accounting change used
in the calculation of basic
and diluted earnings per share $57,997 $1,063 $88,322 $1,305
Cumulative effect of an
accounting change used in the
calculation of basic and
diluted earnings per share.... - - (1,584) -
-------------------------------------------------
Net income used in the
calculation of basic and
diluted earnings per share... $57,997 $1,063 $86,738 $1,305
=================================================
(13) COMPREHENSIVE INCOME
- --------------------------------------------------------------------------------
The following table sets forth the components of other comprehensive income for
each of the three and six months ended June 30, 2004 and 2003 (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
-------------------------------------------------
Net income..................... $57,997 $1,063 $86,738 $1,305
Change in fair value of cash
flow hedges.................. 326 (127) 387 (501)
Foreign currency translation
adjustment................... (1,456) 3,392 (2,258) 6,068
Minimum pension liability
adjustment................... 29 (151) 47 (276)
-------------------------------------------------
Comprehensive income........... $56,896 $4,177 $84,914 $6,596
=================================================
14
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Maverick Tube Corporation
We have reviewed the condensed consolidated balance sheet of Maverick Tube
Corporation and subsidiaries as of June 30, 2004, and the related condensed
consolidated statements of income for the three-month and six-month periods
ended June 30, 2004 and 2003, and the condensed consolidated statements of cash
flows for the six-month periods ended June 30, 2004 and 2003. These financial
statements are the responsibility of the Company's management.
We conducted our reviews in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures to financial
data, and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with the standards of the Public Company Accounting Oversight Board (United
States), which will be performed for the full year with the objective of
expressing an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated financial statements referred
to above for them to be in conformity with U.S. generally accepted accounting
principles.
We have previously audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheet of Maverick Tube Corporation and subsidiaries as of December 31, 2003, and
the related consolidated statements of income, stockholders' equity, and cash
flows for the year then ended [not presented herein] and in our report dated
February 6, 2004, we expressed an unqualified opinion on those consolidated
financial statements. In our opinion, the information set forth in the
accompanying condensed consolidated balance sheet as of December 31, 2003, is
fairly stated, in all material respects, in relation to the consolidated balance
sheet from which it has been derived.
/s/ Ernst & Young LLP
St. Louis, Missouri
July 30, 2004
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- --------------------------------------------------------------------------------
As used herein, Maverick Tube Corporation and its direct and indirect
wholly-owned subsidiaries are collectively referred to as "the Company." Our
operating subsidiaries consists of: Maverick Tube L.P. ("Maverick"), Prudential
Steel Ltd. ("Prudential"), Precision Tube Holding Corporation ("Precision"),
Maverick C&P, Inc. doing business as "Republic Conduit", SeaCAT Corporation
("SeaCAT") and our consolidated variable interest entity, Pennsylvania Cold
Drawn, LLC ("PCD"). Also, unless the context otherwise requires, the terms "we,"
"us" or "our" refer to the Company.
Certain statements contained in the "Management's Discussion and Analysis of
Financial Condition and Results of Operations" section of this report regarding
matters (including statements as to beliefs or expectations) that are not
historical facts are forward-looking statements, as that term is defined under
the Private Securities Litigation Reform Act of 1995. Because such
forward-looking statements include risks and uncertainties, actual results may
differ materially from those expressed or implied by such forward-looking
statements. For example, uncertainty continues to exist as to future levels and
volatility of oil and gas price expectations and their effect on drilling levels
and demand for our energy-related products, the future impact of industry-wide
draw-downs of inventories, future import levels and the value of the U.S.
dollar. Also, uncertainty continues to exist as to the price of steel (our
principal raw material, representing approximately eighty percent of cost of
goods sold).
It is not possible to foresee or identify all factors that could have a material
and negative impact on the future financial performance of the Company. The
forward-looking statements in this report are based on certain assumptions and
analyses we have made in light of our experience and perception of historical
conditions, expected future developments and other factors we believe
appropriate under the circumstances. Further information covering issues that
could materially affect our financial performance is contained in the "Risk
Factors" section of our Annual Report on Form 10-K for the year ended December
31, 2003, filed with the Securities and Exchange Commission on March 8, 2004.
This information can be found on the Company's web site at www.mavericktube.com.
Our condensed, consolidated financial statements have been prepared in
accordance with accounting principles generally applied in the United States. It
should be noted that the application of certain accounting estimates of the
Company require judgment and/or estimates of management that could have a
significant impact on amounts reported in these financial statements. In
particular, the accounting for and analysis with respect to areas such as
goodwill, accounts receivable collectibility, discontinued operations, income
tax matters and pension plan matters are discussed. These critical accounting
estimates are more fully described in the section entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations" of our
2003 Annual Report on Form 10-K.
The market data and other statistical information used throughout this quarterly
report are based on independent industry publications, government publications,
and reports by market research firms or other published independent sources.
Some data are also based on our good faith estimates that are derived from our
review of internal surveys as well as the independent sources listed above.
Although we believe these sources are reliable, we have not independently
verified the information and cannot guarantee its accuracy and completeness.
All dollar amounts are expressed in U.S. currency unless otherwise indicated.
OVERVIEW
- --------------------------------------------------------------------------------
Maverick Tube Corporation is a leading producer of welded tubular steel products
used in energy and industrial applications throughout the world. We are the
largest North American producer of oil country tubular goods (sometimes referred
to as OCTG) and line pipe products for use in newly drilled oil and gas wells
and for transporting oil and natural gas. We primarily sell these products to
distributors in the U.S.
16
and Canada. We expanded our business into coiled tubing products with our
acquisitions of Precision and SeaCAT. Coiled tubing products are used typically
to maintain existing wells and to complete new wells. We sell coiled tubing to
customers throughout North America and internationally. We further expanded our
business into premium grade couplings with our acquisition of Texas Arai, the
largest North American producer of American Petroleum Institute and premium
grade couplings. Premium grade couplings are used to connect tubing and casing
in oil and gas wells. OCTG, line pipe, coiled tubing products and premium grade
couplings comprise our energy product line.
We also manufacture structural tubing, which is generally referred to as hollow
structural sections or HSS, standard pipe and pipe piling. In January 2003, we
entered the steel electrical conduit business with our acquisition of Republic
Conduit. Structural tubing, standard pipe, pipe piling and steel electrical
conduit products comprise our industrial product line. We sell these industrial
products to service centers, fabricators and end-users.
Recent Business Acquisitions
- ----------------------------
On February 28, 2003, we completed the acquisition of SeaCAT, a then privately
held, Houston based, coiled tubular goods manufacturer, in exchange for $4.0
million cash, a $5.0 million secured, 11.0% subordinated note and 733,676 shares
of common stock of the Company. The purchase price could be further increased by
up to an additional $0.5 million if SeaCAT achieves certain performance targets
through 2005.
On April 23, 2004, the Company completed its acquisition of substantially all of
the assets and certain liabilities of Texas Arai, a subsidiary of Grant Prideco,
Inc., a publicly held, Houston based, oilfield service manufacturer, for a
purchase price of $20,033,000 cash (subject to finalization of the working
capital adjustment).
Energy Products Demand and Consumption
- --------------------------------------
OCTG
Demand for our energy-related products depends primarily upon the number of oil
and natural gas wells being drilled, completed and worked over in the U.S. and
Canada and the depth and drilling conditions of these wells. The levels of these
activities are primarily dependent on oil and natural gas prices. Many factors,
such as the supply and demand for oil and natural gas, general economic
conditions and global weather patterns influence, these prices. As a result, the
future level and volatility of oil and natural gas prices are uncertain. In
addition, seasonal fluctuations impact our customers and the demand for our
products to some extent. For instance, weather conditions during the first half
of the year make drilling more difficult in the U.S., while the second and third
quarters are more difficult in western Canada. Consequently, drilling activity
and the corresponding demand for our products are lower at these times in these
respective regions.
U.S. end-users obtain OCTG not only from domestic and foreign pipe producers,
but also from draw-downs of inventory held by the end-user, distributors or
mills. Decreasing industry inventories of our products demonstrate that our
customers are drawing down from inventory rather than purchasing our product.
Accordingly, industry inventory levels, which can change significantly from
period to period, is another indicator of demand for our products. Canadian
distributors and end users do not generally hold significant amounts of
inventories.
17
The following table illustrates certain factors related to industry-wide
drilling activity, energy prices, OCTG consumption, shipment, imports and
inventories for the periods presented:
Three Months Ended
June 30,
2004 2003
-------------------------
U.S. Market Activity:
Average rig count...................................... 1,164 1,028
=========================
Average U.S. energy prices:
Oil per barrel (West Texas Intermediate)........... $38.44 $29.10
=========================
Natural gas per MCF (Average U.S.)................. $5.97 $5.50
========================
U.S. OCTG Consumption:
(in thousands of tons)
U.S. producer shipments............................ 557 547
Imports............................................ 247 209
Inventory (increase)/decrease...................... (73) (124)
Used pipe.......................................... 14 24
-------------------------
Total U.S. Consumption......................... 745 656
========================
Canadian Market Activity:
Average rig count...................................... 202 203
========================
Average Canadian energy prices:
Natural gas per U.S. $ per MCF
(Average Alberta spot price)....................... $5.04 $4.77
=========================
Canadian OCTG Consumption:
(in thousands of tons)
Canadian producer shipments........................ 130 125
Imports............................................ 52 50
Inventory (increase)/decrease...................... (53) (44)
-------------------------
Total Canadian Consumption..................... 129 131
=========================
The U.S. rig count in the above table is based on weekly rig count
reporting from Baker Hughes, Inc. Average U.S. energy prices in the above
table are monthly average period prices as reported by Spears and
Associates for West Texas Intermediate grade crude oil and the average U.S.
monthly natural gas cash prices as reported by Natural Gas Week. U.S. OCTG
imports are as reported by Duane Murphy and Associates in "The OCTG
Situation Report." U.S. OCTG inventory (increase)/decrease is our estimate
based upon independent research by Duane Murphy and Associates. U.S. used
pipe quantities are calculated by multiplying 8.3 recoverable tubing and
casing tons by the number of abandoned oil and gas wells. U.S. consumption
of OCTG is our estimate based on estimated per rig consumption of OCTG
multiplied by the Baker Hughes rig count. U.S. producer shipments are our
estimates based on the components listed above.
The Canadian rig count in the above table is based on weekly rig count
reporting from Baker Hughes, Inc. Average Canadian energy prices in the
above table are the average Alberta natural gas spot prices. Canadian OCTG
imports are as reported by Statistics Canada. Canadian OCTG inventory
(increase)/decrease is our estimate based upon data reported by Statistics
Canada. Canadian producer shipments are reported by Statistics Canada Steel
Pipe and Tube Report. Canadian producer shipments are our estimates based
on the components listed above.
According to published industry reports, average U.S. drilling for the second
quarter of 2004 was approximately 1,164 rigs, representing an increase of 13.2%
compared to the second quarter of 2003. Natural gas drilling levels increased
16.7% in the second quarter of 2004 from the second quarter of 2003 as natural
gas prices continue to be well above historical prices. Oil-related drilling
decreased by 6.0%, primarily attributable to an increase in drilling for natural
gas during the second quarter of 2004 when compared to the second quarter of
2003.
According to published industry reports, average Canadian drilling for the
second quarter of 2004 was approximately 202 rigs, representing a decrease of
0.5% compared to the second quarter of 2003. Natural gas drilling levels
remained strong as natural gas prices continue to be well above historical
prices. The rig count at the end of the quarter was approximately 31.2% higher
than the average rig count during the quarter due to better weather conditions
during the last several weeks of the second quarter which made drilling easier.
18
Imports into the U.S. increased by 18.2%, with import market share increasing
from 31.9% during the second quarter of 2003 to 33.2% during the second quarter
of 2004. During the second quarter of 2004, U.S. producer shipments of OCTG
increased by 1.8% as compared to the comparable prior year period. During that
period, U.S. producer shipments were positively impacted by industry inventory
increases that resulted in a 9.8% increase in demand. Management believes that
at June 30, 2004, industry inventories were still below historical levels in
relation to demand as inventory months of supply decreased slightly from 5.0
months of supply for the second quarter of 2003 to 4.5 months of supply for the
second quarter of 2004.
As a result of the increased drilling activity, we estimate total U.S.
consumption increased by 13.6% in the second quarter of 2004 compared to the
prior year quarter. Over the same periods, our domestic shipments of OCTG
decreased 10.3%, and our export sales, primarily to Canada, decreased by 91.1%.
We estimate our domestic OCTG market share decreased from 20.0% during the
quarter ended June 30, 2003 to 17.1% during the quarter ended June 30, 2004. The
17.1% market share we captured during the quarter ended June 30, 2004 is
comparable to our historical market share. We lost market share in the U.S. as
we pushed pricing higher than some of our competitors.
Imports into Canada increased 4.0%, as import market share increased from 38.2%
during the second quarter of 2003 to 40.3% during the second quarter of 2004.
The increase in imports was primarily due to importing lower priced OCTG,
primarily from the Far East, in the second quarter of 2004 compared to the
second quarter of 2003. During the second quarter of 2004, Canadian producer
shipments of OCTG increased by 4.0% compared to the prior year quarter. Canadian
shipments in the second quarter of 2004 remained stable as drilling activity
remained consistent for the second quarter of 2004 as compared to the prior year
quarter.
As a result of the slight decrease in drilling activities, we estimate total
Canadian consumption decreased by 1.5% in the second quarter of 2004 compared to
the prior year quarter. Over the same periods, our Canadian shipments of OCTG
decreased 25.1%. Also, we estimate our Canadian OCTG market share of domestic
shipments remained unchanged at 31.9% during the quarter ended June 30, 2004.
Line Pipe
Published information suggests U.S. demand for line pipe (under 16") increased
during the second quarter of 2004 by an estimated 9.8% from the second quarter
of 2003 and domestic shipments increased by 45.7%, as the import market share
decreased from 48.9% to 32.2%. Canadian demand for line pipe (under 16")
decreased during the second quarter of 2004 from the prior year quarter by an
estimated 25.4%, and domestic shipments decreased by 40.7%. Import volumes in
Canada decreased by 27.6%, as the import market share decreased from 57.4% in
the second quarter of 2003 to 55.7% in the second quarter of 2004.
Coiled Tubing
Coiled down-hole tubing is primarily used to service existing oil and gas wells
to reestablish well production and extend well life. Commodity pricing and
industry cash flow are primary drivers of well service work and demand for
coiled down-hole tubing. Industry cash flows increased during the second quarter
of 2004 by an estimated 13.5%, from $43.2 billion in the second quarter of 2003
to $49.0 billion in the second quarter of 2004. This was primarily due to
increases in the average natural gas prices of 8.5% year over year in the second
quarter, and by a 32.1% increase in the price of crude oil in the same period.
For 2004, published forecasts of U.S. well service and work-over project
spending to rise 11.0%, with service and work-over rig activity up 7.0% and jobs
flat at 508,400. In the second quarter of 2004, U.S. work-over rig counts
averaged 1,240 working rigs, up 8% from an average of 1,147 active rigs in the
second quarter of 2003. We forecast our well service revenues will increase in
line with industry expenditures. In Canada, published forecasts for 2004
indicate well service and work over expenditures will increase 8.2%, with rig
activity and jobs up 3.1% and 3.4% respectively. We believe U.S. market
conditions reflect what is also happening in Canadian service work, and expect
similar trends in activity
19
and spending in Canada.
Coiled line pipe and umbilical tubing are primarily used in offshore, sub-sea
applications where continuous lengths of steel line pipe are used as flow lines
and umbilical tubing is used as sheathing for sub-sea well controls. Coiled line
pipe is a more cost-effective application compared to traditional jointed line
pipe as it allows for much more rapid installation, which reduces overall
installed costs. Recent published forecasts for U.S. offshore spending in 2004
call for up to $10.8 billion in spending, up slightly over $10.7 billion in
2003. Second quarter U.S. offshore spending of $2.6 billion was down slightly
from the second quarter of 2003 as many offshore projects continued to be
deferred. We expect the decrease in offshore spending to continue to impact 2004
sales in this segment of our business in the U.S.
Our coiled line pipe sales are also made in international offshore drilling
markets. International offshore spending is forecasted to increase to $27.8
billion in 2004 up 4.3% from 2003. Average offshore rig activity of 239 units is
expected in 2004, up 10.1% from 2003, and offshore well completions are
forecasted at 2,174 wells, up 3.4% over 2003. In the second quarter of 2004,
offshore spending was up 2.1%, rig activity of 246 was up 10.3%, and offshore
well completions were up 11 wells, an increase of 2.0% as compared to second
quarter 2003.
Industrial Products Demand and Consumption
- --------------------------------------------------------------------------------
Given the numerous applications for industrial products, sources of demand for
these products are diverse. Demand depends on the general level of economic
activity in the construction, transportation, agricultural, material handling
and recreational market segments, the use of structural tubing as a substitute
for other structural steel forms, such as I-beams and H-beams, and draw-downs of
existing customer inventories.
We estimate the U.S. demand for structural tube products of the type we produce
increased 1.6% during the second quarter of 2004 over the prior year period.
Total U.S. producer shipments decreased 1.5% during the second quarter of 2004
over the prior year period as import market share increased from 21.7% to 24.1%.
Electrical conduit is primarily used as sheathing for electrical and computer
wiring in industrial, commercial and institutional construction, which are
classified as non-residential construction. As such, electrical conduit demand
is primarily influenced by changes in spending on non-residential construction.
Published forecasts for non-residential construction activity in 2004 show a
modest decrease of 0.1% from 2003 compared to the 4.6% decrease experienced in
2003 from 2002. We estimate the U.S. demand for electrical conduit of the types
we produce increased by 9.6% during the second quarter of 2004 as compared to
the prior year period. The Company and three other domestic producers
manufacture most of the electrical conduit consumed in the U.S. The import and
export markets for electrical conduit is limited because this light-walled
product is easily damaged during shipping.
Standard pipe is used primarily in construction applications for transporting
water, steam, gases, waste and other similar gases and fluids. Demand for this
product is primarily affected by general economic activity and non-residential
construction expenditures. According to published reports and management
estimates, preliminary numbers indicate U.S. standard pipe demand in the second
quarter of 2004 was up from the same period last year by about 37.7%. While
domestic shipments were up 28.9% to 481,574 tons, the domestic producers share
of the market fell from 65.3% in 2003 to 61.1% in 2004. Imports increased from
34.7% of the market in the second quarter of 2003 to 38.9% in the second quarter
of 2004.
Pricing and Costs of Our Products
- ---------------------------------
Pricing of our products was up during the second quarter of 2004 compared to the
second quarter of 2003. Pricing of our U.S. OCTG, line pipe, standard product,
structural product and conduit product pricing increased by 71.4%, 82.6%, 76.8%,
126.5% and 104.8%, respectively. Pricing of our Canadian energy products and
industrial products was up 23.8% and 67.3%, respectively, compared to the prior
year quarter.
20
Canadian prices were impacted by a 2.9% increase in the exchange rate.
Since December 2003, we have raised prices on all our U.S. shipments in order to
pass along to end-users the steel surcharges and base price increases our steel
vendors have included on steel purchased by us. We have also raised our prices
on our Canadian energy and industrial products even as our primary competitors
have not raised selling prices. These price increases across our entire product
line are designed to absorb the anticipated increase in the cost of steel, our
principal raw material. Given the mix of our U.S. alliance sales and volume of
our Canadian OCTG business, the timing and the extent to which our future price
increases can be realized, are uncertain. No assurance can be given that we will
succeed in implementing future price increases sufficient to fully absorb the
anticipated steel cost increases described below.
Average steel costs included in cost of goods sold increased during the second
quarter of 2004 over the second quarter of 2003 by $125 per ton, or 37.4%. We
expect our replacement cost of steel will continue to rise sharply in both the
U.S. and Canada as steel vendors have implemented base price increases and
surcharges up approximately 69.6% since the quarter ended December 31, 2003 due
to the cost of scrap, their principal raw materials and tight supplies. In
December 2003, our steel suppliers implemented an unprecedented scrap surcharge
based upon the American Metal Market's Consumer Buying Price for No. 1
Busheling. The surcharge has fluctuated monthly based on scrap prices. The
surcharges for March, April, May, June, July and August 2004 are $100 per ton,
$125 per ton, $95 per ton, $70 per ton, $80 per ton and $180 per ton,
respectively. During the third quarter of 2004, we expect that we may see
increases in cost of goods sold of approximately 40% in the U.S. and 10% in
Canada. We expect steel cost will escalate an additional 20% in the U.S. and 70%
in Canada during the fourth quarter 2004. We expect the replacement cost of
steel to remain volatile throughout 2004. However, the magnitude and timing of
further steel costs changes are unknown at this time.
Purchased steel represents approximately three-quarters of our cost of goods
sold. As a result, the steel industry, which is highly volatile and cyclical in
nature, affects our business both positively and negatively. Numerous factors,
most of which are beyond our control, drive the cycles of the steel industry and
influence steel prices, including general economic conditions, industry capacity
utilization, import duties and other trade restrictions and currency exchange
rates. Changes in steel prices had a significant impact on the margin levels of
our energy products because energy product pricing has historically been driven
by OCTG and line pipe demand. As steel costs have escalated so dramatically,
OCTG and line pipe producers had to push steel cost increases through to their
customers in the form of steel surcharges and base price increases. In addition,
we depend on a few suppliers for a significant portion of our steel. The loss of
one or more of our significant steel suppliers could adversely affect our
ability to produce our products and could have a material adverse effect on our
business.
Impact of Market Conditions
- ---------------------------
The increase in drilling levels and steel surcharges during the second quarter
of 2004 resulted in higher sales. Industry-wide inventory levels increased;
however, we believe these increases generally existed at the mills and thus did
not impact domestic shipments during the second quarter. As our recent
experience indicates, oil and gas prices are volatile and can have a substantial
effect on drilling levels and resulting demand for our energy-related products.
Uncertainty also exists as to the future demand and pricing for our electrical
conduit, HSS and other industrial-related products.
21
Trade Cases
- -----------
U.S. Line Pipe - In early March 2004, an antidumping petition was filed with the
U.S. government covering line pipe from China, the Republic of South Korea, and
Mexico. In April 2004, the U.S. International Trade Commission ("USITC") ruled
unanimously that imports of line pipe under 16 inch in outside diameter from the
three named countries are allegedly being sold in the United States at less than
fair value. As a result of the USITC's affirmative determinations, the U.S.
Department of Commerce has continued its antidumping investigations of imports
of certain circular welded carbon line pipe from China, the Republic of South
Korea, and Mexico. During the current phase of the investigation, the USITC sent
questionnaires to the line pipe manufacturers in the three named countries to
gather data which allows them to calculate the preliminary dumping margins.
China did not respond to the questionnaires which, according to U.S. trade law,
results in the assignment of preliminary margins to those companies at the
maximum percentage alleged in the trade case filing. The scheduled date for the
release of the preliminary antidumping determinations is September 29, 2004.
In October 2003, the Canada Customs and Revenue Agency initiated an inquiry into
imports of HSS into Canada from Republic of South Korea, Republic of Turkey and
the Republic of South Africa. Imports of HSS into Canada can affect our Canadian
HSS selling prices and volumes. The newly named Canadian Border Security Agency
(formerly Canada Customs and Revenue Agency) completed its review and determined
that imports from the three named countries were dumped into Canada at unfair
prices. The Canadian International Trade Commission reviewed the case and
interim duties were assessed against all three countries on December 23, 2003.
Dumping margins were assessed ranging from 44% on all South Korean manufactured
goods, 22.6% on South African goods, and rates ranging from 4.5% to 11.7% on
goods manufactured in Turkey. These dumping margins will apply on all imports of
HSS from the named countries for the next five years.
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
Overall Company
- ---------------
The following table illustrates the operating results and tons shipped for the
three and six month periods ended June 30, 2004 and 2003 (in millions, except
per share data and tons shipped):
Three Months Ended June 30, 2004 vs. 2003
2004 2003 Change % Change
-------------------------------------------------
Energy tons shipped............ 175,739 194,507 (18,768) (9.6%)
Industrial tons shipped........ 118,989 99,526 19,463 19.6%
-------------------------------------
Total tons shipped............. 294,728 294,033 695
Net sales...................... $348.1 $194.9 $153.2 78.6%
Cost of goods sold............. 228.8 179.3 49.5 27.6%
-------------------------------------
Gross profit................... 119.3 15.6 103.7
Income from operations......... 96.7 3.9 92.8 NM
Income before income taxes..... 94.0 1.7 92.3 NM
Income before cumulative effect
of an accounting change..... 58.0 1.1 56.9 NM
Net income..................... 58.0 1.1 56.9 NM
Diluted earnings per share
before cumulative effect of
an accounting change....... 1.36 0.03 1.33 NM
Diluted earnings per share..... 1.36 0.03 1.33 NM
22
Six Months Ended June 30, 2004 vs. 2003
2004 2003 Change % Change
-------------------------------------------------
Energy tons shipped............ 436,182 421,358 14,824 3.5%
Industrial tons shipped........ 237,835 199,346 38,489 19.3%
-------------------------------------
Total tons shipped............. 674,017 620,704 53,313
Net sales...................... $659.4 $414.4 $245.0 59.1%
Cost of goods sold............. 469.6 383.8 85.8 22.4%
-------------------------------------
Gross profit................... 189.8 30.6 159.2
Income from operations......... 147.6 6.5 141.1 NM
Income before income taxes..... 142.3 2.0 140.3 NM
Income before cumulative effect
of an accounting change..... 88.3 1.3 87.0 NM
Net income..................... 86.7 1.3 85.4 NM
Diluted earnings per share
before cumulative effect of
an accounting change........ 2.08 0.03 2.05 NM
Diluted earnings per share..... 2.04 0.03 2.01 NM
NM Not meaningful
Net sales of $348.1 million recorded for the second quarter of 2004 represent an
increase of $153.2 million, or 78.6%, compared to the prior year period. These
results were primarily attributable to increases in overall average net selling
prices from the comparable quarter of the prior year by 78.1%, from an average
of $663 per ton to $1,181 per ton. The increase we experienced in average net
selling prices primarily resulted from strengthening energy market conditions
and steel surcharges charged to our customers to offset steel cost increases
implemented during the second quarter of 2004 by our major steel suppliers. For
the second quarter of 2004, there was only a 0.2% increase in total product
shipments, from 294,033 tons in the second quarter of 2003 to 294,728 tons in
the second quarter of 2004. See "Overview."
Net sales of $659.4 million recorded for the six months ended June 30, 2004
represent an increase of $245.0 million, or 59.1%, compared to the prior year
period. These results were primarily attributable to an increase in overall
average net selling prices from the comparable period of the prior year by
46.4%, from an average of $668 per ton to $978 per ton. For the six months ended
June 30, 2004, there was an 8.6% increase in total product shipments, from
620,704 tons for the six months ended June 30, 2003 to 674,017 tons for the six
months ended June 30, 2004. The increase we experienced in shipments and average
net selling prices primarily resulted from strengthening energy market
conditions and steel surcharges charged to our customers to offset steel cost
increases implemented during the six months ended June 30, 2004 by our major
steel suppliers. See "Overview."
Cost of goods sold of $228.8 million recorded for the second quarter of 2004
represents an increase of $49.5 million, or 27.6%, compared to the prior year
period. Overall unit cost per ton of products sold increased 27.2% in the second
quarter of 2004 from the comparable quarter of the prior year, from an average
of $610 per ton to $776 per ton. Costs increased primarily due to an increase in
steel prices experienced in the second quarter of 2004 as compared to the second
quarter of 2003. We expect our current replacement cost of steel to flow through
our cost of goods sold over the next two quarters. See "Overview."
Cost of goods sold of $469.6 million recorded for the six months ended June 30,
2004 represents an increase of $85.8 million, or 22.4%, compared to the prior
year period. Overall unit cost per ton of products sold increased 12.8% in the
six months ended June 30, 2004 from the comparable prior year period, from an
average of $618 per ton to $697 per ton. Costs increased primarily due to an
increase in steel prices experienced for the six months ended June 30, 2004
compared to the prior year. See "Overview."
The Company earned a gross profit of $119.3 million during the second quarter of
2004, compared to a gross profit of $15.6 million in the prior year period.
Gross profit per ton was $405 per ton in the second quarter of 2004 as compared
to $53 per ton in the comparable prior year period. Accordingly, gross profit,
23
as a percentage of net sales, was 34.3% for the three-month period ended June
30, 2004 compared to 8.0% for the comparable prior year period. Gross profit per
ton primarily increased due to strengthening market conditions in both our
energy and industrial product lines and the sale of generally lower costing
inventory at higher selling prices charged by the Company in response to
increasing steel costs and strong market conditions. We expect the higher steel
costs will begin to flow through our inventory starting in the third and fourth
quarters of 2004. Depending on the conditions in our respective product markets
and our ability to effect selling price increases, these higher steel costs may
impact our gross profit margins in the fourth quarter if selling prices and
steel costs equalize in that quarter.
The Company earned a gross profit of $189.8 million during the six months ended
June 30, 2004, compared to a gross profit of $30.6 million in the prior year
period. Gross profit per ton was $282 per ton for the six months ended June 30,
2004 as compared to $49 per ton in the comparable prior year period.
Accordingly, gross profit, as a percentage of net sales, was 28.8% for the
six-month period ended June 30, 2004 compared to 7.4% for the comparable prior
year period. Gross profit per ton primarily increased due to strengthening
market conditions in both our energy and industrial product lines and the sale
of generally lower costing inventory at higher selling prices charged by the
Company in response to increasing steel costs and strong market conditions. We
expect the higher steel costs will begin to flow through our inventory starting
in the third and fourth quarters of 2004. Depending on the conditions in our
respective product markets and our ability to effect selling price increases,
these higher steel costs may impact our gross profit margins in the fourth
quarter if selling prices and steel costs equalize in that quarter.
Selling, general and administrative expenses increased $10.8 million, or 91.5%,
from $11.8 million in the second quarter of 2003 to $22.6 million in the second
quarter of 2004. Selling, general and administrative expenses as a percentage of
net sales in the second quarter of 2004 were 6.5% compared to 6.1% for the
comparable prior year period. The increase resulted primarily from the
additional commission expense, additional general reserves for allowance for
doubtful accounts and incentive compensation.
Selling, general and administrative expenses increased $18.1 million, or 75.1%,
from $24.1 million during the six months ended June 30, 2003 to $42.2 million
during the six months ended June 30, 2004. Selling, general and administrative
expenses as a percentage of net sales in the six months ended June 30, 2004 were
6.4% compared to 5.8% for the comparable prior year period. The increase
resulted primarily from the additional commission expense, additional general
reserves for allowance for doubtful accounts and incentive compensation.
Interest expense increased $0.5 million, or 22.7%, from $2.2 million in the
second quarter of 2003 to $2.7 million in the second quarter of 2004. This
increase was due to the issuance of the senior subordinated notes in June of
2003 and to higher average borrowings partially offset by lower average interest
rates during the second quarter of 2004 compared to the second quarter of 2003.
Interest expense increased $0.9 million, or 20.5%, from $4.4 million for the six
months ended June 30, 2003 to $5.3 million for the six months ended June 30,
2004. This increase was due to the issuance of the senior subordinated notes in
June of 2003 and to higher average borrowings (primarily as a result of the
acquisition of the SeaCAT Corporation) partially offset by lower average
interest rates for the six months ended June 30, 2004 compared to the six months
ended June 30, 2003. Our net debt to capitalization ratio (the sum of our
current and long-term debt, net of cash and cash equivalents compared to the sum
of our stockholders' equity and our current and long-term debt, net of cash and
cash equivalents) decreased from 27.9% at December 31, 2003 to 22.7% at June 30,
2004. This ratio is a measure of our long-term liquidity and is an indicator of
our financial flexibility.
The results of our operations resulted in generation of pre-tax income of $94.0
million for the second quarter of 2004 compared to pre-tax income in the second
quarter of 2003 of $1.7 million. Accordingly, the provision for income taxes was
$36.0 million for the second quarter of 2004 compared to the comparable prior
year period's provision of $591,000. Also, the effective tax rate for the
quarter was impacted by the generation of more pre-tax income and a greater
proportion of that income was derived from U.S. operations.
24
The results of our operations resulted in generation of pre-tax income of $142.3
million for the six months ended June 30, 2004 compared to pre-tax income for
the six months ended June 30, 2003 of $2.0 million. Accordingly, the provision
for income taxes was $53.9 million for the six months ended June 30, 2004
compared to the comparable prior year period's provision of $710,000. Also, the
effective tax rate for the six months ended June 30, 2004 was impacted by the
generation of more pre-tax income and a greater proportion of that income was
derived from U.S. operations.
The Company adopted Financial Accounting Standards Board ("FASB") Interpretation
No. 46, "Consolidation of Variable Interest Entities," on March 31, 2004, which
resulted in the consolidation of PCD as of that date. As a result, we recorded a
$1.6 million (net of benefit for income taxes of $1.0 million) non-cash
cumulative charge to recognize the prior losses of PCD during the first quarter
of 2004.
Net income of $58.0 million was generated in the second quarter of 2004, an
increase of $56.9 million from the comparable prior year period. Net income of
$86.7 million was generated in the six months ended June 30, 2004, an increase
of $85.4 million from the comparable prior year period.
Segment Information
- -------------------
The Company's two segments are the Energy Products segment and the Industrial
Products segment.
Energy Products Segment
- -----------------------
Energy product sales of $192.2 million for the second quarter of 2004 represent
an increase of $61.0 million, or 46.5%, compared to the prior year period.
Energy product shipments decreased 18,768 tons, or 9.6%, from 194,507 tons to
175,739 tons over the same period. Our energy product shipments decreased as we
raised our prices more aggressively than our competitors. Our average net
selling prices for energy products increased 62.1% from the comparable quarter
of the prior year, from an average of $675 per ton to $1,094 per ton. The U.S.
and Canadian rig counts increased from 1,028 and 203 active rigs, respectively,
for the second quarter of 2003, to 1,164 and 202 active rigs, respectively, for
the second quarter of 2004. The increase in energy product sales was primarily
due to price increases including steel surcharges. See "Overview."
Energy product sales of $402.2 million for the six months ended June 30, 2004
represent an increase of $118.6 million, or 41.8%, compared to the prior year
period. Energy product shipments increased 14,824 tons, or 3.5%, from 421,358
tons to 436,182 tons over the same period. Energy product shipments primarily
increased due to the U.S. and Canadian rig counts increasing from 964 and 348
active rigs, respectively, for the six months ended June 30, 2003, to 1,141 and
365 active rigs, respectively, for the six months ended June 30, 2004. Overall
average net selling prices for energy products increased 37.0% for the six
months ended June 30, 2004 from the comparable period of the prior year, from an
average of $673 per ton to $922 per ton. The increase in energy product sales
was primarily due to price increases including steel surcharges and
strengthening market conditions. See "Overview."
Energy product cost of goods sold of $138.4 million for the second quarter of
2004 represent an increase of $19.3 million, or 16.2%, compared with the prior
year period. The increase was primarily due to steel surcharges implemented by
our suppliers. See "Overview." Gross profit for energy products was $53.8
million for the quarter ended June 30, 2004 compared to a gross profit of $12.1
million for the prior year period. Gross profit per ton primarily increased due
to higher selling prices including steel surcharges. Gross profit was $306 per
ton for the second quarter of 2004 as compared to $62 per ton in the comparable
prior year period, reflecting stronger selling prices including steel
surcharges. Energy product gross profit margin percentage was 28.0% for the
quarter ended June 30, 2004, compared to a gross profit margin percentage of
9.2% for the prior year period. Gross profit per ton primarily increased due to
strengthening market conditions in our energy product lines and the sale of
lower costing inventory at higher selling prices charged by the Company in
response to increasing steel costs and strong market conditions. We expect the
higher steel costs will begin to flow through our inventory starting in the
third and fourth
25
quarters of 2004. Depending on the conditions in our energy product market and
our ability to effect selling price increases, these higher steel costs may
impact our gross profit margins in the fourth quarter if selling prices and
steel costs equalize in that quarter.
Energy product cost of goods sold of $305.3 million for the six months ended
June 30, 2004 represent an increase of $45.4 million, or 17.5%, compared with
the prior year period. The increase was primarily due to increased product
shipments and steel surcharges implemented by our suppliers. See "Overview."
Gross profit for energy products was $96.9 million for the six months ended June
30, 2004 compared to a gross profit of $23.7 million for the prior year period.
Gross profit per ton primarily increased due to higher selling prices including
steel surcharges. Gross profit was $222 per ton for the six months ended June
30, 2004 as compared to $56 per ton in the comparable prior year period,
reflecting stronger selling prices including steel surcharges and higher fixed
cost absorption. Energy product gross profit margin percentage was 24.1% for the
six months ended June 30, 2004, compared to a gross profit margin percentage of
8.4% for the prior year period. Gross profit per ton primarily increased due to
strengthening market conditions in our energy product lines and the sale of
lower costing inventory at higher selling prices charged by the Company in
response to increasing steel costs and strong market conditions. We expect the
higher steel costs will begin to flow through our inventory starting in the
third and fourth quarters of 2004. Depending on the conditions in our energy
product market and our ability to effect selling price increases, these higher
steel costs may impact our gross profit margins in the fourth quarter if selling
prices and steel costs equalize in that quarter.
Industrial Products Segment
- ---------------------------
Industrial product sales of $155.9 million for the second quarter of 2004
represent an increase of $92.2 million, or 144.7%, compared with the prior year
period. Industrial product shipments increased 19,463 tons, or 19.6%, from
99,526 tons to 118,989 tons over the same periods. Overall average net selling
price for industrial products increased 104.7% in the quarter ended June 30,
2004 from the comparable quarter of the prior year from an average of $640 per
ton to $1,310 per ton. This increase in industrial product sales and shipments
resulted from strengthening market conditions, our ability to obtain steel and
higher selling prices including steel surcharges. See "Overview."
Industrial product sales of $257.2 million for the six months ended June 30,
2004 represent an increase of $126.4 million, or 96.6%, compared with the prior
year period. Industrial product shipments increased 38,489 tons, or 19.3%, from
199,346 tons to 237,835 tons over the same periods. Overall average net selling
price for industrial products increased 64.8% for the six months ended June 30,
2004 from the comparable period of the prior year from an average of $656 per
ton to $1,081 per ton. This increase in industrial product sales and shipments
resulted from strengthening market conditions, our ability to obtain steel, and
higher selling prices including steel surcharges. See "Overview."
Industrial product cost of goods sold of $90.4 million in the second quarter of
2004 represents an increase of $30.2 million, or 50.2%, from the prior year
period. The increase was primarily due to increased product shipments and higher
steel costs. See "Overview." Gross profit for industrial products of $65.5
million for the quarter ended June 30, 2004 compared to a gross profit of $3.5
million for the prior year period. Gross profit per ton primarily increased due
to higher selling prices including steel surcharges offset by higher steel
costs. Gross profit was $550 per ton in the quarter ended June 30, 2004 as
compared to $35 per ton in the comparable prior year period, primarily
reflecting stronger selling prices including steel surcharges. Industrial
product gross profit margin percentage was 42.0% for the quarter ended June 30,
2004, compared to 5.5% gross profit margin during the prior year period. Gross
profit per ton primarily increased due to strengthening market conditions in our
industrial product lines and the sale of lower costing inventory at higher
selling prices charged by the Company in response to increasing steel costs and
strong market conditions. We expect the higher steel costs will begin to flow
through our inventory starting in the third and fourth quarters of 2004.
Depending on the conditions in our industrial product market and our ability to
effect selling price increases, these higher steel costs may impact our gross
profit margins in the fourth quarter if selling prices and steel costs equalize
in that quarter.
26
Industrial product cost of goods sold of $164.3 million for the six months ended
June 30, 2004 represents an increase of $40.4 million, or 32.6%, from the prior
year period. The increase was primarily due to increased product shipments and
higher steel costs. See "Overview." Gross profit for industrial products of
$92.9 million for the six months ended June 30, 2004 compared to a gross profit
of $6.9 million for the prior year period. Gross profit per ton primarily
increased due to higher selling prices including steel surcharges offset by
higher steel costs. Gross profit was $391 per ton for the six months ended June
30, 2004 as compared to $35 per ton in the comparable prior year period,
primarily reflecting stronger selling prices including steel surcharges.
Industrial product gross profit margin percentage was 36.1% for the six months
ended June 30, 2004 compared to 5.3% gross profit margin during the prior year
period. Gross profit per ton primarily increased due to strengthening market
conditions in our industrial product lines and the sale of lower costing
inventory at higher selling prices charged by the Company in response to
increasing steel costs and strong market conditions. We expect the higher steel
costs will begin to flow through our inventory starting in the third and fourth
quarters of 2004. Depending on the conditions in our industrial product market
and our ability to effect selling price increases, these higher steel costs may
impact our gross profit margins in the fourth quarter if selling prices and
steel costs equalize in that quarter.
LIQUIDITY AND CAPITAL RESOURCES
- --------------------------------------------------------------------------------
Working capital at June 30, 2004 was $342.7 million, and the ratio of current
assets to current liabilities was 3.4 to 1.0. Working capital at December 31,
2003 was $253.7 million, and the ratio of current assets to current liabilities
was 3.8 to 1.0. The increase in working capital for the six months ended June
30, 2004 was primarily due to a $8.3 million increase in cash and cash
equivalents, a $46.2 million increase in accounts receivable, a $84.9 million
increase in inventory offset by a $10.9 million increase in accounts payable, a
$33.8 million increase in income taxes payable and a $5.7 million increase in
accrued liabilities. The primary reason for the increase in accounts receivable
was an increase in industrial shipment levels and increases in selling prices
during the second quarter of 2004. The primary reason for the change in
inventory is the higher cost of steel experienced in 2004 compared to 2003. We
raised our selling prices to offset increases in steel cost. Cash provided by
operating activities was $36.3 million for the six months ended June 30, 2004.
Cash used by investing activities was $27.7 million for the six months ended
June 30, 2004, which was attributable to expenditures on property, plant and
equipment of $11.7 million, the purchase of Texas Arai for $20.3 million,
partially offset by $5.6 million of proceeds for the sale of the Longview,
Washington facility.
Cash provided by financing activities was $0.6 million for the six months ended
June 30, 2004 as principal payments on long-term borrowings were offset by the
proceeds from the exercise of stock options.
We have a senior credit facility providing a revolving line of credit for up to
a $185.0 million. In addition, we have outstanding letters of credit under this
agreement representing an additional $1.8 million at June 30, 2004. Interest is
payable monthly at either the U.S. or Canadian prime rate, the Bankers'
Acceptance rates plus stamping fees or the LIBOR rate, all adjusted by an
interest margin, depending upon certain financial measurements. Under the
revolving senior credit facility, we can borrow an amount based on a percentage
of eligible accounts receivable, eligible inventory and property, plant and
equipment reduced by outstanding letters of credit. The additional available
borrowings under the senior credit facility was approximately $121.9 million as
of June 30, 2004. The senior credit facility includes a restrictive covenant
requiring a minimum fixed charge coverage ratio if availability falls below
$30.0 million. Also, if availability falls below $50.0 million, the debt will be
classified as current. The senior credit facility also limits capital
expenditures to $30.0 million per year and limits our ability to pay dividends,
create liens, sell assets or enter into transactions with affiliates without the
consent of the lenders.
We anticipate we will comply with the covenants in our senior credit facility
and other debt instruments in 2004 and beyond. We believe our projections for
2004 are based on reasonable assumptions and we believe that it is unlikely we
would default absent a material negative event affecting us, or our industry and
the economy as a whole.
27
In June 2003, the Company issued $120.0 million of contingent convertible,
senior subordinated notes (the "Convertible Notes") due June 15, 2033. The
Company pays interest semi-annually on the Convertible Notes at the rate of 4.0%
per annum. Beginning with the six-month interest period commencing on June 15,
2008, the Company will pay contingent interest during a six-month interest
period if the average trading price of the Convertible Notes equals or exceeds
130.0% of the principal amount of the Convertible Notes during a specified
period prior to such six-month interest period. The Convertible Notes are
general unsecured obligations of the Company and are subordinated to the
Company's present and future senior indebtedness. We applied approximately $73.0
million of the net proceeds of the offering to pay down our borrowings under our
senior credit facility. After application of this amount, our borrowings were
just above $50.0 million, which preserved our interest rate swap agreement
described under Item 3 of this Form 10-Q. We initially applied the remaining net
proceeds to cash and, thereafter, applied approximately $30.0 million of cash to
pay various trade vendors who were offering discounts for early payment.
Our capital budget for 2004 is approximately $22.2 million, which $11.7 million
was expended during the six-month period ended June 30, 2004. The capital budget
includes $6.5 million for upgrading one of our mills at Prudential. The
remaining $15.7 million of our capital budget will be used to acquire new
equipment for our existing manufacturing facilities and to continue full
integration of our recent acquisitions. We expect to meet ongoing working
capital and the capital expenditure requirements from a combination of cash flow
from operating activities and available borrowings under our revolving credit
facility.
The Company has announced its plan to consolidate the Republic Conduit
operations into a state-of-the-art facility located in the Midwestern U.S. Two
sites remain under consideration and final selection will occur during the third
quarter of 2004. The consolidation is expected to cost approximately $55.0
million, consisting primarily of equipment costs. The Company expects that it
will purchase new equipment and upgrade existing equipment to improve efficiency
and productivity of the conduit manufacturing operations. Significant
expenditures are expected to commence in the fourth quarter of 2004 and are
expected to be completed in late 2005. The Company anticipates obtaining the
necessary approvals from our senior lender for capital expenditures related to
this project in an amount up to $55.0 million in the aggregate for the years
2004 and 2005. The anticipated approval from our senior lender for capital
expenditures up to $55.0 million for the consolidation of the Republic Conduit
operations does not impact our normal annual limit on capital expenditures of
$30.0 million dollars. The Company anticipates paying severance and stay bonuses
to certain Republic Conduit employees, which will be expenses as incurred. This
plan is in the process of being finalized. The Company also anticipates that any
impairment charges necessary as a result of moving out of these locations or
abandoning various pieces of equipment will not be material.
Consistent with the Company's business strategy, we currently intend to retain
earnings to finance the growth and development of our business, and we do not
anticipate paying cash dividends in the near future. Any payment of cash
dividends in the future will depend upon our financial condition, capital
requirements and earnings as well as other factors the Board of Directors may
deem relevant. Our long-term revolving credit facility with commercial lenders
restricts the amount of dividends we can pay to our stockholders.
28
CRITICAL ACCOUNTING ESTIMATES
- --------------------------------------------------------------------------------
The preparation of the financial statements in accordance with generally
accepted accounting principles requires management to make judgments, estimates
and assumptions regarding uncertainties that affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities and the
reported amounts of revenues and expenses.
Areas of uncertainty that require judgments, estimates and assumptions include
the valuation of goodwill, the collectibility of accounts receivable, income tax
matters and the pension plan.
Management uses experience and all available information to make these judgments
and estimates; however, actual results will inevitably differ from those
estimates and assumptions used to prepare the Company's financial statements at
any given time. Despite these inherent limitations, management believes
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the financial statements and notes contained in this report
provide a meaningful and fair perspective of the Company.
The Company's critical accounting policies and estimates are more fully
described in our Annual Report on Form 10-K for the year ended December 31,
2003, beginning on page 25. The Company's critical accounting policies and
estimates did not change during the second quarter of 2004. Management believes
the application of these policies on a consistent basis enables the Company to
provide the users of the financial statements with useful and reliable
information about the Company's operating results and financial condition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------------------
Interest Rate Risk
- ------------------
We are subject to interest rate risk to the extent we borrow against our
revolving credit facility with variable interest rates. However, we utilize an
interest rate swap agreement described below to moderate a portion of our
exposure. We do not use derivative financial instruments for trading or other
speculative purposes. Assuming the current level of borrowings at variable rates
and a two-percentage-point change in the average interest rate under these
borrowings and taking into account the swap agreement in place, it is estimated
that our interest expense for the quarter ended June 30, 2004 would not have
changed by a material amount. In the event of an adverse change in interest
rates, we would likely take actions, in addition to the swap agreement currently
in place, that would mitigate our exposure to interest rate risk; however, due
to the uncertainty of the actions that would be taken and their possible
effects, no such actions have been considered. Further, no consideration has
been given to the effects of the change in the level of overall economic
activity that could exist in such an environment.
We have entered into an interest rate swap agreement with a total notional
amount of $50.0 million that fixes the LIBOR-based variable rate in our senior
credit facility at 2.24% (before the applicable margin). The swap agreement
terminates on March 21, 2005. The swap is being accounted for as a cash flow
hedge under Statement of Financial Accounting Standards ("SFAS") No. 133.
Accordingly, the difference between the interest received and interest paid is
reflected as an adjustment to interest expense. Under the terms of the swap
agreement, the next settlement amount is not due until September 2004. At June
30, 2004, the swap agreement is reflected in the accompanying consolidated
balance sheet in other accrued liabilities at its fair value of $(0.1) million.
The unrealized loss on the fair value of the swap agreement is reflected, net of
taxes, in other comprehensive loss.
29
Steel Commodity Risk
- --------------------
We are also subject to commodity price risk with respect to purchases of steel.
Purchased steel represents approximately eighty percent of our cost of goods
sold. As a result, the steel industry, which is highly volatile and cyclical in
nature, affects business both positively and negatively. We estimate that a $10
per ton change in the price of steel that is not offset by a similar selling
price change could impact diluted earnings per share by a range of $0.10 to
$0.15. We expect our current replacement cost of steel to flow through our cost
of goods sold over the next two quarters. See "Overview - Pricing and Costs of
Our Products." In addition, we depend on a few suppliers for a significant
portion of our steel. The loss of one or more of our significant steel suppliers
or the inability to obtain the necessary amount of steel could affect our
ability to produce our products and could have a material adverse effect on our
business.
Foreign Currency Risk
- ---------------------
The Company's reported cash flows related to its Canadian operations are based
on cash flows measured in Canadian dollars converted to the U.S. dollar
equivalent based on published exchange rates for the period reported. The
Company believes its current risk exposure to the exchange rate movements, based
on net cash flows, to be immaterial.
We have entered into a foreign currency hedge agreement with a total notional
amount of $30.0 million that fixes the purchase of Canadian dollars into U.S.
dollars on January 23, 2004 at an exchange rate of 1.3287. The settlement date
for the hedge agreement is July 21, 2004. The swap is being accounted for as a
cash flow hedge. Accordingly, the difference between the spot rate at the
inception of the contract and the forward rate is reflected as an adjustment to
interest expense during the duration of the contract. At June 30, 2004, the
hedge agreement is reflected in the accompanying consolidated balance sheet in
other assets at its fair value of $0.1 million. The unrealized gain on the fair
value of the hedge agreement is reflected in other comprehensive income.
ITEM 4. CONTROLS AND PROCEDURES
- --------------------------------------------------------------------------------
The Company's management, under the supervision and with the participation of
our chief executive officer and chief financial officer, have reviewed and
evaluated the Company's disclosure controls and procedures as of June 30, 2004.
Based on such review and evaluation, our chief executive officer and chief
financial officer have concluded that the disclosure controls and procedures are
effective to ensure that the information required to be disclosed by the Company
in the reports that it files or submits under the Securities Exchange Act of
1934, as amended, (a) is recorded, processed, summarized and reported within the
time period specified in the SEC's rules and forms and (b) is accumulated and
communicated to the Company's management, including the officers, as appropriate
to allow timely decisions regarding required disclosure. There have been no
significant changes in the Company's internal controls over financial reporting
that occurred during the quarter ended June 30, 2004 that have materially
affected or are reasonably likely to materially affect the Company's internal
controls over financial reporting.
30
- --------------------------------------------------------------------------------
MAVERICK TUBE CORPORATION AND SUBSIDIARIES
PART II. OTHER INFORMATION
- --------------------------------------------------------------------------------
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- --------------------------------------------------------------------------------
(a) The annual meeting of the stockholders of the Company was held on May 3,
2004. Of the 42,017,920 shares entitled to vote (39,832,751 common stock
and 2,185,169 exchangeable shares) at such meeting, 39,445,178 shares were
present at the meeting in person or by proxy.
(b) The individuals listed below were elected as directors of the Company at
the meeting:
Gregg Eisenberg
C. Robert Bunch
David H. Kennedy
Wayne P. Mang
Paul McDermott
C. Adams Moore
(c) The stockholders elected each of the following directors at the meeting,
and with respect to each director, the number of shares voted for and
withheld were as follows:
Number of Shares Voted
Name of Nominees For Withheld
---------------------------------------------------------------------------
Gregg Eisenberg 38,204,475 1,240,703
C. Robert Bunch 37,322,862 2,122,316
David H. Kennedy 37,767,427 1,677,751
Wayne P. Mang 37,759,835 1,685,343
Paul McDermott 38,446,447 998,731
C. Adams Moore 39,010,917 434,261
The stockholders approved the Maverick Tube Corporation 2004 Omnibus
Incentive Plan with 31,206,968 shares voting for the proposal, 2,035,906
shares voting against the proposal, 1,160,583 shares abstaining and
5,041,721 broker non-votes.
The stockholders approved the Maverick Tube Corporation 2004 Stock
Incentive Plan for Non-Employee Directors with 30,646,590 shares voting for
the proposal, 2,593,852 shares voting against the proposal, 1,163,015
shares abstaining and 5,041,721 broker non-votes.
The stockholders ratified the appointment of Ernst & Young LLP as the
Company's independent auditors with 36,901,619 shares voting for the
proposal, 2,529,035 shares voting against the proposal and 14,524 shares
abstaining.
Abstentions with respect to the election of directors were treated as votes
withheld.
(d) None.
31
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------------
(a) Exhibit No. Description
10.1 Sixth Amendment to Amended and Restated Credit Agreement dated as of
April 9, 2004 among Registrant and its subsidiaries, on the one hand,
and the Senior Lenders, on the other hand.
15.1 Letter re: Unaudited Interim Financial Information.
31.1 Chief Executive Officer certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Chief Financial Officer certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Chief Executive Officer certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Chief Financial Officer certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K - (excluding Items 9 and 12).
On June 14, 2004, the Company filed a Report on Form 8-K containing the
announcement that the Company plans to consolidate the Republic Conduit
operations into a single facility located in the Midwestern United States
and revised guidance on its second quarter 2004 operating results.
32
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.
Maverick Tube Corporation
-------------------------------------------------
(Registrant)
Date: August 6, 2004 /s/ Gregg Eisenberg
-------------------------------------------------
Gregg Eisenberg, Chairman, President
and Chief Executive Officer
(Principal Executive Officer)
Date: August 6, 2004 /s/ Pamela G. Boone
-------------------------------------------------
Pamela G. Boone, Vice President - Finance
and Administration and Chief Financial Officer
(Principal Financial and Accounting Officer)
33
EXHIBIT INDEX
Exhibit No. Description
- --------------------------------------------------------------------------------
10.1 Sixth Amendment to Amended and Restated Credit
Agreement dated as of April 9, 2004 among Registrant
and its subsidiaries, on the one hand, and the Senior
Lenders, on the other hand.
15.1 Letter re: Unaudited Interim Financial Information.
31.1 Chief Executive Officer certification pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Chief Financial Officer certification pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Chief Executive Officer certification pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Chief Financial Officer certification pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
34