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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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 September 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 0-27378
NUCO2 INC.
(Exact Name of Registrant as Specified in Its Charter)
Florida 65-0180800
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
2800 SE Market Place, Stuart, FL 34997
(Address of Principal Executive Offices) (Zip Code)
(772) 221-1754
(Registrant's Telephone Number, Including Area Code)
N/A
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
Indicate by check X whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
---- ----
Indicate by check X whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No
---- ----
Indicate the number of shares outstanding of each of the issuer's classes
of Common Stock, as of the latest practicable date:
CLASS OUTSTANDING AT SEPTEMBER 30, 2004
----- ---------------------------------
Common Stock, $.001 par value 11,716,587 shares
NUCO2 INC.
INDEX
-----
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Balance Sheets as of September 30, 2004 and 3
June 30, 2004
Statements of Operations for the Three Months Ended 4
September 30, 2004 and September 30, 2003
Statement of Shareholders' Equity for the Three 5
Months Ended September 30, 2004
Statements of Cash Flows for the Three Months 6
Ended September 30, 2004 and September 30, 2003
Notes to Financial Statements 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF 16
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 25
ITEM 4. CONTROLS AND PROCEDURES 26
PART II. OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND 26
USE OF PROCEEDS
ITEM 6. EXHIBITS 26
SIGNATURES 27
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NUCO2 INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
ASSETS
------
SEPTEMBER 30, 2004 JUNE 30, 2004
------------------ -------------
(unaudited)
Current assets:
Cash and cash equivalents $ 3,192 $ 505
Trade accounts receivable, net of allowance for doubtful
accounts of $2,070 and $2,095, respectively 7,218 6,141
Inventories 257 226
Prepaid insurance expense and deposits 2,262 2,104
Prepaid expenses and other current assets 1,311 808
-------- ---------
Total current assets 14,240 9,784
-------- ---------
Property and equipment, net 93,574 92,969
-------- ---------
Other assets:
Goodwill, net 19,222 19,222
Deferred financing costs, net 2,378 2,178
Customer lists, net 42 41
Non-competition agreements, net 632 703
Deferred lease acquisition costs, net 3,577 3,458
Other assets 176 181
-------- ---------
26,027 25,783
-------- ---------
Total assets $ 133,841 $ 128,536
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Current maturities of long-term debt $ 7,199 $ 6,048
Accounts payable 4,590 4,579
Accrued expenses 946 1,840
Accrued interest 408 440
Accrued payroll 740 1,137
Other current liabilities 389 343
-------- ---------
Total current liabilities 14,272 14,387
Long-term debt, excluding current maturities 33,189 30,962
Subordinated debt 29,603 29,163
Customer deposits 3,351 3,247
-------- ---------
Total liabilities 80,415 77,759
-------- ---------
Commitments and contingencies
Redeemable preferred stock 3,150 10,021
-------- ---------
Shareholders' equity:
Preferred stock; no par value; 5,000,000 shares authorized;
issued and outstanding 2,500 shares at September 30, 2004
and 7,500 shares at June 30, 2004 -- --
Common stock; par value $.001 per share; 30,000,000 shares authorized;
issued and outstanding 11,716,587 shares at September 30, 2004
and 10,840,831 shares at June 30, 2004 12 11
Additional paid-in capital 103,886 96,185
Accumulated deficit (53,850) (55,704)
Accumulated other comprehensive income 228 264
-------- --------
Total shareholders' equity 50,276 40,756
-------- --------
Total liabilities and shareholders' equity $ 133,841 $ 128,536
======== ========
See accompanying notes to financial statements.
3
NUCO2 INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30,
2004 2003*
---- -----
Revenues:
Product sales $ 13,545 $ 12,569
Equipment rentals 8,336 7,669
------- -------
Total revenues 21,881 20,238
Costs and expenses:
Cost of products sold, excluding depreciation and amortization 9,407 8,626
Cost of equipment rentals, excluding depreciation
and amortization 553 828
Selling, general and administrative expenses 4,072 4,015
Depreciation and amortization 3,740 3,912
Loss on asset disposal 161 415
------- -------
17,933 17,796
------- -------
Operating income 3,948 2,442
Loss on early extinguishment of debt -- 1,964
Interest expense 2,040 1,897
------- -------
Income (loss) before income taxes 1,908 (1,419)
Provision for income taxes 54 --
------- -------
Net income (loss) $ 1,854 $ (1,419)
======= =======
Weighted average outstanding shares of common stock:
Basic 11,200 10,633
======= =======
Diluted 12,725 10,633
======= =======
Net income (loss) per basic share $ 0.15 $ (0.15)
======= =======
Net income (loss) per diluted share $ 0.14 $ (0.15)
======= =======
See accompanying notes to financial statements.
*Restated to conform to current year presentation.
4
NUCO2 INC.
STATEMENT OF SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER TOTAL
---------------------- PAID-IN ACCUMULATED COMPREHENSIVE SHAREHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT INCOME (LOSS) EQUITY
------ ------ ------- ------- ------------- ------
Balance, June 30, 2004 10,840,831 $ 11 $ 96,185 $ (55,704) $ 264 $ 40,756
Comprehensive income:
Net income -- -- -- 1,854 -- 1,854
Other comprehensive expense:
Interest rate swap transaction -- -- -- -- (36) (36)
---------
Total comprehensive income 1,818
Conversion of 5,000 shares of
Redeemable Preferred Stock 754,982 1 7,005 -- -- 7,006
Issuance of 111,701 shares of
common stock - exercise of warrants 111,701 -- 743 -- -- 743
Issuance of 9,073 shares of
common stock - exercise of options 9,073 -- 88 -- -- 88
Redeemable preferred stock dividend -- -- (135) -- -- (135)
------------ --------- ---------- ---------- --------- ----------
Balance, September 30, 2004 11,716,587 $ 12 $ 103,886 $ (53,850) $ 228 $ 50,276
============ ========= ========== ========== ========= ==========
See accompanying notes to financial statements.
5
NUCO2 INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2004 2003*
---- -----
Cash flows from operating activities:
Net income (loss) $ 1,854 $ (1,419)
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Depreciation and amortization of property and equipment 3,264 3,364
Amortization of other assets 476 548
Amortization of original issue discount 106 87
Paid-in-kind interest 334 133
Loss on disposals 161 415
Loss on early extinguishment of debt -- 1,964
Changes in operating assets and liabilities:
Decrease (increase) in:
Trade accounts receivable (1,077) (569)
Inventories (31) (28)
Prepaid insurance expenses and deposits (158) (416)
Prepaid expenses and other current assets (503) (428)
Increase (decrease) in:
Accounts payable 11 716
Accrued expenses (845) (108)
Accrued payroll (397) (416)
Accrued interest (68) (463)
Other current liabilities 46 25
Customer deposits 104 93
-------- --------
Net cash provided by operating activities 3,277 3,498
-------- --------
Cash flows from investing activities:
Purchase of property and equipment (4,037) (3,230)
Increase in deferred lease acquisition costs (404) (346)
Increase in other assets -- (1)
-------- --------
Net cash used in investing activities (4,441) (3,577)
-------- --------
Cash flows from financing activities:
Repayment of long-term debt (4,272) (70,711)
Proceeds from issuance of long-term debt 7,650 73,200
Exercise of warrants 743 --
Exercise of stock options 88 --
Increase in deferred financing costs (358) (2,712)
-------- --------
Net cash provided by (used in) financing activities 3,851 (223)
-------- --------
Increase (decrease) in cash and cash equivalents 2,687 (302)
Cash and cash equivalents at the beginning of period 505 455
-------- --------
Cash and cash equivalents at the end of period $ 3,192 $ 153
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 1,667 $ 2,053
======== ========
Income taxes $ 75 $ --
======== ========
See accompanying notes to financial statements.
*Restated to conform to current year presentation.
6
NUCO2 INC.
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in
accordance with the instructions to Form 10-Q used for quarterly reports under
Section 13 or 15 (d) of the Securities Exchange Act of 1934, and therefore, do
not include all information and footnotes necessary for a fair presentation of
financial position, results of operations and cash flows in conformity with
generally accepted accounting principles.
The financial information included in this report has been prepared in
conformity with the accounting principles and methods of applying those
accounting principles, reflected in the financial statements for the fiscal year
ended June 30, 2004 included in Form 10-K filed with the Securities and Exchange
Commission.
All adjustments necessary for a fair statement of the results for the
interim periods presented have been recorded. This quarterly report on Form 10-Q
should be read in conjunction with the Company's audited financial statements
for the fiscal year ended June 30, 2004. The results of operations for the
periods presented are not necessarily indicative of the results to be expected
for the full fiscal year. As a result of the adoption of EITF 00-21, the Company
anticipates that reported revenue will fluctuate on a quarterly basis due to
seasonal variations. Based on historical data and expected trends, the Company
anticipates that revenue from the delivery of CO2 will be highest in the first
quarter and lowest in the third quarter.
NOTE 2. ACCOUNTING PRONOUNCEMENTS
On July 1, 2003, the Company adopted EITF Issue No. 00-21, "Revenue
Arrangements with Multiple Deliverables" ("EITF 00-21"). EITF 00-21 addresses
certain aspects of the accounting by a vendor for arrangements under which the
vendor will perform multiple revenue generating activities. The Company's bulk
CO2 budget plan agreements provide for a fixed monthly payment to cover the use
of a bulk CO2 system and a predetermined maximum quantity of CO2. As of
September 30, 2004, approximately 58,000 of the Company's customer locations
utilized this plan. Prior to July 1, 2003, the Company, as lessor, recognized
revenue from leasing CO2 systems under its budget plan agreements on a
straight-line basis over the life of the related leases. The Company developed a
methodology for the purpose of separating the aggregate revenue stream between
the rental of the equipment and the sale of the CO2. Effective July 1, 2003,
revenue attributable to the lease of equipment, including equipment leased under
the budget plan, is recorded on a straight-line basis over the term of the lease
and revenue attributable to the supply of CO2 and other gases, including CO2
provided under the budget plan, is recorded upon delivery to the customer.
The Company has elected to apply EITF 00-21 retroactively to all budget
plan agreements in existence as of July 1, 2003. Based on the Company's
analysis, the aggregate amount of CO2 actually delivered under budget plans
during the quarter ended June 30, 2003 is not materially different than the
corresponding portion of the fixed charges attributable to CO2. Accordingly, the
Company believes the cumulative effect of the adoption of EITF 00-21 as of July
1, 2003 is not significant.
Under the budget plan, each customer has a maximum CO2 allowance that
is measured and reset on the contract anniversary date. At that date, it is
appropriate to record revenue for actual deliveries of CO2 in excess of contract
billings. Because of the large number of customers under the budget plan and the
fact that the anniversary dates for determining maximum quantities are spread
throughout the year, the Company's methodology necessarily involves the use of
estimates and assumptions to separate the aggregate revenue stream derived from
equipment rentals to budget plan customers, and also to approximate the
recognition of revenue from CO2 sales to budget plan customers when earned. The
Company believes that the adoption of EITF 00-21 has the most impact on the
recognition of revenue on a quarterly basis as CO2 usage fluctuates during a
fiscal year based on factors such as weather, and traditional summer and holiday
periods. Over a twelve-month period, the Company believes the effect is less
significant since seasonal variations are largely eliminated and CO2 allowances
under budget plan agreements are measured and reset annually.
In December 2003, the Financial Accounting Standards Board ("FASB")
revised FASB Interpretation No. 46, "Consolidation of Variable Interest
Entities." Application of this Interpretation is required in a company's
financial statements for interests in variable interest entities that are
considered special-purpose entities for reporting periods ending after March 15,
2004. FASB Interpretation No. 46 did not effect the Company's financial
position, results of operations, or cash flows.
7
In December 2003, the FASB revised SFAS No. 132, "Employer Disclosures
about Pensions and Other Postretirement Benefits" ("SFAS 132"). SFAS 132
requires additional disclosures regarding the assets, obligations, cash flows,
and net periodic benefit cost of defined benefit plans and other defined benefit
postretirement plans. SFAS 132 requires that this information be provided
separately for pension plans and other postretirement benefit plans. The
adoption of the revised SFAS No. 132, effective January 1, 2004, had no impact
on the Company's financial position, results of operations, or cash flows.
NOTE 3. EARNINGS (LOSS) PER COMMON SHARE
The Company calculates earnings per share in accordance with the
requirements of SFAS No. 128, "Earnings Per Share." The weighted average shares
outstanding used to calculate basic and diluted earnings (loss) per share were
calculated as follows (in thousands):
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2004 2003
---- ----
Weighted average shares outstanding - basic 11,200 10,633
Outstanding options and warrants to purchase
shares of common stock - remaining shares
after assuming repurchase with proceeds
from exercise 1,525 -
------ ------
Weighted average shares outstanding - diluted 12,725 10,633
======= ======
The Company excluded the equivalent of 535,470 shares of common stock
for the three months ended September 30, 2003, as these options and warrants to
purchase common stock were anti-dilutive for that period. In addition, the
Company excluded the effects of the conversion of its outstanding redeemable
preferred stock using the "if converted" method, as the effect would be
anti-dilutive for both periods (Note 6). The Company's redeemable preferred
stock was convertible into 240,591 and 916,978 shares of common stock as of
September 30, 2004 and 2003, respectively.
The following table presents the Company's net income (loss) available
to common shareholders and income (loss) per share, basic and diluted (in
thousands, except per share amounts):
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2004 2003
-------- --------
Net income (loss) $ 1,854 $ (1,419)
Redeemable preferred stock dividends (135) (185)
-------- --------
Net income (loss) -
available to common shareholders $ 1,719 $ (1,604)
======== ========
Weighted average outstanding shares of
common stock:
Basic 11,200 10,633
Diluted 12,725 10,633
Basic income (loss) per share $ 0.15 $ (0.15)
======== ========
Diluted income (loss) per share $ 0.14 $ (0.15)
======== ========
In August 2004, 5,000 shares of the Company's redeemable preferred
stock were converted into 754,982 shares of common stock (see Note 6).
8
NOTE 4. LONG-TERM DEBT
In September 2001, the Company entered into a $60.0 million second
amended and restated revolving credit facility with a syndicate of banks
("Amended Credit Facility"). The Amended Credit Facility contained interest
rates and an unused commitment fee based on a pricing grid calculated quarterly
on total debt to annualized EBITDA (as defined). The Company was entitled to
select the Base Rate or LIBOR, plus applicable margin, for principal drawings
under the Amended Credit Facility. Interest only was payable periodically until
the termination of the Amended Credit Facility. The Amended Credit Facility was
collateralized by substantially all of the Company's assets. Additionally, the
Company was precluded from declaring or paying any cash dividends, except the
Company was permitted to accrue and accumulate, but not pay, cash dividends on
the redeemable preferred stock. The Company was also required to meet certain
affirmative and negative covenants including, but not limited to, financial
covenants.
Prior to June 30, 2002, the Amended Credit Facility was amended to
adjust certain financial covenants for the quarter ended March 31, 2002 and
prospectively, and non-compliance with the minimum EBITDA covenant for the three
months ended March 31, 2002 was waived. As of June 30, 2002, the Company was not
in compliance with certain of its financial covenants. On September 27, 2002,
the Amended Credit Facility was amended to adjust certain financial covenants
for the quarter ended June 30, 2002, and prospectively, and the maturity of the
Amended Credit Facility was extended to November 17, 2003. As of September 30,
2002, the Company was in compliance with all of the financial covenants under
the Amended Credit Facility. On February 7, 2003, the Amended Credit Facility
was amended to adjust certain financial covenants for the quarter ended December
31, 2002 and prospectively, non-compliance with the minimum EBITDA covenant for
the three months ended December 31, 2002 was waived, the maturity of the Amended
Credit Facility was extended to April 29, 2004, and the Amended Credit Facility
was reduced to $45.0 million. As of March 31, 2003 and June 30, 2003, the
Company was in compliance with all of the financial covenants under the Amended
Credit Facility.
On August 25, 2003, the Company terminated the Amended Credit Facility
and entered into a $50.0 million senior credit facility with a syndicate of
banks (the "Senior Credit Facility"). The Senior Credit Facility initially
consisted of a $30.0 million A term loan facility (the "A Term Loan"), a $10.0
million B term loan facility (the "B Term Loan"), and a $10.0 million revolving
loan facility (the "Revolving Loan Facility"). On October 1, 2004, the Senior
Credit Facility was amended to, among other things, increase the B Term Loan to
$23.0 million and to modify certain financial covenants. The A Term Loan and
Revolving Loan Facility mature on August 25, 2007, while the B Term Loan matures
on August 25, 2008. The Company is entitled to select either Eurodollar Loans
(as defined) or Base Rate Loans (as defined), plus applicable margin, for
principal borrowings under the Senior Credit Facility. Applicable margin is
determined by a pricing grid based on the Company's Consolidated Total Leverage
Ratio (as defined) as follows:
A Term B Term A Term B Term Revolving
Loans Loans Revolving Loans Loans Loans
Consolidated maintained maintained Loans maintained maintained maintained
Total as as maintained as as as
Leverage Base Rate Base Rate as Base Rate Eurodollar Eurodollar Eurodollar
Level Ratio Loans Loans Loans Loans Loans Loans
- ------- -------------- ---------- ----------- ------------ ---------- ------------ -----------
1 Less than
2.50:1.00 2.50% 2.75% 2.50% 3.50% 3.75% 3.50%
Greater than
or equal to
2.50:1.00 but
less than
2 3.00:1.00 2.75% 3.00% 2.75% 3.75% 4.00% 3.75%
Greater than
3 or equal to
3.00:1.00 3.00% 3.25% 3.00% 4.00% 4.25% 4.00%
9
However, from October 1, 2004 until delivery to the lenders of the
Company's financial statements for the quarter ending December 31, 2004, Level 2
pricing applies. Interest is payable periodically on borrowings under the Senior
Credit Facility. In addition, commencing on December 31, 2003 and on the last
day of each quarter thereafter, the Company is required to make principal
repayments on the A Term Loan in increasing amounts and commencing on December
31, 2004 and on the last day of each quarter thereafter, the Company is required
to make principal payments on the B Term Loan in the amount of $57,500 until
August 25, 2008 when the Company is required to make a payment in the amount of
$22,137,500. The Senior Credit Facility is collateralized by all of the
Company's assets. Additionally, the Company is precluded from declaring or
paying any cash dividends, except it may accrue and accumulate, but not pay,
cash dividends on its outstanding redeemable preferred stock. As of September
30, 2004, $25.4 million was outstanding under the A Term Loan, $10.0 million was
outstanding under the B Term Loan and $4.8 million was outstanding under the
Revolving Loan Facility with a weighted average interest rate of 6.6%.
The Company is also required to meet certain affirmative and negative
covenants, including but not limited to financial covenants. The Company is
required to assess its compliance with these financial covenants under the
Senior Credit Facility on a quarterly basis. These financial covenants are based
on a measure that is not consistent with accounting principles generally
accepted in the United States of America. Such measure is EBITDA (as defined),
which represents earnings before interest, taxes, depreciation and amortization,
as further modified by certain defined adjustments. The failure to meet these
covenants, absent a waiver or amendment, would place the Company in default and
cause the debt outstanding under the Senior Credit Facility to immediately
become due and payable. The Senior Credit Facility also includes certain
cross-default provisions to the Company's 16.3% Senior Subordinated Notes due
February 27, 2009. The Company was in compliance with all covenants under the
Senior Credit Facility as of September 30, 2003 and all subsequent quarters up
to and including September 30, 2004.
In connection with the termination of the Amended Credit Facility,
during the first quarter of fiscal 2004, the Company recognized a loss from the
write-off of $0.9 million in unamortized financing costs associated with the
Amended Credit Facility and recorded $2.2 million in financing costs associated
with the Senior Credit Facility. Such costs will be amortized over the life of
the Senior Credit Facility.
Effective July 1, 2000, the Company adopted SFAS No. 133 "Accounting
for Derivative Instruments and Hedging Activities," as amended, which, among
other things, establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities. All derivatives, whether designated in
hedging relationships or not, are required to be recorded on the balance sheet
at fair value. For a derivative designated as a cash flow hedge, the effective
portions of changes in the fair value of the derivative are recorded in other
comprehensive income and are recognized in the income statement when the hedged
item affects earnings. Ineffective portions of changes in the fair value of cash
flow hedges are recognized in earnings.
The Company uses derivative instruments to manage exposure to interest
rate risks. The Company's objectives for holding derivatives are to minimize the
risks using the most effective methods to eliminate or reduce the impacts of
this exposure. Prior to August 25, 2003, the Company was a party to an interest
rate swap agreement (the "Prior Swap") with a notional amount of $12.5 million
and a termination date of September 28, 2003. Under the Prior Swap, the Company
paid a fixed interest rate of 5.23% per annum and received a LIBOR-based
floating rate. In conjunction with the termination of the Prior Swap prior to
maturity, the Company paid $86,000, which represented the fair value of the swap
liability. The $86,000 was reclassified from other comprehensive income and
recognized as a component of the loss on early extinguishment of debt.
The Prior Swap, which was designated as a cash flow hedge, was deemed
to be a highly effective transaction, and accordingly the loss on the derivative
instrument was reported as a component of other comprehensive income (loss). For
the quarter ended September 30, 2003, the Company recorded $43,000, net of the
reclassification adjustment of $86,000, representing the change in fair value of
the Prior Swap, as other comprehensive income.
In order to reduce the Company's exposure to increases in Eurodollar
rates, and consequently to increases in interest payments, the Company entered
into an interest rate swap transaction (the "Swap") on October 2, 2003, in the
amount of $20.0 million ("Notional Amount") with an effective date of March 15,
2004 and a maturity date of September 15, 2005. Pursuant to the Swap, the
Company pays a fixed interest rate of 2.12% per annum and receives a
Eurodollar-based floating rate. The effect of the Swap is to neutralize any
changes in Eurodollar rates on the Notional Amount. As the Swap was not
effective until March 15, 2004 and no cash flows were exchanged prior to that
date, the Swap did not meet the requirements to be designated as a cash flow
hedge. As such, an unrealized loss of $177,000 was recognized in the Company's
results of operations for the fiscal year ended June 30, 2004, reflecting the
change in fair value of the Swap from inception to the effective date. As of
March 15, 2004, the Swap met the requirements to be designated as a cash flow
hedge and is deemed a highly effective transaction. Accordingly, the Company
10
recorded $264,000, representing the change in fair value of the Swap from March
15, 2004 through June 30, 2004, as other comprehensive income. The fair value of
the Swap changed by $36,000 during the first quarter of fiscal 2005 to $51,000.
NOTE 5. SUBORDINATED DEBT
In October 1997, the Company issued $30.0 million of its 12% Senior
Subordinated Promissory Notes (the "1997 Notes") with interest only payable
semi-annually on April 30 and October 31, due October 31, 2004. The 1997 Notes
were sold with detachable seven year warrants to purchase an aggregate of
655,738 shares of common stock at an exercise price of $16.40 per share. At the
date of issuance, in accordance with APB 14, "Accounting for Convertible Debt
and Debt Issued with Purchase Warrants," the Company allocated proceeds of $29.7
million to the debt and $0.3 million to warrants, with the resulting discount on
the debt referred to as the Original Issue Discount. Prior to August 25, 2003,
the Original Issue Discount was being amortized as interest expense over the
life of the debt, resulting in an effective interest rate on the 1997 Notes of
12.1% per annum. The amount allocated to the warrants was credited to Additional
Paid-In Capital. In conjunction with the issuance of the 1997 Notes, the Company
was required to meet certain affirmative and negative covenants. In addition,
NationsBanc Montgomery Securities, Inc., the placement agent, received a warrant
to purchase an aggregate of 30,000 shares of common stock at an exercise price
of $14.64 per share.
On May 4, 1999, the Company sold an additional $10.0 million of its 12%
Senior Subordinated Promissory Notes (the "1999 Notes"). Except for their
October 31, 2005 maturity date, the 1999 Notes were substantially identical to
the 1997 Notes described above. The 1999 Notes were sold with detachable 6-1/2
year warrants to purchase an aggregate of 372,892 shares of common stock at an
exercise price of $6.65 per share.
In return for modifying certain financial covenants governing the 1997
Notes, the exercise price of 612,053 of the warrants issued in connection with
the 1997 Notes was reduced to $6.65 per share. On May 4, 1999, the trading range
of the Company's common stock was $6.44 to $6.88 per share. To assist with the
valuation of the newly issued warrants and the repriced warrants, the Company
hired an outside consultant. Utilizing the Black-Scholes Model, the warrants
issued with the 1997 Notes were valued at $1.26 per warrant, or an aggregate
value of $773,702 and the warrants issued with the 1999 Notes at $1.47 per
warrant, or an aggregate value of $549,032. Both amounts were recorded as
Additional Paid-In Capital, offset by the Original Issue Discount, which is
netted against the outstanding balance of the 1997 Notes and 1999 Notes. After
giving effect to the amortization of the Original Issue Discount, the effective
interest rate on the 1999 Notes was 13.57% per annum.
During the fiscal year ended June 30, 2002, 65,574 of the warrants
issued in connection with the 1997 Notes were exercised and converted into
shares of the Company's common stock. On August 22, 2002, in conjunction with
the private placement of 1,663,846 shares of the Company's common stock, the
remaining warrants issued in conjunction with the 1997 Notes and the warrants
issued in connection with the 1999 Notes were adjusted pursuant to anti-dilution
provisions to provide for the purchase of an additional 21,906 shares of the
Company's common stock. During fiscal 2004, warrants to purchase 30,831 shares
of the Company's common stock issued in connection with the 1997 Notes and 1999
Notes were exercised pursuant to the cashless exercise provision contained in
the warrants. In connection with the cashless exercise, warrants to purchase
50,647 shares of the Company's common stock were canceled. In addition, during
the first quarter of fiscal 2005, warrants to purchase 111,701 shares of the
Company's common stock were exercised for proceeds of $742,812.
As of December 31, 2002, the Company was in compliance with all of the
financial covenants under the 1997 Notes and 1999 Notes. On February 7, 2003,
the interest coverage ratio governing the 1997 Notes and 1999 Notes was amended
for the quarter ending March 31, 2003 and prospectively. As of March 31, 2003
and June 30, 2003, the Company was in compliance with all of the financial
covenants under the 1997 Notes and 1999 Notes.
On August 25, 2003, concurrently with the closing of the Senior Credit
Facility, the Company prepaid the 1997 Notes and 1999 Notes and issued $30.0
million of the Company's 16.3% Senior Subordinated Notes due February 27, 2009
(the "New Notes") with interest only payable quarterly in arrears on February
28, May 31, August 31 and November 30 of each year, commencing November 30,
2003. Interest on the New Notes is 12% per annum payable in cash and 4.3% per
annum payable "in kind" by adding the amount of such interest to the principal
amount of the New Notes then outstanding. Ten year warrants to purchase an
aggregate of 425,000 shares of the Company's common stock at an exercise price
of $8.79 per share were issued in connection with the New Notes. Utilizing the
Black-Scholes Model, the warrants issued in connection with the New Notes were
valued at $3.70 per warrant, or an aggregate value of $1,573,000. In addition,
the maturity date of 665,403 existing warrants, 335,101 due to expire in 2004
and 330,302 due to expire in 2005, was extended to February 2009, resulting in
additional value of $1.31 and $0.97 per warrant, respectively, or an aggregate
value of $760,090. At the date of issuance, in accordance with APB 14,
"Accounting for Convertible Debt and Debt Issued with Purchase Warrants," the
Company allocated proceeds of $27.7 million to the debt and $2.3 million to the
warrants, with the resulting discount on the debt referred to as the Original
Issue Discount. The Original Issue Discount is being amortized as interest
11
expense over the life of the debt. In addition, in fiscal 2004, warrants to
purchase 75,000 shares of the Company's common stock issued in connection with
the New Notes were exercised for proceeds of $659,250, recorded as additional
paid-in-capital on the Company's balance sheet as of June 30, 2004. As of
September 30, 2004, warrants to purchase 1,171,783 shares of common stock issued
in connection with the 1997 Notes, 1999 Notes and New Notes were outstanding.
As with the Senior Credit Facility, the Company is required to meet
certain affirmative and negative covenants under the New Notes, including but
not limited to financial covenants. In conjunction with the modification of the
Senior Credit Facility on October 1, 2004, certain financial covenants of the
New Notes were modified. The Company was in compliance with all covenants under
the New Notes as of September 30, 2003 and all subsequent quarters up to and
including the quarter ended September 30, 2004.
In connection with the early repayment of the 1997 Notes and 1999
Notes, during the first quarter of fiscal 2004, the Company recognized a loss of
$1.0 million attributable to the unamortized financing costs and Original Issue
Discount associated with the 1997 Notes and 1999 Notes, and recorded $0.6
million of financing costs associated with the New Notes. Such fees are being
amortized over the life of the New Notes. The weighted average effective
interest rate of the New Notes, including the amortization of Original Issue
Discount, is 18.0%.
NOTE 6. REDEEMABLE PREFERRED STOCK
In May 2000, the Company sold 5,000 shares of its Series A 8%
Cumulative Convertible Preferred Stock, no par value (the "Series A Preferred
Stock"), for $1,000 per share (the initial "Liquidation Preference"). Cumulative
dividends were payable quarterly in arrears at the rate of 8% per annum on the
Liquidation Preference, and, to the extent not paid in cash, were added to the
Liquidation Preference. Shares of the Series A Preferred Stock were convertible
into shares of common stock at any time at a conversion price of $9.28 per
share. In connection with the sale, costs in the amount of $65,000 were charged
to paid-in capital. Effective August 18, 2004, the holder of the Series A
Preferred Stock converted its shares into 754,982 shares of common stock, and
$7,006,241, representing the Liquidation Preference, was reclassified to common
stock and additional paid-in capital in the Company's balance sheet.
In November 2001, the Company sold 2,500 shares of its Series B 8%
Cumulative Convertible Preferred Stock, no par value (the "Series B Preferred
Stock"), for $1,000 per share (the initial "Liquidation Preference"). Cumulative
dividends are payable quarterly in arrears at the rate of 8% per annum on the
Liquidation Preference, and, to the extent not paid in cash, are added to the
Liquidation Preference. Shares of the Series B Preferred Stock may be converted
into shares of common stock at any time at a current conversion price of $12.92
per share.
During the three months ended September 30, 2004 and 2003, the carrying
amount (and Liquidation Preferences) of the Series A Preferred Stock and Series
B Preferred Stock ("Preferred Stock") was increased by $135 and $185,
respectively, for dividends accrued. The Series B Preferred Stock shall be
mandatorily redeemed by the Company within 30 days after a Change in Control (as
defined) of the Company (the date of such redemption being the "Mandatory
Redemption Date") at an amount equal to the then effective Liquidation
Preference plus accrued and unpaid dividends thereon from the last dividend
payment date to the Mandatory Redemption Date, plus if the Mandatory Redemption
Date is on or prior to the fourth anniversary of the issuance of the Series B
Preferred Stock, the amount of any dividends that would have accrued and been
payable on the Series B Preferred Stock from the Mandatory Redemption Date
through the fourth anniversary date.
In addition, outstanding shares of Series B Preferred Stock vote on an
"as converted basis" with the holders of the common stock as a single class on
all matters that the holders of the common stock are entitled to vote upon.
NOTE 7. STOCK OPTION PLANS
The Board of Directors of the Company adopted the 1995 Option Plan (the
"1995 Plan"). Under the 1995 Plan, the Company has reserved 2,400,000 shares of
common stock for employees of the Company. Under the terms of the 1995 Plan,
options granted may be either incentive stock options or non-qualified stock
options. The exercise price of incentive options shall be at least equal to 100%
of the fair market value of the Company's common stock at the date of the grant,
and the exercise price of non-qualified stock options issued to employees may
not be less than 75% of the fair market value of the Company's common stock at
the date of the grant. The maximum term for all options is ten years. Options
granted to date generally vest in equal annual installments from one to five
years, though a limited number of grants were partially vested at the grant
date. The weighted-average fair value per share of options granted during the
three months ended September 30, 2004 and 2003 was $5.70 and $3.15,
respectively.
12
The following summarizes the transactions pursuant to the 1995 Plan:
WEIGHTED AVERAGE
OPTIONS EXERCISE PRICE PER OPTIONS
OUTSTANDING OPTION EXERCISABLE
----------- ------------------ -----------
Outstanding at June 30, 2003 1,288,420 $ 9.13 640,373
Granted 82,250 8.77
Expired or canceled (70,250) 12.39
Exercised -- --
----------
Outstanding at September 30, 2003 1,300,420 $ 8.93 653,143
==========
Outstanding at June 30, 2004 1,504,523 $ 10.56 640,373
Granted 1,000 19.41
Expired or canceled (688) 18.02
Exercised (7,159) 9.36
----------
Outstanding at September 30, 2004 1,497,676 $ 10.56 900,914
==========
The following table sets forth certain information as of September 30,
2004:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------------ -------------------------------------------
RANGE OF EXERCISE WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
PRICES OPTIONS OUTSTANDING REMAINING LIFE EXERCISE PRICE OPTIONS EXERCISABLE EXERCISE PRICE
- ----------------- ------------------- ---------------- ----------------- --------------------- -----------------
$ 0.00 - $ 5.00 149,613 7.50 $ 4.83 95,261 $ 4.84
$ 5.01 - $10.00 596,000 6.57 7.54 399,844 7.28
$ 10.01 - $15.00 567,463 7.08 12.40 359,660 11.99
$ 15.01 - $20.00 184,600 9.74 19.29 46,149 19.29
------------------- ---------------- ----------------- --------------------- -----------------
1,497,676 7.25 $ 10.56 900,914 $ 9.52
=================== ================ ================= ===================== =================
The Board of Directors of the Company adopted the Directors' Stock
Option Plan (the "Directors' Plan"). Under the Directors' Plan, each
non-employee director will receive options for 6,000 shares of common stock on
the date of his or her first election to the board of directors. In addition, on
the third anniversary of each director's first election to the Board, and on
each three year anniversary thereafter, each non-employee director will receive
an additional option to purchase 6,000 shares of common stock. The exercise
price per share for all options granted under the Directors' Plan will be equal
to the fair market value of the common stock as of the date of grant. All
options vest in three equal annual installments beginning on the first
anniversary of the date of grant. The maximum term for all options is ten years.
The weighted-average fair value per share of options granted during the three
months ended September 30, 2003 was $2.73.
The following summarizes the transactions pursuant to the Directors'
Plan:
WEIGHTED AVERAGE
OPTIONS EXERCISE PRICE PER OPTIONS
OUTSTANDING OPTION EXERCISABLE
----------- ------------------ -----------
Outstanding at June 30, 2003 66,000 $ 9.11 45,997
Granted 6,000 10.83
Expired or canceled -- --
Exercised -- --
-----------
Outstanding at September 30, 2003 72,000 $ 9.25 47,996
===========
Outstanding at June 30, 2004 79,914 10.54 53,994
Granted -- --
Expired or canceled -- --
Exercised (1,914) 10.83
-----------
Outstanding at September 30, 2004 78,000 $ 10.54 53,994
===========
13
The following table sets forth certain information as of September 30,
2004:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------------ -------------------------------------------
RANGE OF EXERCISE WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
PRICES OPTIONS OUTSTANDING REMAINING LIFE EXERCISE PRICE OPTIONS EXERCISABLE EXERCISE PRICE
- ----------------- ------------------- ---------------- ----------------- --------------------- -----------------
$ 5.01 - $10.00 36,000 4.90 $ 7.52 31,998 $ 7.38
$ 10.01 - $15.00 30,000 6.78 12.10 18,000 12.27
$ 15.01 - $20.00 12,000 9.44 15.74 3,996 15.74
------------------- ---------------- ----------------- --------------------- -----------------
78,000 6.32 $ 10.54 53,994 $ 9.63
=================== ================ ================= ===================== =================
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), defines a fair value based method of
accounting for stock options. SFAS 123 allows an entity to continue to measure
cost using the accounting method prescribed by APB Opinion No. 25, "Accounting
for Stock Issued to Employees" ("APB 25") and to make pro forma disclosures of
net income and earnings per share as if the fair value based method of
accounting had been applied. The fair value of each option grant is estimated on
the date of grant using the Black-Scholes option pricing model with the
weighted-average assumptions, expected volatility and risk-free interest rate,
as listed in the table below. The following table (in thousands, except per
share amounts) illustrates the effect on net income and earnings per share if
the Company had applied the fair value recognition provisions of SFAS 123 to
stock-based compensation. However, no stock based compensation was recognized in
the financial statements pursuant to APB 25.
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2004 2003
---------- ---------
Net income (loss), as reported $ 1,854 $ (1,419)
Less:
Stock-based compensation
- fair value measurement (362) (181)
---------- ---------
Net income (loss), pro forma 1,492 (1,600)
Preferred stock dividends (135) (185)
---------- ---------
Net income (loss) available to
common shareholders - pro forma $ 1,357 $ (1,785)
========== =========
Basic income (loss) per share - reported $ 0.15 $ (0.15)
========== =========
Basic income (loss) per share - pro forma $ 0.12 $ (0.17)
========== =========
Diluted income (loss) per share - reported $ 0.14 $ (0.15)
========== =========
Diluted income (loss) per share - pro forma $ 0.11 $ (0.17)
========== =========
Expected volatility 28-40% 37-40%
Risk free interest rate 2.6-6.6% 2.6-6.6%
Expected dividend yield 0% 0%
Expected lives 3-5 years 3-5 years
14
NOTE 8. COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss) are as follows for the
periods presented (in thousands):
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2004 2003
------------- --------------
Net income (loss) $ 1,854 $ (1,419)
Interest rate swap transaction (Note 4) (36) 129
------------- --------------
Comprehensive income (loss) $ 1,818 $ (1,290)
============= ==============
NOTE 9. SUBSEQUENT EVENT
On October 1, 2004, the Company purchased the bulk CO2 beverage
carbonation business of privately-owned Pain Enterprises, Inc., of Bloomington,
Indiana, for total cash consideration of $15.5 million. The Company acquired
approximately 9,800 customer accounts, including 7,000 tanks in service,
vehicles, parts, and supplies. Pain Enterprises' bulk CO2 beverage carbonation
business operated in 12 Midwestern and Southeastern states: Florida, Georgia,
Illinois, Indiana, Iowa, Kentucky, Michigan, Missouri, Minnesota, Ohio,
Tennessee and Wisconsin. The purchase price is expected to allocated between
tangible assets, intangible assets, and goodwill as follows: $6.8 million for
tangible assets, $6.4 million for intangible assets and $2.3 million for
goodwill. The Company is currently evaluating the expected useful lives of the
related asset categories.
In conjunction with this transaction, the Company's Senior Credit
Facility was amended to, among other things, increase the B Term Loan from $10.0
million to $23.0 million and to modify certain covenants.
15
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS REGARDING FUTURE
EVENTS AND OUR FUTURE RESULTS THAT ARE BASED ON CURRENT EXPECTATIONS, ESTIMATES,
FORECASTS, AND PROJECTIONS ABOUT THE INDUSTRY IN WHICH WE OPERATE AND THE
BELIEFS AND ASSUMPTIONS OF OUR MANAGEMENT. WORDS SUCH AS "EXPECTS,"
"ANTICIPATES," "TARGETS," "GOALS," "PROJECTS," "INTENDS," "PLANS," "BELIEVES,"
"SEEKS," "ESTIMATES," VARIATIONS OF SUCH WORDS AND SIMILAR EXPRESSIONS ARE
INTENDED TO IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. IN ADDITION, ANY
STATEMENTS THAT REFER TO PROJECTIONS OF OUR FUTURE FINANCIAL PERFORMANCE, OUR
ANTICIPATED GROWTH AND TRENDS IN OUR BUSINESS, AND OTHER CHARACTERIZATIONS OF
FUTURE EVENTS OR CIRCUMSTANCES, ARE FORWARD-LOOKING STATEMENTS. READERS ARE
CAUTIONED THAT THESE FORWARD-LOOKING STATEMENTS ARE ONLY PREDICTIONS AND ARE
SUBJECT TO RISKS, UNCERTAINTIES, AND ASSUMPTIONS THAT ARE DIFFICULT TO PREDICT.
THEREFORE, ACTUAL RESULTS MAY DIFFER MATERIALLY AND ADVERSELY FROM THOSE
EXPRESSED IN ANY FORWARD-LOOKING STATEMENTS.
OVERVIEW
We believe that we are the largest supplier in the United States of
bulk CO2 systems and bulk CO2 for carbonating fountain beverages based on the
number of bulk CO2 systems leased to customers. As of September 30, 2004, we
operated a national network of 108 service locations in 45 states servicing
approximately 83,000 bulk and high pressure customers. Currently, 99% of
fountain beverage users in the continental United States are within our present
service area. On October 1, 2004, we purchased the bulk CO2 beverage carbonation
business of privately-owned Pain Enterprises, Inc., of Bloomington, Indiana. The
transaction involved the acquisition of approximately 9,800 customer accounts,
including 7,000 tanks in service, vehicles, parts, and supplies, bringing our
total customer count to approximately 93,000. The acquisition of Pain
Enterprises' bulk CO2 beverage carbonation business in 12 Midwestern and
Southeastern states: Florida, Georgia, Illinois, Indiana, Iowa, Kentucky,
Michigan, Missouri, Minnesota, Ohio, Tennessee and Wisconsin, provides further
penetration into markets in which we operate.
We market our bulk CO2 products and services to large customers such as
restaurant and convenience store chains, movie theater operators, theme parks,
resorts and sports venues. Our customers include most of the major national and
regional chains throughout the United States. We approach large chains on a
corporate or regional level for approval to become the exclusive supplier of
bulk CO2 products and services on a national basis or within a designated
territory. We then direct our sales efforts to the managers or owners of the
individual or franchised operating units. Our relationships with chain customers
in one geographic market frequently help us to establish service with these same
chains when we expand into new markets. After accessing the chain accounts in a
new market, we attempt to rapidly build route density by leasing bulk CO2
systems to independent restaurants, convenience stores and theaters.
We have entered into master service agreements with 32 of the largest
100 restaurant and convenience store chains. These master service agreements
generally provide for a commitment on the part of the operator for all of its
currently owned locations and may also include future locations. In addition,
the agreements generally provide that the operator's franchisees may participate
in the program and the franchisor undertakes to promote our services to its
franchisees. We currently service approximately 31,000 locations pursuant to
existing master service agreements and these agreements represent an opportunity
to service an additional 32,000 locations. We are actively working on expanding
the number of master service agreements with numerous restaurant chains,
including some of the largest operators. During the first quarter of fiscal
2005, we signed 4,400 new accounts, 2,200 of which represented two new master
service agreements.
We believe that our future revenue growth, gains in gross margin and
profitability will be dependent upon (i) increases in route density in existing
markets and the expansion and penetration of bulk CO2 system installations in
new market regions, both resulting from successful ongoing marketing, (ii)
improved operating efficiencies and (iii) price increases. New multi-unit
placement agreements combined with single-unit placements will drive
improvements in achieving route density. Our success in reaching multi-placement
agreements is due in part to our national delivery system. We maintain a "hub
and spoke" route structure and establish additional stationary bulk CO2 service
locations as service areas expand through geographic growth. Our entry into many
states was accomplished largely through the acquisition of businesses having
thinly developed route networks. We expect to benefit from route efficiencies
and other economies of scale as we build our customer base in these states
through intensive regional and local marketing initiatives. Greater density
16
should also lead to enhanced utilization of vehicles and other fixed assets and
the ability to spread fixed marketing and administrative costs over a broader
revenue base.
Generally, our experience has been that as our service locations mature
their gross profit margins improve as a result of their volume growing while
fixed costs remain essentially unchanged. New service locations typically
operate at low or negative gross margins in the early stages and detract from
our highly profitable service locations in more mature markets. During the last
two years, we have experienced a significant improvement in gross margin due to
net new customer activations and operating improvements, including efficiencies
in delivery of product to our customers, such as reductions in unscheduled
deliveries, total miles driven, and miles driven between stops and improvements
to our safety record. Accordingly, we believe that we are in position to build
our customer base while maintaining and improving upon our superior levels of
customer service, with minimal changes required to our support infrastructure.
We continue to be focused on improving operating effectiveness, increasing
prices for our services and strengthening our workforce, and anticipate that
these initiatives will contribute positively to all areas of our company.
GENERAL
Substantially all of our revenues have been derived from the rental of
bulk CO2 systems installed at customers' sites, the sale of CO2, and high
pressure cylinder revenues. Revenues have grown from $58.0 million in fiscal
2000 to $80.8 million in fiscal 2004. We believe that our revenue base is stable
due to the existence of long-term contracts with our customers which generally
rollover with a limited number expiring without renewal in any one year. Revenue
growth is largely dependent on (1) the rate of new bulk CO2 system
installations, (2) the growth in bulk CO2 sales and (3) price increases.
Cost of products sold is comprised of purchased CO2, vehicle, and
service location costs associated with the storage and delivery of CO2. Cost of
equipment rentals is comprised of costs associated with customer equipment
leases. Selling, general and administrative expenses consist of wages and
benefits, dispatch and communications costs, as well as expenses associated with
marketing, administration, accounting and administrative employee training.
Consistent with the capital intensive nature of our business, we incur
significant depreciation and amortization expenses. These stem from the
depreciation of our bulk CO2 systems and related installation costs,
amortization of deferred lease acquisition costs, and amortization of deferred
financing costs and other intangible assets. With respect to bulk CO2 systems,
we capitalize costs based on a standard amount per installation that is
associated with specific installations of such systems with customers under
non-cancelable contracts and which would not be incurred but for a successful
placement. Costs incurred in excess of the standard amount per installation, if
any, are expensed in the statement of operations. All other service, marketing
and administrative costs are expensed as incurred.
Since 1990, we have devoted significant resources to building a sales
and marketing organization, adding administrative personnel and developing a
national infrastructure to support the rapid growth in the number of our
installed base of bulk CO2 systems. The costs of this expansion and the
significant depreciation expense recognized on our installed network have
resulted in accumulated net losses of $53.9 million at September 30, 2004.
17
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30,
----------------------------------
Income Statement Data: 2004 2003
---------- ------------
Product sales 61.9 % 62.1 %
Equipment rentals 38.1 37.9
---------- ------------
Total revenues 100.0 100.0
Cost of products sold, excluding
depreciation and amortization 43.0 42.6
Cost of equipment rentals, excluding
depreciation and amortization 2.5 4.1
Selling, general and administrative expenses 18.7 19.8
Depreciation and amortization 17.1 19.3
Loss on asset disposal 0.7 2.1
---------- ------------
Operating income 18.0 12.1
Loss on early extinguishment of debt - 9.7
Interest expense 9.3 9.4
---------- ------------
Income (loss) before income taxes 8.7 (7.0)
Provision for income taxes 0.2 -
---------- ------------
Net income (loss) 8.5 % (7.0)%
========== ============
THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2003
TOTAL REVENUES
Total revenues increased by $1.6 million, or 8.1%, from $20.2 million
in 2003 to $21.9 million in 2004. Revenues derived from our bulk CO2 service
plans increased by $1.7 million, or 8.6%, of which $1.5 million was due to an
increase in the number of customer locations and $0.2 million was primarily due
to a 2.9% increase in CO2 sold to the average customer. These increases were
partially offset by the net impact of a $0.1 million decrease in revenue derived
from high pressure cylinder products and services other than bulk CO2 service
plans.
The following table sets forth, for the periods indicated, the
percentage relationship which our service plans bear to total revenues:
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
Service Plan 2004 2003
---------- ---------
Bulk budget plan1 61.5% 62.1%
Equipment lease/product purchase plan2 13.0 11.3
Product purchase plan3 8.9 8.6
High pressure cylinder4 5.5 6.0
Other revenues5 11.1 12.0
---------- ---------
100.0 % 100.0 %
========== =========
1 Combined fee for bulk CO2 tank and bulk CO2.
2 Fee for bulk CO2 tank and, separately, bulk CO2 usage.
3 Bulk CO2 only.
4 High pressure CO2 cylinders and non-CO2 gases.
5 Surcharges and other charges.
During fiscal 2002, we adopted a plan to phase out those customers that
use only high pressure cylinders and who do not utilize one of our bulk
CO2 service plans. Revenues derived from our stand-alone high pressure
cylinder customers may not be fully eliminated from our ongoing revenues
inasmuch as our goal is to convert these customers to a bulk CO2 service
plan. Accordingly, the expected declining revenues derived from
stand-alone high pressure cylinder customers is not expected to have a
material impact on our results of operations.
Product Sales - Revenues derived from the product sales portion of our
service plans increased by $0.9 million, or 7.8%, from $12.6 million in 2003 to
$13.5 million in 2004. The increase in revenues is due to an 8.8% increase in
the average number of customer locations serviced and a 2.9% increase in CO2
18
used by the average customer. These were partially offset by a 1.3% decrease in
CO2 pricing, and a decrease in revenues derived from the sale of gases and
services other than CO2. As we have implemented master service agreements with
leading national restaurant organizations, revenues derived from increases in
CO2 sold to the average customer have been partially offset by pricing
incentives.
Equipment Rentals - Revenues derived from the lease portion of our
service plans increased by $0.7 million, or 8.7%, from $7.7 million in 2003 to
$8.3 million in 2004, primarily due to a 9.2% increase in the average number of
customer locations leasing equipment from us and price increases to a
significant number of our customers consistent with the Consumer Price Index,
partially offset by incentive pricing provided to multiple national restaurant
organizations utilizing our equipment under the bulk budget and equipment
lease/product purchase plans pursuant to master service agreements.
COST OF PRODUCTS SOLD, EXCLUDING DEPRECIATION AND AMORTIZATION
Cost of products sold, excluding depreciation and amortization,
increased from $8.6 million in 2003 to $9.4 million in 2004, while increasing as
a percentage of product sales revenue from 68.6% to 69.4%. Product costs
increased by $0.4 million from $3.2 million in 2003 to $3.5 million in 2004. The
base price with our primary supplier of CO2 increased by the Producer Price
Index, while the volume of CO2 sold by us increased by 10.2%, primarily due to
an 8.8% increase in our average customer base and a 2.9% increase in CO2 sold
these customers.
Operational costs, primarily wages and benefits related to cost of
products sold, increased from $3.3 million in 2003 to $3.5 million in 2004,
primarily due to an increase in route driver costs. As of September 30, 2004, we
had 279 drivers as compared to 254 last year, primarily representing the filling
of open positions. However, some of the headcount increase in drivers was offset
by a reduction in depot and regional management headcount. In addition, while we
have realized a substantial savings in workers' compensation costs due to a
reduction in claims and severity, we continue to experience higher health care
costs, generally due to market conditions.
Truck delivery expenses increased from $1.3 million in 2003 to $1.5
million in 2004 primarily due to the increased customer base and fuel costs. We
have been able to minimize the impact of increased fuel costs and variable lease
costs associated with truck usage by continuing to improve efficiencies in the
timing and routing of deliveries. While total miles driven increased by 5.6% on
an average customer base that increased by 8.8%, miles driven per average
customer decreased 3.2%. In addition, continued improvements in our safety
record the past year have resulted in a significant reduction in the amount of
workers' compensation and vehicle accident claims expense.
Occupancy and shop costs related to cost of products sold remained
constant at $0.8 million in both 2003 and 2004.
COST OF EQUIPMENT RENTALS, EXCLUDING DEPRECIATION AND AMORTIZATION
Cost of equipment rentals, excluding depreciation and amortization,
decreased by $0.2 million from $0.8 million in 2003 to $0.6 million in 2004,
while deceasing as a percentage of equipment rentals revenue from 10.8% to 6.6%.
The reduction in cost of equipment rentals reflected in expense is primarily
attributable to a greater percentage of costs being capitalized in connection
with our bulk CO2 systems due to increased efficiency of our technical
installers and the number of new activations.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased by $0.1 million
from $4.0 million in 2003 to $4.1 million in 2004, while decreasing as a
percentage of total revenues from 19.8% in 2003 to 18.7% in 2004.
Selling related expenses increased by $0.2 million, from $0.7 million
in 2003 to $0.9 million in 2004, primarily the result of an increase in wages
and related benefits due to an increase in the headcount of our sales
organization specifically directed at marketing and growth opportunities.
General and administrative expenses decreased by $0.1 million, or 2.6%,
from $3.3 million in 2003 to $3.2 million in 2004. This improvement is due to an
improvement in outside contract labor and workers' compensation costs, partially
offset by approximately $0.1 million in hurricane related expenses.
19
DEPRECIATION AND AMORTIZATION
Depreciation and amortization decreased from $3.9 million in 2003 to
$3.7 million in 2004. As a percentage of total revenues, depreciation and
amortization expense decreased from 19.3% in 2003 to 17.1% in 2004.
Depreciation expense decreased from $3.4 million in 2003 to $3.3
million in 2004. As we continue with our plan to replace all 50 and 100 lb.
tanks in service over the next two years, depreciation expense from these tanks,
whose expected useful lives were shortened to coincide with the replacement
plan, resulted in depreciation expense of $0.1 million in 2004, down from $0.2
million in 2003. In addition, certain costs associated with the initial direct
placement of bulk CO2 systems at customer sites which are capitalized, are fully
depreciated upon the completion of the initial contract term, and upon contract
renewal, no such costs are incurred.
Amortization expense decreased from $0.5 million in 2003 to $0.4
million in 2004. This decrease is due to a reduction in the amortization of
deferred charges from our current financing arrangements effective August 25,
2003 compared to our prior facilities.
LOSS ON ASSET DISPOSAL
Loss on asset disposal decreased from $0.4 million in 2003 to $0.2
million in 2004, while decreasing as a percentage of total revenues from 2.1% to
0.7%.
OPERATING INCOME
For the reasons previously discussed, operating income increased by
$1.5 million from $2.4 million in 2003 to $3.9 million in 2004. As a percentage
of total revenues, operating income improved from 12.1% in 2003 to 18.0% in
2004.
LOSS ON EARLY EXTINGUISHMENT OF DEBT
During the quarter ended September 30, 2003, we accelerated the
recognition of $1.5 million in deferred financing costs associated with the
refinancing of our long-term debt. In addition, we accelerated the recognition
of the unamortized portion of the Original Issue Discount associated with our
12% Senior Subordinated Promissory Notes, $0.4 million, and paid $0.1 million in
conjunction with the early termination of an interest rate swap agreement.
INTEREST EXPENSE
Interest expense increased from $1.9 million in 2003 to $2.0 million in
2004, while decreasing as a percentage of total revenues from 9.4% in 2003 to
9.3% in 2004. The effective interest rate of our debt increased from 10.6% to
12.0% per annum, primarily due to the terms of our refinancing in August 2003.
INCOME (LOSS) BEFORE INCOME TAXES
See discussion of Net Income (Loss).
PROVISION FOR INCOME TAXES
As of September 30, 2004, we had net operating loss carryforwards for
federal income tax purposes of approximately $93 million and for state purposes
in varying amounts, which are available to offset future federal taxable income,
if any, in varying amounts through June 2024. However, a portion of our taxable
income is subject to the alternative minimum tax ("AMT"), which is reflected in
our statements of operations for 2004 along with a provision for state income
taxes. Our provision for income taxes in 2004 was $0.1 million. No provision was
made for income tax expense in 2003 due to our net loss.
We continue to evaluate the deferred tax asset valuation allowance.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Substantially all of our
deferred tax assets represent the benefit of loss carryforwards that arose prior
to fiscal year 2004. In assessing the realizability of deferred tax assets, we
consider whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. Among other matters, realization of
the entire deferred tax asset is dependent on our ability to generate sufficient
taxable income prior to the expiration of the carryforwards. While we attained
profitability during fiscal year 2004, based on the available objective evidence
and the recent history of losses, we cannot conclude that it is more likely than
not that the net deferred tax assets will be fully realizable. Accordingly, we
have recorded a valuation allowance equal to the
20
amount of our net deferred tax assets. However, as we continue to generate
future taxable income, the valuation allowance will be reviewed, which could
result in a material income tax benefit being recorded in our statement of
operations.
NET INCOME (LOSS)
For the reasons described above, net income (loss) improved by $3.3
from a $1.4 million net loss in 2003 to net income of $1.9 million in 2004.
EBITDA
Earnings before interest, taxes, depreciation and amortization
("EBITDA") is one of the principal financial measures by which we measure our
financial performance. EBITDA is a widely accepted financial indicator used by
many investors, lenders and analysts to analyze and compare companies on the
basis of operating performance, and we believe that EBITDA provides useful
information regarding our ability to service our debt and other obligations.
However, EBITDA does not represent cash flow from operations, nor has it been
presented as a substitute to operating income or net income as indicators of our
operating performance. EBITDA excludes significant costs of doing business and
should not be considered in isolation or as a substitute for measures of
performance prepared in accordance with accounting principles generally accepted
in the United States of America. In addition, our calculation of EBITDA may be
different from the calculation used by our competitors, and therefore
comparability may be affected. In addition, our lenders also use EBITDA to
assess our compliance with debt covenants. These financial covenants are based
on a measure that is not consistent with accounting principles generally
accepted in the United States of America. Such measure is EBITDA (as defined) as
modified by certain defined adjustments.
EBITDA, as set forth in the table below (in thousands), increased by
$1.3 million, or 21.0%, from $6.4 million in 2003 to $7.7 million in 2004 and
increased as a percentage of total revenues from 31.4% to 35.1%.
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2004 2003
----------- ----------
Net income (loss) $ 1,854 $ (1,419)
Interest expense 2,040 1,897
Depreciation and amortization 3,740 3,912
Provision for income taxes 54 -
Loss on early extinguishment of debt - 1,964
------- -------
EBITDA $ 7,688 $ 6,354
======= =======
Cash flows provided by (used in):
Operating activities $ 3,277 $ 3,498
Investing activities $ (4,441) $ (3,577)
Financing activities $ 3,851 $ (223)
LIQUIDITY AND CAPITAL RESOURCES
Our cash requirements consist principally of (1) capital expenditures
associated with purchasing and placing new bulk CO2 systems into service at
customers' sites; (2) payments of principal and interest on outstanding
indebtedness; and (3) working capital. Whenever possible, we seek to obtain the
use of vehicles, land, buildings, and other office and service equipment under
operating leases as a means of conserving capital. As of September 30, 2004, we
anticipate making cash capital expenditures of approximately $20.0 million for
internal growth over the next twelve months, primarily for purchases of bulk CO2
systems for new customers, the replacement with larger bulk CO2 systems of 50
and 100 lb. bulk CO2 systems in service at existing customers and replacement
units for our truck fleet. In June 2002, we adopted a plan to replace all 50 and
100 lb. bulk CO2 systems in service at customers over a three to four year
period. While this decision may not increase revenues generated from these
customers, it is expected to improve operating efficiencies, gross margins and
profitability. Once bulk CO2 systems are placed into service, we generally
experience positive cash flows on a per-unit basis, as there are minimal
additional capital expenditures required for ordinary operations.
In addition to capital expenditures related to internal growth, we
review opportunities to acquire bulk CO2 service accounts, and may require cash
in an amount dictated by the scale and terms of any such transactions
successfully concluded. On October 1, 2004, we purchased the bulk CO2 beverage
carbonation business of privately-owned Pain Enterprises, Inc., of Bloomington,
21
Indiana, for total cash consideration of $15.5 million. The transaction involved
the acquisition of approximately 9,800 customer accounts, including 7,000 tanks
in service, vehicles, parts, and supplies. Pain Enterprises' bulk CO2 beverage
carbonation business operated in 12 Midwestern and Southeastern states: Florida,
Georgia, Illinois, Indiana, Iowa, Kentucky, Michigan, Missouri, Minnesota, Ohio,
Tennessee and Wisconsin.
On September 24, 2001, we entered into a $60.0 million second amended
and restated revolving credit facility with a syndicate of banks ("Amended
Credit Facility"). Prior to June 30, 2002, the Amended Credit Facility was
amended to adjust certain financial covenants for the quarter ended March 31,
2002 and prospectively, and non-compliance with the minimum EBITDA covenant for
the three months ended March 31, 2002 was waived. As of June 30, 2002, we were
not in compliance with certain of the financial covenants. On September 27,
2002, the Amended Credit Facility was amended to adjust certain financial
covenants for the quarter ended June 30, 2002, and prospectively, and the
maturity of the Amended Credit Facility was extended to November 17, 2003. As of
September 30, 2002, we were in compliance with all of the financial covenants
under the Amended Credit Facility. On February 7, 2003, the Amended Credit
Facility was amended to adjust certain financial covenants for the quarter ended
December 31, 2002 and prospectively, non-compliance with the minimum EBITDA
covenant for the three months ended December 31, 2002 was waived, the maturity
of the Amended Credit Facility was extended to April 29, 2004, and the Amended
Credit Facility was reduced to $45.0 million. As of March 31, 2003 and June 30,
2003, we were in compliance with all of the financial covenants under the
Amended Credit Facility.
On August 25, 2003, we terminated the Amended Credit Facility and
entered into a $50.0 million senior credit facility with a syndicate of banks
(the "Senior Credit Facility"). The Senior Credit Facility initially consisted
of a $30.0 million A term loan facility (the "A Term Loan"), a $10.0 million B
term loan facility (the "B Term Loan"), and a $10.0 million revolving loan
facility (the "Revolving Loan Facility"). On October 1, 2004, in conjunction
with the Pain Enterprises transaction, the Senior Credit Facility was amended
to, among other things, increase the B Term Loan to $23.0 million and to modify
certain financial covenants. The A Term Loan and Revolving Loan Facility mature
on August 25, 2007, while the B Term Loan matures on August 25, 2008. The
Company is entitled to select either Eurodollar Loans (as defined) or Base Rate
Loans (as defined), plus applicable margin, for principal borrowings under the
Senior Credit Facility. Applicable margin is determined by a pricing grid based
on our Consolidated Total Leverage Ratio (as defined) as follows:
A Term B Term A Term B Term Revolving
Loans Loans Revolving Loans Loans Loans
Consolidated maintained maintained Loans maintained maintained maintained
Total as as maintained as as as
Leverage Base Rate Base Rate as Base Rate Eurodollar Eurodollar Eurodollar
Level Ratio Loans Loans Loans Loans Loans Loans
- ------- -------------- ---------- ----------- ------------ ---------- ------------ -----------
1 Less than
2.50:1.00 2.50% 2.75% 2.50% 3.50% 3.75% 3.50%
Greater than
or equal to
2.50:1.00 but
less than
2 3.00:1.00 2.75% 3.00% 2.75% 3.75% 4.00% 3.75%
Greater than
3 or equal to
3.00:1.00 3.00% 3.25% 3.00% 4.00% 4.25% 4.00%
However, from October 1, 2004 until delivery to the lenders of our
financial statements for the quarter ending December 31, 2004, Level 2 pricing
applies. Interest is payable periodically on borrowings under the Senior Credit
Facility. In addition, commencing on December 31, 2003 and on the last day of
each quarter thereafter, we are required to make principal repayments of the A
Term Loan in increasing amounts and commencing on December 31, 2004 and on the
last day of each quarter thereafter, we are required to make principal payments
on the B Term Loan in the amount of $57,500 until August 25, 2008 when we will
be required to make a final payment of $22,137,500. The Senior Credit Facility
is collateralized by all of our assets. Additionally, we are precluded from
declaring or paying any cash dividends, except we may accrue and accumulate, but
not pay, cash dividends on our outstanding redeemable preferred stock. As of
September 30, 2004, $25.4 million was outstanding under the A Term Loan, $10.0
million was outstanding under the B Term Loan and $4.8 million was outstanding
under the Revolving Loan Facility with a weighted average interest rate of 6.6%.
22
We are also required to meet certain affirmative and negative
covenants, including but not limited to financial covenants. We are required to
assess our compliance with these financial covenants under the Senior Credit
Facility on a quarterly basis. These financial covenants are based on a measure
that is not consistent with accounting principles generally accepted in the
United States of America. Such measure is EBITDA (as defined), which represents
earnings before interest, taxes, depreciation and amortization, as further
modified by certain defined adjustments. The failure to meet these covenants,
absent a waiver or amendment, would place us in default and cause the debt
outstanding under the Senior Credit Facility to immediately become due and
payable. The Senior Credit Facility also includes certain cross-default
provisions to our 16.3% Senior Subordinated Notes Due February 27, 2009. We were
in compliance with all covenants under the Senior Credit Facility as of
September 30, 2003 and all subsequent quarters up to and including September 30,
2004.
In connection with the termination of the Amended Credit Facility,
during the first quarter of fiscal 2004, we recognized a loss of $0.9 million
from the write-off of unamortized financing costs associated with the Amended
Credit Facility and recorded $2.3 million in financing costs associated with the
Senior Credit Facility. Such costs are being amortized over the life of the
Senior Credit Facility.
In October 1997, we issued $30.0 million of our 12% Senior Subordinated
Promissory Notes ("1997 Notes") with interest only payable semi-annually on
April 30 and October 31, due October 31, 2004. On May 4, 1999, we sold an
additional $10.0 million of our 12% Senior Subordinated Promissory Notes ("1999
Notes"). Except for their October 31, 2005 maturity date, the 1999 Notes were
substantially identical to the 1997 Notes. As of June 30, 2002 and at various
dates in the past we have been unable to meet certain covenants under the 1997
Notes and 1999 Notes and have had to obtain waivers or modifications. On
September 27, 2002, concurrently with the amendment to the Amended Credit
Facility, certain financial covenants of the 1997 Notes and 1999 Notes were
amended to adjust certain financial covenants for the quarter ended June 30,
2002, and prospectively. As of December 31, 2002, we were in compliance with all
of the financial covenants under the 1997 Notes and 1999 Notes. On February 7,
2003, the interest coverage ratio governing the 1997 Notes and 1999 Notes was
amended for the quarter ending March 31, 2003 and prospectively. As of March 31,
2003 and June 30, 2003, we were in compliance with all of the financial
covenants under the 1997 Notes and 1999 Notes.
On August 25, 2003, concurrently with the closing of the Senior Credit
Facility, we prepaid the 1997 Notes and 1999 Notes and issued $30.0 million of
our 16.3% Senior Subordinated Notes Due February 27, 2009 (the "New Notes") with
interest only payable quarterly in arrears on February 28, May 31, August 31 and
November 30 of each year, commencing November 30, 2003. Interest on the New
Notes is 12% per annum payable in cash and 4.3% per annum payable "in kind" by
adding the amount of such interest to the principal amount of the New Notes then
outstanding. Ten year warrants to purchase an aggregate of 425,000 shares of our
common stock at an exercise price of $8.79 per share were issued in connection
with the New Notes. Utilizing the Black-Scholes Model, the warrants issued in
connection with the New Notes were valued at $3.70 per warrant, or an aggregate
value of $1,573,000. In addition, the maturity date of 665,403 existing
warrants, 335,101 due to expire in 2004 and 330,302 due to expire in 2005, was
extended to February 2009, resulting in additional value of $1.31 and $0.97 per
warrant, respectively, or an aggregate value of $760,090. At the date of
issuance, in accordance with APB 14, "Accounting for Convertible Debt and Debt
Issued with Purchase Warrants," we allocated proceeds of $27.7 million to the
debt and $2.3 million to the warrants, with the resulting discount on the debt
referred to as the Original Issue Discount. The Original Issue Discount is being
amortized as interest expense over the life of the debt. As with the Senior
Credit Facility, we are required to meet certain affirmative and negative
covenants under the New Notes, including but not limited to financial covenants.
We were in compliance with all covenants under the New Notes as of September 30,
2003 and all subsequent quarters up to and including September 30, 2004.
In connection with the early repayment of the 1997 Notes and 1999
Notes, during the first quarter of fiscal 2004, we recognized a loss of $1.1
million attributable to the unamortized financing costs and Original Issue
Discount associated with the 1997 Notes and 1999 Notes, and recorded $0.5
million of financing costs and Original Issue Discount associated with New
Notes. Such fees are being amortized over the life of the New Notes. The
weighted average effective interest rate of the New Notes, including the
amortization of deferred financing costs and Original Issue Discount, is 18.0%.
In May 2000, we sold 5,000 shares of Series A 8% Cumulative Convertible
Preferred Stock, no par value (the "Series A Preferred Stock"), for $1,000 per
share. Shares of the Series A Preferred Stock were convertible into shares of
common stock at any time at a conversion price of $9.28 per share. Effective
August 18, 2004, the holder of the Series A Preferred Stock converted its shares
into 754,982 shares of our common stock.
23
During the quarter ended September 30, 2004, our capital resources
included cash flows from operations and available borrowing capacity under the
Senior Credit Facility. We believe that cash flows from operations and available
borrowings under the Senior Credit Facility will be sufficient to fund proposed
operations for at least the next twelve months.
The table below sets forth our contractual obligations as of September
30, 2004 (in thousands):
Less than 1
CONTRACTUAL OBLIGATIONS Total Year 2-3 Years 4-5 Years Thereafter
- ----------------------- ---------------------------------------------------------------------------------
Senior Credit Facility
Principal $ 40,189 $ 7,150 $ 23,039 $ 10,000 $ --
Interest 6,208 2,303 3,139 766 --
-------- -------- -------- -------- --------
Total Senior Credit Facility 46,397 9,453 26,178 10,766 --
-------- -------- -------- -------- --------
Subordinated debt
Principal 31,441 -- -- 31,441 --
Interest* 24,695 3,834 8,179 12,682 --
-------- -------- -------- -------- --------
Total subordinated debt 56,136 3,834 8,179 44,123 --
-------- -------- -------- -------- --------
Other debt, including interest 233 65 130 38 --
Employment agreements 1,050 733 317 -- --
Operating leases 13,101 4,139 6,057 2,638 267
-------- -------- -------- -------- --------
Total obligations $116,917 $ 18,224 $ 40,861 $ 57,565 $ 267
======== ======== ======== ======== ========
* includes paid-in-kind interest paid upon loan termination
As previously discussed, on October 1, 2004, we purchased the bulk CO2
beverage carbonation business of Pain Enterprises, Inc. for cash consideration
of $15.5 million. Concurrent with the acquisition, the B Loan Note of our Senior
Credit Facility was increased by $13.0 million from $10.0 million to $23.0
million.
In addition, in May 1997 we entered into an exclusive bulk CO2
requirements contract with The BOC Group, Inc.
Working Capital. At September 30, 2004 and June 30, 2004, we had
working capital of $32,000 and $(4.6) million, respectively. Included in our
working capital as of September 30, 2004, was $3.0 million advanced from our
Senior Credit Facility (see Cash Flows from Financing Activities).
Cash Flows from Operating Activities. Cash flows provided by operations
decreased by $0.2 million from $3.5 million in 2003 to $3.3 million in 2004. The
improvement derived from net income (excluding non-cash charges) of $1.2 million
was offset by a reduction in cash generated by the working capital components of
our balance sheet, due in large part to the timing of cash collections and
payments being temporarily impacted by weather conditions in September 2004.
Cash Flows from Investing Activities. During 2004 and 2003, net cash
used in investing activities was $4.4 million and $3.6 million, respectively.
These investing activities were primarily attributable to the acquisition,
installation and direct placement costs of bulk CO2 systems.
Cash Flows from Financing Activities. During 2004, cash flows provided
by financing activities was $3.9 million compared to $0.2 million used in
financing activities in 2003. On September 30, 2004, we received a $3.0 million
advance from our Revolving Loan Facility in anticipation of the acquisition of
the bulk CO2 beverage carbonation assets of Pain Enterprises, Inc., which closed
on October 1, 2004. In 2003, we refinanced our debt, as previously discussed,
receiving proceeds of $73.2 million, paying fees associated with the refinancing
of $2.7 million, while simultaneously paying off our previous financing
facilities.
INFLATION
The modest levels of inflation in the general economy have not affected
our results of operations. Additionally, our customer contracts generally
provide for annual increases in the monthly rental rate based on increases in
the consumer price index. We believe that inflation will not have a material
adverse effect on our future results of operations.
24
Our bulk CO2 exclusive requirements contract with The BOC Group, Inc.
("BOC") provides for annual adjustments in the purchase price for bulk CO2 based
upon increases or decreases in the Producer Price Index for Chemical and Allied
Products or the average percentage increase in the selling price of bulk
merchant carbon dioxide purchased by BOC's large, multi-location beverage
customers in the United States.
RECENT ACCOUNTING PRONOUNCEMENTS
On July 1, 2003, we adopted EITF Issue No. 00-21, "Revenue Arrangements
with Multiple Deliverables" ("EITF 00-21"). EITF 00-21 addresses certain aspects
of the accounting by a vendor for arrangements under which the vendor will
perform multiple revenue generating activities. As of September 30, 2004,
approximately 58,000 of our customer locations utilized a plan agreement that
provides for a fixed monthly payment to cover the use of a bulk CO2 system and a
predetermined maximum quantity of CO2 ("budget plan"). Prior to July 1, 2003, as
lessor, we recognized revenue from leasing CO2 systems under our budget plan
agreements on a straight-line basis over the life of the related leases. We have
developed a methodology for the purpose of separating the aggregate revenue
stream between the rental of the equipment and the sale of the CO2. Effective
July 1, 2003, revenue attributable to the lease of equipment, including
equipment leased under the budget plan, is recorded on a straight-line basis
over the term of the lease and revenue attributable to the supply of CO2 and
other gases, including CO2 provided under the budget plan, is recorded upon
delivery to the customer.
We have elected to apply EITF 00-21 retroactively to all budget plan
agreements in existence as of July 1, 2003. Based on our analysis, the aggregate
amount of CO2 actually delivered under budget plans during the quarter ended
June 30, 2003 is not materially different than the corresponding portion of the
fixed charges attributable to CO2. Accordingly, we believe the cumulative effect
of the adoption of EITF 00-21 as of July 1, 2003 is not significant.
Under the budget plan, each customer has a maximum CO2 allowance that
is measured and reset on the contract anniversary date. At that date, it is
appropriate to record revenue for actual deliveries of CO2 in excess of contract
billings. Because of the large number of customers under the budget plan and the
fact that the anniversary dates for determining maximum quantities are spread
throughout the year, our methodology involves the use of estimates and
assumptions to separate the aggregate revenue stream derived from equipment
rentals to budget plan customers, and also to approximate the recognition of
revenue from CO2 sales to budget plan customers when earned. We believe that the
adoption of EITF 00-21 has the most impact on the recognition of revenue on a
quarterly basis as CO2 usage fluctuates during a fiscal year based on factors
such as weather, and traditional summer and holiday periods. Over a twelve-month
period, we believe that the effect is less significant since seasonal variations
are largely eliminated and CO2 allowances under budget plan agreements are
measured and reset annually.
In December 2003, the Financial Accounting Standards Board ("FASB")
revised FASB Interpretation No. 46, "Consolidation of Variable Interest
Entities." Application of this Interpretation is required in a company's
financial statements for interests in variable interest entities that are
considered special-purpose entities for reporting periods ending after March 15,
2004. FASB Interpretation No. 46 did not effect our financial position, results
of operations, or cash flows.
In December 2003, the FASB revised SFAS No. 132, "Employer Disclosures
about Pensions and Other Postretirement Benefits" (SFAS 132). SFAS 132 requires
additional disclosures regarding the assets, obligations, cash flows, and net
periodic benefit cost of defined benefit plans and other defined benefit
postretirement plans. SFAS 132 requires that this information be provided
separately for pension plans and other postretirement benefit plans. The
adoption of the revised SFAS No. 132, effective January 1, 2004, had no material
impact on our financial position, results of operations, or cash flows.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As discussed under "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources" above, as
of September 30, 2004, a total of $40.2 million was outstanding under the Senior
Credit Facility with a weighted average interest rate of 6.6%. Based upon the
$40.2 million outstanding under the Senior Credit Facility at September 30,
2004, our annual interest cost under the Senior Credit Facility would increase
by $0.4 million for each 1% increase in Eurodollar interest rates.
In order to reduce our exposure to increases in Eurodollar interest
rates, and consequently to increases in interest payments, on October 2, 2003,
we entered into an interest rate swap transaction (the "Swap") in the amount of
$20.0 million (the "Notional Amount") with an effective date of March 15, 2004.
Pursuant to the Swap, we pay a fixed interest rate of 2.12% per annum and
receive a Eurodollar-based floating rate. The effect of the Swap is to
neutralize any changes in Eurodollar rates on the Notional Amount. We do not, on
25
a routine basis, enter into speculative derivative transactions or leveraged
swap transactions, except as disclosed. As the Swap was not effective until
March 15, 2004 and no cash flows were exchanged prior to that date, the Swap did
not meet the requirements to be designated as a cash flow hedge. As such, an
unrealized loss of $177,000 was recognized in our results of operations for the
fiscal year ended June 30, 2004, reflecting the change in fair value of the Swap
from inception to the effective date. As of March 15, 2004, the Swap met the
requirements to be designated as a cash flow hedge and is deemed a highly
effective transaction. Accordingly, we recorded $264,000 representing the change
in fair value of the Swap from March 15, 2004 through June 30, 2004, as other
comprehensive income. The fair value of the Swap changed by $36,000 during the
first quarter of fiscal 2005 to 51,000.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Based on our
management's evaluation (with the participation of our principal executive
officer and principal financial officer), as of the end of the period covered by
this report, our principal executive officer and principal financial officer
have concluded that our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended,
(the "Exchange Act") are effective to ensure that information required to be
disclosed by us in reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in SEC rules and forms.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING. There was no
change in our internal control over financial reporting during our first fiscal
quarter that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
On August 18, 2004, J.P. Morgan Partners (BHCA), L.P., the holder of
5,000 shares of our Series A 8% cumulative convertible preferred stock, no par
value (the "Series A Preferred Stock"), with a liquidation preference of
$7,006,241 (the "Liquidation Preference") converted such Liquidation Preference
into 754,982 shares of our common stock at a price of $9.28 per share without
registration under the Securities Act of 1933, as amended ("Securities Act"), in
reliance upon the exemption from registration provided by Section 4(2) of the
Securities Act. Following the conversion of the Series A Preferred Stock, no
shares of Series A Preferred Stock are outstanding.
On September 28, 2004, Kane & Co., the holder of a warrant to purchase
111,701 shares of our common stock, exercised such warrant in its entirety
without registration under the Securities Act in reliance upon the exemption
from registration provided by Section 4(2) of the Securities Act. In connection
with such exercise, we received cash proceeds of $742,812, or $6.65 per share.
No commissions were paid.
ITEM 6. EXHIBITS
(a) EXHIBIT NO. EXHIBIT
----------- -------
31.1 Section 302 Certification of Principal Executive Officer.
31.2 Section 302 Certification of Principal Financial Officer.
32.1 Section 906 Certification of Principal Executive Officer.
32.2 Section 906 Certification of Principal Financial Officer.
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NuCO2 Inc.
Dated: November 9, 2004 By: /s/ Robert R. Galvin
----------------------------
Robert R. Galvin
Chief Financial Officer