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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED JUNE 27, 2003
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 333-102430
NATIONAL WATERWORKS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 05-0532711
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 WEST HIGHWAY 6
SUITE 620
WACO, TEXAS 76712
(Address of principal executive offices)
(254) 772-5355
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes /X/ No / /
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act)
Yes / / No /X/
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
COMMON STOCK OUTSTANDING AS OF AUGUST 7, 2003
------------ --------------------------------
$.01 Par Value 100
NATIONAL WATERWORKS, INC.
FORM 10-Q
INDEX
..
PAGE(S)
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets of National Waterworks, Inc. as of
June 27, 2003 (unaudited) and December 31, 2002 3
Statements of Operations of National Waterworks, Inc.
(Successor) for the Three Months and Six Months Ended
June 27, 2003 and of U.S. Filter Distribution Group, Inc. and
subsidiary (Predecessor) for the Three Months and Six Months
Ended June 28, 2002 (unaudited) 4
Statements of Cash Flows of National Waterworks, Inc.
(Successor) for the Six Months Ended June 27, 2003 and
of U.S. Filter Distribution Group, Inc. and subsidiary
(Predecessor) for the Six Months Ended June 28, 2002
(unaudited) 5
Notes to Financial Statements (unaudited) 6-9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 9-18
Item 3. Quantitative and Qualitative Disclosures about Market Risk 18
Item 4. Controls and Procedures 18
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 20
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Successor
National Waterworks, Inc.
-Note 1
June 27
2003 December 31,
(unaudited) 2002
Assets
Current assets:
Cash and cash equivalents $ 19,303 $ 39,888
Trade accounts receivable, net 218,924 174,012
Inventories 102,134 91,619
Deferred income taxes 3,522 4,713
Other current assets 2,136 2,402
--------- ---------
Total current assets 346,019 312,634
Property and equipment, net 20,756 21,805
Goodwill 456,080 465,662
Deferred financing fees, net 21,056 12,667
Other assets 1,152 49
--------- ---------
$ 845,063 $ 812,817
========= =========
Liabilities and Stockholder's Equity
Current liabilities:
Trade accounts payable $ 145,534 $ 126,662
Current installments of long-term debt 11,250 10,000
Accrued compensation and benefits 16,884 22,036
Other accrued expenses 11,496 8,989
--------- ---------
Total current liabilities 185,164 167,687
Long-term debt, excluding current installments 436,250 440,000
Deferred income taxes 4,371 1,025
Other long term liabilities 1,200 --
--------- ---------
Total liabilities 626,985 608,712
Commitments and Contingencies
Stockholder's Equity:
Common stock, par value $.01 per share; 100 shares
authorized, issued and outstanding -- --
Additional paid-in capital 210,999 209,999
Retained earnings (accumulated deficit) 7,079 (5,894)
--------- ---------
Total stockholder's equity 218,078 204,105
--------- ---------
$ 845,063 $ 812,817
========= =========
The accompanying notes are an integral part of these financial statements.
3
STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS)
Successor Predecessor Successor Predecessor
-------------- --------------- -------------- --------------
U.S. Filter U.S. Filter
Distribution Distribution
National Group, Inc. National Group, Inc.
Waterworks, and Waterworks, and
Inc. Subsidiary Inc. Subsidiary
-Note 1 -Note 1 -Note 1 -Note 1
Three Months Ended Six Months Ended
June 27, 2003 June 28, 2002 June 27, 2003 June 28, 2002
-------------- --------------- -------------- --------------
Net sales $ 329,715 $ 312,012 $ 599,494 $ 538,679
Cost of goods sold 260,143 246,335 476,455 422,290
--------- --------- --------- ---------
Gross profit 69,572 65,677 123,039 116,389
Operating expenses:
Selling, general and administrative 41,803 39,016 80,499 73,107
Loss - accounts receivable securitization -- 862 -- 1,540
--------- --------- --------- ---------
Income before depreciation and amortization 27,769 25,799 42,540 41,742
Depreciation and amortization 641 831 1,366 1,661
--------- --------- --------- ---------
Operating income 27,128 24,968 41,174 40,081
Other income (expense):
Interest expense, net (10,069) (10) (19,540) (20)
Other 33 66 (12) 74
--------- --------- --------- ---------
Income before income taxes 17,092 25,024 21,622 40,135
Income tax expense 6,837 9,677 8,649 15,561
--------- --------- --------- ---------
Income before cumulative effect of change in 10,255 15,347 12,973 24,574
accounting principle
Cumulative effect of a change in accounting principle -- -- -- (459,000)
--------- --------- --------- ---------
Net income (loss) $ 10,255 $ 15,347 $ 12,973 $(434,426)
========= ========= ========= =========
The accompanying notes are an integral part of these financial statements.
4
STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
Successor Predecessor
--------- -----------
U.S. Filter
National Distribution Group,
Waterworks, Inc. Inc. and Subsidiary
-Note 1 -Note 1
Six Months Ended
------------------------------------------
June 27, 2003 June 28, 2002
------------- -------------
Cash flows from operating activities:
Net income (loss) $ 12,973 $(434,426)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Deferred income taxes 8,423 1,202
Amortization of deferred financing fees 1,113 --
Depreciation and amortization 1,366 1,661
Loss on goodwill impairment -- 459,000
Gain on disposal of equipment (39) (65)
Provision for doubtful accounts 581 431
Changes in operating assets and liabilities, net
of businesses acquired:
Trade accounts receivable (45,493) (9,331)
Inventories (10,515) (22,268)
Other current assets 266 330
Other assets (1,107) 4,298
Trade accounts payable 18,872 38,900
Accrued compensation and benefits (5,152) (8,725)
Other accrued expenses 2,507 635
Other long term liabilities 1,200 --
--------- ---------
Net cash provided by (used in) operating activities (15,005) 31,642
--------- ---------
Cash flows from investing activities:
Capital expenditures (738) (667)
Additional NWW acquisition costs (3,224) --
Business acquisitions, net of cash -- (18,706)
Proceeds from sales of property and equipment 464 792
--------- ---------
Net cash used in investing activities (3,498) (18,581)
--------- ---------
Cash flows from financing activities:
Capital contribution 1,000 --
Financing fees (582) --
Principal payments on long-term debt (2,500) (112)
Investment by US Filter -- 19,200
Funds transferred to US Filter -- (564,974)
Expenditures funded by US Filter -- 506,295
Allocation of expenses from US Filter -- 23,878
--------- ---------
Net cash used in financing activities (2,082) (15,713)
--------- ---------
Net decrease in cash and cash equivalents (20,585) (2,652)
Cash and cash equivalents at beginning of period 39,888 13,288
--------- ---------
Cash and cash equivalents at end of period $ 19,303 $ 10,636
========= =========
Cash paid for interest $ 16,051 $ 21
========= =========
Cash paid for income taxes $ 224 $ 14,359
========= =========
The accompanying notes are an integral part of these financial statements.
5
NATIONAL WATERWORKS, INC.
(Successor)
US FILTER DISTRIBUTION GROUP, INC. AND SUBSIDIARY
(Predecessor)
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
National Waterworks, Inc. ("NWW", "Company", or "Successor"), a wholly owned
subsidiary of National Waterworks Holding, Inc. ("Parent"), was incorporated in
September 2002 for the purpose of acquiring substantially all of the assets and
assuming certain obligations of U.S. Filter Distribution Group, Inc. ("USFDG",
"Predecessor" or the "Group"), a wholly owned subsidiary of United States Filter
Corporation ("US Filter"), which is an indirect-wholly owned subsidiary of
Veolia Environnement ("Veolia", formerly Vivendi Environnement S.A.). The
acquisition was consummated on November 22, 2002.
As a result of the NWW acquisition, the balance sheets as of June 27, 2003
(unaudited) and December 31, 2002, the unaudited statements of operations for
the three months and six months ended June 27, 2003, and the unaudited statement
of cash flows for the six months ended June 27, 2003 represent NWW's financial
position and the results of its operations and cash flows as of those dates and
for those periods. The unaudited statements of operations for the three months
and six months ended June 28, 2002, and the unaudited statement of cash flows
for the six months ended June 28, 2002 represent USFDG's consolidated results of
their operations and cash flows as of those dates and for those periods.
The financial statements of USFDG include the financial statements of USFDG and
its wholly owned subsidiary, United States Filter Receivables Corporation
("USFRC"). All significant intercompany balances and transactions have been
eliminated in consolidation. NWW has no subsidiaries.
The information contained in the accompanying notes to the financial statements
is condensed from that which would appear in the annual financial statements;
accordingly, the financial statements included herein should be reviewed in
conjunction with the financial statements for the year ended December 31, 2002,
and related notes thereto, included in the prospectus dated April 18, 2003
included in the Company's Registration Statement on Form S-4 (No. 333-102430)
relating to its 10.50% Senior Subordinated Notes due 2012.
The accompanying unaudited financial statements include all adjustments
(consisting only of normal recurring adjustments) which, in the opinion of
management, are necessary for a fair presentation. Accounting measurements at
interim dates inherently involve greater reliance on estimates than at year end.
The results of operations for the interim periods presented are not necessarily
indicative of the results to be expected for the entire year.
FISCAL YEAR
The Company's calendar year begins on January 1 of the year stated and ends on
December 31 of that same year. The Company reports results using the fiscal
quarter method; each quarter is reported as of the last Friday of the period.
The results for the three months ended June 27, 2003 and June 28, 2002 include
thirteen weeks. The results for the six months ended June 27, 2003 and June 28,
2002 include twenty five weeks and three days and twenty five weeks and four
days, respectively.
RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No.148, Accounting for
Stock-Based Compensation - Transition and Disclosure. This statement amends FASB
SFAS No. 123, Accounting for Stock-Based Compensation to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, SFAS 148 amends
the disclosure requirements of SFAS 123 to require prominent disclosures in both
annual and interim financial statements of the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. SFAS 148 is effective for fiscal years
6
beginning after December 15, 2002. The adoption of SFAS 148 is not expected to
have any impact on the Company's financial statements.
In April 2003 the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. This statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities. SFAS No. 149 provides greater clarification of the
characteristics of a derivative instrument so that contracts with similar
characteristics will be accounted for consistently. In general, SFAS No. 149 is
effective for contracts entered into or modified after June 30, 2003, and for
hedging relationships designated after June 30, 2003. As the Company does not
currently have any derivative financials instruments, the adoption of SFAS No.
149 is not expected to have any impact on the Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This statement
clarifies the accounting for certain financial instruments with characteristics
of both liabilities and equity and requires that those instruments be classified
as liabilities in statements of financial position. Previously, many of those
financial instruments were classified as equity. SFAS No. 150 is effective for
financial instruments entered into or modified after May 31, 2003 and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. As the Company does not have any of these financial instruments, the
adoption of SFAS No. 150 is not expected to have any impact on the Company's
financial statements.
NOTE 2. GOODWILL
The changes in the carrying amount of goodwill for the six-month period ended
June 27, 2003, are as follows (in thousands):
GOODWILL
--------
Balance at December 31, 2002 $ 465,662
Additional goodwill related to the NWW acquisition of USFDG:
Additional transaction costs 84
Working capital purchase price adjustment 3,140
Purchase accounting adjustment-change in tax basis of assets acquired (3,886)
Additional financing fees initially considered direct costs of the
acquisition (8,920)
---------
Balance at June 27, 2003 $ 456,080
=========
During the second quarter of 2003, the Company recorded additional deferred
financing fees of $8.9 million that will be amortized over the remaining life of
the related debt. Also, additional deferred tax assets of $3.9 million were
recorded based on management's best estimate of the acquired assets that will
ultimately be accepted by the taxing authorities.
Effective January 1, 2002, the Predecessor fully adopted the provisions of SFAS
No. 142, Goodwill and Other Intangible Assets, for all business combinations
consummated before July 1, 2001. As of the date of adoption, unamortized
goodwill totaled $933.4 million. The Predecessor evaluated its existing goodwill
that was acquired in prior purchase business combinations and determined that no
reclassifications were necessary in order to conform to the new classification
criteria in SFAS No. 141, Business Combinations, for recognition apart from
goodwill.
In the first quarter of 2002, the Predecessor completed the transitional
assessment required by SFAS No. 142 of whether there was an indication that
goodwill was impaired and concluded that it was probable that the goodwill then
assigned to its reporting units was impaired. The fair value of its reporting
units was estimated using, among other factors, the sales price included in the
agreement relating to the sale of substantially all of the assets, net of
7
certain liabilities, of USFDG to National Waterworks, Inc. The Predecessor
estimated an impairment loss of $459.0 million. The goodwill impairment is
reported as a cumulative effect of change in accounting principle in the
accompanying financial statements for the six month period ended June 28, 2002.
NOTE 3. SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION
Management has implemented the provisions of SFAS No. 131, Disclosure about
Segments of an Enterprise and Related Information. The Company has determined
that the six geographic regions, to which substantially all income and expenses
are allocated for purposes of allocating resources by the chief operating
decision maker, meet all of the aggregation criteria of SFAS No. 131, including
similar economic characteristics. Accordingly, there is one reportable segment.
Products include pipe, fire hydrants, meters, valves, fittings and other
complementary products for waterworks construction and maintenance/repair. The
following table sets forth net sales by product category (in thousands):
Three Months Ended Six Months Ended
Product Category June 27, 2003 June 28, 2002 June 27, 2003 June 28, 2002
---------------- ------------- ------------- ------------- -------------
Pipe $ 128,458 $ 131,492 $ 239,995 $ 215,027
Fittings 50,727 46,801 91,303 82,633
Valves 43,484 38,357 77,429 67,416
Meters 29,647 24,699 53,025 47,912
Fire Hydrants 20,698 19,666 35,773 33,579
Service and Repair Products 22,092 19,888 39,911 35,731
Other 34,609 31,109 62,058 56,381
---------- ---------- ---------- ----------
$ 329,715 $ 312,012 $ 599,494 $ 538,679
========== ========== ========== ==========
All revenues are derived from customers domiciled in the United States and there
are no long-lived assets located outside of the United States, and no single
customer, as defined in SFAS No. 131, represents ten percent or more of revenues
for any period presented.
NOTE 4. ACQUISITIONS AND DIVESTITURES
On March 29, 2002, the Group acquired substantially all of the assets and
certain liabilities of Utility Piping Systems, Inc. for an aggregate purchase
price of $20.1 million, including post-closing purchase price adjustments as
stated in the Asset Purchase Agreement. US Filter paid this amount on the
Group's behalf.
NOTE 5. ACCOUNTS RECEIVABLE SECURITIZATION
The Predecessor utilized a standard third-party receivables sale program, to
provide low-cost funding based upon a securitization agreement entered into on
December 19, 2001. Under this maximum $170 million program, the Predecessor sold
monthly, on a revolving basis, all of its rights, title and interest in, to and
under these eligible accounts receivable to the Receivables Company, a
bankruptcy-remote special purpose limited liability company. This company in
turn transferred the eligible accounts receivable to a master trust which issued
undivided interests in eligible accounts receivable to a third-party,
multi-seller asset-backed commercial paper program, existing solely for the
purpose of issuing commercial paper.
The sale of receivables under this Receivables Securitization Program was
accounted for as a sale in accordance with SFAS No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.
8
Losses recognized on the sale of accounts receivable totaled approximately $0.9
million and $1.5 million for the three-month and six-month periods ending June
28, 2002, respectively. These costs are included in the accompanying unaudited
statement of operations under the caption "Loss-accounts receivable
securitization."
Concurrent with the sale of USFDG business to NWW, the accounts receivable
securitization facility was terminated using proceeds from the sale.
NOTE 6. COMMITMENTS AND CONTINGENCIES
The Company is involved in various claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's financial position, results of operations or liquidity.
Certain of USFDG's predecessors distributed or may have distributed cement pipe
containing asbestos. Except for one predecessor, the cement pipe distributed was
primarily used in water and sewage application where the pipe was typically
buried underground. Management believes that the nature of the
asbestos-containing pipe distributed by the predecessors and the uses of such
pipe makes it unlikely that a large number of plaintiffs would be exposed to
friable asbestos emanating from the pipe. Management is not aware of any
predecessor manufacturing or fabricating asbestos containing products of any
type or assuming any product liability for such products.
As discussed in Note 1, US Filter and USFDG sold substantially all of the
Group's assets, net of certain liabilities as defined in the sales agreement, to
NWW. As part of the agreement, US Filter and USFDG have retained the liabilities
related to all existing and future, if any, asbestos claims. Additionally,
Veolia, the parent of US Filter, has agreed to guarantee all obligations of
USFDG and US Filter under the asset purchase agreement up to an aggregate of
$50.0 million for a period of 15 years. As the asbestos claims were retained and
in view of the indemnity provisions included in the sale agreement, management
of NWW believes that it has no liability related to asbestos claims at June 27,
2003.
The uncertainties of asbestos claim litigation and resolution make it difficult
to accurately predict the results of the ultimate resolutions of asbestos
claims. That uncertainty is increased by the possibility of adverse court
rulings or new legislation effecting asbestos claim litigation or the settlement
process. Subject to these uncertainties and based on the Predecessor's
experience defending asbestos claims, the estimate of the amounts to be
recovered from insurance companies and the indemnity provision provided in the
sales agreement, NWW management believes that it has no liability related to
asbestos claims.
NOTE 7. SUBSEQUENT EVENT
In August 2003 the Company amended its senior credit facility in connection with
the refinancing of the outstanding term loan portion thereof. The amendment,
among other things, provides for lower applicable margins for both Eurodollar
rate and base rate term loans under the refinanced facility. In addition the
minimum Eurodollar rate of 2.50% for term loans that existed prior to the
amendment has been removed. The amendment also permits the Company to issue,
without the consent of lenders under the senior credit facility, an incremental
$50.0 million of credit facilities in addition to the $50.0 million permitted
prior to the amendment.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
In this Report on Form 10-Q, unless the context otherwise requires, references
to the "Company," "we," "our," and "us" refer to U.S. Filter Distribution Group,
Inc. and its consolidated subsidiary ("USFDG", "Predecessor" or the "Group") for
periods prior to November 22, 2002 and to National Waterworks, Inc. for periods
from and after November 22, 2002.
The following is management's discussion and analysis of significant factors
which have affected the financial condition of the Company as of June 27, 2003
and the results of operations for the three months and six months then ended.
This information should be read in conjunction with the Company's financial
statements and the notes
9
thereto contained herein and in the prospectus dated April 18, 2003 included in
the Company's Registration Statement on Form S-4 (No. 333-102430) relating to
our 10.50% Senior Subordinated Notes due 2012.
FORWARD-LOOKING STATEMENTS
Certain statements set forth in this Report on Form 10-Q constitute
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as
amended, and are subject to the safe harbor created by such sections.
Forward-looking statements include statements concerning our plans, objectives,
goals, strategies, future events, future revenue or performance, capital
expenditures, financing needs, plans or intentions relating to acquisitions,
business trends and other information that is not historical information. When
used in this report, the words "believe", "anticipate", "estimate", "expect",
"may", "will", "should", "plan", "intend", "forecast" and similar expressions
are intended to identify forward-looking statements. All forward-looking
statements, including, without limitation, management's examination of
historical operating trends, are based upon our current expectations and various
assumptions. Our expectations, beliefs and projections are expressed in good
faith and we believe there is a reasonable basis for them. However, there can be
no assurance that management's expectations, beliefs and projections will result
or be achieved. Actual results or events may differ significantly from those
expressed in, or implied by, such forward-looking statements as a result of
various important factors. These factors include, but are not limited to,
national, regional and local general economic and business conditions; trends in
the water and wastewater transmission products industry and trends in the
construction industry; changes in municipal funding and spending levels; our
high level of indebtedness and the restrictions imposed by the terms of our
indebtedness; our ability to generate cash to service our debt; failure to
successfully implement, or changes in, our business strategy and the risk that
our business strategy may not be successful in improving our operating results;
competition and the development of alternatives to water and wastewater
transmission products distributors in the supply chain; the loss of one or more
of the Company's major suppliers or a reduction in supplier participation in our
preferred vendor program; changes in the cost of polyvinyl chloride ("PVC") pipe
or reductions in PVC pipe and other product availability; the risk that our
quarterly operating results are subject to substantial fluctuations; the
availability of qualified branch managers and sales personnel and the loss of
members of our senior management team; disruptions in our IT systems which
manage numerous aspects of our business and customer and supplier relationships;
and changes in, or the failure or inability to comply with, environmental and
safety regulations and increased costs of such regulations, as well as the other
risk factors affecting the Company detailed from time to time in the documents
filed by the Company with the Securities and Exchange Commission, including
those set forth in the prospectus dated April 18, 2003 included in the Company's
Registration Statement on S-4 (No. 333-102430) relating to our 10.50% Senior
Subordinated Notes due 2012. Except as otherwise required by the federal
securities laws, the Company assumes no obligation to publicly update or revise
any forward-looking statements to reflect subsequent events or circumstances.
OVERVIEW
We are a leading distributor of water and wastewater transmission products in
the United States with approximately a 20% share of the estimated $6 billion
U.S. waterworks product distribution market. We distribute a full line of pipes,
fittings, valves, meters, fire hydrants and other components that are used to
transport clean water and wastewater between reservoirs and treatment plants and
residential and commercial locations. Our products are integral to building,
repairing and maintaining water and wastewater (sewer) systems and serve as part
of the basic municipal infrastructure required to support population and
economic growth and residential and commercial construction. In addition, we
provide a broad array of value-added services that we believe are critical to
our customers' success. These services include project estimation, project
management and product advice. Through our network of 136 branches in 35 states,
we sell directly to municipalities and to contractors who serve municipalities
and also perform residential, commercial and industrial waterworks projects. In
addition to significant customer and geographic diversification, we estimate
that our net sales are split approximately evenly between publicly-funded and
privately-funded sales.
Acquisition of United States Filter Corporation. On April 23, 1999, Veolia
acquired United States Filter Corporation, the parent of U.S. Filter
Distribution Group, Inc. The acquisition was accounted for as a purchase and the
related purchase accounting adjustments have been reflected, or "pushed-down,"
in the consolidated financial statements of U.S. Filter Distribution Group, Inc.
for periods subsequent to April 30, 1999.
Acquisition of Assets of U.S. Filter Distribution Group, Inc. On November 22,
2002, we consummated the purchase of substantially all of the assets and
businesses of, and assumed certain liabilities and obligations of, U.S. Filter
10
Distribution Group, Inc., a wholly-owned subsidiary of United States Filter
Corporation, which is an indirect-wholly owned subsidiary of Veolia. We refer to
the foregoing transaction as the "acquisition." The total cost of the
acquisition, including the payment of transaction fees and expenses incurred by
us and our stockholders, was approximately $662.2 million, after giving effect
to a $3.1 million post-closing adjustment made on February 13, 2003 related to
the level of our working capital at the time of closing. The acquisition of the
assets and businesses of U.S. Filter Distribution Group, Inc. has been accounted
for as a purchase in accordance with Statement of Financial Accounting Standards
No. 141, Business Combinations. The excess of the purchase consideration over
the historical basis of the net assets acquired has been applied, based on final
valuations, to revalue the assets acquired and liabilities assumed to their fair
values as of November 22, 2002, the date of acquisition. The post-closing
adjustment has been reflected as an adjustment to goodwill in National
Waterworks' financial statements as of June 27, 2003.
The acquisition was financed through $250.0 million of term loans under our
senior credit facility, the issuance of $200.0 million principal amount of our
10.50% Senior Subordinated Notes due 2012, a $210.0 million cash equity
investment in our parent, National Waterworks Holdings, Inc., of which an
aggregate of $206.0 million was made equally by affiliates of each of J.P.
Morgan Partners, LLC and Thomas H. Lee Partners, L.P. (the "Sponsors") and $4.0
million was made by certain members of our management and our parent's board of
directors, and $2.2 million from cash from operations. In addition, concurrent
with the closing of the acquisition, U.S. Filter Distribution Group, Inc. used a
portion of the acquisition consideration to repay and terminate its accounts
receivable securitization facility. The acquisition, the offering of the notes,
the initial borrowings under our senior credit facility, the cash equity
investment described above, the repayment of the accounts receivable
securitization facility and the other related transactions are collectively
referred to in this Report on Form 10-Q as the "Transactions."
FACTORS AFFECTING OUR BUSINESS
PVC Pipe Pricing. The price of polyvinyl chloride ("PVC") pipe is volatile due
to supply and demand dynamics in the PVC pipe and PVC resin markets. Volatility
in these markets can cause fluctuations in our revenues and, to a lesser extent,
in our gross profit. PVC pipe products accounted for approximately 20% and 23%
of our net sales in the three months ended June 27, 2003 and June 28, 2002,
respectively, and 22% and 20% of our net sales in the six months ended June 27,
2003 and June 28, 2002, respectively. The purchase price of PVC pipe ranged from
$0.29 to $0.60 per pound between 1997 and 2001, which we believe to be the most
recent peak to trough period. Our purchase price of PVC pipe averaged $0.36,
$0.34 and $0.49 per pound for the years ended December 31, 2002 (combined), 2001
and 2000, respectively, with our 2002 PVC purchase price ranging from a
quarterly average of $0.30 to $0.42 per pound. Our purchase price of PVC pipe
averaged $0.44 and $0.36 per pound for the three months ended June 27, 2003 and
June 28, 2002, respectively, and $0.41 and $0.33 per pound for the six months
ended June 27, 2003 and June 28, 2002, respectively. In periods of higher PVC
pipe pricing, assuming constant sales volumes, our net sales of PVC pipe would
be higher as the same volume of pipe sales generates higher revenue. Conversely,
in periods of lower PVC pipe prices, assuming constant sales volumes, our net
sales of PVC pipe would be lower as the same volume of PVC pipe sales generates
lower revenue. In general, we can experience a decline in the volume of PVC pipe
sales (but an increase in the volume of ductile iron pipe sales) in periods of
higher PVC pipe pricing, as our customers can substitute ductile iron pipe for
PVC pipe in certain applications. PVC pipe accounts for approximately one-half
of our pipe sales. As a result of this interchangeability, pricing of ductile
iron pipe tends to move in the same direction as the pricing of PVC pipe but in
a less volatile fashion. Consequently, we can experience a change in product mix
between PVC pipe and ductile iron pipe as the prices of these products
fluctuate.
The impact of PVC pipe pricing on our gross profit has been less pronounced than
the impact on our net sales. Historically, we have been able to maintain our
gross profit dollars on a given volume of PVC pipe sales, even when PVC pipe
prices have fallen, as we have been able to pass through a majority of the
increase or decrease in PVC pipe prices to our customers. The impact of PVC
price changes is minimized because we sell the majority of our PVC pipe
utilizing direct shipments from suppliers and target and achieve high turnover
for PVC pipe sales out of our inventory. Gross margins, defined as gross profits
as a percentage of net sales, are affected by PVC price fluctuations because we
focus on maintaining gross profit to the extent possible even when net sales are
impacted and because of the effect that changes in the PVC pipe/ductile iron
pipe product mix have on gross margins, given that PVC pipe typically carries a
higher gross margin than ductile iron pipe.
Demand Fluctuations. Our sales are also affected by regional and local changes
in commercial and residential construction activity and the level of municipal
waterworks spending. The level of activity in the commercial
11
construction market depends on the general economic outlook, corporate
profitability, interest rates and existing plant capacity utilization. The level
of activity in the residential construction market depends on new housing
starts, which are influenced by interest rates, availability of financing,
housing affordability, unemployment rates, demographic trends, gross domestic
product and consumer confidence. Changing economic conditions in our markets
could affect the level of construction activity and, consequently, our net
sales. In addition, water and wastewater transmission products sales are subject
to the level of waterworks spending by municipalities. We believe municipal
spending is a function of the amount of repair and improvements required for
existing systems, which are functions of the age of the infrastructure, weather
and construction-related damage, the level of maintenance spending, the water
infrastructure needs of the municipality relative to other spending needs and
the availability of municipal, state or federal funds for waterworks projects.
Seasonality. Given the seasonal nature of construction activity in many regions
of the United States, our results of operations and working capital, including
our accounts receivable, inventory and accounts payable, fluctuate during the
year. We believe that our significant operations in more mild southern climates
moderate our seasonality. Historically, consistent with annual construction
seasonality, our net sales are typically higher during the second and third
calendar quarters as compared to the first and fourth calendar quarters. In
addition, we typically generate cash from a reduction in net working capital in
the fourth quarter of each year and utilize cash from operations to fund
increases in net working capital in the first and second quarter of each year.
Other important factors that could affect our results of operations are set
forth under the heading "Risk factors" in the prospectus dated April 18, 2003
included in our Registration Statement on Form S-4 (No. 333-102430) relating to
our 10.50% Senior Subordinated Notes due 2012.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's significant accounting policies are more fully described in the
notes to our audited financial statements which are set forth in the prospectus
dated April 18, 2003 included in our Registration Statement on Form S-4 (No.
333-102430) relating to our 10.50% Senior Subordinated Notes due 2012. Certain
of the Company's accounting policies require management to make estimates and
assumptions that affect amounts reported in the financial statements and
accompanying notes. These judgments are based on our historical experience,
current economic and industry trends, information provided by outside sources
and management estimates. As with all judgments, they are subject to an inherent
degree of uncertainty. Actual results may vary from the underlying estimates and
such differences may be material to our results of operations.
Allowance for Doubtful Accounts. We evaluate the collectibility of accounts
receivable based on historical trends, customer transaction history, accounts
receivable aging and an evaluation of customer credit worthiness. Initially, a
monthly provision is made based on historical experience. On a quarterly basis,
we perform a detailed analysis of accounts receivable and adjust the allowance
for doubtful accounts when necessary. While we have a large customer base that
is geographically diverse, an economic slowdown in the markets in which we
operate may result in higher uncollected accounts receivable and therefore the
need to revise estimates for bad debts. To the extent actual credit experience
or other assumptions used by management change, the allowance for doubtful
accounts would be adjusted, which could affect our operating results.
Inventories. We periodically evaluate our inventories to ensure they are
recorded at the lower of cost or market value. Inventories are adjusted based on
this analysis as well as other factors including potential adjustments from
physical inventory counts. Significant unusual events giving rise to changes in
our inventory valuation are adjusted for when appropriate. To the extent future
events impact the salability of our products, we may have to make future lower
of cost or market inventory adjustments.
Goodwill and Long-Lived Assets. At June 27, 2003, $456.1 million of goodwill was
reflected in our consolidated financial statements. We review the carrying value
of our goodwill for impairment at least annually. To accomplish this, we
estimate the fair value of each of our reporting units and compare the fair
value estimate to the unit's carrying value. The fair value of a reporting unit
may be estimated using methods such as a discounted cash flow analysis. If the
carrying value of a reporting unit exceeds its fair value estimate, an
indication exists that goodwill is impaired and we must perform additional
analysis to determine the extent of any impairment. Any such impairment would be
reflected as a charge in the statement of operations at that time.
12
We assess the impairment of our other long-lived assets whenever events or
changes indicate that the carrying value of those assets may not be recoverable.
If we determine that the sum of the estimated future cash flows (undiscounted)
that we expect to result from the use and eventual deposition of those assets is
less than the carrying value of the assets, we will recognize an impairment
charge. Measurement of such impairment charge is based on our estimate of the
fair value of our assets.
Consideration Received From Vendors. The Company enters into agreements with
many of its vendors providing for inventory purchase rebates ("vendor rebates")
upon achievement of specified volume purchasing levels. The Company accrues the
receipt of vendor rebates as part of its cost of sales for products sold based
on progress towards earning the vendor rebates, taking into consideration
cumulative purchases of inventory to date and projected purchases through the
end of the year. An estimate of unearned vendor rebates is included in the
carrying value of inventory at a period end for vendor rebates received on
products not yet sold. While management believes the Company will continue to
recognize consideration from vendors pursuant to underlying agreements, there
can be no assurance that vendors will continue to provide comparable amounts of
vendor rebates in the future, which could impact our operating results.
RESULTS OF OPERATIONS
The following table sets forth the percentage relationship that certain items
from our unaudited financial statements bear in relation to net sales.
Successor Predecessor Successor Predecessor
--------- ----------- --------- -----------
U.S. Filter U.S. Filter
Distribution Distribution
National Group, Inc. National Group, Inc.
Waterworks, and Waterworks, and
Inc. Subsidiary Inc. Subsidiary
-Note 1 -Note 1 -Note 1 -Note 1
Three Months Ended Six Months Ended
June 27, 2003 June 28, 2002 June 27, 2003 June 28, 2002
------------- ------------- ------------- -------------
STATEMENT OF OPERATIONS DATA:
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 78.9% 78.9% 79.5% 78.4%
----- ----- ----- -----
Gross profit 21.1% 21.1% 20.5% 21.6%
Operating expenses:
Selling, general and administrative 12.7% 12.5% 13.4% 13.6%
Loss - accounts receivable securitization 0.0% 0.3% 0.0% 0.3%
----- ----- ----- -----
Income before depreciation
and amortization 8.4% 8.3% 7.1% 7.7%
Depreciation and amortization 0.2% 0.3% 0.2% 0.3%
----- ----- ----- -----
Operating income 8.2% 8.0% 6.9% 7.4%
Other income (expense):
Interest expense, net (3.1%) 0.0% (3.3%) 0.0%
Other 0.0% 0.0% 0.0% 0.0%
----- ----- ----- -----
Income before income taxes 5.1% 8.0% 3.6% 7.4%
Income taxes expense 2.1% 3.1% 1.4% 2.9%
----- ----- ----- -----
Income before cumulative effect of
change in accounting principle 3.0% 4.9% 2.2% 4.5%
Cumulative effect of a change in
accounting principle - - - (85.2%)
===== ===== ===== =====
Net income (loss) 3.0% 4.9% 2.2% (80.7%)
===== ===== ===== =====
13
THE FOLLOWING DISCUSSION REGARDING THE THREE MONTH AND SIX MONTH PERIODS ENDED
JUNE 27, 2003 AND JUNE 28, 2002 IS BASED ON THE RESULTS OF OPERATIONS OF U. S.
FILTER DISTRIBUTION GROUP, INC. FOR THE 2002 PERIODS AND OF NATIONAL WATERWORKS,
INC. FOR THE 2003 PERIODS.
THREE MONTHS ENDED JUNE 27, 2003 VERSUS THREE MONTHS ENDED JUNE 28, 2002
Net Sales. Net sales for the three months ended June 27, 2003 increased $17.7
million, or 5.7%, to $329.7 million from $312.0 million for the three months
ended June 28, 2002. Net sales increased in all product areas except pipe. PVC
pipe volume decreased primarily due to significant pipe shipments in the
previous quarter and weather-related project delays throughout much of the
country. The PVC pipe volume decrease is partially offset by an increase in our
sales price of PVC pipe, resulting from the pass through of an approximate 22%
increase in our purchase price of PVC pipe. The net decrease in sales of PVC
pipe products was $5.2 million. As described above, we believe our ability to
quickly pass-through increases or decreases in raw material prices to our
customers significantly mitigates the impact of these fluctuations on our
profitability.
Cost of Goods Sold. Cost of goods sold for the three months ended June 27, 2003
increased $13.8 million, or 5.6%, to $260.1 million from $246.3 million for the
three months ended June 28, 2002. The increase reflects the increase in net
sales discussed above. As a percentage of net sales, cost of goods remained
unchanged at 78.9% for the 2003 period compared to 2002.
Gross Profit. As a result of the foregoing, gross profit for the three months
ended June 27, 2003 increased $3.9 million, to $69.6 million from $65.7 million
for the three months ended June 28, 2002. Our gross profit margin of 21.1% for
the 2003 period remained unchanged as compared to 2002.
Selling, General and Administrative. Selling, general and administrative
expenses for the three months ended June 27, 2003 increased $2.8 million, or
7.2%, to $41.8 million from $39.0 million for the three months ended June 28,
2002. This increase is primarily related to sales increases discussed above. As
a percentage of net sales, selling, general and administrative expenses were
12.7% for the second quarter 2003 period compared to 12.5% in second quarter
2002.
Operating Income. Operating income for the three months ended June 27, 2003
increased $2.1 million, or 8.4%, to $27.1 million from $25.0 million for the
three months ended June 28, 2002. As a percentage of net sales, operating income
increased to 8.2% for the second quarter 2003 period from 8.0% for the second
quarter 2002 period, which is primarily attributable to sales volume increases.
Interest Expense, Net. Interest expense, net for the three months ended June 27,
2003 was $10.1 million and was less than $0.1 million for the three months ended
June 28, 2002. The increase reflects the additional debt we incurred on November
22, 2002 to finance the acquisition of substantially all of the assets and
certain liabilities of USFDG.
Net Income (Loss). We reported net income of $10.3 million for the three months
ended June 27, 2003, compared to a net income of $15.3 million for the three
months ended June 28, 2002. The decrease of $5.0 million primarily reflects
increased interest expense during the 2003 period as discussed above.
SIX MONTHS ENDED JUNE 27, 2003 VERSUS SIX MONTHS ENDED JUNE 28, 2002
Certain Financial Statement Impacts of the Acquisition. As more fully discussed
below, the revaluation of the net assets acquired in the acquisition did not
affect our net sales. However, we recorded a $13.0 million valuation increase in
inventory at November 22, 2002 as a result of the asset revaluation. While the
increase in the value of our inventory had no cash impact, it did increase our
costs of goods sold, adversely impacting our gross profit. We recognized $9.0
million of the impact of the inventory revaluation during the November 22 to
December 31, 2002
14
period. The final $4.0 million of the inventory revaluation was recognized in
the first quarter of 2003.
Net Sales. Net sales for the six months ended June 27, 2003 increased $60.8
million, or 11.3%, to $599.5 million from $538.7 million for the six months
ended June 28, 2002. The increase reflects the combined effects of a $6.0
million increase in net sales from the acquisition of Utility Piping Systems,
Inc., a regional waterworks distribution company operating in Pennsylvania, New
Jersey and Delaware, which we acquired on March 29, 2002, and a $54.8 million
increase in net sales of our historical operations. The increase in net sales of
our historical operations was attributable to increases recorded in all product
areas. The increase in net sales of pipe was primarily attributable to an
increase of $18.6 million in our net sales of PVC pipe, resulting from the pass
through of an approximate 24% increase in our purchase price of PVC pipe. As
described above, we believe our ability to quickly pass-through increases or
decreases in raw material prices to our customers significantly mitigates the
impact of these fluctuations on our profitability.
Cost of Goods Sold. Cost of goods sold for the six months ended June 27, 2003
increased $54.2 million, or 12.8%, to $476.5 million from $422.3 million for the
six months ended June 28, 2002. The increase reflects an increase in cost of
goods sold of our historical operations which was primarily attributable to
increased volume. An approximate 24% increase in our purchase price of PVC pipe
resulted in an increase in cost of goods sold of PVC pipe products of $17.5
million. Additionally the increase reflects the combined effects of a $4.8
million increase in cost of goods sold associated with sales resulting from our
Utility Piping Systems, Inc. acquisition and the recognition of the final $4.0
million impact of the inventory revaluation as discussed above. As a percentage
of net sales, cost of goods sold increased to 79.5% for the 2003 period compared
to 78.4% in 2002.
Gross Profit. As a result of the foregoing, gross profit for the six months
ended June 27, 2003 increased $6.6 million, to $123.0 million from $116.4
million for the six months ended June 28, 2002. Gross profit increases as a
result of the acquisition of Utility Piping Systems and increased volume in our
historical operations, were partially offset by the adverse impact of the
inventory revaluation, representing .7% of net sales, recognized during the 2003
period. Our gross profit margin decreased to 20.5% for the 2003 period compared
to 21.6% in 2002 as a result of the foregoing factors.
Selling, General and Administrative. Selling, general and administrative
expenses for the six months ended June 27, 2003 increased $7.4 million, or
10.1%, to $80.5 million from $73.1 million for the six months ended June 28,
2002. This increase is primarily related to sales volume increases discussed
above and $0.9 million of additional expenses resulting from the March 29, 2002
acquisition of Utility Piping Systems, Inc. As a percentage of net sales,
selling, general and administrative expenses were 13.4% for the 2003 period
compared to 13.6% in 2002.
Operating Income. Operating income for the six months ended June 27, 2003
increased $1.1 million, or 2.7%, to $41.2 million from $40.1 million for the six
months ended June 28, 2002. As a percentage of net sales, operating income
decreased to 6.9% for the 2003 period from 7.4% for the 2002 period, which is
primarily attributable to the adverse impact of the inventory revaluation
discussed above.
Interest Expense, Net. Interest expense, net for the six months ended June 27,
2003 was $19.5 million and was less than $0.1 million for the six months ended
June 28, 2002. The increase reflects the additional debt we incurred on November
22, 2002 to finance the acquisition of substantially all of the assets and
certain liabilities of USFDG.
Cumulative Effect of Change in Accounting Principle. As a result of the adoption
of SFAS No. 142 prior to the consummation of the acquisition, USFDG completed an
assessment of whether its goodwill at January 1, 2002, the date of adoption of
SFAS No. 142, was impaired. As a result of this assessment, USFDG concluded that
it was probable that the goodwill then assigned to its reporting units was
impaired based in part upon the anticipated sale price of substantially all of
its assets and liabilities to National Waterworks, Inc. Accordingly, 2002
included a charge for the estimated goodwill impairment of $459.0 million.
During this period, goodwill was primarily comprised of amounts resulting from
the purchase accounting adjustments associated with the acquisition of US Filter
by Veolia in 1997 and reflected, or "pushed-down", in USFDG's consolidated
financial statements, and, to a lesser extent, amounts resulting from
acquisitions since the date of the Veolia acquisition.
Net Income (Loss). We reported net income of $13.0 million for the six months
ended June 27, 2003, compared to a net loss of $434.4 million for the six months
ended June 28, 2002. Excluding the cumulative effect of a change in accounting
principle in 2002, net income decreased $11.6 million to $13.0 million in the
2003 period from $24.6 million in the 2002 period. This decline primarily
reflects increased interest expense during the 2003 period and the
15
effect of the inventory revaluation discussed above.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we participated in the centralized cash management program of our
former parent, US Filter, whereby all of our cash receipts were remitted to our
former parent and substantially all of our cash disbursements were funded by our
former parent. As a result of the acquisition and our separation from US Filter,
we no longer participate in such program. Historically, our primary cash
requirements were to fund our operations, working capital and capital
expenditures. Following the acquisition, our primary cash requirements are to
make the interest and principal payments on our debt and to fund our operations,
working capital and capital expenditures. We expect to fund these needs
principally from cash flow from operations and, if necessary, borrowings under
the revolving credit portion of our senior credit facility. In addition, as the
acquisition was structured as an asset acquisition, we will be able to deduct
for tax purposes, on a straight-line basis over 15 years, the related goodwill.
We expect that this amortization will result in significant cash tax savings.
Net working capital is comprised of current assets, excluding cash and cash
equivalents, minus current liabilities. We had net working capital of $141.6
million at June 27, 2003 compared to net working capital of $105.1 million at
December 31, 2002. The increase in net working capital is primarily attributable
to the seasonal nature of our business resulting in increased accounts
receivable, inventory and accounts payable.
On December 19, 2001, the Predecessor entered into an accounts receivable
securitization facility pursuant to which from time to time the Predecessor sold
its eligible accounts receivable to a wholly-owned, qualified special purpose
entity ("QSPE"). The QSPE, in turn, sold the receivables to a securitization
company. See Note 5 to our unaudited financial statements included elsewhere in
this quarterly report. Concurrently with the closing of, and as a condition
precedent to the Transactions, USFDG utilized a portion of the acquisition
consideration to repay and terminate the securitization facility, which resulted
in National Waterworks, Inc. acquiring all of USFDG's accounts receivable at
closing, including those that had been previously sold pursuant to the
securitization facility.
Net cash used in operating activities for the six months ended June 27, 2003 was
$15.0 million compared to net cash provided by operating activities for the six
months ended June 28, 2002 of $31.6 million. The change in net cash related to
operating activities in 2003 compared to 2002 was primarily attributable to an
increase of $45.5 million in accounts receivable for the 2003 period, resulting
from seasonal volume and higher net sales. The seasonal impact of accounts
receivable in the 2002 period was offset through a $30.0 million increase in the
Receivables Securitization Program of the Predecessor.
Net cash used in investing activities for the six months ended June 27, 2003 and
June 28, 2002 was $3.5 million and $18.6 million, respectively. Net cash used in
investing activities for the period ended June 27, 2003 reflected the
post-closing cash adjustment of $3.1 million paid to USFDG, related to the level
of our working capital at the time of closing of the Transactions. Net cash used
in investing activities for the six months ended June 28, 2002 reflected the one
operating acquisition we completed in 2002 for a net consideration of $19.6
million. Of this consideration, $0.9 million, representing a purchase price
adjustment, was paid during the third quarter of 2002. Capital expenditures for
the six months ended June 27, 2003 and June 28, 2002 were unchanged at $0.7
million. We estimate that our capital expenditures for the remainder of 2003
will be approximately $1.5 million. Capital expenditures principally relate to
improvements at our branch facilities and on-going investments to our IT system.
Net cash used in financing activities for the six months ended June 27, 2003 and
June 28, 2002 was $2.1 million and $15.7 million, respectively. Net cash
provided in the 2003 period included a $1.0 million cash equity investment in
our Parent by one of our and our Parent's directors, who had not made an
investment in our Parent at the time the Transactions were consummated. The
Parent made a concurrent $1.0 million capital contribution to the Company. The
2003 period also reflects a $2.5 million principal payment on the term loan. Net
cash used in financing activities for the 2002 period reflected the excess of
funds transferred to our former parent, US Filter, through the cash management
program over investments and expenditures funded by US Filter during the period.
Our senior credit facility consists of a $250.0 million term loan facility, of
which $247.5 million was outstanding at June 27, 2003, and a $75.0 million
revolving credit facility. No amount was outstanding under the revolving credit
facility at June 27, 2003 but approximately $3.4 million of the availability
under the facility was used to support outstanding letters of credit. We repaid
$2.5 million of the term loan on June 30, 2003. The borrowings under the
16
revolving credit facility will be available until its maturity to fund our
working capital requirements, capital expenditures and other general corporate
needs. The revolving credit facility will mature on November 22, 2008 and will
have no scheduled amortization or commitment reductions. The term loan facility
will mature on November 22, 2009 and has quarterly scheduled amortization
payments of $2.5 million in 2003, $3.75 million in 2004 and 2005, $5.0 million
in 2006 and $6.25 million in 2007 and 2008, with the balance of the facility to
be repaid quarterly during 2009. In addition, commencing with the year ending
December 31, 2003, we will be required to make annual mandatory prepayments of
the term loans under the senior credit facility in an amount equal to 75% of
Excess Cash Flow, determined generally as the amount by which our operating cash
flow exceeds the sum of our capital expenditures (including in respect of
permitted acquisitions), repayments of indebtedness and certain other amount,
or, 50% of Excess Cash Flow if our ratio of consolidated total debt to
consolidated EBITDA as of the last day of the fiscal year is not greater than
4:0 to 1:0. The term loans are also subject to mandatory prepayments in an
amount equal to (i) 75% of the net proceeds from certain equity issuances (or
50% if we meet the foregoing leverage ratio); (ii) 100% of the net cash proceeds
of certain debt issuances; and (iii) 100% of the net cash proceeds of certain
asset sales or other dispositions of property, in each case subject to certain
exceptions. Borrowing under the term loan portion and revolving credit facility
each bear interest at a variable rate based on, at our option, the Eurodollar
rate (but not less than 2.50%) plus an applicable margin, or a base rate plus a
margin. The base rate is the higher of the prime rate or the federal funds rate
plus 0.5%. At June 27, 2003, the interest rate on the term loan was 6.5% per
annum. Our senior credit facility permits us to issue up to an additional $50.0
million of credit facilities without the consent of the lenders there under, so
long as no default or event of default under the senior credit facility has
occurred or would occur after giving effect to such issuance and certain other
conditions are satisfied, including pro forma compliance with certain leverage
ratios. Our $200.0 million principal amount of senior subordinated notes due
2012 bear interest at 10.50% per annum with interest due semi-annually on June 1
and December 1 of each year. Interest payments on the senior subordinated notes
and required principal and interest payments on borrowings under our senior
credit facility have substantially increased our liquidity requirements.
In August 2003 we amended our senior credit facility in connection with the
refinancing of the outstanding term loan portion thereof. The amendment, among
other things, provides for lower applicable margins for both Eurodollar rate and
base rate term loans under the refinanced facility. In addition the minimum
Eurodollar rate of 2.50% for term loans that existed prior to the amendment has
been removed. The amendment also permits us to issue, without the consent of
lenders under the senior credit facility, an incremental $50.0 million of credit
facilities in addition to the $50.0 million permitted prior to the amendment.
The amendment is included as Exhibit 4.1.
The senior credit facility and the indenture for the notes impose certain
restrictions on us, including restrictions on our ability to incur indebtedness,
pay dividends, make investments, grant liens, sell our assets and engage in
certain other activities. Our senior credit facility also requires that we
satisfy leverage and interest coverage ratios and contains a capital
expenditures limitation. We were in compliance with all covenants at June 27,
2003. Indebtedness under the senior credit facility is secured by substantially
all of our and our parent's assets, including our real and personal property,
inventory, accounts receivable, intellectual property and other intangibles. In
addition, the senior credit facility is secured by the stock and substantially
all of the assets of our future domestic subsidiaries, if any. We do not
currently have any subsidiaries.
Our ability to pay principal and interest on our indebtedness and to satisfy our
other obligations will depend upon, among other things:
- our future financial and operating performance, which will be
affected by prevailing economic conditions and financial, business,
regulatory and other factors, many of which are beyond our control;
and
- the future availability of borrowings under our senior credit
facility or any successor facility, the availability of which
depends or may depend on, among other things, our complying with the
covenants in our senior credit facility.
We believe that, based on our current levels of operations, our cash flow from
operations, together with available borrowings under the senior credit facility,
will be adequate for at least the next few years to make scheduled amortization
and interest payments on our indebtedness and to fund anticipated capital
expenditures and for working capital requirements. We cannot assure you,
however, that our business will generate sufficient cash flow from operations or
that future borrowings will be available under the senior credit facility in an
amount sufficient to enable us to service our indebtedness or to fund our other
liquidity needs.
17
RECENT ACCOUNTING PRONOUNCEMENTS
See discussion regarding recent accounting pronouncements in Note 1 to the
accompanying financial statements.
RELATED PARTY TRANSACTIONS
In January 2003, one of our and our Parent's directors, who had not made an
investment in the Parent at the time the Transactions were consummated, made a
$1.0 million cash equity investment in the Parent in exchange for the issuance
of shares of common stock of the Parent. The Parent made a concurrent $1.0
million capital contribution to the Company. The investment was made at the same
price per share as the original investment made by the Sponsors and management
on November 22, 2002.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain market risks as part of our on-going business
operations. Primary exposure includes changes in interest rates as borrowings
under our senior credit facility bear interest at floating rates based on the
London InterBank Offered Rate ("LIBOR") or the prime rate, in each case plus an
applicable borrowing margin. We manage our interest rate risk by balancing the
amount of fixed-rate and floating-rate debt. For fixed rate debt, interest rate
changes affect the fair market value but do not impact earnings or cash flows.
Conversely, for floating-rate debt, interest rate changes generally do not
affect the fair market value but do impact our earnings and cash flows, assuming
other factors are held constant. As of June 27, 2003, we had $200 million
principal amount of fixed-rate debt represented by the notes and $247.5 million
of floating-rate debt represented by borrowings under the term loan portion of
the senior credit facility. We repaid $2.5 million of the term loan on June 30,
2003. In addition, up to $75 million of floating rate borrowings are available
under the revolving credit portion of the senior credit facility, of which $3.4
million was used to support outstanding letters of credit at June 27, 2003.
Based on the amount outstanding under the term loans at June 27, 2003, an
immediate increase of one percentage point in the applicable interest rate would
not cause an increase in annual interest expense due to the 2.5% Libor floor.
Libor was less than 1.5% at June 27, 2003. We may use derivative financial
instruments, where appropriate, to manage our interest rate risks. However, as a
matter of policy, we will not enter into derivative or other financial
investments for trading or speculative purposes. All of our sales are
denominated in U.S. dollars; thus our financial results are not subject to
foreign currency exchange risks or weak economic conditions in foreign markets.
For a discussion of the effect of PVC pipe price changes on our business, see
"Factors affecting our business -- PVC Pipe Pricing" above.
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms, and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure. In designing and evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the
desired control objectives, and management necessarily was required to apply its
judgment in evaluating the cost-benefit relationship of possible controls and
procedures.
As of the end of the second quarter, the Company carried out an evaluation,
under the supervision and with the participation of our management, including
the Chief Executive Officer and Chief Financial Officer, of the effectiveness of
the design and operation of our disclosure controls and procedures. Based on the
foregoing, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were effective.
There have been no significant changes in our internal controls over financial
reporting or in other factors that have materially affected, or are reasonably
likely to materially affect, our internal controls over financial reporting in
the three months since the Company last evaluated the system of internal
controls in conjunction with the preparation of financial statements for the
quarter ended March 27, 2003.
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PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
10.32 First Amendment to the Credit Agreement (dated November 22,
2002) entered into by and between the Company and the
syndication of lenders dated August 7, 2003.
31.1 Certification of Chief Executive Officer pursuant to Rule
15d-14(a) of the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Rule
15d-14(a) of the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) REPORTS ON FORM 8-K
On May 6, 2003, the Company filed a Current Report on Form 8-K pursuant
to Item 9 thereof reporting that a press release was issued regarding
the Company's financial results for the quarter ended March 28, 2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NATIONAL WATERWORKS, INC.
Date: August 7, 2003 By: /s/ Harry K. Hornish, Jr.
--------------------------
Harry K. Hornish, Jr.
President and Chief Executive Officer
Date: August 7, 2003 By: /s/ Mechelle Slaughter
----------------------
Mechelle Slaughter
Chief Financial Officer
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