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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 SEPTEMBER 26, 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 OCTOBER 29, 2003
------------ ----------------------------------
$.01 Par Value 100
NATIONAL WATERWORKS, INC.
FORM 10-Q
INDEX
PAGE(S)
-------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets of National Waterworks, Inc. as of
September 26, 2003 (unaudited) and December 31, 2002 3
Statements of Operations of National Waterworks, Inc.
(Successor) for the Three Months and Nine Months Ended
September 26, 2003 and of U.S. Filter Distribution Group, Inc. and
subsidiary (Predecessor) for the Three Months and Nine Months
Ended September 27, 2002 (unaudited) 4
Statements of Cash Flows of National Waterworks, Inc.
(Successor) for the Nine Months Ended September 26, 2003 and
of U.S. Filter Distribution Group, Inc. and subsidiary
(Predecessor) for the Nine Months Ended September 27, 2002
(unaudited) 5
Notes to Financial Statements (unaudited) 6-9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 9-17
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
September 26,
2003 December 31,
(unaudited) 2002
----------- ----
Assets
Current assets:
Cash and cash equivalents $ 53,808 $ 39,888
Trade accounts receivable, net 234,181 174,012
Inventories 99,465 91,619
Deferred income taxes 3,044 4,713
Other current assets 1,178 2,402
--------- ---------
Total current assets 391,676 312,634
Property and equipment, net 20,695 21,805
Goodwill 456,080 465,662
Deferred financing fees, net 25,123 12,667
Other assets 1,352 49
--------- ---------
$ 894,926 $ 812,817
========= =========
Liabilities and Stockholder's Equity
Current liabilities:
Trade accounts payable $ 168,214 $ 126,662
Current installments of long-term debt 12,500 10,000
Accrued compensation and benefits 22,839 22,036
Other accrued expenses 19,615 8,989
--------- ---------
Total current liabilities 223,168 167,687
Long-term debt, excluding current installments 432,500 440,000
Deferred income taxes 7,305 1,025
Other long term liabilities 1,389 --
--------- ---------
Total liabilities 664,362 608,712
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) 19,565 (5,894)
--------- ---------
Total stockholder's equity 230,564 204,105
--------- ---------
$ 894,926 $ 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 Nine Months Ended
September 26, September 27, September 26, September 27,
2003 2002 2003 2002
---- ---- ---- ----
Net sales $ 357,781 $ 329,997 $ 957,275 $ 868,676
Cost of goods sold 282,417 261,225 758,872 683,515
--------- --------- --------- ---------
Gross profit 75,364 68,772 198,403 185,161
Operating expenses:
Selling, general and administrative 43,521 40,682 124,020 113,789
Loss-accounts receivable securitization -- 874 -- 2,414
--------- --------- --------- ---------
Income before depreciation and
amortization 31,843 27,216 74,383 68,958
Depreciation and amortization 608 774 1,974 2,435
--------- --------- --------- ---------
Operating income 31,235 26,442 72,409 66,523
Other income (expense):
Interest expense, net (10,368) (11) (29,908) (31)
Other (58) (13) (70) 61
--------- --------- --------- ---------
Income before income taxes 20,809 26,418 42,431 66,553
Income tax expense 8,323 10,217 16,972 25,778
--------- --------- --------- ---------
Income before cumulative effect of
change in accounting principle 12,486 16,201 25,459 40,775
Cumulative effect of a change in accounting
principle -- -- -- (459,000)
--------- --------- --------- ---------
Net income(loss) $ 12,486 $ 16,201 $ 25,459 $(418,225)
========= ========= ========= =========
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
Nine Months Ended
-----------------
September 26, 2003 September 27, 2002
------------------ ------------------
Cash flows from operating activities:
Net income (loss) $ 25,459 $(418,225)
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Deferred income taxes 11,835 1,457
Amortization of deferred financing fees 1,946 --
Depreciation and amortization 1,974 2,435
Loss on goodwill impairment -- 459,000
Gain on disposal of equipment (37) (71)
Provision for doubtful accounts 969 914
Changes in operating assets and liabilities,
net of businesses acquired:
Trade accounts receivable (61,138) (30,034)
Inventories (7,846) (11,399)
Other current assets 1,224 520
Other assets (1,309) 4,298
Trade accounts payable 41,552 35,173
Accrued compensation and benefits 803 (3,780)
Other accrued expenses 10,626 1,250
Other long term liabilities 1,389 --
--------- ---------
Net cash provided by operating activities 27,447 41,538
--------- ---------
Cash flows from investing activities:
Capital expenditures (1,444) (1,062)
Additional NWW acquisition costs (3,224) --
Business acquisitions, net of cash -- (19,594)
Proceeds from sales of property and equipment 623 906
--------- ---------
Net cash used in investing activities (4,045) (19,750)
--------- ---------
Cash flows from financing activities:
Capital contribution 1,000 --
Financing fees (5,482) --
Principal payments on long-term debt (5,000) (193)
Investment by US Filter -- 20,093
Funds transferred to US Filter -- (887,206)
Expenditures funded by US Filter -- 805,738
Allocation of expenses from US Filter -- 39,038
--------- ---------
Net cash used in financing activities (9,482) (22,530)
--------- ---------
Net increase (decrease) in cash
and cash equivalents 13,920 (742)
Cash and cash equivalents at beginning of period 39,888 13,288
--------- ---------
Cash and cash equivalents at end of period $ 53,808 $ 12,546
========= =========
Cash paid for interest $ 22,985 $ 31
========= =========
Cash paid for income taxes $ 845 $ 24,576
========= =========
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 Holdings, 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 September 26, 2003
(unaudited) and December 31, 2002, the unaudited statements of operations for
the three months and nine months ended September 26, 2003, and the unaudited
statement of cash flows for the nine months ended September 26, 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 nine months ended September 27, 2002, and the unaudited
statement of cash flows for the nine months ended September 27, 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 September 26, 2003 and September 27, 2002
include thirteen weeks. The results for the nine months ended September 26, 2003
and September 27, 2002 include thirty eight weeks and three days and thirty
eight 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 had no 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 had no 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 had no impact on the Company's financial statements.
NOTE 2. GOODWILL
The changes in the carrying amount of goodwill for the nine-month period ended
September 26, 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 September 26, 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
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 nine month period ended September 27,
2002.
7
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 Nine Months Ended
September 26, September 27, September 26, September 27,
2003 2002 2003 2002
-------- -------- -------- --------
Pipe $144,611 $134,722 $384,165 $349,285
Fittings 54,965 51,390 146,777 133,811
Valves 43,478 40,513 121,238 108,039
Meters 29,397 27,203 82,347 75,264
Fire Hydrants 23,355 20,907 59,152 54,495
Service and Repair Products 25,290 21,795 65,161 57,499
Other 36,685 33,467 98,435 90,283
-------- -------- -------- --------
$357,781 $329,997 $957,275 $868,676
======== ======== ======== ========
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 (the "Receivables Securitization Program"). 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.
Losses recognized on the sale of accounts receivable totaled approximately $0.9
million and $2.4 million for the three-month and nine-month periods ending
September 27, 2002, respectively. These costs are included in the accompanying
unaudited statement of operations under the caption "Loss-accounts receivable
securitization."
8
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 September
26, 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.
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 September 26,
2003 and the results of operations for the three months and nine months then
ended. This information should be read in conjunction with the Company's
financial statements and the notes 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,
9
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 134 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
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 September 26, 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
10
$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% of our
net sales in the three months ended September 26, 2003 and September 27, 2002,
and 21% of our net sales in the nine months ended September 26, 2003 and
September 27, 2002. 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 $0.39 and
$0.42 per pound for the three months ended September 26, 2003 and September 27,
2002, respectively, and $0.41 and $0.36 per pound for the nine months ended
September 26, 2003 and September 27, 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 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
11
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 subsequent working capital peak periods.
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 September 26, 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.
The company will complete its evaluation of the carrying value of goodwill, at
the reporting unit level, prior to December 31, 2003. The valuation date will be
as of September 26, 2003.
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.
12
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 Nine Months Ended
September 26, September 27, September 26, September 27,
2003 2002 2003 2002
------ ------ ------ ------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 78.9% 79.2% 79.3% 78.7%
------ ------ ------ ------
Gross profit 21.1% 20.8% 20.7% 21.3%
Operating expenses:
Selling, general and
administrative 12.2% 12.3% 13.0% 13.1%
Loss - accounts receivable
securitization 0.0% 0.3% 0.0% 0.3%
------ ------ ------ ------
Income before
depreciation and
amortization 8.9% 8.2% 7.7% 7.9%
Depreciation and amortization 0.2% 0.2% 0.2% 0.3%
------ ------ ------ ------
Operating income 8.7% 8.0% 7.5% 7.6%
Other income (expense):
Interest expense, net (2.9%) 0.0% (3.1%) 0.0%
Other 0.0% 0.0% 0.0% 0.0%
------ ------ ------ ------
Income before income
taxes 5.8% 8.0% 4.4% 7.6%
Income tax expense 2.3% 3.1% 1.8% 3.0%
------ ------ ------ ------
Income before cumulative
effect of change in
accounting principle 3.5% 4.9% 2.6% 4.6%
Cumulative effect of a change
in accounting principle 0.0% 0.0% 0.0% (52.8%)
------ ------ ------ ------
Net income (loss) 3.5% 4.9% 2.6% (48.2%)
====== ====== ====== ======
THE FOLLOWING DISCUSSION REGARDING THE THREE MONTH AND NINE MONTH PERIODS ENDED
SEPTEMBER 26, 2003 AND SEPTEMBER 27, 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 SEPTEMBER 26, 2003 VERSUS THREE MONTHS ENDED SEPTEMBER 27,
2002
Net Sales. Net sales for the three months ended September 26, 2003 increased
$27.8 million, or 8.4%, to $357.8 million from $330.0 million for the three
months ended September 27, 2002. Net sales increased in all product areas
brought by continued favorable economic conditions.
13
Cost of Goods Sold. Cost of goods sold for the three months ended September 26,
2003 increased $21.2 million, or 8.1%, to $282.4 million from $261.2 million for
the three months ended September 27, 2002. The increase reflects the increase in
net sales discussed above. As a percentage of net sales, cost of goods sold
decreased to 78.9% for the third quarter 2003 period as compared to 79.2% in
third quarter 2002.
Gross Profit. As a result of the foregoing, gross profit for the three months
ended September 26, 2003 increased $6.6 million, to $75.4 million from $68.8
million for the three months ended September 27, 2002. Our gross profit margin
increased to 21.1% for the third quarter 2003 period as compared to 20.8% in
third quarter 2002.
Selling, General and Administrative. Selling, general and administrative
expenses for the three months ended September 26, 2003 increased $2.8 million,
or 6.9%, to $43.5 million from $40.7 million for the three months ended
September 27, 2002. This increase is primarily related to sales increases
discussed above. As a percentage of net sales, selling, general and
administrative expenses were 12.2% for the third quarter 2003 period compared to
12.3% in third quarter 2002.
Operating Income. Operating income for the three months ended September 26, 2003
increased $4.8 million, or 18.2%, to $31.2 million from $26.4 million for the
three months ended September 27, 2002. As a percentage of net sales, operating
income increased to 8.7% for the third quarter 2003 period from 8.0% for the
third quarter 2002 period, which is primarily attributable to sales volume
increases.
Interest Expense, Net. Interest expense, net for the three months ended
September 26, 2003 was $10.4 million and was less than $0.1 million for the
three months ended September 27, 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 $12.5 million for the three months
ended September 26, 2003, compared to a net income of $16.2 million for the
three months ended September 27, 2002. The decrease of $3.7 million primarily
reflects increased interest expense during the 2003 period as discussed above.
NINE MONTHS ENDED SEPTEMBER 26, 2003 VERSUS NINE MONTHS ENDED SEPTEMBER 27, 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 period. The final $4.0 million of the inventory revaluation
was recognized in the first quarter of 2003.
Net Sales. Net sales for the nine months ended September 26, 2003 increased
$88.6 million, or 10.2%, to $957.3 million from $868.7 million for the nine
months ended September 27, 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
an $82.6 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 brought by continued favorable economic
conditions.
Cost of Goods Sold. Cost of goods sold for the nine months ended September 26,
2003 increased $75.4 million, or 11.0%, to $758.9 million from $683.5 million
for the nine months ended September 27, 2002. The increase reflects an increase
in cost of goods sold of our historical operations which was primarily
attributable to increased volume. 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
79.3% for the 2003 period compared to 78.7% in 2002.
Gross Profit. As a result of the foregoing, gross profit for the nine months
ended September 26, 2003 increased $13.2 million, to $198.4 million from $185.2
million for the nine months ended September 27, 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 0.4% of net sales, recognized during the
2003 period. Our gross profit margin decreased to 20.7% for the 2003 period
compared to 21.3% in 2002
14
as a result of the foregoing factors.
Selling, General and Administrative. Selling, general and administrative
expenses for the nine months ended September 26, 2003 increased $10.2 million,
or 9.0%, to $124.0 million from $113.8 million for the nine months ended
September 27, 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 13.0% for the 2003
period compared to 13.1% in 2002.
Operating Income. Operating income for the nine months ended September 26, 2003
increased $5.9 million, or 8.9%, to $72.4 million from $66.5 million for the
nine months ended September 27, 2002. As a percentage of net sales, operating
income decreased to 7.5% for the 2003 period from 7.6% 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 nine months ended September
26, 2003 was $29.9 million and was less than $0.1 million for the nine months
ended September 27, 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 was impaired at January 1, 2002, the date of
adoption of SFAS No. 142. 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 $25.5 million for the nine months
ended September 26, 2003, compared to a net loss of $418.2 million for the nine
months ended September 27, 2002. Excluding the cumulative effect of a change in
accounting principle in 2002, net income decreased $15.3 million to $25.5
million in the 2003 period from $40.8 million in the 2002 period. This decline
primarily reflects increased interest expense during the 2003 period and the
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 $114.7
million at September 26, 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
15
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 provided by operating activities for the nine months ended September
26, 2003 and September 27, 2002 was $27.4 million and $41.5 million,
respectively. The change in net cash provided by operating activities in 2003
compared to 2002 was primarily attributable to an increase of $61.1 million in
accounts receivable for the 2003 period, resulting from seasonal volume and
higher net sales. The $30.0 million increase of accounts receivable in the 2002
period is net of a $30.0 million increase in the Receivables Securitization
Program of the Predecessor. The effect of the increase in accounts receivable
for the 2003 period relative to the 2002 period is partially offset by increases
in trade accounts payable and other accrued expenses.
Net cash used in investing activities for the nine months ended September 26,
2003 and September 27, 2002 was $4.0 million and $19.8 million, respectively.
Net cash used in investing activities for the period ended September 26, 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 nine months ended
September 27, 2002 reflected the one operating acquisition we completed in 2002
for a net consideration of $19.6 million. Capital expenditures for the nine
months ended September 26, 2003 and September 27, 2002 were $1.4 million and
$1.1 million, respectively. We estimate that our capital expenditures for the
remainder of 2003 will be approximately $0.6 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 nine months ended September 26,
2003 and September 27, 2002 was $9.5 million and $22.5 million, respectively.
Net cash used in financing activities 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 $5.0 million in principal payments 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.
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, provided 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,
contingent upon meeting certain covenants. In connection with the amendment, we
paid approximately $6.0 million of financing fees, including a $4.9 million call
premium. The call premium is recorded as deferred financing fees with the
remaining finance fees recorded as interest expense.
Our senior credit facility, as amended, consists of a $250.0 million term loan
facility, of which $245.0 million was outstanding at September 26, 2003, and a
$75.0 million revolving credit facility. No amount was outstanding under the
revolving credit facility at September 26, 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 September 30, 2003. The
borrowings under the 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 amounts, 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. Borrowings under the term loan portion
and revolving credit facility bear interest at a variable
16
rate based on, at our option, the Eurodollar rate 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 September 26, 2003, the interest rate on the
term loan was 3.87% per annum. Our senior credit facility permits us to issue up
to an additional $100.0 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.
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 September
26, 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.
In the fourth quarter of 2003, we anticipate that we will incur an additional
$80 million term loan under our senior credit facility. We plan to use a portion
of the proceeds, together with internally generated cash, to pay a $110 million
dividend to our parent company so that our parent company can pay a $110 million
dividend to its stockholders. Concurrently with the incurrence of the new term
loan, we will seek an amendment of our senior credit facility and the consent of
the holders of a majority of our senior subordinated notes, in each case to
permit the payment of the dividend. The incurrence of the additional term loan,
the bank amendment and the consent solicitation will each be conditioned on the
other.
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.
17
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 September 26, 2003, we had $200 million
principal amount of fixed-rate debt represented by the notes and $245.0 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 September
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
September 26, 2003. Based on the amount outstanding under the term loans at
September 26, 2003, an immediate increase of one percentage point in the
applicable interest rate would cause an approximate $2.4 million increase in
annual interest expense based on scheduled amortization payments. 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 third 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 June 27, 2003.
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PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
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 August 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 June 27, 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: October 29, 2003 By: /s/ Harry K. Hornish, Jr.
-------------------------------------
Harry K. Hornish, Jr.
President and Chief Executive Officer
Date: October 29, 2003 By: /s/ Mechelle Slaughter
-------------------------------------
Mechelle Slaughter
Chief Financial Officer
20