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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2004 Commission File Number 0-21054
SYNAGRO TECHNOLOGIES, INC.
(Exact name of Registrant as specified in its Charter)
DELAWARE 76-0511324
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
1800 BERING DRIVE, SUITE 1000
HOUSTON, TEXAS 77057
(Address of principal executive offices) (Zip Code)
(713) 369-1700
(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 is
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 close of the latest practicable date.
CLASS OUTSTANDING AT AUGUST 16, 2004
----------------------------- ------------------------------
Common stock, par value $.002 19,775,821
SYNAGRO TECHNOLOGIES, INC.
INDEX
PAGE
----
PART I - FINANCIAL INFORMATION
Condensed Consolidated Balance Sheets as of June 30, 2004 (Unaudited),
and December 31, 2003 (Derived from Audited Financial Statements) ......... 3
Condensed Consolidated Statements of Operations for the
Three and Six Months Ended June 30, 2004 and 2003 (Unaudited) ............. 4
Condensed Consolidated Statement of Stockholders' Equity for the Six Months
Ended June 30, 2004 (Unaudited) ........................................... 5
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2004 and 2003 (Unaudited) ....................... 6
Notes to Condensed Consolidated Financial Statements (Unaudited) .............. 7
Management's Discussion and Analysis of Financial
Condition and Results of Operations ....................................... 20
Item 3. Quantitative and Qualitative Disclosures About Market Risk ........... 26
Item 4. Controls and Procedures .............................................. 26
PART II - OTHER INFORMATION ................................................... 27
2
SYNAGRO TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE DATA)
JUNE 30, DECEMBER 31,
2004 2003
--------- ---------
(DERIVED
FROM AUDITED
FINANCIAL
(UNAUDITED) STATEMENTS)
ASSETS
Current Assets:
Cash and cash equivalents ................................ $ 180 $ 206
Restricted cash .......................................... 2,304 1,410
Accounts receivable, net ................................. 58,916 59,581
Note receivable, current portion ......................... 610 342
Prepaid expenses and other current assets ................ 14,197 10,840
--------- ---------
Total current assets .................................. 76,207 72,379
Property, machinery & equipment, net ........................ 220,006 213,697
Other Assets:
Goodwill ................................................. 172,868 172,398
Restricted cash - construction fund ...................... 4,939 12,184
Restricted cash - debt service fund ...................... 8,560 7,275
Other, net ............................................... 13,982 14,091
--------- ---------
Total assets ....................................... $ 496,562 $ 492,024
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term debt ..................... $ 937 $ 955
Current maturities of nonrecourse project revenue bonds .. 2,570 2,570
Current maturities of capital lease obligations .......... 2,964 2,678
Accrued interest payable ................................. 4,078 4,222
Accounts payable and accrued expenses .................... 48,788 43,257
--------- ---------
Total current liabilities ............................. 59,337 53,682
Long-Term Debt:
Long-term debt obligations, net .......................... 182,802 194,084
Nonrecourse project revenue bonds, net ................... 62,314 62,301
Capital lease obligations, net ........................... 12,376 12,748
--------- ---------
Total long-term debt .................................. 257,492 269,133
Other long-term liabilities ........................... 21,734 17,536
--------- ---------
Total liabilities ................................. 338,563 340,351
Commitments and Contingencies
Redeemable Preferred Stock, 69,792.29 shares issued and
outstanding, redeemable at $1,000 per share .............. 90,613 86,299
Stockholders' Equity:
Preferred stock, $.002 par value, 10,000,000 shares
authorized, none issued and outstanding ............... -- --
Common stock, $.002 par value, 100,000,000 shares
authorized, 19,775,821 and 19,775,821 shares issued and
outstanding, respectively .............................. 40 40
Additional paid-in capital ............................... 77,799 82,113
Accumulated deficit ...................................... (9,403) (15,477)
Accumulated other comprehensive loss ..................... (1,050) (1,302)
--------- ---------
Total stockholders' equity ............................ 67,386 65,374
--------- ---------
Total liabilities and stockholders' equity .................. $ 496,562 $ 492,024
========= =========
The accompanying notes are an integral part of
these condensed consolidated financial statements.
3
SYNAGRO TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS EXCEPT SHARE DATA)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Revenue ................................................. $ 82,301 $ 75,641 $ 154,962 $ 138,870
Cost of services ........................................ 63,280 55,501 123,624 106,888
------------ ------------ ------------ ------------
Gross profit ............................................ 19,021 20,140 31,338 31,982
Selling, general and administrative expenses ............ 5,699 5,926 11,521 12,230
------------ ------------ ------------ ------------
Income from operations ............................... 13,322 14,214 19,817 19,752
Other (income) expense:
Other income, net .................................... (774) (42) (892) (11)
Interest expense, net ................................ 5,582 6,208 10,751 12,055
------------ ------------ ------------ ------------
Total other expense, net .......................... 4,808 6,166 9,859 12,044
------------ ------------ ------------ ------------
Income before provision for income taxes ................ 8,514 8,048 9,958 7,708
Provision for income taxes ........................... 3,320 3,058 3,884 2,929
------------ ------------ ------------ ------------
Net income before cumulative effect of change
in accounting for asset retirement obligations and
preferred stock dividends ............................ 5,194 4,990 6,074 4,779
Cumulative effect of change in accounting for asset
Retirement obligations, net of tax benefit of $292 ... -- -- -- 476
------------ ------------ ------------ ------------
Net income before preferred stock dividends ............. 5,194 4,990 6,074 4,303
Preferred stock dividends ............................... 2,176 2,029 4,314 4,004
------------ ------------ ------------ ------------
Net income applicable to common stock ................... $ 3,018 $ 2,961 $ 1,760 $ 299
============ ============ ============ ============
Earnings per share:
Basic
Earnings per share before cumulative effect of
change in accounting for asset retirement
obligations ......................................... $ 0.15 $ 0.15 $ 0.09 $ 0.04
Cumulative effect of change in accounting for asset
retirement obligations ............................ -- -- -- (0.02)
------------ ------------ ------------ ------------
Earnings per share ................................... $ 0.15 $ 0.15 $ 0.09 $ 0.02
============ ============ ============ ============
Diluted
Earnings per share before preferred stock
dividends and cumulative effect of change in
accounting for asset retirement obligations ........ $ 0.09 $ 0.09 $ 0.09 $ 0.04
Cumulative effect of change in accounting for asset
retirement obligations ............................ -- -- -- (0.02)
------------ ------------ ------------ ------------
Earnings per share ................................... $ 0.09 $ 0.09 $ 0.09 $ 0.02
============ ============ ============ ============
Weighted average shares outstanding:
Weighted average shares outstanding for basic earnings
per share calculation ............................. 19,775,821 19,775,821 19,775,821 19,775,821
Effect of dilutive stock options ..................... 679,672 171,761 -- --
Effect of convertible preferred stock under the
"if converted" method ............................. 37,976,978 35,049,792 -- --
------------ ------------ ------------ ------------
Weighted average shares outstanding for diluted
earnings per share ................................ 58,432,471 54,997,374 19,775,821 19,775,821
============ ============ ============ ============
The accompanying notes are an integral part of these
condensed consolidated financial statements.
4
SYNAGRO TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
(IN THOUSANDS EXCEPT SHARE DATA)
COMMON STOCK ACCUMULATED
------------------------- ADDITIONAL OTHER COMPREHENSIVE
PAID-IN ACCUMULATED COMPREHENSIVE INCOME
SHARES AMOUNT CAPITAL DEFICIT INCOME (LOSS) TOTAL (see Note 1)
----------- ----------- ----------- ----------- ----------- ----------- -------------
BALANCE, January 1, 2004 ........ 19,775,821 $ 40 $ 82,113 $ (15,477) $ (1,302) $ 65,374 $ --
Change in comprehensive
income ....................... -- -- -- -- 252 252 252
Preferred stock dividends ...... (4,314) (4,314)
Net income before preferred
stock dividends .............. -- -- -- 6,074 -- 6,074 6,074
----------- ----------- ----------- ----------- ----------- ----------- -----------
BALANCE, June 30, 2004 .......... 19,775,821 $ 40 $ 77,799 $ (9,403) $ (1,050) $ 67,386 $ 6,326
=========== =========== =========== =========== =========== =========== ===========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
5
SYNAGRO TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
SIX MONTHS ENDED JUNE 30,
-------------------------
2004 2003
-------- --------
Cash flows from operating activities:
Net income applicable to common stock .......................... $ 1,760 $ 299
Adjustments to reconcile net income applicable to common
stock to net cash provided by operating activities:
Preferred stock dividends ................................. 4,314 4,004
Cumulative effect of change in accounting for
asset retirement obligations ........................... -- 476
Depreciation and amortization ............................. 9,490 8,425
Amortization of debt financing costs ...................... 615 517
Provision for deferred income taxes ....................... 3,806 2,870
Gain on sale of property, machinery and equipment ......... (892) (95)
(Increase) decrease in the following, net:
Accounts receivable .................................... 665 (6,303)
Prepaid expenses and other current assets .............. (187) (860)
Increase (decrease) in the following, net:
Accrued interest payable ............................... (144) 215
Accounts payable and accrued expenses
and other long-term liabilities ..................... 396 (4,179)
-------- --------
Net cash provided by operating activities ...................... 19,823 5,369
-------- --------
Cash flows from investing activities:
Purchase of businesses ...................................... (470) (4,418)
Purchases of property, machinery and equipment .............. (7,563) (7,932)
Proceeds from sale of property, machinery and equipment ..... 1,672 14,103
Facility construction funded by restricted cash ............. (7,240) --
Decrease in restricted cash for facility construction ....... 7,240 461
Increase in other restricted cash accounts .................. (2,174) (243)
Other ....................................................... (269) (169)
-------- --------
Net cash (used) provided by investing activities .................. (8,804) 1,802
-------- --------
Cash flows from financing activities:
Payments of debt ............................................ (12,869) (6,478)
Net increase in bank revolver borrowings .................... 2,000 --
Debt issuance costs ......................................... (176) (774)
-------- --------
Net cash used in financing activities ............................. (11,045) (7,252)
-------- --------
Net decrease in cash and cash equivalents ......................... (26) (81)
Cash and cash equivalents, beginning of period .................... 206 239
-------- --------
Cash and cash equivalents, end of period .......................... $ 180 $ 158
======== ========
Supplemental Cash Flow Information
Interest paid during the period .............................. 9,119 8,931
Taxes paid during the period ................................. 355 154
The accompanying notes are an integral part of these
condensed consolidated financial statements.
6
SYNAGRO TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) BASIS OF PRESENTATION
GENERAL
The accompanying unaudited, condensed consolidated financial statements have
been prepared by Synagro Technologies, Inc. ("Synagro" or the "Company")
pursuant to the rules and regulations of the Securities and Exchange Commission.
These condensed consolidated financial statements reflect all normal recurring
adjustments which are, in the opinion of management, necessary for the fair
presentation of such financial statements for the periods indicated. Certain
information relating to the Company's organization and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles has been condensed or omitted in this Form 10-Q
pursuant to Rule 10-01 of Regulation S-X for interim financial statements
required to be filed with the Securities and Exchange Commission. However, the
Company believes that the disclosures herein are adequate to make the
information presented not misleading. The results for the six months ended June
30, 2004, are not necessarily indicative of future operating results. It is
suggested that these financial statements be read in conjunction with the
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the year ended December 31, 2003.
The accounting policies followed by the Company in preparing interim
consolidated financial statements are consistent with those described in the
"Notes to Consolidated Financial Statements" in the Company's Form 10-K for the
year ended December 31, 2003.
Synagro Technologies, Inc., a Delaware corporation, and collectively with its
subsidiaries is a national water and wastewater residuals management company
serving more than 1,000 municipal and industrial water and wastewater treatment
plants with operations in 37 states and the District of Columbia. Synagro offers
services that focus on the beneficial reuse of organic nonhazardous residuals
resulting from the water and wastewater treatment process. Synagro provides its
customers with complete, vertically integrated services and capabilities,
including facility operations, facility cleanout services, regulatory
compliance, dewatering, collection and transportation, composting, drying and
pelletization, product marketing, incineration, alkaline stabilization, and land
application.
RESTATEMENT OF COMPREHENSIVE INCOME
In our previous financial statements we deducted preferred stock dividends from
our calculation of comprehensive income. We have determined that preferred stock
dividends should not be included in the Company's calculation of its
comprehensive income. Therefore, we have restated our financial statements for
the three and six months ended June 30, 2003 and the three months ended March
31, 2004 and 2003, to exclude preferred stock dividends from comprehensive
income. This restatement also had no effect on our consolidated balance sheets,
statements of operations or statements of cash flows.
The following reflects the adjustments related to the restatement of our
comprehensive income (loss) for the periods presented (in thousands):
SIX MONTHS ENDED JUNE 30,
--------------------------------------------------------
2003
As Previously 2003
2004 Reported As Restated
------- ------------- -----------
Net income before preferred stock
dividends $ 6,074 $ 4,303 $ 4,303
Amortization of impact of
SFAS No. 133 252 252 252
Preferred Stock Dividends -- (4,004) --
------- ------- -------
Comprehensive Income $ 6,326 $ 551 $ 4,555
======= ======= =======
THREE MONTHS ENDED JUNE 30,
--------------------------------------------------------
2003
As Previously 2003
2004 Reported As Restated
------- ------------- -----------
Net income before preferred stock
dividends $ 5,194 $ 4,990 $ 4,990
Amortization of impact of
SFAS No. 133 126 126 126
Preferred Stock Dividends -- (2,029) --
------- ------- -------
Comprehensive Income $ 5,320 $ 3,087 $ 5,116
======= ======= =======
THREE MONTHS ENDED MARCH 31,
-----------------------------------------------------------
2004 2003
As Previously 2004 As Previously 2003
Reported As Restated Reported As Restated
------------- ----------- ------------- -----------
Net income (loss) before preferred stock
dividends $ 880 $ 880 ($ 687) ($ 687)
Amortization of impact of
SFAS No. 133 126 126 126 126
Preferred Stock Dividends (2,138) -- (1,975) --
------- ------ ------- -------
Comprehensive income (loss) ($1,132) $1,006 ($2,536) ($ 561)
======= ====== ======= =======
The Company is in the process of having a reaudit of its consolidated financial
statements for the year ended December 31, 2001 completed and will file a Form
10-K/A reflecting the results of the reaudit in the near future. The Company
will restate comprehensive income/(loss) by $7.2 million, $7.7 million and $8.2
million to remove preferred stock dividends for the years ended December 31,
2003, 2002 and 2001, respectively, in this Form 10-K/A. For a further discussion
of the reaudit, refer to the Company's previously filed Annual Report on Form
10-K for the year ended December 31, 2003.
ACCOUNTING PRONOUNCEMENTS
On January 1, 2003, the Company adopted Statement on Financial Accounting
Standards ("SFAS") No. 143, "Asset Retirement Obligations." SFAS No. 143
requires entities to record the fair value of a liability for an asset
retirement obligation in the period in which it is incurred and a corresponding
increase in the carrying amount of the related long-lived asset. Subsequently,
the asset retirement cost should be allocated to expense using a systematic and
rational method. The Company's asset retirement obligations primarily consist of
equipment dismantling and foundation removal at certain facilities and temporary
storage facilities. During the first quarter of 2003, the Company recorded a
charge related to the cumulative effect of change in accounting for asset
retirement obligations, net of tax, totaling approximately $0.5 million
(approximately $0.8 million before tax), increased liabilities by approximately
$1.6 million, and increased property, plant and equipment by approximately $0.5
million. There was no impact on the Company's cash flows as a result of adopting
SFAS No. 143. The asset retirement obligation, which is included on the
condensed consolidated balance sheet in other long-term liabilities including
accretion of approximately $0.1 million, was approximately $1.8 million at June
30, 2004.
In December 2002, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure -
An Amendment of FASB Statement No. 123." SFAS No. 148 provides alternative
methods of transition for a voluntary change to the fair-value-based method of
accounting for stock-based employee compensation. Companies must disclose in
both annual and interim financial statements the method used to account for
stock-based compensation. The Company will continue to apply Accounting
Principles Board ("APB") Opinion No. 25 and related interpretations in
accounting for its plans. Therefore, no compensation cost has been recognized in
the accompanying condensed consolidated financial statements for the Company's
stock option plans.
7
Had the Company elected to apply SFAS No. 123, the Company's net income (loss)
and income (loss) per diluted share would have approximated the pro forma
amounts indicated below (in thousands):
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
-------------------------- -------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Net income applicable to common stock, as
reported ................................. $ 3,018 $ 2,961 $ 1,760 $ 299
Less: Compensation expense per SFAS No
123, net of tax ........................... $ 289 $ 368 $ 554 $ 732
---------- ---------- ---------- ----------
Pro forma after effect of SFAS No. 123 ..... $ 2,729 $ 2,593 $ 1,206 $ (433)
========== ========== ========== ==========
Diluted income per share, as reported ...... $ 0.09 $ 0.09 $ 0.09 $ 0.02
Pro forma after effect of SFAS No. 123 ..... $ 0.08 $ 0.08 $ 0.06 $ (0.02)
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model resulting in a weighted average fair value
per share of $2.55 and $1.36 for grants made during the six months ended June
30, 2004 and 2003, respectively. The following assumptions were used for option
grants in 2004 and 2003, respectively: expected volatility of 114 percent and 47
percent; risk-free interest rates of 4.34 percent and 4.03 percent; expected
lives of up to ten years and no expected dividends to be paid. For the quarter
ended June 30, 2004, the weighted average fair value per share was $2.74. The
following assumptions were used for option grants during the three months ended
June 30, 2004: expected volatility of 124 percent; risk-free interest rate of
4.69 percent; expected lives of up to ten years and no expected dividends to be
paid. The compensation expense included in the above pro forma data may not be
indicative of amounts to be included in future periods as the fair value of
options granted prior to 1995 was not determined and the Company expects future
grants.
USE OF ESTIMATES
In preparing financial statements in conformity with accounting principles
generally accepted in the United States, management makes estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements, as well as the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. The
following are the Company's significant estimates and assumptions made in
preparation of its financial statements:
Allowance for Doubtful Accounts -- The Company estimates losses for
uncollectible accounts based on the aging of the accounts receivable and the
evaluation and the likelihood of success in collecting the receivable. Allowance
for doubtful accounts was approximately $ 1.2 million at June 30, 2004 and $1.5
million at December 31, 2003.
Loss Contracts -- The Company evaluates its revenue producing contracts to
determine whether the projected revenues of such contracts exceed the direct
cost to service such contracts. These evaluations include estimates of the
future revenues and expenses. Accruals for loss contracts are adjusted based on
these evaluations.
Property and Equipment/Long-Lived Assets -- Property and equipment is reviewed
for impairment pursuant to the provisions of SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." The carrying amount of an asset
(group) is considered impaired if it exceeds the sum of the Company's estimate
of the undiscounted future cash flows expected to result from the use and
eventual disposition of the asset (group), excluding interest charges.
The Company regularly incurs costs to develop potential projects or facilities
and procure contracts for the design, permitting, construction and operations of
facilities. The Company has recorded $23.6 million in property and long-term
assets related to these activities at June 30, 2004, compared to $14.7 million
at December 31, 2003. The Company routinely reviews the status of each of these
projects to determine if these costs are realizable. If the Company is
unsuccessful in obtaining the required permits, government approvals, or
fulfilling the contract requirements, these costs will be expensed.
Goodwill -- Goodwill attributable to the Company's reporting units is tested for
impairment by comparing the fair value of each reporting unit with its carrying
value. Significant estimates used in the determination of fair value include
estimates of future cash flows, future growth rates, costs of capital and
estimates of market multiples. As required under current accounting standards,
the Company tests for impairment annually at year end unless factors become
known that an impairment may have occurred prior to year end. During the six
months ended June 30, 2004, the Company recorded certain adjustments related to
tax payments with previous owners and payments related to earnouts. These
adjustments increased goodwill by $0.5 million as of June 30, 2004.
8
Purchase Accounting -- The Company estimates the fair value of assets, including
property, machinery and equipment and its related useful lives and salvage
values, and liabilities when allocating the purchase price of an acquisition.
Income Taxes -- The Company assumes the deductibility of certain costs in its
income tax filings and estimates the recovery of deferred income tax assets. The
ultimate realization of deferred tax assets is dependent upon the generation of
future taxable income during the periods in which the activity underlying these
assets becomes deductible. The Company considers the scheduled reversal of
deferred tax liabilities, projected future taxable income and tax planning
strategies in making this assessment. If actual future taxable income differs
from its estimates, the Company may not realize deferred tax assets to the
extent it was estimated.
Legal and Contingency Accruals -- The Company estimates and accrues the amount
of probable exposure it may have with respect to litigation, claims and
assessments. These estimates are based on management's facts and probabilities
of the ultimate resolution of the litigation.
Self-Insurance Reserves -- The Company is substantially self-insured for
worker's compensation, employer's liability, auto liability, general liability
and employee group health claims in view of the relatively high per-incident
deductibles the Company absorbs under its insurance arrangements for these
risks. Losses up to deductible amounts are estimated and accrued based on known
facts, historical trends, industry averages and actuarial assumptions regarding
future claims development and claims incurred but not reported.
Actual results could differ materially from the estimates and assumptions that
the Company uses in the preparation of its financial statements.
(2) ACQUISITIONS
In May 2003, the Company purchased Aspen Resources, Inc. ("Aspen"). The purchase
of Aspen provides the Company with added expertise in the management of pulp and
paper organic residuals. The allocation of purchase price resulted in
approximately $3.4 million of goodwill. The assets acquired and liabilities
assumed relating to the acquisition are summarized below (in thousands):
Cash paid, including transaction costs, net of cash $ 4,093
acquired...........................................
Note payable to seller............................... 500
Less: Net assets acquired........................... (1,182)
-------
Goodwill............................................. $ 3,411
=======
The note payable to the former owners is due in equal monthly installments with
interest payable at an annual rate of five percent beginning May 2004.
Results of operations of Aspen are included in the accompanying condensed
consolidated statements of operations as of May 7, 2003. Pro forma results of
operations, as if Aspen had been acquired as of the beginning of its respective
acquisition year, have not been presented as such results are not considered to
be materially different from the Company's actual results.
(3) PREFERRED STOCK
PREFERRED STOCK
The Company is authorized to issue up to 10,000,000 shares of Preferred Stock,
which may be issued in one or more series or classes by the Board of Directors
of the Company. Each such series or class shall have such powers, preferences,
rights and restrictions as determined by resolution of the Board of Directors.
Series A Junior Participating Preferred Stock will be issued upon exercise of
the Stockholders' Rights described below.
(4) REDEEMABLE PREFERRED STOCK
SERIES D REDEEMABLE PREFERRED STOCK
The Company has authorized 32,000 shares of Series D Preferred Stock, par value
$.002 per share. In 2000, the Company issued a total of 25,033.601 shares of the
Series D Preferred Stock to GTCR Fund VII, L.P. and its affiliates, which is
convertible by the holders into a number of shares of the Company's common stock
computed by dividing (i) the sum of (a) the number of shares to be converted
multiplied by the liquidation value and (b) the amount of accrued and unpaid
dividends by (ii) the conversion price then in
9
effect. The initial conversion price is $2.50 per share, provided that in order
to prevent dilution, the conversion price may be adjusted. The Series D
Preferred Stock is senior to the Company's common stock and any other of its
equity securities. The liquidation value of each share of Series D Preferred
Stock is $1,000 per share. Dividends on each share of Series D Preferred Stock
accrue daily at the rate of eight percent per annum on the aggregate liquidation
value and may be paid in cash or accrued, at the Company's option. Upon
conversion of the Series D Preferred Stock by the holders, the holders may elect
to receive the accrued and unpaid dividends in shares of the Company's common
stock at the conversion price. The Series D Preferred Stock is entitled to one
vote per share. Shares of Series D Preferred Stock are subject to mandatory
redemption by the Company on January 26, 2010, at a price per share equal to the
liquidation value plus accrued and unpaid dividends. If the outstanding shares
of Series D Preferred Stock, excluding accrued dividends, were converted at June
30, 2004, they would represent 10,013,441 shares of common stock.
SERIES E REDEEMABLE PREFERRED STOCK
The Company has authorized 55,000 shares of Series E Preferred Stock, par value
$.002 per share. GTCR Fund VII, L.P. and its affiliates own 37,504.229 shares of
Series E Preferred Stock and certain affiliates of The TCW Group, Inc. own
7,254.462 shares. The Series E Preferred Stock is convertible by the holders
into a number of shares of the Company's common stock computed by dividing (i)
the sum of (a) the number of shares to be converted multiplied by the
liquidation value and (b) the amount of accrued and unpaid dividends by (ii) the
conversion price then in effect. The initial conversion price is $2.50 per
share, provided that in order to prevent dilution, the conversion price may be
adjusted. The Series E Preferred Stock is senior to the Company's common stock
and any other of its equity securities. The liquidation value of each share of
Series E Preferred Stock is $1,000 per share. Dividends on each share of Series
E Preferred Stock accrue daily at the rate of eight percent per annum on the
aggregate liquidation value and may be paid in cash or accrued, at the Company's
option. Upon conversion of the Series E Preferred Stock by the holders, the
holders may elect to receive the accrued and unpaid dividends in shares of the
Company's common stock at the conversion price. The Series E Preferred Stock is
entitled to one vote per share. Shares of Series E Preferred Stock are subject
to mandatory redemption by the Company on January 26, 2010, at a price per share
equal to the liquidation value plus accrued and unpaid dividends. If the
outstanding shares of Series E Preferred Stock, excluding accrued dividends,
were converted at June 30, 2004, they would represent 17,903,475 shares of
common stock.
The future issuances of Series D and Series E Preferred Stock may result in
noncash beneficial conversions valued in future periods recognized as preferred
stock dividends if the market value of the Company's common stock is higher than
the conversion price at date of issuance.
(5) STOCKHOLDERS' RIGHTS PLAN
In December 1996, the Company adopted a stockholders' rights plan (the "Rights
Plan"). The Rights Plan provides for a dividend distribution of one preferred
stock purchase right ("Right") for each outstanding share of the Company's
common stock, to stockholders of record at the close of business on January 10,
1997. The Rights Plan is designed to deter coercive takeover tactics and to
prevent an acquirer from gaining control of the Company without offering a fair
price to all of the Company's stockholders. The Rights will expire on December
31, 2006.
Each Right entitles stockholders to buy one one-thousandth of a newly issued
share of Series A Junior Participating Preferred Stock of the Company at an
exercise price of $10. The Rights are exercisable only if a person or group
acquires beneficial ownership of 15 percent or more of the Company's common
stock or commences a tender or exchange offer which, if consummated, would
result in that person or group owning 15 percent or more of the common stock of
the Company. However, the Rights will not become exercisable if common stock is
acquired pursuant to an offer for all shares which a majority of the Board of
Directors determines to be fair to and otherwise in the best interests of the
Company and its stockholders. If, following an acquisition of 15 percent or more
of the Company's common stock, the Company is acquired by that person or group
in a merger or other business combination transaction, each Right would then
entitle its holder to purchase common stock of the acquiring company having a
value of twice the exercise price. The effect will be to entitle the Company
stockholders to buy stock in the acquiring company at 50 percent of its market
price.
The Company may redeem the Rights at $.001 per Right at any time on or prior to
the tenth business day following the acquisition of 15 percent or more of its
common stock by a person or group or commencement of a tender offer for such 15
percent ownership.
10
(6) DEBT
Long-term debt obligations consist of the following:
JUNE 30, DECEMBER 31,
2004 2003
--------- ---------
(IN THOUSANDS)
Senior credit facility -
Revolving line of credit ............... $ 2,000 $ --
Term loans ............................. 32,840 44,274
Subordinated debt ........................... 150,000 150,000
Fair value adjustment of subordinated debt
as a result of interest rate swaps ....... (2,508) (755)
Notes payable to sellers of acquired
businesses ................................ 1,394 1,500
Other notes payable ......................... 13 20
--------- ---------
Total debt ............................. $ 183,739 $ 195,039
Less: Current maturities ................... (937) (955)
--------- ---------
Long-term debt, net of current
maturities ........................... $ 182,802 $ 194,084
========= =========
CREDIT FACILITY
On May 8, 2002, the Company entered into a $150 million amended and restated
Senior Credit Agreement (the "Senior Credit Agreement") by and among the
Company, Bank of America, N.A., and certain other lenders to fund working
capital for acquisitions, to refinance existing debt, to provide working capital
for operations, to fund capital expenditures and for other general corporate
purposes. The Senior Credit Agreement bears interest at LIBOR or prime plus a
margin based on a pricing schedule as set out in the Senior Credit Agreement.
During May 2003, the Company further amended its Senior Credit Agreement to
increase the revolving loan commitment to approximately $95 million.
The current loan commitments under the Senior Credit Agreement are as follows:
(i) Revolving Loan up to $95 million outstanding at any one time;
(ii) Term B Loans (which, once repaid, may not be reborrowed) of $70
million; and
(iii) Letters of Credit up to $50 million as a subset of the Revolving
Loan. At June 30, 2004, the Company had approximately $32.9 million
of Letters of Credit outstanding.
The amounts borrowed under the Senior Credit Agreement are subject to repayment
as follows:
REVOLVING TERM
PERIOD ENDING DECEMBER 31, LOAN LOANS
- -------------------------- ---- -----
2002 ........................ -- 0.25%
2003 ........................ -- 1.00%
2004 ........................ -- 1.00%
2005 ........................ -- 1.00%
2006 ........................ -- 1.00%
2007 ........................ 100.00% 1.00%
2008 ........................ -- 94.75%
------ ------
100.00% 100.00%
====== ======
The Senior Credit Agreement includes mandatory repayment provisions related to
excess cash flows, proceeds from certain asset sales, debt issuances and equity
issuances, all as defined in the Senior Credit Agreement. These mandatory
repayment provisions may also reduce the available commitment. The Senior Credit
Agreement contains standard covenants including compliance with laws,
limitations on capital expenditures, restrictions on dividend payments,
limitations on mergers and compliance with financial covenants. The Company was
in compliance with those covenants as of June 30, 2004. The Senior Credit
Agreement is collateralized by substantially all of the Company's assets and
those of it subsidiaries and expires on December 31, 2008. As of June 30, 2004,
the
11
Company had approximately $62.1 million of unused borrowings under the Senior
Credit Agreement, of which approximately $44.4 million is available for
borrowing based on the ratio limitations included in the Senior Credit
Agreement. On March 9, 2004, the Company amended its Senior Credit Agreement to,
among other things, exclude certain charges from its financial covenant
calculations, to clarify certain defined terms, to increase the amount of
indebtedness permitted under its total leverage ratio, and to reset capital and
operating lease limitations.
SENIOR SUBORDINATED NOTES
In April 2002, the Company issued $150 million aggregate in principal amount of
its 9 1/2 percent Senior Subordinated Notes due on April 1, 2009 (the "Notes").
The Notes are unsecured senior indebtedness and are guaranteed by all of the
Company's existing and future domestic subsidiaries, other than subsidiaries
treated as unrestricted subsidiaries (the "Guarantors"). As of June 30, 2004,
all subsidiaries, other than the subsidiaries formed to own and operate the
Sacramento dryer project, Synagro Organic Fertilizer Company of Sacramento, Inc.
and Sacramento Project Finance, Inc. (see Note 10), were Guarantors of the
Notes. Interest on the Notes accrues from April 17, 2002, and is payable
semi-annually on April 1 and October 1 of each year, commencing October 1, 2002.
On or after April 1, 2006, the Company may redeem some or all of the Notes at
the redemption prices (expressed as percentages of principal amount) listed
below, plus accrued and unpaid interest and liquidated damages, if any, on the
Notes redeemed, to the applicable date of redemption, if redeemed during the
12-month period commencing on April 1 of the years indicated below:
YEARS LOAN
- ----- ----
2006................. 104.750%
2007................. 102.375%
2008 and thereafter.. 100.000%
At any time prior to April 1, 2005, the Company may redeem up to 35 percent of
the original aggregate principal amount of the Notes at a premium of 9 1/2
percent with the net cash of public offerings of equity, provided that at least
65 percent of the original aggregate principal amount of the Notes remains
outstanding after the redemption. Upon the occurrence of specified change of
control events, unless the Company has exercised its option to redeem all the
Notes as described above, each holder will have the right to require the Company
to repurchase all or a portion of such holder's Notes at a purchase price in
cash equal to 101 percent of the aggregate principal amount of the Notes
repurchased plus accrued and unpaid interest and liquidated damages, if any, on
the Notes repurchased, to the applicable date of purchase. The Notes were issued
under an indenture, dated as of April 17, 2002, among the Company, the
Guarantors and Wells Fargo Bank Minnesota, National Association, as trustee (the
"Indenture"). The Indenture limits the ability of the Company and the restricted
subsidiaries to, among other things, incur additional indebtedness and issue
preferred stock, pay dividends or make other distributions, make other
restricted payments and investments, create liens, incur restrictions on the
ability of certain of its subsidiaries to pay dividends or other payments to the
Company, enter into transactions with affiliates, and engage in mergers,
consolidations and certain sales of assets.
The Notes and the guarantees of the Guarantors are (i) unsecured; (ii)
subordinate in right of payment to all existing and future senior indebtedness
(including all borrowings under the Senior Credit Agreement and surety
obligations) of Synagro and the Guarantors; (iii) equal in right of payment to
all future and senior subordinated indebtedness of Synagro and the Guarantors;
and (iv) senior in right of payment to future subordinated indebtedness of
Synagro and the Guarantors.
NOTES PAYABLE TO SELLERS OF ACQUIRED BUSINESSES
In connection with the Aspen acquisition, the Company entered into a $0.5
million note payable with the former owners of Aspen. The note payable is due in
equal monthly installments with interest payable at an annual rate of five
percent beginning May 2004.
DERIVATIVES AND HEDGING ACTIVITIES
On July 24, 2003, the Company entered into two interest rate swap transactions
with two financial institutions to hedge the Company's exposure to changes in
the fair value on $85 million of its Notes. The purpose of these transactions
was to convert future interest due on $85 million of the Notes to a lower
variable rate in an attempt to realize savings on the Company's future interest
payments. The terms of the interest rate swap contract and the underlying debt
instruments are identical. The Company has designated these swap agreements as
fair value hedges. The swaps have notional amounts of $50 million and $35
million and mature in April 2009 to mirror the maturity of the Notes. Under the
agreements, the Company pays on a semi-annual basis (each April 1 and October 1)
a floating rate based on a six-month U.S. dollar LIBOR rate, plus a spread, and
receives a fixed-rate interest of 9 1/2 percent. During the three and six months
ended June 30, 2004, the Company recorded interest savings related to these
interest rate swaps of $0.5 million and
12
$1.1 million, respectively, which served to reduce interest expense. The $2.5
million fair value of these derivative instruments is included in other
long-term liabilities, as of June 30, 2004. The carrying value of the Notes was
decreased by the same amount.
On June 25, 2001, the Company entered into a reverse swap on its 12 percent
subordinated debt and used the proceeds from the reverse swap agreement to
retire previously outstanding floating-to-fixed interest rate swap agreements
(the "Retired Swaps") and option agreements. Accordingly, the balance included
in accumulated other comprehensive loss included in stockholders' equity related
to the Retired Swaps is being recognized in future periods' income over the
remaining term of the original swap agreement. The amount of accumulated other
comprehensive income recognized for the three and six months ended June 30,
2004, was approximately $0.1 million and $0.3 million, respectively.
The 12 percent subordinated debt was repaid on April 17, 2002, with the proceeds
from the sale of the Notes. On June 25, 2002, the Company entered into a
floating-to-fixed interest rate swap agreement that substantially offsets market
value changes in the Company's reverse swap agreement. The liability related to
this reverse swap agreement and the floating-to-fixed offset agreement totaling
approximately $2.5 million is reflected in other long-term liabilities at June
30, 2004. The loss recognized during the period ended June 30, 2004, related to
the floating-to-fixed interest rate swap agreement was approximately $1.1
million, while the gain recognized related to the reverse swap agreement was
approximately $1.1 million.
(7) NONRECOURSE PROJECT REVENUE BONDS
JUNE 30, DECEMBER 31,
2004 2003
------------ ----------
(IN THOUSANDS)
Maryland Energy Financing Administration Limited Obligation
Solid Waste Disposal Revenue Bonds, 1996 series --
Revenue bonds due 2001 to 2005 at stated interest
rates of 5.4% to 5.85% ......................................... $ 5,280 $ 5,280
Term revenue bond due 2010 at stated interest rate of 6.30% ...... 16,295 16,295
Term revenue bond due 2016 at stated interest rate of 6.45% ...... 22,360 22,360
-------- --------
43,935 43,935
California Pollution Control Financing Authority Solid Waste
Revenue Bonds --
Series 2002A -- Revenue bonds due 2008 to 2024
at stated interest rates of 4.375% to 5.50% .................... 19,741 19,741
Series 2002B -- Revenue bonds due 2006 at stated
interest rate of 4.25%, net of discount ........................ 1,208 1,195
-------- --------
20,949 20,936
-------- --------
Total nonrecourse project revenue bonds .............................. 64,884 64,871
Less: Current maturities ........................................ (2,570) (2,570)
-------- --------
Nonrecourse project revenue bonds, net of current maturities ..... $ 62,314 $ 62,301
======== ========
Amounts recorded in other assets as restricted cash -
debt service fund .............................................. $ 8,560 $ 7,275
======== ========
MARYLAND PROJECT REVENUE BONDS
In 1996, the Maryland Energy Financing Administration (the "Administration")
issued nonrecourse tax-exempt project revenue bonds (the "Maryland Project
Revenue Bonds") in the aggregate amount of $58.6 million. The Administration
loaned the proceeds of the Maryland Project Revenue Bonds to Wheelabrator Water
Technologies Baltimore L.L.C., now Synagro's wholly owned subsidiary known as
Synagro-Baltimore, L.L.C., pursuant to a June 1996 loan agreement, and the terms
of the loan mirror the terms of the Maryland Project Revenue Bonds. The loan
financed a portion of the costs of constructing thermal facilities located in
Baltimore County, Maryland, at the site of its Back River Wastewater Treatment
Plant, and in the City of Baltimore, Maryland, at the site of its Patapsco
Wastewater Treatment Plant. The Company assumed all obligations associated with
the Maryland Project Revenue Bonds in connection with its acquisition of the Bio
Gro division of Waste Management, Inc. ("Bio Gro") in 2000. Maryland Project
Revenue Bonds in the aggregate amount of approximately $14.6 million have
already been repaid. The remaining Maryland Project Revenue Bonds bear interest
at annual rates between 5.75 percent and 6.45 percent and mature on dates
between December 1, 2004, and December 1, 2016.
The Maryland Project Revenue Bonds are primarily collateralized by the pledge of
revenues and assets related to the Company's Back River and Patapsco thermal
facilities. The underlying service contracts between us and the City of
Baltimore obligated the Company to design, construct and operate the thermal
facilities and obligated the City of Baltimore to deliver biosolids for
processing at the
13
thermal facilities. The City of Baltimore makes all payments under the service
contracts directly with a trustee for the purpose of paying the Maryland Project
Revenue Bonds.
At the Company's option, it may cause the redemption of the Maryland Project
Revenue Bonds at any time on or after December 1, 2006, subject to redemption
prices specified in the loan agreement. The Maryland Project Revenue Bonds will
be redeemed at any time upon the occurrence of certain extraordinary conditions,
as defined in the loan agreement.
Synagro-Baltimore, L.L.C. guarantees the performance of services under the
underlying service agreements with the City of Baltimore. Under the terms of the
Bio Gro acquisition purchase agreement, Waste Management, Inc. also guarantees
the performance of services under those service agreements. Synagro has agreed
to pay Waste Management $0.5 million per year beginning in 2007 until the
Maryland Project Revenue Bonds are paid or its guarantee is removed. Neither
Synagro-Baltimore, L.L.C. nor Waste Management has guaranteed payment of the
Maryland Project Revenue Bonds or the loan funded by the Maryland Project
Revenue Bonds.
The loan agreement, based on the terms of the related indenture, requires that
Synagro place certain monies in restricted fund accounts and that those funds be
used for various designated purposes (e.g., debt service reserve funds, bond
funds, etc.). Monies in these funds will remain restricted until the Maryland
Project Revenue Bonds are paid.
At June 30, 2004, the Maryland Project Revenue Bonds were collateralized by
property, machinery and equipment with a net book value of approximately $54.8
million and restricted cash of approximately $9.0 million, of which
approximately $6.8 million is in a debt service fund that is established to
partially secure certain payments and can be utilized to make the final payment
at the Company's request.
SACRAMENTO PROJECT BONDS
In December 2002, the California Pollution Control Financing Authority (the
"Authority") issued nonrecourse revenue bonds in the aggregate amount of $20.9
million (net of original issue discount of $0.4 million). The nonrecourse
revenue bonds consist of $19.7 million (net of original issue discount of $0.4
million) Series 2002-A and $1.2 million (net of original issue discount of
$9,000) Series 2002-B (collectively, the "Sacramento Bonds"). The Authority
loaned the proceeds of the Sacramento Bonds to Sacramento Project Finance, Inc.,
a wholly owned subsidiary of the Company, pursuant to a loan agreement dated
December 1, 2002. The purpose of the loan is to finance the design, permitting,
constructing and equipping of a biosolids dewatering and heat drying/pelletizing
facility for the Sacramento Regional Sanitation District. The Sacramento Bonds
bear interest at annual rates between 4.25 percent and 5.5 percent and mature on
dates between December 1, 2006, and December 1, 2024. Currently, the Company is
in the construction phase of the project with a start up expected in the fourth
quarter of 2004.
The Sacramento Bonds are primarily collateralized by the pledge of certain
future revenues and all of the property of Sacramento Project Finance, Inc. The
facility will be owned by Sacramento Project Finance, Inc. and leased to Synagro
Organic Fertilizer Company of Sacramento, Inc., another wholly owned subsidiary
of the Company. Synagro Organic Fertilizer Company of Sacramento, Inc. will be
obligated under a lease agreement dated December 1, 2002, to pay base rent to
Sacramento Project Finance, Inc. in an amount exceeding the debt service of the
Sacramento Bonds. The facility will be located on property owned by the
Sacramento Regional County Sanitation District ("Sanitation District"). The
Sanitation District will provide the principal source of revenues to Synagro
Organic Fertilizer Company of Sacramento, Inc. through a service fee under a
contract that has been executed.
At the Company's option, it may cause the early redemption of some Sacramento
Bonds subject to redemption prices specified in the loan agreement.
The loan agreement requires that Sacramento Project Finance, Inc. place certain
monies in restricted accounts and that those funds be used for designated
purposes (e.g., operation and maintenance expense account, reserve requirement
accounts, etc.). Monies in these funds will remain restricted until the
Sacramento Bonds are paid.
At June 30, 2004, the Sacramento Bonds are partially collateralized by
restricted cash of approximately $4.9 million, of which approximately $1.7
million is in a debt service fund that is established to secure certain payments
and can be utilized to make the final payment at the Company's request, and the
remainder is reserved for construction costs. The Company is not a guarantor of
the Sacramento Bonds or the loan funded by the Sacramento Bonds.
14
The Maryland Project Revenue Bonds and the Sacramento Bonds are excluded from
the financial covenant calculations required by the Company's Senior Credit
Agreement.
(8) COMMITMENTS AND CONTINGENCIES
LITIGATION
The Company's business activities are subject to environmental regulation under
federal, state and local laws and regulations. In the ordinary course of
conducting its business activities, the Company becomes involved in judicial and
administrative proceedings involving governmental authorities at the federal,
state and local levels. The Company believes that these matters will not have a
material adverse effect on its business, financial condition, results of
operations and cash flows. However, the outcome of any particular proceeding
cannot be predicted with certainty. The Company is required under various
regulations to procure licenses and permits to conduct its operations. These
licenses and permits are subject to periodic renewal without which its
operations could be adversely affected. There can be no assurance that any
changes in regulatory requirements will not have a materially adverse effect on
the Company's financial condition, results of operations or cash flows.
Reliance Insurance
For the 24 months ended October 31, 2000 (the "Reliance Coverage Period"), the
Company insured certain risks, including automobile, general liability, and
worker's compensation, with Reliance National Indemnity Company ("Reliance")
through policies totaling $26 million in annual coverage. On May 29, 2001, the
Commonwealth Court of Pennsylvania entered an order appointing the Pennsylvania
Insurance Commissioner as Rehabilitator and directing the Rehabilitator to take
immediate possession of Reliance's assets and business. On June 11, 2001,
Reliance's ultimate parent, Reliance Group Holdings, Inc., filed for bankruptcy
under Chapter 11 of the United States Bankruptcy Code of 1978, as amended. On
October 3, 2001, the Pennsylvania Insurance Commissioner removed Reliance from
rehabilitation and placed it into liquidation.
Claims have been asserted and/or brought against the Company and its affiliates
related to alleged acts or omissions occurring during the Reliance Coverage
Period. It is possible, depending on the outcome of possible claims made with
various state insurance guaranty funds, that the Company will have no, or
insufficient, insurance funds available to pay any potential losses. There are
uncertainties relating to the Company's ultimate liability, if any, for damages
arising during the Reliance Coverage Period, the availability of the insurance
coverage, and possible recovery for state insurance guaranty funds.
In June 2002, the Company settled one such claim that was pending in Jackson
County, Texas. The full amount of the settlement was paid by insurance proceeds;
however, as part of the settlement, the Company agreed to reimburse the Texas
Property and Casualty Insurance Guaranty Association an amount ranging from $0.6
to $2.5 million depending on future circumstances. The Company believes accruals
of approximately $1.0 million as of June 30, 2004, are adequate to provide for
its exposures to the Texas Property and Casualty Insurance Guaranty Association
for costs associated with the settlement of this case and for unpaid insurance
claims and other costs for which coverage may not be available due to the
pending liquidation of Reliance. The final resolution of these exposures could
be substantially different from the amount recorded.
DESIGN AND BUILD CONTRACT RISK
The Company participates in design and build construction operations, usually as
a general contractor. Virtually all design and construction work is performed by
unaffiliated subcontractors. As a consequence, the Company is dependent upon the
continued availability of and satisfactory performance by these subcontractors
for the design and construction of its facilities. There is no assurance that
there will be sufficient availability of and satisfactory performance by these
unaffiliated subcontractors. In addition, inadequate subcontractor resources and
unsatisfactory performance by these subcontractors could have a material adverse
effect on the Company's business, financial condition, results of operation and
cash flows. Further, as the general contractor, the Company is legally
responsible for the performance of its contracts and, if such contracts are
under-performed or nonperformed by its subcontractors, the Company could be
financially responsible. Although the Company's contracts with its
subcontractors typically provide for indemnification if its subcontractors do
not satisfactorily perform their obligations under the contract, there can be no
assurance that such indemnification would cover the Company's financial losses
in attempting to fulfill the contractual obligations.
15
OTHER
There are various other lawsuits and claims pending against the Company that
have arisen in the normal course of business and relate mainly to matters of
environmental, personal injury and property damage. The outcome of these matters
is not presently determinable but, in the opinion of the Company's management,
the ultimate resolution of these matters will not have a material adverse effect
on the consolidated financial condition, results of operations or cash flows of
the Company.
SELF-INSURANCE
The Company is substantially self-insured for worker's compensation, employer's
liability, auto liability, general liability and employee group health claims in
view of the relatively high per-incident deductibles the Company absorbs under
its insurance arrangements for these risks. Losses up to deductible amounts are
estimated and accrued based upon known facts, historical trends, industry
averages, and actuarial assumptions regarding future claims development and
claims incurred but not reported.
(9) EARNINGS (LOSS) PER COMMON SHARE
Basic earnings per share (EPS) is computed by dividing net income applicable to
common stock by the weighted average number of common shares outstanding for the
period. For periods in which the Company has reported a cumulative effect of an
accounting change, the Company uses income from continuing operations as the
"control number" in determining whether potential common shares are dilutive or
antidilutive. That is, the same number of potential common shares used in
computing the diluted per-share amount for income from continuing operations has
been used in computing all other reported diluted per-share amounts even if
those amounts will be antidilutive to their respective basic per-share amounts.
Diluted EPS is computed by dividing net income before preferred stock dividends
by the total of the weighted average number of common shares outstanding for the
period, the weighted average number of shares of common stock that would be
issued assuming conversion of the Company's preferred stock, and other common
stock equivalents for options and warrants outstanding determined using the
treasury stock method.
16
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- ---------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
(in thousands except share data)
Net income applicable to common stock:
Net income before cumulative effect of change in
accounting for asset retirement obligations
and preferred stock dividends ...................... $ 5,194 $ 4,990 $ 6,074 $ 4,779
Cumulative effect of change in accounting for
asset retirement obligations, net of tax benefit
of $292 ............................................ -- -- -- 476
------------ ------------ ------------ ------------
Net income before preferred stock dividends .......... 5,194 4,990 6,074 4,303
Preferred stock dividends ............................ 2,176 2,029 4,314 4,004
------------ ------------ ------------ ------------
Net income applicable to common stock ................ $ 3,018 $ 2,961 $ 1,760 $ 299
============ ============ ============ ============
Earnings per share:
Basic
Earnings per share before cumulative effect of
change in accounting for asset retirement
obligation ........................................ $ 0.15 $ 0.15 $ 0.09 $ 0.04
Cumulative effect of change in accounting for
asset retirement obligations ...................... -- -- -- (0.02)
------------ ------------ ------------ ------------
Earnings per share .................................. $ 0.15 $ 0.15 $ 0.09 $ 0.02
============ ============ ============ ============
Weighted average shares outstanding for basic
earnings per share calculation .................... 19,775,821 19,775,821 19,775,821 19,775,821
Diluted
Earnings per share before preferred stock
dividends and cumulative effect of change in
accounting for asset retirement obligations ...... $ 0.09 $ 0.09 $ 0.09 $ 0.04
Cumulative effect of change in accounting for
asset retirement obligations ..................... -- -- -- (0.02)
------------ ------------ ------------ ------------
Earnings per share .................................. $ 0.09 $ 0.09 $ 0.09 $ 0.02
============ ============ ============ ============
Weighted average shares outstanding for basic
earnings per share ............................... 19,775,821 19,775,821 19,775,821 19,775,821
Effect of dilutive stock options ..................... 679,672 171,761 -- --
Effect of convertible preferred stock under the "if
converted" method ................................ 37,976,978 35,049,792 -- --
------------ ------------ ------------ ------------
Weighted average shares outstanding for diluted
earnings per share ............................... 58,432,471 54,997,374 19,775,821 19,775,821
============ ============ ============ ============
Basic and diluted EPS are the same for the six months ended June 30, 2004 and
2003, because diluted EPS was less dilutive than basic EPS ("antidilutive").
Accordingly, 38,058,648 and 34,819,687 shares representing common stock
equivalents (related to convertible preferred stock and stock options) have been
excluded from the diluted EPS calculations for the six months ending June 30,
2004 and 2003, respectively.
(10) CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
As discussed in Note 7, as of June 30, 2004, all of the Company's subsidiaries,
except the subsidiaries formed to own and operate the Sacramento biosolids
processing facility, Synagro Organic Fertilizer Company of Sacramento, Inc. and
Sacramento Project Finance, Inc. (the "Non-Guarantor Subsidiaries"), are
Guarantors of the Notes. Each of the Guarantors is ultimately wholly owned by
the parent company and the guarantees are unconditional and joint and several.
Additionally, the Company is not a Guarantor for the debt of the Non-Guarantor
Subsidiaries. Accordingly, the following consolidating balance sheets as of June
30, 2004, and December 31, 2003, have been provided. The parent company has no
independent assets or operations. In addition, the Non-Guarantor Subsidiaries
had no operations and cash flows from December 31, 2003, through June 30, 2004
because the construction of the facility is still in progress. Accordingly, no
consolidating statements of operations or cash flows have been provided.
17
CONSOLIDATING BALANCE SHEETS
AS OF JUNE 30, 2004
(DOLLARS IN THOUSANDS)
NON-
GUARANTOR GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ----------- ------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents ........................... $ 84 $ 45 $ 51 $ -- $ 180
Restricted cash ..................................... -- 2,304 -- -- 2,304
Accounts receivable, net ............................ -- 58,916 -- -- 58,916
Note receivable, current portion .................... -- 610 -- -- 610
Prepaid expenses and other current assets ........... -- 14,197 -- -- 14,197
--------- --------- --------- --------- ---------
Total current assets ........................ 84 76,072 51 -- 76,207
Property, machinery & equipment, net .................. -- 206,448 13,558 -- 220,006
Other Assets:
Goodwill ............................................ -- 172,868 -- -- 172,868
Investments in subsidiaries ......................... 79,241 -- -- (79,241) --
Restricted cash - construction fund ................. -- -- 4,939 -- 4,939
Restricted cash - debt service fund ................. -- 6,846 1,714 -- 8,560
Other, net .......................................... 6,198 4,812 2,972 -- 13,982
--------- --------- --------- --------- ---------
Total assets ................................ $ 85,523 $ 467,046 $ 23,234 $ (79,241) $ 496,562
========= ========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term debt ................ $ 334 $ 603 $ -- $ -- $ 937
Current maturities of nonrecourse project
revenue bonds ...................................... -- 2,570 -- -- 2,570
Current maturities of capital lease obligations ..... -- 2,964 -- -- 2,964
Accrued interest payable ............................ 4,078 -- -- -- 4,078
Accounts payable and accrued expenses ............... -- 47,788 1,000 -- 48,788
--------- --------- --------- --------- ---------
Total current liabilities ................... 4,412 53,925 1,000 -- 59,337
Long-Term Debt:
Long-term debt obligations, net ..................... 181,996 806 -- -- 182,802
Nonrecourse project revenue bonds, net .............. -- 41,365 20,949 -- 62,314
Intercompany ........................................ (260,149) 260,149 -- -- --
Capital lease obligations, net ...................... -- 12,376 -- -- 12,376
--------- --------- --------- --------- ---------
Total long-term debt ............................. (78,153) 314,696 20,949 -- 257,492
Other long-term liabilities ...................... 1,265 20,469 -- -- 21,734
--------- --------- --------- --------- ---------
Total liabilities ........................... (72,476) 389,090 21,949 -- 338,563
Commitments and Contingencies
Redeemable Preferred Stock,
69,792.29 shares issued and outstanding,
redeemable at $1,000 per share ...................... 90,613 -- -- -- 90,613
Stockholders' Equity:
Capital ............................................. 77,839 37,804 1,285 (39,089) 77,839
Accumulated deficit ................................. (9,403) 40,152 -- (40,152) (9,403)
Accumulated other comprehensive loss ................ (1,050) -- -- -- (1,050)
--------- --------- --------- --------- ---------
Total stockholders' equity .................. 67,386 77,956 1,285 (79,241) 67,386
--------- --------- --------- --------- ---------
Total liabilities and stockholders' equity ............ $ 85,523 $ 467,046 $ 23,234 $ (79,241) $ 496,562
========= ========= ========= ========= =========
18
CONSOLIDATING BALANCE SHEETS
AS OF DECEMBER 31, 2003
(DOLLARS IN THOUSANDS)
NON-
GUARANTOR GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- --------- --------- --------- ---------
ASSETS
Current Assets:
Cash and cash equivalents ........................ $ 91 $ 64 $ 51 $ -- $ 206
Restricted cash .................................. -- 1,410 -- -- 1,410
Accounts receivable, net ......................... -- 59,581 -- -- 59,581
Note receivable, current portion ................. -- 342 -- -- 342
Prepaid expenses and other current assets ........ -- 10,840 -- -- 10,840
--------- --------- --------- --------- ---------
Total current assets ..................... 91 72,237 51 -- 72,379
Property, machinery & equipment, net ............... -- 207,833 5,864 -- 213,697
Other Assets:
Goodwill ......................................... -- 172,398 -- -- 172,398
Investments in subsidiaries ...................... 76,551 -- -- (76,551) --
Restricted cash - construction fund .............. -- -- 12,184 -- 12,184
Restricted cash - debt service fund .............. -- 5,561 1,714 -- 7,275
Other, net ....................................... 6,217 4,902 2,972 -- 14,091
--------- --------- --------- --------- ---------
Total assets ............................. $ 82,859 $ 462,931 $ 22,785 $ (76,551) $ 492,024
========= ========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term debt ............. $ 955 $ -- $ -- $ -- $ 955
Current maturities of nonrecourse project
revenue bonds .................................. -- 2,570 -- -- 2,570
Current maturities of capital lease obligations .. -- 2,678 -- -- 2,678
Accrued interest payable ......................... 4,222 -- -- -- 4,222
Accounts payable and accrued expenses ............ -- 42,693 564 -- 43,257
--------- --------- --------- --------- ---------
Total current liabilities ................ 5,177 47,941 564 -- 53,682
Long-Term Debt:
Long-term debt obligations, net .................. 194,084 -- -- -- 194,084
Nonrecourse project revenue bonds, net ........... -- 41,365 20,936 -- 62,301
Intercompany ..................................... (271,655) 271,655 -- -- --
Capital lease obligations, net ................... -- 12,748 -- -- 12,748
--------- --------- --------- --------- ---------
Total long-term debt .......................... (77,571) 325,768 20,936 -- 269,133
Other long-term liabilities ................... 3,580 13,956 -- -- 17,536
--------- --------- --------- --------- ---------
Total liabilities ........................ (68,814) 387,665 21,500 -- 340,351
Commitments and Contingencies
Redeemable Preferred Stock,
69,792.29 shares issued and outstanding,
redeemable at $1,000 per share ................... 86,299 -- -- -- 86,299
Stockholders' Equity:
Capital .......................................... 82,153 37,804 1,285 (39,089) 82,153
Accumulated deficit .............................. (15,477) 37,462 -- (37,462) (15,477)
Accumulated other comprehensive loss ............. (1,302) -- -- -- (1,302)
--------- --------- --------- --------- ---------
Total stockholders' equity ............... 65,374 75,266 1,285 (76,551) 65,374
--------- --------- --------- --------- ---------
Total liabilities and stockholders' equity ......... $ 82,859 $ 462,931 $ 22,785 $ (76,551) $ 492,024
========= ========= ========= ========= =========
(11) LEASE TRANSACTIONS
During 2003 and 2004, the Company entered into various capital lease
transactions to purchase transportation and operating equipment. The capital
leases have lease terms of three to six years with interest rates from 5.0
percent to 7.18 percent. The net book value of the equipment related to these
capital leases totaled approximately $16.5 million as of June 30, 2004.
During 2003 and 2004, the Company entered into operating lease transactions to
use transportation and operating equipment. The operating leases have terms of
two to eight years. Additionally, the Company has guaranteed a maximum lease
risk amount to the lessor of one of the operating leases. The fair value of this
guaranty is approximately $0.3 million as of June 30, 2004.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with our consolidated
historical financial statements and related notes thereto included elsewhere in
this Form 10-Q and the Annual Report on Form 10-K for the year ended December
31, 2003. This discussion contains forward-looking statements regarding the
business and industry within the meaning of the Private Securities Litigation
Reform Act of 1995. These statements are based on the current plans and
expectations and involve risks and uncertainties that could cause actual future
activities and results of operations to be materially different from those set
forth in the forward-looking statements, but are not limited to those factors
more thoroughly disclosed in our Annual Report on Form 10-K.
BACKGROUND
We generate substantially all of our revenue by providing water and wastewater
residuals management services to municipal and industrial customers. We provide
our customers with complete, vertically-integrated services and capabilities,
including facility operations, facility cleanout services, regulatory
compliance, dewatering, collection and transportation, composting, drying and
pelletization, product marketing, incineration, alkaline stabilization, and land
application. We currently serve more than 1,000 customers in 37 states and the
District of Columbia. Our contracts typically have inflation price adjustments,
renewal clauses and broad force majeure provisions. In 2003, we experienced a
contract retention rate (both renewals and rebids) of approximately 86 percent.
We categorize our revenues into five types -- contract, purchase order, product
sales, design\build construction and event work.
Contract revenues are generated primarily from land application, collection and
transportation services, dewatering, incineration, composting, drying and
pelletization services and facility operations and maintenance services, and are
typically performed under a contract with terms ranging from 1 to 25 years.
Contract revenues accounted for approximately 84 percent and 83 percent of total
revenues in the six month periods ended June 30, 2004 and 2003, respectively,
and 85 percent and 82 percent in the three month periods ended June 30, 2004 and
2003, respectively.
Purchase order revenues are primarily from facility operations, maintenance
services, and collection and transportation services where services are
performed on a recurring basis, but not under a long-term contract. Purchase
order revenues accounted for approximately 4 percent and 5 percent of total
revenues in the six months ended June 30, 2004 and 2003, respectively, and
4 percent and 5 percent of total revenues in the three months ended June 30,
2004 and 2003, respectively.
Product sales revenues are primarily generated from sales of composted and
pelletized biosolids from internal and external facilities. Revenues from
product sales accounted for approximately 5 percent of total revenues in the six
months ended June 30, 2004 and 2003 and 4 percent of total revenues in the three
months ended June 30, 2004 and 2003, respectively.
Design\build construction revenues are derived from contracts where we agree to
design, build and then operate under a long term operating contract certain
processing facilities (examples include drying and pelletization, composting,
incineration and dewatering facilities). We typically subcontract the
design/build work to subcontractors under fixed price contracts. Revenues
from construction projects accounted for less than approximately 1 percent and
2 percent of total revenues in the six months and three months ended June 30,
2004 and 2003, respectively.
Event project revenues are typically generated from digester or lagoon cleanout
projects and temporary dewatering projects. Revenue from event projects
accounted for approximately 7 percent and 6 percent of total revenues in the six
months and three months ended June 30, 2004 and 2003, respectively.
Revenues under our facilities operations and maintenance contracts are
recognized either when wastewater residuals enter the facility or when the
residuals have been processed, depending on the contract terms. All other
revenues under service contracts are recognized when the service is performed.
Revenues from design/build construction projects are accounted for under the
percentage-of-completion method of accounting. We provide for losses in
connection with long-term contracts where an obligation exists to perform
services and it becomes evident that the projected contract costs will exceed
the related revenue.
Our costs relating to service contracts include processing, transportation,
spreading and disposal costs, and depreciation of operating assets. Our
spreading, transportation and disposal costs can be adversely affected by
unusual weather conditions and unseasonably heavy rainfall, which can
temporarily reduce the availability of land application. Material must be
transported to either a permitted storage facility (if available) or to a local
landfill for disposal. In either case, this results in additional costs for
transporting, storage
20
and disposal of the biosolid materials compared to land application in a period
of normal weather conditions. Our costs relating to construction contracts
primarily include subcontractor costs related to design, permit and general
construction. Our selling, general and administrative expenses are comprised of
accounting, information systems, marketing, legal, human resources, regulatory
compliance, and regional and executive management costs.
HISTORICAL RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
------------------------------------------- ------------------------------------------
2004 2003 2004 2003
------------------- -------------------- ------------------- -------------------
Revenue ....................... $ 82,301 100.0% $ 75,641 100.0% $154,962 100.0% $138,870 100.0%
Cost of services .............. 63,280 76.9% 55,501 73.4% 123,624 79.8% 106,888 77.0%
-------- -------- -------- -------- -------- -------- -------- --------
Gross profit .................. 19,021 23.1% 20,140 26.6% 31,338 20.2% 31,982 23.0%
Selling, general and
administrative expenses .... 5,699 6.9% 5,926 7.8% 11,521 7.4% 12,230 8.8%
-------- -------- -------- -------- -------- -------- -------- --------
Income from
operations ................ 13,322 16.2% 14,214 18.8% 19,817 12.8% 19,752 14.2%
-------- -------- -------- -------- -------- -------- -------- --------
Other (income) expense:
Other income, net ........... (774) (0.9)% (42) 0.0% (892) (0.5)% (11) 0.0%
Interest expense, net ....... 5,582 6.8% 6,208 8.2% 10,751 6.9% 12,055 8.7%
-------- -------- -------- -------- -------- -------- -------- --------
Total other expense,net .... 4,808 5.9% 6,166 8.2% 9,859 6.4% 12,044 8.7%
-------- -------- -------- -------- -------- -------- -------- --------
Income before provision for
income taxes ................ 8,514 10.3% 8,048 10.6% 9,958 6.4% 7,708 5.5%
Provision for income taxes .. 3,320 4.0% 3,058 4.0% 3,884 2.5% 2,929 2.1%
-------- -------- -------- -------- -------- -------- -------- --------
Net income before
cumulative effect of
change in accounting for
asset retirement
obligations and preferred
stock dividends ............. 5,194 6.3% 4,990 6.6% 6,074 3.9% 4,779 3.4%
-------- -------- -------- -------- -------- -------- -------- --------
Cumulative effect of
change in accounting for
asset retirement
obligations, net of tax
benefit of $292 ............. -- 0.0% -- 0.0% -- 0.0% 476 0.3%
-------- -------- -------- -------- -------- -------- -------- --------
Net income before preferred
stock dividends ............. 5,194 6.3% 4,990 6.6% 6,074 3.9% 4,303 3.1%
-------- ======== -------- ======== -------- ======== -------- ========
Preferred stock dividends ..... 2,176 2,029 4,314 4,004
-------- -------- -------- --------
Net income applicable to
common stock ................ $ 3,018 $ 2,961 $ 1,760 $ 299
======== ======== ======== ========
THREE MONTHS ENDED JUNE 30, 2004 COMPARED TO THREE MONTHS ENDED JUNE 30, 2003
For the three months ended June 30, 2004, revenue was approximately $82.3
million compared to approximately $75.6 million for the three months ended June
30, 2003, an increase of approximately $6.7 million, or 8.9 percent.
Approximately $7.2 million of the increase related to contract service revenues,
approximately $1.2 million of the increase related to event type work primarily
in the Northeast and Central regions, and approximately $0.4 million of the
increase related to an acquisition that was completed in May 2003. These
increases in revenue were partially offset by declines in design/build
construction and purchase order revenues in the second quarter of 2004.
Gross profit for the three months ended June 30, 2004, was approximately $19.0
million compared to approximately $20.1 million for the three months ended June
30, 2003, a decrease of $1.1 million, or 5.5 percent. Gross profit as a
percentage of revenue decreased to 23.1 percent in 2004 from 26.6 percent in
2003. Gross profit in the second quarter of 2003 included a one time non-cash
gain of approximately $2.1 million recorded as a reduction of cost of operations
related to a positive settlement of a warranty obligation. Excluding the
settlement of the warranty obligation in 2003, gross profit increased as a
result of the internal growth discussed above and an improvement in land
application operating margins (related to more normal weather patterns in 2004
compared to 2003) which were partially offset by an increase in repairs and
maintenance expenses primarily associated with our dryer and incineration
facilities.
Selling, general and administrative expenses for the three months ended June 30,
2004 were approximately $5.7 million compared to approximately $5.9 million for
the three months ended June 30, 2003, a decrease of $0.2 million or 3.4 percent.
Selling, general and administrative expenses as a percentage of revenues
decreased to 6.9 percent in the second quarter of 2004 from 7.8 percent in the
21
second quarter of 2003. The decrease as a percentage of revenues relates to the
leverage of certain fixed administrative costs and a reduction in expenses
attributed to cost reduction initiatives put in place in the fourth quarter of
2003.
As a result of the foregoing, income from operations for the three months ended
June 30, 2004, was approximately $13.3 million compared to approximately $14.2
million for the three months ended June 30, 2003, a decrease of $0.9 million or
6.3 percent. Operating income as a percentage of revenues decreased to 16.2
percent for the second quarter of 2004 from 18.8 percent for the same period of
2003. As noted above, operating income in the second quarter of 2003 included a
one time non-cash gain of approximately $2.1 million recorded as a reduction of
cost of operations related to a positive settlement of a warranty obligation.
Excluding the one time non-cash gain from the second quarter of 2003, operating
income increased by approximately $1.2 million or 9.9 percent to $13.3 million.
Other expense, net, was approximately $4.8 million for the three months ended
June 30, 2004, compared to approximately $6.2 million for the three months ended
June 30, 2003, representing a decrease in other expense of approximately $1.4
million. The decrease relates primarily to a reduction of $0.6 million in
interest expense related to reductions in debt and savings associated with
interest rate swaps and an increase in other income of $ 0.7 million related
primarily to gains from asset sales in the second quarter of 2004.
For the three months ended June 30, 2004, we recorded a provision for income
taxes of approximately $3.3 million compared to $3.1 million for the three
months ended June 30, 2003. Our effective tax rate was approximately 39 percent
in the first three months of 2004 compared to 38 percent in the first three
months of 2003. The increase in the effective tax rate is primarily due to the
increase in state income taxes. Our tax provision is principally a deferred tax
provision that will not significantly impact cash flow since we have significant
tax deductions in excess of book deductions and net operating loss carryforwards
available to offset future taxable income.
SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO SIX MONTHS ENDED JUNE 30, 2003
For the six months ended June 30, 2004, revenue was approximately $155.0 million
compared to approximately $138.9 million for the six months ended June 30, 2003,
an increase of approximately $16.1 million, or 11.6 percent. Approximately $14.4
million of the increase related to contract service revenues, approximately $2.6
million related to event type work primarily in the Northeast and Central
regions, and approximately $1.1 million of the increase related to the
acquisition discussed above. These revenue increases were partially offset by
declines in design build and purchase order revenues in the fist six months of
2004.
Gross profit for the six months ended June 30, 2004, was approximately $31.3
million compared to approximately $32.0 million for the six months ended June
30, 2003, a decrease of $0.7 million or 2.2 percent. Gross profit as a
percentage of revenue decreased to 20.2 percent in 2004 from 23.0 percent in
2003. Gross profit in the second quarter included a one time non-cash gain of
approximately $2.1 million recorded as a reduction of cost of operations related
to a positive settlement of a warranty obligation. Excluding the settlement of
the warranty obligation in 2003, gross profit increased $1.5 million or 4.9
percent as a result of the internal growth discussed above, an improvement in
land application operating margins (related to more normal weather patterns in
2004 compared to 2003), which were partially offset by higher repairs and
maintenance expenses at our drying and incineration facilities.
Selling, general and administrative expenses for the six months ended June 30,
2004 were approximately $11.5 million compared to approximately $12.2 million
for the six months ended June 30, 2003, a decrease of $0.7 million or 5.7
percent. Selling, general and administrative expenses as a percentage of
revenues decreased to 7.4 percent in the first six months of 2004 from 8.8
percent in the same period of 2003. The decrease as a percentage of revenues
relates to leverage of certain fixed administrative costs and a reduction in
expenses attributed to cost reduction initiatives put in place in the fourth
quarter of 2003.
As a result of the foregoing, income from operations for the six months ended
June 30, 2004 and 2003 was approximately $19.8 million. Operating income as a
percentage of revenues decreased to 12.8 percent in the first half of 2004 from
14.2 percent for the same period of 2003. As noted above, operating income in
the second quarter of 2003 included a one time non-cash gain of approximately
$2.1 million recorded as a reduction of cost of operations related to a positive
settlement of a warranty obligation.
Other expense, net, was approximately $9.9 million for the six months ended June
30, 2004, compared to approximately $12.0 million for the six months ended June
30, 2003, representing a decrease in other expense of approximately $2.1
million. The decrease relates primarily to a reduction of $1.3 million in
interest expense related to reductions in debt and savings associated with
interest rate swaps and an increase in other income of $0.9 million related
primarily to gains from asset sales in the second quarter of 2004.
22
For the six months ended June 30, 2004, we recorded a provision for income taxes
of approximately $3.9 million compared to $2.9 million for the six months ended
June 30, 2003. Our effective tax rate was approximately 39 percent in the first
six months of 2004 compared to 38 percent in the first six months of 2003. The
increase in the effective tax rate is primarily due to the increase in state
income taxes. Our tax provision is principally a deferred tax provision that
will not significantly impact cash flow since we have significant tax deductions
in excess of book deductions and net operating loss carryforwards available to
offset future taxable income.
On January 1, 2003, we adopted SFAS No. 143, "Asset Retirement Obligations."
SFAS No. 143 requires entities to record the fair value of a liability for an
asset retirement obligation in the period in which it is incurred and a
corresponding increase in the carrying amount of the related long-lived asset.
Subsequently, the asset retirement cost should be allocated to expense using a
systematic and rational method. During the first quarter of 2003, we recorded a
cumulative effect of change in accounting for asset retirement obligations, net
of tax, totaling approximately $0.5 million (approximately $0.8 million before
tax).
During the quarter ended June 30, 2003, we entered into a settlement agreement
with one of our customers related to certain outstanding issues including, among
other things, equipment and building acceptance and warranty obligations. We
assumed these obligations in connection with the acquisition of Bio Gro, which
closed in August 2000. We recorded these obligations as a liability in the
opening balance sheet for the acquisition of Bio Gro. Under the agreement, the
customer agreed to pay approximately $0.7 million for amounts due to us, while
we agreed to pay the customer approximately $1.4 million in exchange for the
settlement of the outstanding issues, including termination of future warranty
obligations. In connection with the agreement, we reduced our liabilities for
these obligations by approximately $2.1 million. This amount was recorded as a
reduction of cost of sales in the accompanying condensed consolidated statements
of operations for the three and six months ended June 30, 2003.
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW
Our principal sources of funds have historically been cash generated from
operating activities and long-term borrowings and equity issuances. We use cash
mainly for working capital, capital expenditures and debt service. In the
future, we expect that we will use cash principally to fund working capital,
debt service, repayment obligations and capital expenditures. In addition, we
may use cash to pay dividends on preferred and common stock, the repurchase of
shares and potential earn-out payments resulting from prior acquisitions.
Historically, we have financed our acquisitions principally through the issuance
of equity and debt securities, our credit facility, and funds provided by
operating activities.
HISTORICAL CASH FLOWS
Cash Flows from Operating Activities -- For the six months ended June 30, 2004,
cash flows from operating activities were approximately $19.8 million compared
to approximately $5.4 million for the same period in 2003, an increase of
approximately $14.4 million or 267 percent. The increase primarily relates to an
improvement in cash required for working capital of $10.5 million and increased
net income.
Cash Flows from Investing Activities -- For the six months ended June 30, 2004,
cash flows used by investing activities were approximately $8.8 million compared
to cash flows provided of approximately $1.8 million for the same period in
2003, a decrease of approximately $10.6 million. This decrease primarily relates
to $14.1 million of proceeds from asset sales in 2003. Additionally, we
completed an acquisition in the second quarter of 2003 which resulted in cash
payments of $3.8 million.
Cash Flows from Financing Activities -- For the six months ended June 30, 2004,
cash flows used in financing activities were approximately $11.0 million
compared to approximately $7.3 million for the same period in 2003, an increase
of approximately $3.8 million. The increase primarily relates to net repayments
on debt totaling approximately $10.9 million during the first half of 2004
compared to $6.5 million for the first half of 2003.
23
CAPITAL EXPENDITURE REQUIREMENTS
Capital expenditures for the six months ended June 30, 2004, totaled
approximately $14.8 million (which included approximately $7.2 million to fund
construction of the Sacramento biosolids processing facility) compared to
approximately $7.9 million in the same period of 2003. Our ongoing capital
expenditure program consists of expenditures for replacement equipment,
betterments, and growth. We expect our capital expenditures for 2004 to be
approximately $28 million to $30 million, which should include approximately
$13.0 million related to the construction of the Sacramento biosolids processing
facility. Capital expenditures related to the construction of the Sacramento
biosolids processing facility are primarily funded by restricted cash (See Note
7).
DEBT SERVICE REQUIREMENTS
In May 2003, we incurred indebtedness of $0.5 million in connection with the
Aspen Resources acquisition. The note payable to the former owners is due
monthly at an annual interest rate of five percent beginning May 2004.
In May 2002, we entered into an amended and restated $150 million Senior Credit
Agreement that provides for a $70 million funded term loan and up to a $50
million revolver, with the ability to increase the total commitment to $150
million. The term loan proceeds were used to pay off the existing senior debt
that remained unpaid after the private placement of our 9 1/2 percent Senior
Subordinated Notes due 2009. This credit facility is secured by substantially
all of our assets and those of our subsidiaries (other than assets securing
nonrecourse debt) and includes covenants restricting the incurrence of
additional indebtedness, liens, certain payments and sale of assets. The Senior
Credit Agreement contains standard covenants, including compliance with laws,
limitations on capital expenditures, restrictions on dividend payments,
limitations on mergers and compliance with certain financial covenants. During
May 2003, we amended our Senior Credit Agreement to increase the revolving loan
commitment to approximately $95 million. Requirements for mandatory debt
payments from excess cash flows, as defined, are unchanged in the new credit
facility. On March 9, 2004, we further amended our Senior Credit Agreement to,
among other things, exclude certain charges from its financial covenant
calculations, to clarify certain defined terms, to increase the amount of
indebtedness permitted under its total leverage ratio, and to reset capital and
operating lease limitations.
In 1996, the Maryland Energy Financing Administration issued nonrecourse
tax-exempt project revenue bonds (the "Maryland Project Revenue Bonds") in the
aggregate amount of $58.6 million. The Administration loaned the proceeds of the
Maryland Project Revenue Bonds to Wheelabrator Water Technologies Baltimore
L.L.C., now our wholly owned subsidiary known as Synagro -- Baltimore, L.L.C.,
pursuant to a June 1996 loan agreement, and the terms of the loan mirror the
terms of the Maryland Project Revenue Bonds. The loan financed a portion of the
costs of constructing thermal facilities located in Baltimore County, Maryland,
at the site of its Back River Wastewater Treatment Plant, and in the City of
Baltimore, Maryland, at the site of its Patapsco Wastewater Treatment Plant. We
assumed all obligations associated with the Maryland Project Revenue Bonds in
connection with our acquisition of the Bio Gro Division of Waste Management,
Inc. in 2000. Maryland Project Revenue Bonds in the aggregate amount of $14.6
million have already been paid, and the remaining Maryland Project Revenue Bonds
bear interest at annual rates between 5.65 percent and 6.45 percent and mature
on dates between December 1, 2004, and December 1, 2016.
In December 2002, the California Pollution Control Financing Authority (the
"Authority") issued nonrecourse revenue bonds ("Sacramento Biosolids Facility
Project") in the aggregate amount of $21.3 million. The nonrecourse revenue
bonds consist of $20.1 million Series 2002-A and $1.2 million Series 2002-B
(taxable) (collectively, the "Sacramento Bonds"). The Authority loaned the
proceeds of the Bonds to Sacramento Project Finance, Inc., one of our wholly
owned subsidiaries, pursuant to a loan agreement dated December 1, 2002. The
loan will finance the acquisition, design, permitting, constructing and
equipping of a biosolids dewatering and heat drying/pelletizing facility for the
Sacramento Regional Sanitation District. The Sacramento Bonds bear interest at
annual rates between 4.25 percent and 5.5 percent and mature on dates between
December 1, 2006, and December 1, 2024.
We believe we will have sufficient cash generated by our operations and
available through our existing credit facility to provide for future working
capital and capital expenditure requirements that will be adequate to meet our
liquidity needs for the foreseeable future, including payment of interest on our
credit facility and payments on the Maryland Project Revenue Bonds and the
Sacramento Bonds. We cannot assure, however, that our business will generate
sufficient cash flow from operations, that any cost savings and any operating
improvements will be realized or that future borrowings will be available to us
under our credit facility in an amount sufficient to enable us to pay our
indebtedness or to fund our other liquidity needs. We may need to refinance all
or a portion of our indebtedness on or before maturity. We make no assurance
that we will be able to refinance any of our indebtedness, including our credit
facility, on commercially reasonable terms or at all.
24
We have entered into various lease transactions to purchase transportation and
operating equipment that have been accounted for as capital lease obligations
and operating leases. The capital leases have lease terms of three to six years
with interest rates from 5.0 percent to 7.18 percent. The net book value of the
equipment related to these capital leases totaled approximately $16.6 million as
of June 30, 2004. The operating leases have terms of two to eight years.
Additionally, we have guaranteed a maximum lease risk amount to the lessor of
one of the operating leases. The fair value of this guaranty is approximately
$0.3 million as of June 30, 2004.
SERIES D REDEEMABLE PREFERRED STOCK
We have authorized 32,000 shares of Series D Preferred Stock, par value $.002
per share. In 2000, we issued a total of 25,033.601 shares of the Series D
Preferred Stock to GTCR Fund VII, L.P. and its affiliates, which is convertible
by the holders into a number of shares of our common stock computed by dividing
(i) the sum of (a) the number of shares to be converted multiplied by the
liquidation value and (b) the amount of accrued and unpaid dividends by (ii) the
conversion price then in effect. The initial conversion price is $2.50 per share
provided that in order to prevent dilution, the conversion price may be
adjusted. The Series D Preferred Stock is senior to our common stock or any
other of our equity securities. The liquidation value of each share of Series D
Preferred Stock is $1,000 per share. Dividends on each share of Series D
Preferred Stock accrue daily at the rate of eight percent per annum on the
aggregate liquidation value and may be paid in cash or accrued, at our option.
Upon conversion of the Series D Preferred Stock by the holders, the holders may
elect to receive the accrued and unpaid dividends in shares of our common stock
at the conversion price. The Series D Preferred Stock is entitled to one vote
per share. Shares of Series D Preferred Stock are subject to mandatory
redemption by us on January 26, 2010, at a price per share equal to the
liquidation value plus accrued and unpaid dividends. If the outstanding shares
of Series D Preferred Stock excluding accrued dividends were converted at June
30, 2004, they would represent 10,013,441 shares of common stock.
SERIES E REDEEMABLE PREFERRED STOCK
We have authorized 55,000 shares of Series E Preferred Stock, par value $.002
per share. GTCR Fund VII, L.P. and its affiliates own 37,504.229 shares of
Series E Preferred Stock and certain affiliates of The TCW Group, Inc. own
7,254.462 shares. The Series E Preferred Stock is convertible by the holders
into a number of shares of our common stock computed by dividing (i) the sum of
(a) the number of shares to be converted multiplied by the liquidation value and
(b) the amount of accrued and unpaid dividends by (ii) the conversion price then
in effect. The initial conversion price is $2.50 per share provided that in
order to prevent dilution, the conversion price may be adjusted. The Series E
Preferred Stock is senior to our common stock and any other of our equity
securities. The liquidation value of each share of Series E Preferred Stock is
$1,000 per share. Dividends on each share of Series E Preferred Stock accrue
daily at the rate of eight percent per annum on the aggregate liquidation value
and may be paid in cash or accrued, at our option. Upon conversion of the Series
E Preferred Stock by the holders, the holders may elect to receive the accrued
and unpaid dividends in shares of our common stock at the conversion price. The
Series E Preferred Stock is entitled to one vote per share. Shares of Series E
Preferred Stock are subject to mandatory redemption by us on January 26, 2010,
at a price per share equal to the liquidation value plus accrued and unpaid
dividends. If the outstanding shares of Series E Preferred Stock excluding
accrued dividends were converted at June 30, 2004, they would represent
17,903,475 shares of common stock.
The future issuance of Series D and Series E Preferred Stock may result in
non-cash beneficial conversions valued in future periods recognized as preferred
stock dividends if the market value of our common stock is higher than the
conversion price at date of issuance.
INTEREST RATE RISK
Total debt at June 30, 2004, included approximately $32.8 million in floating
rate debt attributed to the Senior Credit Agreement at a base interest rate plus
3.0 percent, or approximately 4.25 percent at June 30, 2004. We also have
interest rate swaps outstanding on our fixed rate debt. As a result, our
interest cost in 2004 will fluctuate based on short-term interest rates. The
impact on annual cash flow of a ten percent change in the floating rate (i.e.
LIBOR) would be approximately $0.1 million.
WORKING CAPITAL
At June 30, 2004, we had working capital of approximately $16.9 million compared
to approximately $18.7 million at December 31, 2003, a decrease of approximately
$1.8 million. The decrease in working capital is principally due to the increase
in accounts payable and accrued expenses offset by a reduction in accounts
receivable due to the seasonal increase in activity.
25
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DERIVATIVES AND HEDGING ACTIVITIES
On July 24, 2003, we entered into two interest rate swap transactions with two
financial institutions to hedge our exposure to changes in the fair value on $85
million of our Notes. The purpose of these transactions was to convert future
interest due on $85 million of the Notes to a lower variable rate in an attempt
to realize savings on our future interest payments. The terms of the interest
rate swap contract and the underlying debt instruments are identical. We have
designated these swap agreements as fair value hedges. The swaps have notional
amounts of $50 million and $35 million and mature in April 2009 to mirror the
maturity of the Notes. Under the agreements, we pay on a semi-annual basis (each
April 1 and October 1) a floating rate based on a six-month U.S. dollar LIBOR
rate, plus a spread, and receives a fixed-rate interest of 9 1/2 percent. During
the three and six months ended June 30, 2004, we recorded interest savings
related to these interest rate swaps of $0.5 million and $1.1 million,
respectively, which served to reduce interest expense. The $2.5 million fair
value of these derivative instruments is included in other long-term
liabilities, as of June 30, 2004. The carrying value of our Notes was decreased
by the same amount.
On June 25, 2001, we entered into a reverse swap on our 12 percent subordinated
debt and used the proceeds from the reverse swap agreement to retire previously
outstanding floating-to-fixed interest rate swap agreements (the "Retired
Swaps") and option agreements. Accordingly, the balance included in accumulated
other comprehensive loss included in stockholders' equity related to the Retired
Swaps is being recognized in future periods' income over the remaining term of
the original swap agreement. The amount of accumulated other comprehensive
income recognized for the three and six months ended June 30, 2004, was
approximately $0.1 million and $0.3 million, respectively.
The 12 percent subordinated debt was repaid on April 17, 2002, with the proceeds
from the sale of the Notes. On June 25, 2002, we entered into a
floating-to-fixed interest rate swap agreement that substantially offsets market
value changes in our reverse swap agreement. The liability related to this
reverse swap agreement and the floating-to-fixed offset agreement totaling
approximately $2.5 million is reflected in other long-term liabilities at June
30, 2004. The loss recognized during the period ended June 30, 2004, related to
the floating-to-fixed interest rate swap agreement was approximately $1.1
million, while the gain recognized related to the reverse swap agreement was
approximately $1.1 million.
INTEREST RATE RISK
Total debt at June 30, 2004, included approximately $32.8 million in floating
rate debt attributed to the Senior Credit Agreement at a base interest rate plus
3.0 percent, or approximately 4.25 percent at June 30, 2004. We also have
interest rate swaps outstanding on our fixed rate debt. As a result, our
interest cost in 2004 will fluctuate based on short-term interest rates. The
impact on annual cash flow of a ten percent change in the floating rate (i.e.
LIBOR) would be approximately $0.1 million.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
We carried out an evaluation, under the supervision and with the participation
of our management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of "disclosure controls and procedures" (as such
term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange
Act of 1934, as amended (the "Exchange Act")) as of the end of the period
covered by this quarterly report. Based on this evaluation, such officers have
concluded that these disclosure controls and procedures are effective in
alerting them on a timely basis to material information relating to us
(including our consolidated subsidiaries) required to be included in our
periodic filings under the Exchange Act.
There has been no change in our internal control over financial reporting (as
defined in Rules 13a - 13(f) and 15d - 15(f) of the Exchange Act) that occurred
during the period covered by this quarterly report that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting.
26
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information regarding our legal proceedings can be found under the "Litigation"
section of Note (8), "Commitments and Contingencies," to the Condensed
Consolidated Financial Statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 1, 2004, the annual meeting of stockholders was held, at which the only
item for voting was the election of directors.
Election of Directors:
DIRECTOR VOTES FOR VOTES WITHHELD
-------- --------- --------------
Ross M. Patten 42,415,500 1,091,808
Kenneth Ch'uan-k'ai Leung 42,826,512 680,796
Gene Meredith 42,826,712 680,596
Alfred Tyler 2nd 42,826,712 680,596
David A. Donnini 42,327,300 1,180,008
Vincent J. Hemmer 42,416,500 1,090,808
Robert C. Boucher, Jr. 42,415,000 1,092,308
J. Paul Withrow 42,416,000 1,091,308
George E. Sperzel 42,336,700 1,170,608
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) Exhibit Index
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
32.1 Section 1350 Certification of Chief Executive Officer
32.2 Section 1350 Certification of Chief Financial Officer
(B) Reports on Form 8-K
Current report on Form 8-K furnished on May 10, 2004, announcing the Company's
first quarter earnings.
Current report on Form 8-K furnished on August 13, 2004, announcing the
Company's second quarter earnings.
27
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.
SYNAGRO TECHNOLOGIES, INC.
Date: August 16, 2004 By: /s/ Robert C. Boucher, Jr.
--------------------------
Chief Executive Officer
Date: August 16, 2004 By: /s/ J. Paul Withrow
--------------------------
Chief Financial Officer
28
EXHIBIT INDEX
Exhibit
Number Description
------- -----------
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
32.1 Section 1350 Certification of Chief Executive Officer
32.2 Section 1350 Certification of Chief Financial Officer