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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 September 30, 2004 Commission File Number
0-21054
SYNAGRO TECHNOLOGIES, INC.
(Exact name of Registrant as specified in its Charter)
DELAWARE 88-0219860
(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 NOVEMBER 5, 2004
--------------------------------- -------------------------------
Common stock, par value $.002 19,775,821
SYNAGRO TECHNOLOGIES, INC.
INDEX
PAGE
----
PART I - FINANCIAL INFORMATION
Condensed Consolidated Balance Sheets as of September 30, 2004 (Unaudited),
and December 31, 2003 (Derived From Audited Financial Statements)................................................ 3
Condensed Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 2004 and 2003 (Unaudited).............................................. 4
Condensed Consolidated Statement of Stockholders' Equity (Unaudited)............................................... 5
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2004 and 2003 (Unaudited)........................................................ 6
Notes to Condensed Consolidated Financial Statements............................................................... 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 PER SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
(DERIVED
FROM AUDITED
FINANCIAL
(UNAUDITED) STATEMENTS)
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 335 $ 206
Restricted cash........................................... 999 1,410
Accounts receivable, net.................................. 65,628 59,581
Note receivable, current portion.......................... 604 342
Cost and estimated earnings in excess of billings......... 6,766 864
Prepaid expenses and other current assets................. 10,057 9,976
------------ ------------
Total current assets................................... 84,389 72,379
Property, machinery & equipment, net......................... 225,765 213,697
Other Assets:
Goodwill.................................................. 171,855 171,051
Restricted cash - construction fund....................... 3,483 12,184
Restricted cash - debt service fund....................... 9,203 7,275
Other, net................................................ 14,112 14,091
------------ ------------
Total assets................................................. $ 508,807 $ 490,677
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Short term debt........................................... $ 4,000 $ --
Current portion of long-term debt......................... 889 955
Current portion of nonrecourse project revenue bonds...... 2,570 2,570
Current portion of capital lease obligations.............. 3,002 2,678
Accrued interest payable.................................. 8,631 4,222
Accounts payable and accrued expenses..................... 48,632 41,437
------------ ------------
Total current liabilities.............................. 67,724 51,862
Long-Term Debt:
Long-term debt obligations, net........................... 181,327 194,084
Nonrecourse project revenue bonds, net.................... 62,321 62,301
Capital lease obligations, net............................ 11,602 12,748
------------ ------------
Total long-term debt................................... 255,250 269,133
Other long-term liabilities.................................. 24,511 19,361
------------- ------------
Total liabilities............................................ 347,485 340,356
Commitments and Contingencies
Redeemable Preferred Stock, 69,792.29 shares issued and
outstanding, redeemable at $1,000 per share............... 92,850 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 shares issued and outstanding... 40 40
Additional paid-in capital................................ 75,562 82,113
Accumulated deficit....................................... (6,206) (16,829)
Accumulated other comprehensive loss...................... (924) (1,302)
------------ ------------
Total stockholders' equity............................. 68,472 64,022
------------ ------------
Total liabilities and stockholders' equity................... $ 508,807 $ 490,677
============ ============
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ -------------------------------
2004 2003 2004 2003
----------- ----------- ------------ ------------
Revenue................................................... $ 86,294 $ 79,634 $ 241,255 $ 218,503
Cost of services.......................................... 66,636 60,974 190,260 167,862
----------- ----------- ------------ ------------
Gross profit.............................................. 19,658 18,660 50,995 50,641
Selling, general and administrative expenses.............. 6,128 6,044 17,649 18,274
Special charge............................................ 320 -- 320 --
----------- ----------- ------------ ------------
Income from operations................................. 13,210 12,616 33,026 32,367
Other expense:
Interest expense, net.................................. 5,677 5,566 16,428 17,622
Other (income) expense, net............................ 76 92 (816) 78
----------- ----------- ------------ ------------
Total other expense, net............................ 5,753 5,658 15,612 17,700
----------- ----------- ------------ ------------
Income before provision for income taxes.................. 7,457 6,958 17,414 14,667
Provision for income taxes............................. 2,908 2,644 6,791 5,574
----------- ----------- ------------ ------------
Net income before cumulative effect of change
in accounting for asset retirement obligations and
preferred stock dividends.............................. 4,549 4,314 10,623 9,093
Cumulative effect of change in accounting for asset
retirement obligations, net of tax benefit of $292..... -- -- -- 476
----------- ----------- ------------ ------------
Net income before preferred stock dividends............... 4,549 4,314 10,623 8,617
Preferred stock dividends................................. 2,237 2,084 6,551 6,088
----------- ----------- ------------ ------------
Net income applicable to common stock..................... $ 2,312 $ 2,230 $ 4,072 $ 2,529
=========== =========== ============ ============
Earnings per share:
Basic
Earnings per share before cumulative effect of
change in accounting for asset retirement
obligations............................................... $ 0.12 $ 0.11 $ 0.21 $ 0.15
Cumulative effect of change in accounting for asset
retirement obligations.............................. -- -- -- (0.02)
----------- ----------- ------------- -------------
Net earnings per share................................. $ 0.12 $ 0.11 $ 0.21 $ 0.13
=========== =========== ============= =============
Diluted
Earnings per share before preferred stock
dividends and cumulative effect of change in
accounting for asset retirement obligations......... $ 0.08 $ 0.08 $ 0.18 $ 0.15
Cumulative effect of change in accounting for asset
retirement obligations.............................. -- -- -- (0.02)
----------- ----------- ------------- -------------
Net earnings per share................................. $ 0.08 $ 0.08 $ 0.18 $ 0.13
=========== =========== ============= =============
Weighted average shares:
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....................... 515,777 52,954 478,547 --
Effect of convertible preferred stock under the
"if converted" method............................... 38,741,956 35,755,808 37,982,012 --
----------- ----------- ------------- ------------
Weighted average shares outstanding for diluted
earnings per share.................................. 59,033,554 55,584,583 58,236,380 19,775,821
=========== =========== ============= ============
The accompanying notes are an integral part of these
condensed consolidated financial statements.
4
SYNAGRO TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(UNAUDITED)
(IN THOUSANDS EXCEPT SHARE DATA)
ACCUMULATED
ADDITIONAL OTHER
COMMON STOCK PAID-IN ACCUMULATED COMPREHENSIVE COMPREHENSIVE
SHARES AMOUNT CAPITAL DEFICIT INCOME (LOSS) TOTAL INCOME
---------- -------- ------------ ------------- -------------- ----------- --------
BALANCE, December 31, 2003..... 19,775,821 $ 40 $ 82,113 $ (16,829) $ (1,302) $ 64,022 $ --
Change in comprehensive
income.................... -- -- -- -- 378 378 378
Preferred stock dividend.... -- -- (6,551) -- -- (6,551) --
Net income before preferred
stock dividends........... -- -- -- 10,623 -- 10,623 10,623
---------- -------- ------------ ------------ ----------- ----------- --------
BALANCE, September 30, 2004.... 19,775,821 $ 40 $ 75,562 $ (6,206) $ (924) $ 68,472 $ 11,001
========== ======== ============ ============ =========== =========== ========
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)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2004 2003
----------- -----------
Cash flows from operating activities:
Net income applicable to common stock.................. $ 4,072 $ 2,529
Adjustments to reconcile net income applicable to common
stock to net cash provided by operating activities:
Preferred stock dividend.......................... 6,551 6,088
Cumulative effect of change in accounting for
asset retirement obligations, net.............. -- 476
Depreciation and amortization..................... 14,346 12,857
Amortization of debt financing costs.............. 930 762
Bad debt expense.................................. 150 --
Provision for deferred income taxes............... 6,656 5,574
Gain on sale of property, machinery and equipment. (850) (1)
(Increase) decrease in the following, net:
Accounts receivable............................ (6,199) (9,392)
Prepaid expenses and other current assets...... (4,094) 640
Increase (decrease) in the following:
Accrued interest payable....................... 4,408 4,513
Accounts payable and accrued expenses
and other long-term liabilities............. 1,341 (8,232)
----------- -----------
Net cash provided by operating activities.............. 27,311 15,814
----------- -----------
Cash flows from investing activities:
Purchase of businesses.............................. (804) (4,634)
Purchases of property, machinery and equipment...... (11,534) (11,134)
Proceeds from sale of property, machinery and equipment 1,764 14,219
Facility construction funded by restricted cash..... (8,699) (2,787)
Decrease in restricted cash for facility construction 8,699 2,787
Increase in other restricted cash accounts.......... (1,515) (2,318)
Other............................................... (262) 470
----------- -----------
Net cash used in investing activities..................... (12,351) (3,397)
----------- -----------
Cash flows from financing activities:
Payments of debt.................................... (18,155) (11,679)
Debt issuance costs................................. (176) (774)
Net increase in bank revolver borrowings............ 3,500 --
----------- -----------
Net cash used in financing activities.................. (14,831) (12,453)
----------- -----------
Net increase (decrease) in cash and cash equivalents...... 129 (36)
Cash and cash equivalents, beginning of period............ 206 239
----------- -----------
Cash and cash equivalents, end of period.................. $ 335 $ 203
=========== ===========
Supplemental Cash Flow Information
Interest paid during the period........................ $ 10,510 $ 9,747
Taxes paid during the period........................... $ 385 $ 190
Non-cash investing and financing activities:
Short-term debt issued for purchase of land $ 4,000 $ --
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 nine months ended
September 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/A 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/A 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.
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 to approximately
$1.6 million, and increased property, machinery 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
September 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. SFAS No. 123 provides that
companies record compensation expense for the estimated fair-value of
stock-based compensation, but also allows companies to continue to apply
Accounting Principles Board ("APB") Opinion No. 25 and related interpretations
in accounting for its plans. 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 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.
Had the Company elected to apply SFAS No. 123, the Company's net income and
income per diluted share would have approximated the pro forma amounts indicated
below (in thousands):
7
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
------------------------------- -------------------------------
2004 2003 2004 2003
---------- ---------- --------- ---------
Net income applicable to common stock, as $ 2,312 $ 2,230 $ 4,072 $ 2,529
reported................................
Less: Compensation expense per SFAS No.
123, net of tax......................... 312 373 875 1,106
---------- ---------- --------- ---------
Pro forma after effect of SFAS No. 123.... $ 2,000 $ 1,857 $ 3,197 $ 1,423
========== ========== ========= =========
Diluted income per share, as reported..... $ 0.08 $ 0.08 $ 0.18 $ 0.13
Pro forma after effect of SFAS No. 123.... $ 0.07 $ 0.07 $ 0.17 $ 0.07
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 $2.51 and $1.59 for grants made during the nine months ended
September 30, 2004 and 2003, respectively. The following assumptions were used
for option grants in 2004 and 2003, respectively: expected volatility of 111
percent and 56 percent; risk-free interest rates of 4.33 percent and 3.99
percent; expected lives of up to ten years and no expected dividends to be paid.
For the quarters ended September 30, 2004 and 2003, the weighted average fair
value per share was $2.11 and $1.76, respectively. The following assumptions
were used for option grants during the three months ended September 30, 2004 and
2003: expected volatility of 80 percent and 63.5 percent; risk-free interest
rate of 4.24 percent and 4.0 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 September 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 $31.4 million in property and long-term
assets related to these activities at September 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 nine
months ended September 30, 2004, the Company recorded certain adjustments
totaling $0.8 million related to earn out payments to former owners.
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 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. The purchase of Aspen
provides the Company with added expertise in the management of pulp and paper
organic residuals. The allocation of the 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 acquired..................................... $ 4,093
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.
During the nine months ended September 30, 2004, the Company recorded certain
adjustments totaling $0.8 million related to earn out payments to former owners.
(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.
9
(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 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 September 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 September 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 the 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.
10
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.
(6) SHORT TERM DEBT
In August 2004, the Company entered into a $4.0 million short term note with a
bank for the purchase of land. The note is repayable in February 2005 and bears
interest at LIBOR or prime plus a margin which currently approximates 4.67
percent. The Company plans to use the land as part of the development of a
compost facility in Southern California. The total capital required to develop
the project is estimated at $30 to $35 million and the facility is expected to
generate annual revenues of approximately $12 million upon commencement of
operations which is expected in 2006. The Company is currently considering
alternatives for the permanent financing of this project, which would include
the repayment of the short term note.
(7) DEBT
Long-term debt obligations consist of the following:
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
(in thousands)
Senior credit facility -
Revolving line of credit............... $ 3,500 $ --
Term loans............................. 28,315 44,274
Subordinated debt.......................... 150,000 150,000
Fair value adjustment of subordinated debt
as a result of interest rate swaps....... (983) (755)
Notes payable to sellers of acquired
businesses............................... 1,371 1,500
Other notes payable........................ 13 20
------------- ------------
Total debt....................... $ 182,216 $ 195,039
Less: Current maturities.................. (889) (955)
------------- ------------
Long-term debt, net of current
maturities..................... $ 181,327 $ 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
which currently approximates 6.25 percent for the Revolving Loan and 4.72
percent on the Term B loans.
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, as amended, 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 September 30, 2004, the Company had approximately $33.5
million of Letters of Credit outstanding.
11
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 September 30, 2004. The Senior Credit
Agreement is collateralized by substantially all of the Company's assets and
those of its subsidiaries and expires on December 31, 2008. As of September 30,
2004, the Company had approximately $58.0 million of unused borrowings under the
Senior Credit Agreement, of which approximately $45.8 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 September 30,
2004, all of the Company's wholly owned domestic subsidiaries, other than the
subsidiaries formed to own and operate the compost project in Southern
California, South Kern Industrial Center, L.L.C. (see Note 6), and the
Sacramento dryer project, Synagro Organic Fertilizer Company of Sacramento, Inc.
and Sacramento Project Finance, Inc. (see Note 8), 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.
12
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 new credit facility 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.
The net proceeds from the sale of the Notes was approximately $145 million, and
were used to repay and refinance existing indebtedness under the Company's
previously existing credit facility and subordinated debt as of April 17, 2002.
NOTES PAYABLE TO SELLERS OF ACQUIRED BUSINESSES
In connection with previous acquisitions, the Company has $1.4 million in notes
payable with certain former owners. The notes payable are due over 5 years in
installments with interest payable at an annual rate of five percent.
DERIVATIVES AND HEDGING ACTIVITIES
On September 21, 2004, the Company entered into an interest rate swap
transaction on $67 million of its 9 1/2 percent Senior Subordinated Notes due
2009 that matures on April 1, 2005. Under the terms of the agreement, the
Company pays a fixed rate of 2.62 percent and receives a floating rate based on
six month LIBOR. The mark to market value of this swap was recorded as a
reduction in interest expense of $33,000 during the quarter ended September 30,
2004.
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. On September 23, 2004, the Company unwound $18 million of
these swaps and received a settlement payment of approximately $0.1 million that
was deducted from interest expense. Accordingly, the Company currently has $67
million of the original $85 million of interest rate swaps outstanding. The
swaps have notional amounts of $50 million and $17 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 nine months ended September 30,
2004, the Company recorded interest savings related to these interest rate swaps
of $ 0.1 million and $1.3 million, respectively, which reduced interest expense.
The $1.0 million fair value of these derivative instruments is included in other
long-term liabilities, as of September 30, 2004. The carrying value of the Notes
was decreased by the same amount.
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
September 30, 2004. The gain recognized during the nine months ended September
30, 2004, related to the floating-to-fixed interest rate swap agreement was
approximately $32,000, while the loss recognized related to the reverse swap
agreement was approximately $67,000. The amount of the ineffectiveness of the
reverse swap agreement charged to other expense was approximately $35,000 for
the nine months ended September 30, 2004.
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 nine months ended September
30, 2004, was approximately $0.1 million and $0.4 million, respectively.
13
(8) NONRECOURSE PROJECT REVENUE BONDS
SEPTEMBER 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%, net
of discount of $316 ................................. 19,759 19,741
Series 2002B -- Revenue bonds due 2006 at stated
interest rate of 4.25%, net of discount of $4 ....... 1,197 1,195
------------ -----------
20,956 20,936
------------ -----------
Total nonrecourse project revenue bonds..................... 64,891 64,871
Less: Current maturities.............................. (2,570) (2,570)
------------ -----------
Nonrecourse project revenue bonds, net of current
maturities.......................................... $ 62,321 $ 62,301
============ ===========
Amounts recorded in other assets as restricted cash -
Debt service fund...................................... $ 9,203 $ 7,275
============ ===========
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 the Company 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 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.
14
At September 30, 2004, the Maryland Project Revenue Bonds were collateralized by
property, machinery and equipment with a net book value of approximately $54.1
million and restricted cash of approximately $8.5 million, of which
approximately $7.5 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
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 September 30, 2004, the Sacramento Bonds are partially collateralized by
restricted cash of approximately $5.2 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 expected to be incurred after
notice to proceed is received. The Company is not a guarantor of the Sacramento
Bonds or the loan funded by the Sacramento Bonds.
The Maryland Project Revenue Bonds and the Sacramento Bonds are excluded from
the financial covenant calculations required by the Company's Senior Credit
Agreement.
(9) 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.
15
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 September 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.
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 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.
(10) 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 either an extraordinary
item or a cumulative effect of an accounting change, the Company uses income
from continuing operations as the "control number" in
16
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.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 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................... $ 4,549 $ 4,314 $ 10,623 $ 9,093
Cumulative effect of change in accounting for
asset retirement obligations, net of tax benefit
of $292......................................... -- -- -- 476
----------- ----------- ------------ ------------
Net income before preferred stock dividends........ 4,549 4,314 10,623 8,617
Preferred stock dividends.......................... 2,237 2,084 6,551 6,088
----------- ----------- ------------ ------------
Net income applicable to common stock.............. $ 2,312 $ 2,230 $ 4,072 $ 2,529
=========== =========== ============ ============
Earnings per share:
Basic
Earnings per share before cumulative effect of
change in accounting for asset retirement
obligations.................................. $ 0.12 $ 0.11 $ 0.21 $ 0.15
Cumulative effect of change in accounting for
asset retirement obligations................. -- -- -- (0.02)
----------- ------------ ------------ ------------
Net income per share............................ $ 0.12 $ 0.11 $ 0.21 $ 0.13
=========== ============ ============ ============
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.. $ 0.08 $ 0.08 $ 0.18 $ 0.15
Cumulative effect of change in accounting for
asset retirement obligations................. -- -- -- (0.02)
----------- ------------ ------------ ------------
Net income per share............................ $ 0.08 $ 0.08 $ 0.18 $ 0.13
=========== ============ ============ ============
Weighted average shares:
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................ 515,777 52,954 478,547 --
Effect of convertible preferred stock under the
"if converted" method........................ 38,741,956 35,755,808 37,982,012 --
----------- ------------ ----------- ------------
Weighted average shares outstanding for diluted
earnings per share........................... 59,033,554 55,584,583 58,236,380 19,775,821
=========== ============ =========== ============
Basic and diluted EPS are the same for the nine months ended September 30, 2003
because diluted earnings per share was less dilutive than basic earnings per
share ("antidilutive"). Accordingly, 35,149,761 shares representing common stock
equivalents (related to convertible preferred stock and stock options) have been
excluded from the diluted EPS calculations for the nine months ended September
30, 2003.
17
(11) CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
As discussed in Note 8, as of September 30, 2004, all of the Company's wholly
owned domestic subsidiaries, except the subsidiaries formed to own and operate
the compost project in southern California, South Kern Industrial Center, L.L.C.
(see Note 6), and the Sacramento biosolids processing facility, Synagro Organic
Fertilizer Company of Sacramento, Inc. and Sacramento Project Finance, Inc. (see
Note 8) (collectively the "Non-Guarantor Subsidiaries"), are Guarantors of the
Notes. Each of the Guarantors is 100 percent 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 condensed consolidating balance sheets as of September 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 September 30, 2004,
because the construction of the related facilities is still in progress, and
operations have not commenced. Accordingly, no condensed consolidating
statements of operations or cash flows have been provided
CONDENSED CONSOLIDATING BALANCE SHEETS
AS OF SEPTEMBER 30, 2004
(DOLLARS IN THOUSANDS)
NON-
GUARANTOR GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------ ------------ ------------ ------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents..................... $ 14 $ 48 $ 273 $ -- $ 335
Restricted cash............................... -- 999 -- -- 999
Accounts receivable, net...................... -- 65,628 -- -- 65,628
Note receivable, current portion.............. -- 604 -- -- 604
Prepaid expenses and other current assets..... -- 16,823 -- -- 16,823
--------- --------- ------- --------- ---------
Total current assets.................. 14 84,102 273 -- 84,389
Property, machinery & equipment, net............ -- 205,083 20,682 -- 225,765
Other Assets:
Goodwill...................................... -- 171,855 -- -- 171,855
Investments in subsidiaries................... 81,553 -- -- (81,553) --
Restricted cash - construction fund........... -- -- 3,483 -- 3,483
Restricted cash - debt service fund........... -- 7,489 1,714 -- 9,203
Other, net.................................... 5,869 5,218 3,025 -- 14,112
--------- --------- ------- --------- ---------
Total assets.......................... $ 87,436 $ 473,747 $29,177 $ (81,553) $ 508,807
========= ========= ======= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Short term debt............................... $ -- $ -- $ 4,000 $ -- $ 4,000
Current maturities of long-term debt.......... 286 603 -- -- 889
Current maturities of nonrecourse project -- 2,570 -- -- 2,570
revenue bonds...............................
Current maturities of capital lease
obligations................................. -- 3,002 -- -- 3,002
Accrued interest payable...................... 8,229 -- 402 -- 8,631
Accounts payable and accrued expenses......... -- 47,264 1,368 -- 48,632
--------- --------- ------- --------- ---------
Total current liabilities............. 8,515 53,439 5,770 -- 67,724
Long-Term Debt:
Long-term debt obligations, net............... 180,546 781 -- -- 181,327
Nonrecourse project revenue bonds, net........ -- 41,365 20,956 -- 62,321
Intercompany.................................. (265,461) 265,461 -- -- --
Capital lease obligations, net................ -- 11,602 -- -- 11,602
--------- --------- ------- --------- ---------
Total long-term debt....................... (84,915) 319,209 20,956 -- 255,250
Other long-term liabilities..................... 2,514 21,997 -- -- 24,511
--------- --------- ------- --------- ----------
Total liabilities..................... (73,886) 394,645 26,726 -- 347,485
Commitments and Contingencies
Redeemable Preferred Stock,
69,792.29 shares issued and outstanding,
redeemable at $1,000 per share................ 92,850 -- -- -- 92,850
Stockholders' Equity:
Capital....................................... 75,602 36,638 2,451 (39,089) 75,602
Accumulated deficit........................... (6,206) 42,464 -- (42,464) (6,206)
Accumulated other comprehensive loss.......... (924) -- -- -- (924)
--------- --------- ------- --------- ---------
Total stockholders' equity............ 68,472 79,102 2,451 (81,553) 68,472
--------- --------- ------- --------- ---------
Total liabilities and stockholders' equity...... $ 87,436 $ 473,747 $29,177 $ (81,553) $ 508,807
========= ========= ======= ========= =========
18
CONDENSED 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........................................... -- 171,051 -- -- 171,051
Investments in subsidiaries........................ 75,199 -- -- (75,199) --
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............................... $ 81,507 $ 461,584 $ 22,785 $ (75,199) $ 490,677
========== ========= ======== ========= =========
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.............. -- 40,873 564 -- 41,437
---------- --------- -------- --------- ---------
Total current liabilities.................. 5,177 46,121 564 -- 51,862
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 15,781 -- -- 19,361
---------- --------- -------- --------- ---------
Total liabilities.......................... (68,814) 387,670 21,500 -- 340,356
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................................ (16,829) 36,110 -- (36,110) (16,829)
Accumulated other comprehensive loss............... (1,302) -- -- -- (1,302)
---------- --------- -------- --------- ---------
Total stockholders' equity................. 64,022 73,914 1,285 (75,199) 64,022
---------- --------- -------- --------- ---------
Total liabilities and stockholders' equity........... $ 81,507 $ 461,584 $ 22,785 $ (75,199) $ 490,677
========== ========= ======== ========= =========
(12) 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 $15.8 million as of September 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 $0.2 million as of September 30, 2004 and is included
in current liabilities.
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/A 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/A.
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 85 percent and 83 percent of total
revenues in the nine month periods ended September 30, 2004 and 2003,
respectively, and 84 percent and 83 percent in the three months periods ended
September 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 3 percent and 4 percent of total
revenues in the nine months ended September 30, 2004 and 2003, respectively, and
3 percent and 4 percent of total revenues in the three months ended September
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 4 percent of total revenues in each of
the nine months and three months ended September 30, 2004 and 2003.
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 approximately 1 percent and 2 percent of
total revenues in the nine months and three months ended September 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 of total revenues in the nine months ended
September 30, 2004 and 2003 and 8 percent and 7 percent for the three months
ended September 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 as well as certain other
projects which meet the criteria for construction contracts 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.
20
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 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 SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------- ----------------------------------------------
2004 2003 2004 2003
---------------------- ------------------------ ---------------------- --------------------
(in thousands)
Revenue..................... $ 86,294 100.0% $ 79,634 100.0% $ 241,255 100.0% $ 218,503 100.0%
Cost of services............ 66,636 77.2% 60,974 76.6% 190,260 78.9% 167,862 76.8%
----------- ----- ----------- ----- ------------- ----- ---------- -----
Gross profit................ 19,658 22.8% 18,660 23.4% 50,995 21.1% 50,641 23.2%
Selling, general and
administrative
expenses.................. 6,128 7.1% 6,044 7.6% 17,649 7.3% 18,274 8.4%
Special charge.............. 320 0.4% -- --% 320 0.1% -- --%
----------- ----- ----------- ----- ------------- ----- ---------- -----
Income from
operations.............. 13,210 15.3% 12,616 15.8% 33,026 13.7% 32,367 14.8%
----------- ----- ----------- ----- ------------- ----- ---------- -----
Other expense:
Other (income) expense,
net..................... 76 0.1% 92 0.1% (816) (0.3)% 78 0.0%
Interest expense, net..... 5,677 6.6% 5,566 7.0% 16,428 6.8% 17,622 8.1%
---------- ----- ----------- ----- ------------- ----- ---------- ----
Total other expense,
net.................... 5,753 6.7% 5,658 7.1% 15,612 6.5% 17,700 8.1%
----------- ----- ----------- ----- ------------- ----- ---------- ----
Income before provision
for income taxes.......... 7,457 8.6% 6,958 8.7% 17,414 7.2% 14,667 6.7%
Provision for income
taxes............... 2,908 3.3% 2,644 3.3% 6,791 2.8% 5,574 2.5%
----------- ----- ----------- ----- ------------- ----- ---------- -----
Net income before
cumulative effect of
change in accounting
for asset retirement
obligations and
preferred stock
Dividends................. 4,549 5.3% 4,314 5.4% 10,623 4.4% 9,093 4.2%
Cumulative effect of
change in accounting
for asset retirement
obligations, net of
tax benefit of $292....... -- 0.0% -- 0.0% -- 0.0% 476 0.2%
----------- ----- ----------- ----- ------------- ----- ---------- -----
Net income before
preferred stock
dividends................. 4,549 5.3% 4,314 5.4% 10,623 4.4% 8,617 4.0%
===== ===== ===== =====
Preferred stock dividends... 2,237 2,084 6,551 6,088
----------- ----------- ------------- ----------
Net income applicable to
common stock.............. $ 2,312 $ 2,230 $ 4,072 $ 2,529
=========== =========== ============= ==========
THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2003
For the three months ended September 30, 2004, revenue was approximately $86.3
million compared to approximately $79.6 million for the three months ended
September 30, 2003, an increase of approximately $6.7 million, or 8.4 percent.
Approximately $6.8 million of the increase related to contract service revenues
and approximately $1.0 million of the increase related to event type work
primarily in the Northeast and Central regions. These increases in revenue were
partially offset by declines in design/build construction and purchase order
revenues in the third quarter of 2004.
Gross profit for the three months ended September 30, 2004, was approximately
$19.7 million compared to approximately $18.7 million for the three months ended
September 30, 2003, an increase of $1.0 million, or 5.3 percent. Gross profit
increased as a result of the internal growth discussed above, an improvement in
land application (related to more normal weather patterns in 2004 compared to
2003) and cleanout operating margins, which were partially offset by a $0.4
million increase in depreciation expense and an increase in repairs and
maintenance expenses primarily associated with our dryer and incineration
facilities. Gross profit as a percentage of revenue
21
decreased to 22.8 percent in 2004 from 23.4 percent in 2003 as a result of the
increase in depreciation expense and repairs and maintenance expenses discussed
above.
Selling, general and administrative expenses for the three months ended
September 30, 2004 were approximately $6.1 million compared to approximately
$6.0 million for the three months ended September 30, 2003, an increase of $0.1
million or 1.4 percent. Selling, general and administrative expenses as a
percentage of revenues decreased to 7.1 percent in the third quarter of 2004
from 7.6 percent in the third 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.
We incurred a special charge of $0.3 million for costs associated with the
re-audit of our 2001 financial statements during the third quarter of 2004.
There was no such special charge during 2003.
As a result of the foregoing, income from operations for the three months ended
September 30, 2004, was approximately $13.2 million compared to approximately
$12.6 million for the three months ended September 30, 2003, an increase of $0.6
million or 4.7 percent. Operating income as a percentage of revenues decreased
to 15.3 percent (15.7 percent excluding the $0.3 million of costs associated
with the re-audit of our 2001 financial statements) for the third quarter of
2004 from 15.8 percent for the same period of 2003.
Other expense, net, was approximately $5.8 million for the three months ended
September 30, 2004, compared to approximately $5.7 million for the three months
ended September 30, 2003, representing an increase in other expense of
approximately $0.1 million. The increase relates primarily to an increase in
interest expense due to an increase in market interest rates partially offset by
savings due to debt repayments.
For the three months ended September 30, 2004, we recorded a provision for
income taxes of approximately $2.9 million compared to $2.6 million for the
three months ended September 30, 2003. Our effective tax rate was approximately
39 percent in the third quarter of 2004 compared to 38 percent in the third
quarter 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.
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2003
For the nine months ended September 30, 2004, revenue was approximately $241.3
million compared to approximately $218.5 million for the nine months ended
September 30, 2003, an increase of approximately $22.8 million, or 10.4 percent.
Approximately $22.7 million of the increase related to contract service
revenues, approximately $2.2 million related to event type work primarily in the
Northeast and Central regions, and approximately $1.2 million of the increase
related to an acquisition that was completed in the second quarter of 2003.
These revenue increases were partially offset by declines in design/build and
purchase order revenues in the first nine months of 2004.
Gross profit for the nine months ended September 30, 2004, was approximately
$51.0 million compared to approximately $50.6 million for the nine months ended
September 30, 2003, an increase of $0.4 million or 0.7 percent. 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 $2.5 million or 5.1 percent as a
result of the increased revenue growth discussed above, an improvement in land
application (related to more normal weather patterns in 2004 compared to 2003)
and cleanout operating margins partially offset by an increase of $0.4 million
in depreciation expense and higher repairs and maintenance expenses at our
drying and incineration facilities. Gross profit as a percentage of revenue
decreased to 21.1 percent in 2004 from 23.2 percent in 2003 primarily due to the
increase in depreciation expense and repairs and maintenance expense in 2004 and
the reversal of the $2.1 million warranty settlement in 2003 as discussed above.
Selling, general and administrative expenses for the nine months ended September
30, 2004 were approximately $17.6 million compared to approximately $18.3
million for the nine months ended September 30, 2003, a decrease of $0.6 million
or 3.4 percent. Selling, general and administrative expenses as a percentage of
revenues decreased to 7.3 percent in the first nine months of 2004 from 8.4
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.
We incurred a special charge of $0.3 million for costs associated with the
re-audit of our 2001 financial statements during the third quarter of 2004.
There was no such special charge during 2003.
22
As a result of the foregoing, income from operations for the nine months ended
September 30, 2004 was approximately $33.0 million compared to approximately
$32.4 million for the same period in 2003. Operating income as a percentage of
revenues decreased to 13.7 percent in the first nine months of 2004 from 14.8
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.
Other expense, net, was approximately $15.6 million for the nine months ended
September 30, 2004, compared to approximately $17.7 million for the nine months
ended September 30, 2003, representing a decrease in other expense of
approximately $2.1 million. The decrease relates primarily to a reduction of
$1.2 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.
For the nine months ended September 30, 2004, we recorded a provision for income
taxes of approximately $6.8 million compared to $5.6 million for the nine months
ended September 30, 2003. Our effective tax rate was approximately 39 percent in
the first nine months of 2004 compared to 38 percent in the first nine 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 the Bio Gro
division of Waste Management, Inc., 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 nine months ended September 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 nine months ended September 30,
2004, cash flows from operating activities were approximately $27.3 million
compared to approximately $15.8 million for the same period in 2003, an increase
of approximately $11.5 million or 72.7 percent. The increase primarily relates
to increased net income and a reduction of cash required for working capital of
$7.9 million.
Cash Flows from Investing Activities -- For the nine months ended September 30,
2004, cash flows used by investing activities were approximately $12.4 million
compared to cash flows used of approximately $3.4 million for the same period in
2003, an increase of
23
approximately $9.0 million. This increase primarily relates to $14.2 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 nine months ended September 30,
2004, cash flows used in financing activities were approximately $14.8 million
compared to approximately $12.5 million for the same period in 2003, an increase
of approximately $2.4 million. The increase primarily relates to net repayments
on debt totaling approximately $14.7 million during the first nine months of
2004 compared to $11.7 million for the same period in 2003.
CAPITAL EXPENDITURE REQUIREMENTS
Capital expenditures for the nine months ended September 30, 2004, totaled
approximately $20.2 million (which included approximately $8.7 million to fund
construction of the Sacramento biosolids processing facility) compared to
approximately $13.9 million (which included $2.8 million to fund construction of
the Sacramento biosolids processing facility) 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 8).
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 over 5 years 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 Bio Gro 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
5.75 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 face amount of $21.3 million. The nonrecourse revenue
bonds consist of a face amount of $20.1 million Series 2002-A and of a face
amount of $1.2 million Series 2002-B (taxable) (collectively, the "Sacramento
Bonds"). The Authority loaned the proceeds of the Sacramento 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.
24
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.
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 $15.8 million as
of September 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
$0.2 million as of September 30, 2004 and is included in current liabilities.
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
September 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 September 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 September 30, 2004, included approximately $28.3 million in
floating rate debt attributed to the Senior Credit Agreement at a base interest
rate plus 3.0 percent, or approximately 4.72 percent at September 30, 2004. We
also have interest rate swaps
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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
$0.2 million.
WORKING CAPITAL
At September 30, 2004, we had working capital of approximately $16.7 million
compared to approximately $20.5 million at December 31, 2003, a decrease of
approximately $3.8 million. The decrease in working capital is principally due
to a $4.0 million short term note for the purchase of land (see Note 6) as
increases in receivables and other assets were offset by increases in accounts
payable and accrued expenses due to the seasonal increase in business activity.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DERIVATIVES AND HEDGING ACTIVITIES
On September 21, 2004, we entered into an interest rate swap transaction on $67
million of our 9 1/2 percent Senior Subordinated Notes due 2009 that matures on
April 1, 2005. Under the terms of the agreement, we pay a fixed rate of 2.62
percent and receives a floating rate based on six month LIBOR. The mark to
market value of this swap was recorded as a reduction in interest expense of
$33,000 during the quarter ended September 30, 2004.
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. On September 23, 2004, we
unwound $18 million of these swaps and received a settlement payment of
approximately $0.1 million that was deducted from interest expense. Accordingly,
we currently have $67 million of the original $85 million of interest rate swaps
outstanding. The swaps have notional amounts of $50 million and $17 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 nine months ended September 30,
2004, we recorded interest savings related to these interest rate swaps of $0.1
million and $1.3 million, respectively, which reduced interest expense. The $1.0
million fair value of these derivative instruments is included in other
long-term liabilities, as of September 30, 2004. The carrying value of our Notes
was decreased by the same amount.
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
September 30, 2004. The gain recognized during the nine months ended September
30, 2004, related to the floating-to-fixed interest rate swap agreement was
approximately $32,000, while the loss recognized related to the reverse swap
agreement was approximately $67,000. The amount of the ineffectiveness of the
reverse swap agreement charged to other expense was approximately $35,000
million for the nine months ended September 30, 2004.
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 nine months ended September 30, 2004, was
approximately $0.1 million and $0.4 million, respectively.
INTEREST RATE RISK
Total debt at September 30, 2004, included approximately $28.3 million in
floating rate debt attributed to the Senior Credit Agreement at a base interest
rate plus 3.0 percent, or approximately 4.72 percent at September 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 $0.2 million.
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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.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information regarding the Company's legal proceedings can be found under the
"Litigation" section of Note (9), "Commitments and Contingencies," to the
Condensed Consolidated Financial Statements.
ITEM 6. EXHIBITS
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
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SYNAGRO TECHNOLOGIES, INC.
Date: November 5, 2004 By: /s/ Robert C. Boucher, Jr.
--------------------------------------
Chief Executive Officer and Director
Date: November 5, 2004 By: /s/ J. Paul Withrow
--------------------------------------
Chief Financial Officer and Director
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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
31.2 Section 1350 Certification of Chief Financial Officer