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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 27, 2004

 

OR

 

¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

 

Commission File Number: 001-16501

 

GLOBAL POWER EQUIPMENT GROUP INC.

(Exact name of registrant as specified in its charter)

 

Delaware   73-1541378

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

6120 South Yale, Suite 1480, Tulsa, Oklahoma

(Address of principal executive offices)

 

74136

(Zip Code)

 

(918) 488-0828

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  x    No  ¨

 

The number of shares of the Registrant’s common stock, $.01 par value, outstanding at May 3, 2004 was 46,323,798.

 



Table of Contents

GLOBAL POWER EQUIPMENT GROUP INC.

 

FORM 10-Q

March 27, 2004

 

INDEX

 

              Page

Part I.

  Financial Information     
    Item 1.    Financial Statements     
         Condensed Consolidated Balance Sheets at March 27, 2004 and December 27, 2003    1
         Condensed Consolidated Statements of Income for the Three Months Ended March 27, 2004 and March 29, 2003    2
         Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 27, 2004 and March 29, 2003    3
         Notes to Condensed Consolidated Financial Statements    4
    Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    14
    Item 3.    Quantitative and Qualitative Disclosures About Market Risk    22
    Item 4.    Controls and Procedures    23

Part II.

  Other Information     
    Item 1.    Legal Proceedings    23
    Item 6.    Exhibits and Reports on Form 8-K    23

Signatures

        25

Exhibit Index

        26


Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM I. FINANCIAL STATEMENTS

GLOBAL POWER EQUIPMENT GROUP INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands, except share data)

 

     March 27,
2004


   

December 27,

2003


 

ASSETS

                

Current assets:

                

Cash and cash equivalents

   $ 53,414     $ 51,315  

Accounts receivable, net of allowance of $1,333 and $1,325

     34,889       42,582  

Inventories at FIFO

     3,881       3,013  

Costs and estimated earnings in excess of billings

     42,206       40,706  

Deferred income taxes

     15,209       17,315  

Other current assets

     8,833       3,983  
    


 


Total current assets

     158,432       158,914  

Property, plant and equipment, net

     20,030       20,740  

Deferred income taxes

     53,409       55,094  

Goodwill

     45,000       45,000  

Other assets

     1,595       1,248  
    


 


Total assets

   $ 278,466     $ 280,996  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY

                

Current liabilities:

                

Current maturities of long-term debt

   $ 14     $ 14  

Accounts payable

     14,787       18,974  

Accrued compensation and employee benefits

     3,779       7,285  

Accrued warranty

     15,038       15,004  

Billings in excess of costs and estimated earnings

     60,494       53,293  

Other current liabilities

     4,724       5,203  
    


 


Total current liabilities

     98,836       99,773  

Other long-term liabilities

     1,888       1,888  

Long-term debt, net of current maturities

     16,633       24,949  

Commitments and contingencies

                

Stockholders’ equity:

                

Preferred stock, $0.01 par value, 5,000,000 shares authorized,

no shares issued or outstanding

     —         —    

Common stock, $0.01 par value, 100,000,000 shares authorized,

46,323,798 and 45,207,930 shares issued and outstanding, respectively

     463       452  

Paid-in capital deficit

     (19,553 )     (25,492 )

Accumulated other comprehensive income

     2,551       2,616  

Retained earnings

     177,648       176,810  
    


 


Total stockholders’ equity

     161,109       154,386  
    


 


Total liabilities and stockholders’ equity

   $ 278,466     $ 280,996  
    


 


 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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GLOBAL POWER EQUIPMENT GROUP INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(in thousands, except per share amounts)

 

     Three Months Ended

    

March 27,

2004


  

March 29,

2003


Revenues

   $ 55,126    $ 77,026

Cost of sales

     43,313      55,808
    

  

Gross profit

     11,813      21,218

Selling and administrative expenses

     10,261      9,464
    

  

Operating income

     1,552      11,754

Interest expense, net

     200      498
    

  

Income before income taxes

     1,352      11,256

Income tax provision

     514      4,390
    

  

Net income available to common stockholders

   $ 838    $ 6,866
    

  

Earnings per weighted average common share:

             

Basic

   $ 0.02    $ 0.16
    

  

Weighted average number of shares of common stock outstanding-basic

     45,657      43,988
    

  

Diluted

   $ 0.02    $ 0.15
    

  

Weighted average number of shares of common stock outstanding-diluted

     46,727      45,609
    

  

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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GLOBAL POWER EQUIPMENT GROUP INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

 

     Three Months Ended

 
     March 27,
2004


    March 29,
2003


 

Operating activities:

                

Net income

   $ 838     $ 6,866  

Adjustments to reconcile net income to

net cash provided by (used in) operating activities-

                

Depreciation and amortization

     940       1,058  

Deferred income taxes

     3,791       5,481  

Loss on disposal of equipment

     62       —    

Stock-based compensation

     487       —    

Changes in operating items (Note 9)

     3,136       (14,725 )
    


 


Net cash provided by (used in) operating activities

     9,254       (1,320 )
    


 


Investing activities:

                

Proceeds from sale of equipment

     1       —    

Purchases of property, plant and equipment

     (134 )     (59 )
    


 


Net cash used in investing activities

     (133 )     (59 )
    


 


Financing activities:

                

Payments on long-term debt

     (8,316 )     (15 )

Proceeds from issuance of common stock

     1,416       5  
    


 


Net cash used in financing activities

     (6,900 )     (10 )
    


 


Effect of exchange rate changes on cash

     (122 )     378  

Net increase (decrease) in cash and cash equivalents

     2,099       (1,011 )

Cash and cash equivalents, beginning of period

     51,315       59,042  
    


 


Cash and cash equivalents, end of period

   $ 53,414     $ 58,031  
    


 


 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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GLOBAL POWER EQUIPMENT GROUP INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

1. BUSINESS AND ORGANIZATION

 

Global Power Equipment Group Inc. and Subsidiaries (the Company or GPEG) designs, engineers and manufactures heat recovery and auxiliary power equipment. Our products include:

 

Ÿ    heat recovery steam generators;    Ÿ    exhaust systems;
Ÿ    filter houses;    Ÿ    diverter dampers; and
Ÿ    inlet systems;    Ÿ    specialty boilers and related products
Ÿ    gas turbine, steam turbine and generator enclosures;          

 

The Company’s corporate headquarters are located in Tulsa, Oklahoma, with operating facilities in Plymouth, Minnesota; Tulsa, Oklahoma; Auburn, Massachusetts; Clinton, South Carolina; Monterrey, Mexico; Toluca, Mexico; Shanghai, China; and Heerlen, Netherlands.

 

2. INTERIM FINANCIAL STATEMENTS

 

The unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. The information furnished in the condensed consolidated financial statements, in the opinion of management, includes normal recurring adjustments and reflects all adjustments which are necessary for a fair presentation of such financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. Although the Company believes that the disclosures are adequate to make the information presented not misleading, these condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Form 10-K for the fiscal year ended December 27, 2003, filed with the Securities and Exchange Commission. The quarterly results are not necessarily indicative of the actual results that may occur for the entire fiscal year.

 

3. GOODWILL

 

There were no changes in the carrying amount of goodwill during the first three months of fiscal 2004. The Company will complete its annual impairment testing during the fourth quarter of fiscal year 2004 or as necessary if circumstances warrant a possible impairment charge. The balances by operating segment as of March 27, 2004 and December 27, 2003 were as follows (in thousands):

 

Heat

Recovery

Equipment


  

Auxiliary

Power

Equipment


   Corporate

   Total

$ 25,230    $ 18,623    $ 1,147    $ 45,000


  

  

  

 

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4. EARNINGS PER SHARE

 

Basic and diluted earnings per common share are calculated as follows (in thousands, except share and per share data):

 

     Three Months Ended

    

March 27,

2004


  

March 29,

2003


Basic earnings per common share:

             

Numerator:

             

Net income available to common stockholders

   $ 838    $ 6,866
    

  

Denominator:

             

Weighted average shares outstanding

     45,656,937      43,987,970
    

  

Basic earnings per common share

   $ 0.02    $ 0.16
    

  

Diluted earnings per common share:

             

Numerator:

             

Net income available to common stockholders

   $ 838    $ 6,866
    

  

Denominator:

             

Weighted average shares outstanding

     45,656,937      43,987,970

Dilutive effect of options to purchase common stock *

     1,070,390      1,620,896
    

  

Weighted average shares outstanding assuming dilution

     46,727,327      45,608,866
    

  

Diluted earnings per common share

   $ 0.02    $ 0.15
    

  

 

* There were 560,000 and 566,000 of anti-dilutive stock options excluded from this calculation for the three months ended March 27, 2004 and March 29, 2003, respectively.

 

5. DERIVATIVE FINANCIAL INSTRUMENTS

 

SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” establishes accounting and reporting standards requiring that every derivative instrument be recorded on the balance sheet as either an asset or a liability measured at fair value. SFAS 133 requires that changes in a derivative’s fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative’s gains and losses to be deferred in other comprehensive income until the transaction occurs (“cash flow hedge”) or to offset related results on the hedged item in the income statement (“fair value hedge”). Hedge accounting requires that a company formally document, designate and assess the effectiveness of transactions that receive hedge accounting treatment.

 

Periodically, the Company uses derivative financial instruments in the management of its foreign currency exchange and interest rate exposures. As of March 27, 2004, there were foreign currency forward exchange contracts outstanding with a notional amount of approximately $2.2 million with varying amounts due through December 2004. Currently, the Company recognizes changes in fair values of the forward agreements through earnings. The fair values of unrealized losses on the forward agreements of approximately $0.05 million for the period ended March 27, 2004 are included in earnings through cost of sales. As of March 29, 2003, amounts outstanding under foreign currency forward exchange agreements were $12.8 million with varying amounts due through July 2003. The Company recorded unrealized gains on the forward agreements of approximately $0.4 million for the period ended March 29, 2003.

 

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6. LITIGATION, COMMITMENTS AND CONTINGENCIES

 

In June 2003, Stone & Webster, Inc. and Stone & Webster Purchasing, Inc. (collectively, “S&W”) commenced a lawsuit in the U.S. District Court for the Southern District of Iowa Central Division, against Deltak, L.L.C. (“Deltak”), one of the Company’s subsidiaries. The lawsuit alleged Deltak committed breach of contract and warranty and made certain intentional misrepresentations in connection with a contract to provide two heat recovery steam generators for a project in which S&W was the general contractor. S&W alleged it incurred significant cost increases and delays on the project resulting from certain design, constructability and fabrication issues related to the heat recovery steam generators provided by Deltak and sought an unspecified amount of damages for costs. Deltak filed counterclaims against S&W seeking damages from S&W for breach of contract and unjust enrichment. On March 8, 2004, this lawsuit was settled for the payment by Deltak of an amount that was less than the reserve for this contingency the Company had accrued in fiscal 2003 resulting in an increase to the first quarter 2004 pre-tax net income of $1.1 million. Under the confidential settlement agreement, all claims by the parties were mutually dismissed and the parties were mutually released from any and all damages.

 

The Company is also involved in other legal actions which arise in the ordinary course of its business. Although the outcomes of any such legal actions cannot be predicted, in the opinion of management, the resolution of any currently pending or threatened actions will not have a material adverse effect upon the consolidated financial position or results of operations of the Company.

 

Estimated costs related to product warranty are accrued and included in cost of sales as revenue is recognized. Estimated costs are based upon past warranty claims and sales history. Warranty terms vary by contract but generally provide for a term of three years or less. We manage our exposure to warranty claims by having our field service and quality assurance personnel regularly monitor our projects and maintain ongoing and regular communications with the customer.

 

A reconciliation of the changes to our warranty accrual for the periods indicated is as follows:

 

     Three Months Ended

 
     March 27,
2004


    March 29,
2003


 

Balance at beginning of period

   $ 15,004     $ 19,460  

Accruals during the period

     2,042       1,654  

Changes in previous accruals

     (607 )     (676 )

Settlements made (in cash or in kind) during the period

     (1,401 )     (714 )
    


 


Ending balance

   $ 15,038     $ 19,724  
    


 


 

During the periods presented above, the Company had changes in previous accruals due to the lapse of warranty periods and lesser than expected settlements under warranty claims. The Company continues to review its warranty accrual policy in light of its changing business operations and settlement experience.

 

At March 27, 2004, the Company had a contingent liability for stand-by letters of credit totaling $41.1 million that have been issued and are outstanding that generally were issued to secure performance on customer contracts. Currently, there are no amounts drawn upon these letters of credit.

 

During the first quarter of fiscal 2004, the Company entered into two loan agreements with banks in China. The agreements allow for the Company to borrow $4.8 million at a rate of 5.31%. The agreements expire April 1, 2005. As of March 27, 2004, no amounts have been borrowed under the loan agreements. The loans are collateralized by letters of credit from the Company’s senior credit facility.

 

The Company’s amended and restated senior credit facility:

 

  is guaranteed by all of its domestic subsidiaries;

 

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  is secured by a lien on all of its and its domestic subsidiaries’ property and assets, including, without limitation, a pledge of all capital stock owned by it and its domestic subsidiaries, subject to a limitation of 65% of the voting stock of any foreign subsidiary;

 

  requires the Company to maintain minimum interest and fixed charge coverage ratios and limit its maximum leverage; and

 

  among other things, restricts the Company’s ability to (1) incur additional indebtedness, (2) sell assets other than in the ordinary course of business, (3) pay dividends in excess of 25% of its cumulative net income from January 1, 2001 through the most recent fiscal quarter end, subject to leverage and liquidity thresholds and other customary restrictions, (4) make capital expenditures in excess of $13 million in fiscal year 2001 or $10 million in any fiscal year, thereafter, with adjustments for carry-overs from the previous year, (5) make investments and acquisitions and (6) enter into mergers, consolidations or similar transactions.

 

In the first quarter of fiscal year 2004, the Company’s senior credit facility was amended to provide for a one-time reduction in the fixed charge ratio covenant to reflect the reduction of the Company’s EBITDA (as defined in the credit agreement) related to the restructuring charges taken in the fourth quarter of fiscal year 2003 and the first quarter of fiscal year 2004.

 

The Company is currently in compliance with these covenants and restrictions.

 

Under a management agreement with Harvest Partners, Inc. we are contractually committed to annual payments of certain fees for financial advisory and strategic planning services to Harvest of $1.3 million per year. The terms of the management agreement provide for automatic renewals of additional one-year periods commencing each August unless terminated for cause or by Harvest. During any subsequent renewal period of the management agreement, the management fee will decrease to $750,000 per year if the affiliates of Harvest Partners, Inc. sell more than 50% of the shares of the Company’s common stock they owned at the time of the Company’s initial public offering on May 23, 2001. The management fee will be eliminated and the management agreement will terminate, if in any subsequent renewal period the affiliates of Harvest Partners, Inc. sell more than 66.6% of the shares of the Company’s common stock they owned on May 23, 2001.

 

7. SEGMENT INFORMATION

 

The “management approach” called for by SFAS 131, “Disclosures about Segments of an Enterprise and Related Information” has been used by GPEG management to present the segment information which follows. GPEG considered the way its management team organizes its operations for making operating decisions and assessing performance and considered which components of its enterprise have discrete financial information available. Management makes decisions using a product group focus and its analysis resulted in two operating segments, Heat Recovery Equipment and Auxiliary Power Equipment. The Company evaluates performance based on net income or loss not including certain items as noted below. Intersegment revenues and transactions were not significant. Corporate assets consist primarily of cash and deferred tax assets. Interest income has not been allocated as cash management activities are handled at a corporate level. During the period ended March 27, 2004, we changed the basis by which we allocated corporate general and administrative expenses to the operating segments. This new manner of allocating corporate expenses better reflects the use of corporate resources by the operating segments. Prior year amounts were reclassified to conform to the 2004 presentation.

 

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The following table presents information about segment income and assets (in thousands):

 

     Heat Recovery Equipment

   Auxiliary Power Equipment

     Three Months Ended

   Three Months Ended

     March 27,
2004


   March 29,
2003


   March 27,
2004


    March 29,
2003


Revenues

   $ 28,436    $ 36,697    $ 26,690     $ 40,329

Interest expense

     116      263      188       367

Depreciation and amortization

     320      344      505       555

Income tax provision (benefit)

     908      381      (286 )     4,092

Segment income (loss)

     1,480      597      (466 )     6,399

Assets*

     68,405      118,417      88,286       108,566

 

* As of December 27, 2003, total assets in the Heat Recovery Equipment and Auxiliary Power Equipment segments were $77,027 and $97,545, respectively.

 

The following tables present information which reconciles segment information to consolidated totals (in thousands):

 

     Three Months Ended

 
     March 27,
2004


    March 29,
2003


 

Net income:

                

Total segment income

   $ 1,014     $ 6,996  

Unallocated interest income

     104       132  

Other

     (280 )     (262 )
    


 


Consolidated net income

   $ 838     $ 6,866  
    


 


     March 27,
2004


   

December 27,

2003


 

Assets:

                

Total segment assets

   $ 156,691     $ 174,572  

Corporate cash and cash equivalents

     50,444       42,172  

Other unallocated amounts, principally deferred tax assets

     71,331       64,252  
    


 


Consolidated total assets

   $ 278,466     $ 280,996  
    


 


 

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The following table represents revenues by product group (in thousands):

 

     Three Months Ended

     March 27,
2004


   March 29,
2003


Heat Recovery Equipment segment:

             

HRSGs

   $ 20,628    $ 27,958

Specialty boilers

     7,808      8,739
    

  

       28,436      36,697
    

  

Auxiliary Power Equipment segment:

             

Exhaust systems

     11,387      17,664

Inlet systems

     8,579      11,964

Other

     6,724      10,701
    

  

       26,690      40,329
    

  

Total

   $ 55,126    $ 77,026
    

  

 

The following table presents revenues by geographic region (in thousands):

 

     Three Months Ended

     March 27,
2004


   March 29,
2003


North America

   $ 28,854    $ 54,062

South America

     329      1,104

Europe

     5,853      6,722

Asia

     6,693      3,475

Middle East

     12,721      9,074

Other

     676      2,589
    

  

Total

   $ 55,126    $ 77,026
    

  

 

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8. MAJOR CUSTOMERS

 

The Company has certain customers that represent more than 10 percent of consolidated revenues. The revenue for these customers, as well as corresponding accounts receivable, as a percentage of the consolidated revenues and accounts receivable balances, at and for the three months ended March 27, 2004 and March 29, 2003 are as follows:

 

     Revenues

             
     Three Months Ended

    Accounts Receivable

 
     March 27,
2004


   

March 29,

2003


    March 27,
2004


    March 29,
2003


 

General Electric

   20 %   19 %   14 %   9 %

ExxonMobil

   10 %   2 %   0 %   1 %

Calpine

   10 %   0 %   7 %   2 %

Seimens Westinghouse

   9 %   16 %   9 %   7 %

Tenaska

   1 %   14 %   0 %   3 %

 

9. SUPPLEMENTAL CASH FLOW INFORMATION

 

Changes in current operating items were as follows (in thousands):

 

     Three Months Ended

 
     March 27,
2004


    March 29,
2003


 

Accounts receivable

   $ 7,693     $ (12,385 )

Inventories

     (868 )     186  

Costs and estimated earnings in excess of billings

     (1,500 )     30,411  

Accounts payable

     (4,187 )     (1,310 )

Accrued expenses and other

     (5,203 )     (9,215 )

Billings in excess of costs and estimated earnings

     7,201       (22,412 )
    


 


     $ 3,136     $ (14,725 )
    


 


 

Supplemental cash flow disclosures are as follows (in thousands):

 

     Three Months Ended

     March 27,
2004


    March 29,
2003


Cash paid (received) during the period for:

              

Interest

   $ 183     $ 601

Income taxes

     (2,320 )     3,238

 

During the first quarter of fiscal years 2004 and 2003, there was $4.0 million and $0 million, respectively, of tax benefit related to stock options exercised. The Company reflected the tax benefit of stock options exercised as a non-cash transaction in the condensed consolidated statements of cash flows.

 

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10. RECENT ACCOUNTING PRONOUNCEMENTS

 

In January 2003, the Financial Accounting Standards Board (FASB) issued FIN 46, “Consolidation of Variable Interest Entities.” This is an interpretation of ARB No. 51 “Consolidation of Financial Statements,” which addresses the consolidation by business enterprises of variable interest entities that either: (1) do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) the equity investors lack an essential characteristic of a controlling interest. In December 2003, the FASB issued a revision of FIN 46 (FIN 46R), which clarified certain complexities of FIN 46 and generally requires adoption of all special-purpose entities that qualify as variable interest entities no later than the end of the first reporting period ending after December 15, 2003 and to all non special-purpose entities that qualify as variable interest entities no later than the end of the first reporting period ending after March 15, 2004. At March 27, 2004, the Company did not have any entities that require disclosure or new consolidation as a result of adopting the provisions of FIN 46 or FIN 46R.

 

11. COMPREHENSIVE INCOME

 

The table below presents comprehensive income for all applicable periods (in thousands):

 

     Three Months Ended

     March 27,
2004


    March 29,
2003


Net income

   $ 838     $ 6,866

Foreign currency translation adjustments

     (65 )     378
    


 

Comprehensive income

   $ 773     $ 7,244
    


 

 

12. RESTRUCTURING

 

In October 2003, the Company announced a management restructuring plan pursuant to which certain employees were offered either one-time termination or retirement benefits. Certain employees that were offered the retirement incentive packages entered into consulting agreements with the Company subsequent to their retirement. The expense of the consulting agreements will be recognized as the services are provided over the term of the agreements. In addition, retiring employees were offered the right to amend their stock option agreements to extend the date such options remain exercisable from the original period of 90 days after termination of employment to a new period extending to one year after termination of employment. In some cases, this plan also provided for the acceleration of vesting for certain unvested stock options. Due to variable plan option accounting under APB Opinion No. 25, “Accounting for Stock Issued to Employees,” the Company will expense the intrinsic value of the options. The Company recorded charges of approximately $2.0 million during the first quarter of fiscal year 2004 related to the restructuring plan in selling and administrative expenses.

 

Under the 2003 management restructuring plan, a retirement benefits agreement was entered into with the Company’s Chief Executive Officer (CEO), Larry Edwards, pursuant to which he determines his own future retirement date. At this time, the retirement date is unknown. Upon retirement, Mr. Edwards will receive a payment of approximately $1.9 million, which was expensed in 2003 and is included in other long-term liabilities as of March 27, 2004.

 

From the inception of the management restructuring plan through March 27, 2004, the Company has incurred costs of approximately $5.9 million related to the plan. The Company expects to incur approximately $4.8 million of restructuring charges in the future, including an estimate of $2.7 million for the expected consulting fees and variable stock option expense related to the CEO’s retirement benefits agreement.

 

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A reconciliation of the liability (included in other current liabilities) for the restructuring costs from December 27, 2003 to March 27, 2004 is as follows:

 

Balance, December 27, 2003

   $ 797  

Payments to employees

     (797 )
    


Balance, March 27, 2004

   $ —    
    


 

The balance of $1.9 million in other long-term liabilities remained unchanged from December 27, 2003 to March 27, 2004.

 

Approximately $0.8 million and $1.2 million of the fiscal year 2004 restructuring costs were allocated to the Heat Recovery Equipment and Auxiliary Power Equipment segments, respectively.

 

13. STOCK-BASED COMPENSATION

 

Stock-based compensation is accounted for using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” No compensation expense is recorded for stock options when granted, as option prices have historically been set at the market value of the underlying stock at the date of grant.

 

SFAS 123 “Accounting for Stock-Based Compensation,” requires the measurement of the fair value of options to be included in the statement of operations or disclosed in the notes to the financial statements. The Company elected the disclosure-only alternative under SFAS 123.

 

Had compensation cost been determined consistent with SFAS 123, the Company’s pro forma net income would have been as follows:

 

     Three Months Ended

 
     March 27,
2004


    March 29,
2003


 

Net income available to common stockholders:

                

As reported

   $ 838     $ 6,866  

Stock-based compensation expense included return in net income as reported *

     302       —    

Additional stock-based compensation expense return had the fair value been applied to all awards

     (569 )     (147 )
    


 


Pro forma

   $ 571     $ 6,719  
    


 


Basic income per common share :

                

As reported

   $ 0.02     $ 0.16  

Pro forma

     0.01       0.15  

Diluted income per common share:

                

As reported

   $ 0.02     $ 0.15  

Pro forma

     0.01       0.15  

 

* Intrinsic value of stock options that were accelerated as a result of the management restructuring plan described in footnote 12 above.

 

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The paid-in capital deficit decreased significantly from December 27, 2003 to March 27, 2004 primarily as a result of 1,115,868 stock options that were exercised during this period. A reconciliation of the changes in the account is as follows:

 

Balance, December 27, 2003

   $ (25,492 )

Tax benefit of stock options exercised

     4,047  

Proceeds from stock options exercised in excess of par value

     1,405  

Stock-based compensation

     487  
    


Balance, March 27, 2004

   $ (19,553 )
    


 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Overview

 

In addition to historical information, this Form 10-Q includes certain “forward-looking statements.” Forward-looking statements represent our beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside of our control. These forward-looking statements include, in particular, the statements about our plans, strategies and prospects. When used in this report, the words “expect,” “may,” “intend,” “plan,” “anticipate,” “believe,” “seek” and similar expressions, as well as statements regarding our focus for the future, are generally intended to identify forward-looking statements. Although we believe that our plans, intentions and expectations reflected in or suggested by these forward-looking statements are reasonable, these forward-looking statements rely on assumptions and are subject to risks and uncertainties that may prevent us from achieving our plans, intentions or expectations.

 

Information concerning some of the risks, uncertainties and other factors that could cause actual results to differ materially from those in, or implied by, the forward-looking statements we make in this Form 10-Q is set forth under “Risk Factors” in Item 1 of our Form 10-K for the fiscal year ended December 27, 2003, and in this section. All forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by the cautionary statements, risks and uncertainties found in the sections mentioned above. Accordingly, undue reliance should not be placed on these forward-looking statements, which speak only as of the date of this Form 10-Q. We undertake no obligation to update or revise the forward-looking statements.

 

We design, engineer and fabricate a comprehensive portfolio of heat recovery and auxiliary power equipment and provide related services. We conduct our business through two operating segments: our Heat Recovery Equipment segment and our Auxiliary Power Equipment segment. The Company’s corporate headquarters are located in Tulsa, Oklahoma, with operating facilities in Plymouth, Minnesota; Tulsa, Oklahoma; Auburn, Massachusetts; Clinton, South Carolina; Monterrey, Mexico; Toluca, Mexico; Shanghai, China and Heerlen, Netherlands. During fiscal year 2003, we focused our efforts on maintaining profitability despite the decrease in revenues. These efforts included closing one manufacturing plant, reducing debt and implementing a management restructuring plan to reduce staff and related costs and improve competitiveness. In addition, we strengthened our sales and operating initiatives in China and Southeast Asia allowing us to take advantage of the increasing need for additional power in that region. However, the demand for new power plants in the United States has decreased significantly, and we enter the second quarter of fiscal year 2004 with uncertainty regarding when that demand may increase.

 

During the second quarter of 2003, we decided to permanently close our San Antonio, Mexico plant effective April 30, 2003. The decision was based primarily on a reduction in volume due to the downturn in new power plant construction within the U.S. The Auxiliary Power Equipment segment recorded approximately $170,000 in severance and other costs associated with the elimination of approximately 35 employees and the closing of the plant. During 2003, we have also scaled back operations at other locations in our efforts to continually seek to further our use of low-cost subcontractor fabrication as well as manage our costs due to the downturn in the U.S. market. Also in 2003, the Auxiliary Power Equipment and Heat Recovery segments further reduced their workforce by 201 and 41, respectively. The severance costs associated with these 2003 workforce reductions totaled approximately $390,000. All amounts have been paid.

 

In October 2003, we announced a management restructuring plan pursuant to which certain employees were offered either one-time termination or retirement benefits. Certain employees that were offered the retirement incentive packages entered into consulting agreements with us subsequent to their retirement. The expense of the consulting agreements will be recognized as the services are provided over the term of the agreements. In addition, retiring employees were offered the right to amend their stock option agreements to extend the date such options remain exercisable from the original period of 90 days after termination of employment to a new period extending to one year after termination of employment. In some cases, this plan also provided for the acceleration of vesting for certain unvested stock options. Due to variable plan option accounting under APB Opinion No. 25 (APB 25), “Accounting for Stock Issued to Employees,” we will expense the intrinsic value of the options.

 

Under the 2003 management restructuring plan, a retirement benefits agreement was entered into with our Chief Executive Officer (CEO), Larry Edwards, pursuant to which he determines his own future retirement date. At this time, his retirement date is unknown. Upon retirement, Mr. Edwards will receive a payment of approximately $1.9 million, which was expensed in 2003 and included in Other long-term liabilities as of March 27, 2004. This amount is included in the $3.9 million of restructuring costs recognized in fiscal year 2003. In addition, we agreed to pay Mr. Edwards approximately $812,000 in the future upon signing a release agreement on the

 

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retirement date. This amount will be expensed in the fiscal quarter in which he retires. On the retirement date, we plan to enter into a one-year consulting agreement with Mr. Edwards. The consulting fees, currently estimated at approximately $850,000, will be expensed as the services are rendered over the term of the agreement. This amount will change based on the actual salary and target bonus at the retirement date.

 

Under our current stock option plans, participants may exercise their vested options up to 90 days after their termination date. As part of his retirement benefits package, Mr. Edwards may execute an extension agreement, on the retirement date, whereby certain of his stock options become immediately fully vested. In addition, instead of the normal 90-day exercise period, Mr. Edwards would have one year from the retirement date to exercise his options. If this extension agreement were executed and these modifications were made to Mr. Edwards’ original stock option agreements, the Company could incur significant compensation expense in accordance with APB 25. The compensation expense would be measured on the retirement date, as the excess of the fair value of the stock over the exercise prices times the number of stock options outstanding. Assuming the number of options outstanding ($0.36/share options – 202,151 shares; $4.87/share options – 100,000 shares; $6.10/share options – 100,000 shares) and the closing stock price of $7.24 as of April 30, 2004, we estimate that this pre-tax charge would be approximately $1.9 million. This amount would vary based on the number of unexercised options and the stock price as of the retirement date.

 

We recorded charges of approximately $2.0 million during the first quarter of fiscal year 2004 related to the restructuring plan in selling and administrative expenses.

 

Results of Operations

 

The table below represents the operating results of the Company for the periods indicated (in thousands):

 

     Three Months Ended

     March 27,
2004


   March 29,
2003


Revenues

   $ 55,126    $ 77,026

Cost of sales

     43,313      55,808
    

  

Gross profit

     11,813      21,218

Selling and administrative expenses

     10,261      9,464
    

  

Operating income

     1,552      11,754

Interest expense, net

     200      498
    

  

Income before income taxes

     1,352      11,256

Income tax provision

     514      4,390
    

  

Net income available to common stockholders

   $ 838    $ 6,866
    

  

 

Our fiscal year ends on the last Saturday in December. As a result, references in this quarterly report to fiscal year 2003 refer to the fiscal year ending December 27, 2003. References to the first quarter of fiscal year 2004 refer to the three months ended March 27, 2004 and references to the first quarter of fiscal year 2003 refer to the three months ended March 29, 2003.

 

Three months ended March 27, 2004 compared to three months ended March 29, 2003

 

Revenues

 

Revenues decreased 28.4% to $55.1 million for the first quarter of fiscal year 2004 from $77.0 million for the first quarter of fiscal year 2003. This decrease is due to a continued decline in new orders for both Heat Recovery and Auxiliary Power equipment. Demand in the gas turbine power generation equipment industry in the United States began to decrease during the latter half of 2001 and that trend has continued into 2004. Consequently, the development of domestic gas turbine power plants has slowed considerably. We anticipate that revenues in fiscal 2004 will be lower than revenues in 2003 primarily due to the continued downturn in new power plant construction within the United States.

 

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The following table sets forth our segment revenues for the first quarter of fiscal years 2004 and 2003 (dollars in thousands):

 

     Three Months Ended

   Percentage
Change


 
     March 27,
2004


  

March 29,

2003


  

Heat Recovery Equipment segment:

                    

HRSGs

   $ 20,628    $ 27,958    -26.2 %

Specialty boilers

     7,808      8,739    -10.7 %
    

  

      

Total segment

   $ 28,436    $ 36,697    -22.5 %
    

  

      

Auxiliary Power Equipment segment:

                    

Exhaust systems

   $ 11,387    $ 17,664    -35.5 %

Inlet systems

     8,579      11,964    -28.3 %

Other

     6,724      10,701    -37.2 %
    

  

      

Total segment

   $ 26,690    $ 40,329    -33.8 %
    

  

      

 

The Heat Recovery Equipment segment revenues decreased 22.5% to $28.4 million for the first quarter of fiscal year 2004. Revenues for HRSGs decreased 26.2% to $20.6 million. Revenues for specialty boilers decreased by 10.7% to $7.8 million. The Auxiliary Power Equipment segment revenues decreased 33.8% to $26.7 million for the first quarter of fiscal year 2004. Revenues for exhaust systems decreased by 35.5% to $11.4 million. Revenues for inlet systems and other equipment decreased by 28.3% to $8.6 million and 37.2% to $6.7 million, respectively. The significant decrease this quarter is due to a significantly lower level of orders booked (including some sizable cancellations) during the second and third quarters of fiscal 2003. We expect that our second quarter of fiscal 2004 revenues will represent the low point for the year. Revenues for the second half of fiscal year 2004 are expected to improve given the higher level of bookings that began in the fourth quarter of fiscal year 2003 and extended into the first quarter of 2004.

 

The following table presents our revenues by geographic region (dollars in thousands):

 

     Three Months Ended

 
     March 27, 2004

    March 29, 2003

 
     Revenue

  

Percent

of Total


    Revenue

  

Percent

of Total


 

North America

   $ 28,854    52.4 %   $ 54,062    70.3 %

South America

     329    0.6 %     1,104    1.4 %

Europe

     5,853    10.6 %     6,722    8.7 %

Asia

     6,693    12.1 %     3,475    4.5 %

Middle East

     12,721    23.1 %     9,074    11.8 %

Other

     676    1.2 %     2,589    3.3 %
    

  

 

  

Total

   $ 55,126    100.0 %   $ 77,026    100.0 %
    

  

 

  

 

Revenues in North America comprised 52.4% of our revenues for the first quarter of fiscal year 2004 and 70.3% for the first quarter of fiscal year 2003. Revenues in North America decreased 46.6% to $28.9 million for the first quarter of fiscal year 2004, primarily as a result of the continued decrease in demand in the United States for our products. A number of factors have contributed to this situation such as debt and liquidity issues of several merchant power producing companies. While it is believed that the long-term need for power plants on a world-wide basis is substantial, we are unaware of when the demand in the United States will increase.

 

Revenues in Asia increased 92.6% for the first quarter of fiscal year 2004 to $6.7 million from $3.5 million for the first quarter of 2003. Asia represents a significant growth opportunity and is expected to account for an increasingly larger proportion of the Company’s revenues over the next several years. Revenues in Europe decreased by 12.9% to $5.9 million from $6.7 million for the first quarter of 2003 due to the timing of revenue recognized on several projects being sold last year compared to this year.

 

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Middle East revenues increased to $12.7 million for the first quarter of fiscal year 2004 from $9.1 million for the first quarter of 2003 primarily as a result of several large orders in Saudi Arabia.

 

Gross Profit

 

Gross profit decreased 44.3% to $11.8 million for the first quarter of fiscal year 2004 from $21.2 million for the first quarter of fiscal year 2003. Gross profit as a percentage of revenues decreased to 21.4% in the first quarter of fiscal year 2004 from 27.5% in the first quarter of fiscal year 2003. As expected, our first quarter of 2004 gross margin decreased to a more historical level. The primary reasons for the decrease are continued competitive pressures in the marketplace coupled with higher steel prices. We expect the margin to continue to decline somewhat in 2004; however, we are making efforts to minimize this by passing on the impact of higher steel prices to customers as new orders are negotiated.

 

Selling and Administrative Expenses

 

Selling and administrative expenses increased 8.4% to $10.3 million for the first quarter of fiscal year 2004 from $9.5 million for the first quarter of fiscal year 2003. This increase is due to the approximately $2.0 million of restructuring costs recognized in the first quarter of fiscal year 2004 partially offset by approximately $0.9 million of acquisition costs recognized in the first quarter of fiscal year 2003. As a percentage of revenues, selling and administrative expenses increased to 18.6% for the first quarter of fiscal year 2004 from 12.3% for the comparable period of fiscal year 2003 mainly as a result of our decreasing revenues.

 

Operating Income

 

Operating income decreased to $1.6 million for the first quarter of fiscal year 2004 from $11.8 million in the first quarter of fiscal year 2003. The decrease in revenues and associated gross profit were the main contributors to this decrease.

 

Interest Expense

 

Interest expense decreased to $0.2 million for the first quarter of fiscal year 2004 from $0.5 million for the first quarter of fiscal year 2003. This decrease is due primarily to a reduction in total debt of $43.4 million, of which, voluntary principal payments made in the first quarter amounted to $8.3 million. In addition, our significant levels of cash continue to result in substantial amounts of interest income. Our borrowing rate has decreased by approximately 19 basis points from March 29, 2003 due to general market interest rate reductions. At March 27, 2004, our term debt bore interest at an average rate of 2.26%.

 

Income Taxes

 

The Company is currently reflecting a 38.0% effective tax rate in the tax provision. Also, the reduction of the deferred tax asset related to the amortization of goodwill will allow us to reduce cash paid for future taxes by approximately $5.6 million annually, but will not reduce future income tax expense. We did not have any net operating loss carryforwards at March 27, 2004.

 

Liquidity and Capital Resources

 

Our primary sources of cash are net cash flow from operations and borrowings under our credit facilities. Our primary uses of this cash are principal and interest payments on indebtedness, capital expenditures and general corporate purposes.

 

Operating Activities

 

Net cash provided by (used in) operations increased to $9.3 million for the first three months of fiscal year 2004 from $(1.3) million for the first three months of fiscal year 2003. Significant collections of accounts receivable and an increase in billings in excess of costs and estimated earnings were the primary factors for this fluctuation.

 

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Investing Activities

 

Net cash used in investing activities increased to $0.1 million for the first three months of fiscal year 2004 from $0.06 million for the first three months of fiscal year 2003 due to a slight increase in capital expenditures.

 

Financing Activities

 

Net cash used in financing activities was $6.9 million in the first three months of fiscal year 2004 compared to $0.01 million in the first three months of fiscal year 2003. Long-term debt payments and proceeds from the issuance of common stock comprise the activity for the first three months of 2004. The long-term debt payments include a voluntary prepayment of $8.3 million. The proceeds from the issuance of common stock were higher in the first quarter of fiscal year 2004 due to approximately 1.1 million of stock options exercised.

 

The Company’s senior credit facility consists of a term loan of $60 million and a revolving loan of up to $75 million, which revolving loan supports the Company’s letters of credit. At March 27, 2004, the Company had $16.6 million outstanding under the term loan and no amount was outstanding under the revolver. Letters of credit totaling $41.1 million were issued and outstanding at March 27, 2004. Currently, there are no amounts drawn upon these letters of credit.

 

At the Company’s option, amounts borrowed under the amended and restated senior credit facility will bear interest at either the Eurodollar rate or an alternate base rate, plus, in each case, an applicable margin. The applicable margin will range from 1.0% to 2.25% in the case of a Eurodollar based loan and from 0% to 1.25% in the case of a base rate loan, in each case, based on a leverage ratio. At March 27, 2004, the term debt of $16.6 million bore interest at an average rate of approximately 2.26%.

 

The Company’s amended and restated senior credit facility:

 

  is guaranteed by all of its domestic subsidiaries;

 

  is secured by a lien on all of its and its domestic subsidiaries’ property and assets, including, without limitation, a pledge of all capital stock owned by it and its domestic subsidiaries, subject to a limitation of 65% of the voting stock of any foreign subsidiary;

 

  requires the Company to maintain minimum interest and fixed charge coverage ratios and limit its maximum leverage; and

 

  among other things, restricts the Company’s ability to (1) incur additional indebtedness, (2) sell assets other than in the ordinary course of business, (3) pay dividends in excess of 25% of its cumulative net income from January 1, 2001 through the most recent fiscal quarter end, subject to leverage and liquidity thresholds and other customary restrictions, (4) make capital expenditures in excess of $13 million in fiscal year 2001 or $10 million in any fiscal year, thereafter, with adjustments for carry-overs from the previous year, (5) make investments and acquisitions and (6) enter into mergers, consolidations or similar transactions.

 

The Company is currently in compliance with all covenant requirements under the senior credit facility. Because our financial performance is impacted by various economic, financial, and industry factors, we cannot say with certainty whether we will satisfy these covenants in the future. Noncompliance with these covenants would constitute an event of default, allowing the lenders to accelerate the repayment of any borrowings outstanding under the related amended and restated senior credit facility. While no assurances can be given, we believe that we would be able to successfully negotiate amended covenants or obtain waivers if an event of default were imminent; however, we might be required to make certain financial concessions. Our business, results of operations and financial condition may be adversely affected if we were unable to successfully negotiate amended covenants or obtain waivers on acceptable terms.

 

In the first quarter of fiscal year 2004, the Company’s senior credit facility was amended to provide for a one-time reduction in the fixed charge ratio covenant to reflect the reduction of the Company’s EBITDA (as defined in the credit agreement) related to the restructuring charges taken in the fourth quarter of fiscal year 2003 and the first quarter of fiscal year 2004. The Company was in compliance with the covenant for the fiscal quarter ended March 27, 2004.

 

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During the first quarter of fiscal 2004, the Company entered into two loan agreements with banks in China. The agreements allow for the Company to borrow $4.8 million at a rate of 5.31%. The agreements expire April 1, 2005. As of March 27, 2004, no amounts have been borrowed under the loan agreements. The loans are collateralized by letters of credit from the Company’s senior credit facility.

 

Cash Obligations

 

Under various agreements, we are obligated to make future cash payments in fixed amounts. These include payments under our amended and restated senior credit facility, our agreement with Harvest Partners, Inc., the 2003 management restructuring plan (including retirement and severance benefits and consulting fees) and rent payments required under operating lease agreements.

 

The following table summarizes our fixed cash obligations as of March 27, 2004 over various future periods (in thousands):

 

     Payments Due by Period

Contractual Cash Obligations


   Less than
1 Year


   1-3
Years


   4-5
Years


   After 5
Years


    Total

Long-term Debt

   $ 14    $ 16,633    $ —      $ —       $ 16,647

Restructuring Costs

     1,145      196      —        3,550 (1)     4,891

Operating Leases

     2,117      3,132      3,187      2,202       10,638
    

  

  

  


 

Total Contractual Cash Obligations

   $ 3,276    $ 19,961    $ 3,187    $ 5,752     $ 32,176
    

  

  

  


 

 

(1) Represents amount due to the Company’s CEO in a year subsequent to 2003 in which he resigns, which resignation will result in retirement benefits payments in the year of resignation and consulting fees in the 12-month period following the resignation.

 

At March 27, 2004 we had a contingent liability for stand-by letters of credit totaling $41.1 million that have been issued and are outstanding that generally were issued to secure performance on customer contracts. Currently, there are no amounts drawn upon these letters of credit.

 

In addition, the Company has various future obligations in connection with its 2003 management restructuring plan. A full discussion of the management restructuring plan is located in the Overview section above.

 

Finally, under a management agreement with Harvest Partners, Inc., we are contractually committed to annual payments of certain fees for financial advisory and strategic planning services to Harvest of $1.3 million per year. The terms of the management agreement provide for automatic renewals of additional one-year periods commencing each August unless terminated for cause or by Harvest. During any subsequent renewal period of the management agreement the management fee will decrease to $750,000 per year if the affiliates of Harvest Partners, Inc. sell more than 50% of the shares of the Company’s common stock they owned at the time of the Company’s initial public offering on May 23, 2001. The management fee will be eliminated and the management agreement will terminate, if in any subsequent renewal period the affiliates of Harvest Partners, Inc. sell more than 66.6% of the shares of the Company’s common stock they owned on May 23, 2001.

 

At March 27, 2004, the Company had available cash on hand of approximately $53.4 million and approximately $33.9 million of available capacity under its revolving credit facility. The Company may utilize borrowings under the revolving credit facility to supplement its cash requirements from time to time. The Company anticipates that it will generate sufficient cash flows from operations to satisfy its cash commitments and capital requirements for fiscal year 2004. The amount of cash flows generated from operations is subject to a number of risks and uncertainties, including the continued construction of gas turbine power generation plants as well as other risks described under “Item 1. Business- Risk Factors” in the Company’s Form 10-K for the fiscal year ended December 27, 2003, filed with the Securities and Exchange Commission. In fiscal 2004, the Company may actively seek and consider acquisitions of or investments in complementary businesses, products or services. The consummation of any acquisition using cash will affect the Company’s liquidity.

 

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Critical Accounting Policies

 

The following discussion of accounting policies is intended to supplement the Summary of Significant Accounting Policies presented as Note 2 to the consolidated financial statements, included in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the Company’s Form 10-K for the fiscal year ended December 27, 2003, filed with the U.S. Securities and Exchange Commission. These policies were selected because a fluctuation in actual results versus expected results could materially affect our operating results and because the policies require significant judgments and estimates to be made each quarter. Our accounting related to these policies is initially based on our best estimates at the time of original entry in our accounting records. Adjustments are periodically recorded when our actual experience differs from the expected experience underlying the estimates. These adjustments could be material if our experience were to change significantly in a short period of time. We regularly, on a monthly basis, compare our actual experience and expected experience in order to further mitigate the likelihood of material adjustments.

 

Revenue Recognition- GPEG currently has two segments: Heat Recovery Equipment and Auxiliary Power Equipment. Revenues and cost of sales for our Heat Recovery Equipment segment are recognized on the percentage-of-completion method based on the percentage of actual hours incurred to date in relation to total estimated hours for each contract. Our estimate of the total hours to be incurred at any particular time has a significant impact on the revenue recognized for the respective period. The percentage-of-completion method is only allowed under certain circumstances in which the revenue process is long-term in nature (often in excess of one year), the products sold are highly customized and a process is in place whereby revenues, costs and margins can be accurately estimated. Changes in job performance, job conditions, estimated profitability and final contract settlements may result in revisions to costs and income, and the effects of such revisions are recognized in the period that the revisions are determined. Under percentage-of-completion accounting, management must also make key judgments in areas such as percent complete, estimates of project costs and margin, estimates of total and remaining project hours and liquidated damages assessments. Any deviations from estimates could have a significant positive or negative impact on the results of operations. A one percent fluctuation of our estimate of percent complete would have increased or decreased first quarter of fiscal 2004 revenues by approximately $0.3 million.

 

Revenues for our Auxiliary Power Equipment segment are recognized on the completed-contract method due to the short-term nature of the product production period. Under this method, no revenue can be recognized until the contract is complete and the customer takes risk of loss and title. Similar to our Heat Recovery segment, changes in job performance, job conditions, estimated profitability and final contract settlements may result in revisions to job costs and income amounts that are different than were originally estimated.

 

During the course of a project or when a project has been completed, management may become aware of circumstances in which it should make provisions for estimated costs. Costs of this nature are common in our industry and inherent in the nature of our business. The Company records the estimated costs in the period in which they are identified. The costs are typically the result of warranty claims, final contract settlements and liquidated damages due to late delivery. Unanticipated cost increases or delays may occur as a result of several factors, including:

 

  increases in the cost or shortages of components, materials or labor;

 

  unanticipated technical problems;

 

  required project modifications not initiated by the customer; and

 

  suppliers’ or subcontractors’ failure to perform.

 

In some cases, cost overruns can be passed on to our customers, which are recognized in the period when agreement is reached with the customers as to the amount of the claims. The agreement may occur after project completion. Cost overruns that we cannot pass on to our customers or the payment of liquidated damages under our contracts will lower our gross profit and resulting operating income.

 

From time to time, customers have claims against the Company that result in litigation. The Company recognizes these claims as a charge to cost of sales in the period when it is probable they will result in a loss and the amount can be reasonably estimated.

 

While management has made its best efforts to record known adjustments to revenues and cost of sales for claims, settlements and damages for projects in process, it is possible that there are significant unknown adjustments that will be made in the future for those projects. These adjustments could have a material impact on gross profit percentages and resulting profitability in a given annual or quarterly reporting period.

 

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Nearly all of our contracts are entered into on a fixed-price basis. As a result, we benefit from cost savings, but have limited ability to recover for any cost overruns, except in those contracts where the scope has changed. Contract prices are established based in part on our projected costs, which are subject to a number of assumptions. The costs that we incur in connection with each contract can vary, sometimes substantially, from our original projections. Because of the large scale and long duration of our contracts, unanticipated changes may occur, such as customer budget decisions, design changes, delays in receiving permits and cost increases, which may delay delivery of our products and, in turn, delays revenue recognition.

 

Warranty- Estimated costs related to product warranty are accrued as revenue is recognized and included in cost of sales. Estimated costs are based upon past warranty claims and sales history. Warranty terms vary by contract but generally provide for a term of three years or less. We manage our exposure to warranty claims by having our field service and quality assurance personnel regularly monitor our projects and maintain ongoing and regular communications with the customer. In the first quarter of 2004, a one percent fluctuation of our warranty expense could increase or decrease cost of goods sold by approximately $0.02 million.

 

A reconciliation of the changes to our warranty accrual for the periods indicated are as follows:

 

     Three Months Ended

 
    

March 27,

2004


   

March 29,

2003


 

Balance at beginning of period

   $ 15,004     $ 19,460  

Accruals during the period

     2,042       1,654  

Changes in previous accruals

     (607 )     (676 )

Settlements made (in cash or in kind)
during the period

     (1,401 )     (714 )
    


 


Ending balance

   $ 15,038     $ 19,724  
    


 


 

Income Taxes- Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Company classifies deferred tax assets and liabilities into current and non-current amounts based on the classification of the related assets and liabilities. Certain judgments are made relating to recoverability of deferred tax assets, level of expected future taxable income and available tax planning strategies. These judgments are routinely reviewed by management.

 

Stock-based Compensation- Stock-based compensation is accounted for using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” No compensation expense is recorded for stock options when granted, as option prices have historically been set at the market value of the underlying stock at the date of grant.

 

Goodwill and Impairment of Long-Lived Assets- We perform annual impairment analyses on our recorded goodwill and long-lived assets whenever events and circumstances indicate that they may be impaired. The analysis includes assumptions related to future revenues, cash flows, and net assets. This analysis is based primarily on assumptions about future events such as revenue and cash flow growth rates, discount rates and terminal value of the Company. Actual deviations from the assumptions used in the analysis could have a significant impact on the estimated fair values calculated. Factors that would cause a more frequent test for impairment include, among other things, a significant negative change in the estimated future cash flows of a reporting unit that has goodwill because of an event or a combination of events. We did not record any impairment provisions upon the adoption of SFAS 142 nor have we recorded any in fiscal year 2003 or the first quarter of 2004.

 

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Related Parties

 

Affiliates of Harvest Partners, Inc. are our largest stockholders. In addition, two of the directors that serve on our board are both general partners of Harvest Partners, Inc. During the first three months of fiscal 2004 and the first three months of fiscal 2003, we incurred consulting expenses from Harvest in the amounts of $0.3 million in each three month period. Under a management agreement with Harvest, we are contractually committed to annual payments of certain fees for financial advisory and strategic planning services to Harvest of $1.3 million per year. The terms of the management agreement provide for automatic renewals of additional one-year periods commencing each August unless terminated for cause or by Harvest. During any subsequent renewal period of the management agreement, the management fee will decrease to $750,000 per year if the affiliates of Harvest Partners, Inc. sell more than 50% of the shares of the Company’s common stock they owned at the time of the Company’s initial public offering on May 23, 2001. The management fee will be eliminated and the management agreement will terminate, if in any subsequent renewal period the affiliates of Harvest Partners, Inc. sell more than 66.6% of the shares of the Company’s common stock they owned on May 23, 2001.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We are exposed to market risks. Market risk is the potential loss arising from adverse changes in market prices and interest and foreign currency rates. We do not enter into derivative or other financial instruments for speculative purposes. Our market risk could arise from changes in the credit worthiness of customers, interest rates and foreign currency exchange.

 

Credit Risks

 

Our financial instruments that are exposed to concentrations of credit risk consist primarily of trade receivables. Given the nature of our business, we typically have significant amounts due from a relatively low number of customers. At March 27, 2004, 30% of our trade receivables were due from three customers. In order to reduce our risk of non-collection, we perform extensive credit investigation of all new customers.

 

Interest Rate Risk

 

We are subject to market risk exposure related to changes in interest rates. Assuming our current level of borrowings, a 100 basis point increase in interest rates under these borrowings would have increased our interest expense for first quarter of fiscal year 2004 by approximately $0.06 million. However, under the terms of our amended and restated senior credit facility we are allowed to lock into interest rates for a period of up to twelve months on our long-term debt. In January 2004, we entered into fixed rate agreements currently yielding an average rate of 2.26% with varying maturity dates extending as long as eleven months on all of our outstanding long-term debt.

 

Foreign Currency Exchange Risk

 

Portions of our operations are located in foreign jurisdictions including Europe, Mexico and China. Our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. In addition, sales of products and services are affected by the value of the United States dollar relative to other currencies. Changes in currency rates may affect our cost of materials or labor purchased in foreign countries. We attempt to manage portions of our foreign currency exposure through denomination of cash receipts and cash disbursements in the same currency. Periodically, we manage our foreign currency exposure through the use of foreign currency forward exchange agreements. Forward agreements with a notional amount of $2.2 million were in place at March 27, 2004 with varying amounts due through December 2004. Currently, the Company recognizes changes in the fair values of the forward agreements through earnings. The fair values of unrealized losses on the forward agreements of approximately $0.05 million for the period ended March 27, 2004 are included in earnings.

 

Recent Accounting Pronouncements

 

In January 2003, the Financial Accounting Standards Board (FASB) issued FIN 46, “Consolidation of Variable Interest Entities.” This is an interpretation of ARB No. 51 “Consolidation of Financial Statements,” which addresses the consolidation by business enterprises of variable interest entities that either: (1) do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) the equity investors lack an essential characteristic of a controlling

 

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interest. In December 2003, the FASB issued a revision of FIN 46 (FIN 46R), which clarified certain complexities of FIN 46 and generally required adoption for all special-purpose entities that qualify as variable interest entities no later than the end of the first reporting period ending after December 15, 2003 and to all non special-purpose entities that qualify as variable interest entities no later than the end of the first reporting period ending after March 15, 2004. At March 27, 2004, the Company did not have any entities that required disclosure or new consolidation as a result of adopting the provisions of FIN 46 or FIN 46R.

 

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures (as such term is defined under Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information related to us, including our consolidated subsidiaries, required to be disclosed in our periodic reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Security and Exchange Commissions rules and forms.

 

Changes in Internal Controls Over Financial Reporting

 

There have been no changes in our internal controls over financial reporting during the period covered by this report that have materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

 

 

PART II. OTHER INFORMATION

 

 

ITEM 1. LEGAL PROCEEDINGS

 

Reference is made to the disclosure provided in Note 6, “Litigation, Commitments and Contingencies” to the Condensed Consolidated Financial Statements included in Item 1 of Part I of this Form 10-Q, which disclosure is incorporated herein.

 

 

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

 

  (a) Exhibits

 

10.1    Separation Agreement dated January 30, 2004, by and between Global Power Equipment Group Inc. and Gary J. Obermiller.
10.2    Consulting Agreement dated January 30, 2004, by and between Global Power Equipment Group Inc. and Gary J. Obermiller.
10.3    Employment Agreement, dated February 12, 2004, by and among Global Power Equipment Group Inc., Deltak, L.L.C. and Monte E. Ness.
31.1    Chief Executive Officer Certification pursuant to Rule 13a-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002.
31.2    Chief Financial Officer Certification pursuant to Rule 13a-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002.

 

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32.1    Chief Executive Officer Certification pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2    Chief Financial Officer Certification pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

  (b) Reports on Form 8-K

 

(1)   Form 8-K dated January 30, 2004 filed to report certain management changes under Item. 5.
(2)   Form 8-K dated February 17, 2004, filed to report under Item 12 earnings for the quarter and fiscal year ended December 27, 2003.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

   

Global Power Equipment Group Inc.

DATED: May 6, 2004

 

By: /s/ Larry Edwards


   

Larry Edwards

   

Chairman, Chief Executive Officer and President

 

 

    Global Power Equipment Group Inc.

DATED: May 6, 2004

 

By: /s/ James P. Wilson


   

James P. Wilson

   

Chief Financial Officer and Vice President of Finance

   

(Principal Financial Officer)

 

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Exhibit Index

 

Exhibit No.     
10.1    Separation Agreement dated January 30, 2004, by and between Global Power Equipment Group Inc. and Gary J. Obermiller.
10.2    Consulting Agreement dated January 30, 2004, by and between Global Power Equipment Group Inc. and Gary J. Obermiller.
10.3    Employment Agreement, dated February 12, 2004, by and among Global Power Equipment Group Inc., Deltak, L.L.C. and Monte E. Ness.
31.1    Chief Executive Officer Certification pursuant to Rule 13a-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002.
31.2    Chief Financial Officer Certification pursuant to Rule 13a-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002.
32.1    Chief Executive Officer Certification pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2    Chief Financial Officer Certification pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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