Gross profit from Fabricated Products increased to $334,000 (8.5% of segment net sales) in the second quarter of 2006 from $133,000 (3.7% of segment net sales) in the second quarter of 2005 and increased to $717,000 (9.1% of segment net sales) in the first six months of 2006 from $246,000 (3.6% of segment net sales) in the first six months of 2005. Fabricated Products gross profit increased for the three and six months ended June 30, 2006 over the same periods last year as a result of the improved propane tank market conditions that began late in the second quarter of 2005. This general market improvement resulted in higher demand and prices for our propane tank products. Sales of our other fabricated products should increase in the coming quarters as prototypes are approved, which will also help improve segment gross profit.
On May 31, 2006, we completed the sale of our manufacturing facility in Riverside, California, included in Assets Held for Sale at December 31, 2005. A gain of $7.7 million was recorded.
We finance operations with internally generated funds and available borrowings. At June 30, 2006, we had cash and cash equivalents of $75,000.
Net cash provided by operating activities in the first six months of 2006 was $14.8 million. This was primarily the result of our net income of $10.0 million, net of a gain on sale or property and equipment of $7.6 million, an increase in accounts payable and accrued liabilities of $8.8 million and a decrease in costs and estimated earnings in excess of billings and trade and other receivables, net of $10.6 million and $1.6, respectively, offset in part by a increase in inventories of $11.6 million. The increase in accounts payable resulted from the increase in steel inventory since the end of 2005. The change in costs and estimated earnings in excess of billings on uncompleted contracts, inventories, and trade and other receivables, net resulted from timing differences between production, shipment and invoicing of products.
Net cash used in investing activities in the first six months of 2006 was $5.1 million, which resulted from additions of property and equipment of $15.5 million, offset in part by proceeds from the sale of property and equipment of $10.4 million. Included in the additions of property and equipment is the payment of $4.1 million that resulted from our election to exercise the purchase option on an operating lease that matured in May 2006. Capital expenditures, excluding payments made for the purchase option of operating leases, are expected to be between $13.0 and $15.0 million in 2006.
Net cash used in financing activities in the first six months of 2006 was $9.8 million, which resulted primarily from the net payments on the notes payable to financial institutions of $5.9 million and the payments on the long-term debt of $4.3 million.
We had the following significant components of debt at June 30, 2006: a $65.0 million credit agreement, under which $35.5 million was outstanding; $8.6 million of Series B Senior Notes; $10.0 million of Senior Notes; $15.0 million of Series A Term Note, $10.5 million of Series B Term Notes, $10.0 million of Series C Term Notes, and $4.5 million of Series D Term Notes.
The credit agreement expires on May 20, 2010. The balance outstanding under the credit agreement bears interest at rates related to LIBOR plus 0.75% to 1.50%, or the lending institution's prime rate, minus 0.5% to 0.0%. We had $38.9 million outstanding under the line of credit bearing interest at a weighted average rate of 6.68%, partially offset by $3.4 million in cash receipts that had not been applied to the loan balance. At June 30, 2006 we had an additional net borrowing capacity under the line of credit of $29.5 million.
The Series A Term Note in the principal amount of $15.0 million matures on February 25, 2014 and requires annual payments in the amount of $2.1 million that begin February 25, 2008 plus interest of 8.75% paid quarterly on February 25, May 25, August 25 and November 25. The Series B Term Notes in the principal amount of $10.5 million mature on June 21, 2014 and require annual payments in the amount of $1.5 million that begin June 21, 2008 plus interest of 8.47% paid quarterly on March 21, June 21, September 21 and December 21. The Series C Term Notes in the principal amount of $10.0 million mature on October 26, 2014 and require annual payments of $1.4 million that begin October 26, 2008 plus interest of 7.36% paid quarterly on January 26, April 26, July 26 and October 26. The Series D Term Notes in the principal amount of $4.5 million mature on January 24, 2015 and require annual payments in the amount of $643,000 that begin January 24, 2009 plus interest of 7.32% paid quarterly on January 24, April 24, July 24, and October 24. The Series B Senior Notes in the principal amount of $8.6 million mature on April 1, 2008 and require annual payments of $4.3 million that began April 1, 2002 plus interest at 6.91% paid quarterly on January 1, April 1, July 1 and October 1. The Senior Notes in the principal amount of $10.0 million mature on November 15, 2007 and require annual payments in the amount of $5.0 million that began November 15, 2001 plus interest of 6.87% paid quarterly on February 15, May 15, August 15, and November 15. The Senior Notes and Series B Senior Notes (together, the “Notes”) also include supplemental interest from 0.0% to 1.5% (0.75% at June 30, 2006), based on our total minimum net earnings before tax plus interest expense (net of capitalized interest expense), depreciation expense and amortization expense (“EBITDA”) to total debt leverage ratio, which is paid with the required quarterly interest payments. The Notes, the Series A Term Note, the Series B Term Notes, the Series C Term Notes, and the Series D Term Notes (together, the “Term Notes”) and the credit agreement are collateralized by accounts receivable, inventory and certain equipment.
We lease certain equipment used in the manufacturing process. The average interest rate on the capital leases is 6.7%.
We have operating leases with respect to certain manufacturing equipment that require us to pay property taxes, insurance and maintenance. Under the terms of certain operating leases, we sold equipment to an unrelated third party (the “lessor”) who then leased the equipment back to us. These leases, along with other debt instruments already in place, and our credit agreement, best met our near term financing and operating capital requirements compared to other available options at the time they were entered into.
Certain of our operating lease agreements include renewals and/or purchase options set to expire at various dates. During the three months ended June 30, 2006 we elected to exercise the purchase option on an operating lease scheduled to expire and made a payment of $4.1 million. If we choose to elect the purchase options on the remaining lease scheduled to expire during 2006, we will be required to make a payment of $10.3 million. In addition, certain of our operating lease agreements, primarily manufacturing equipment leases, with terms of 3 years, contain provisions related to residual value guarantees, which provide that if we do not purchase the leased equipment from the lessor at the end of the lease term, then we are liable to the lessor for an amount equal to the shortage (if any) between the proceeds from the sale of the equipment and an agreed value. The maximum potential liability to us under such guarantees is $16.6 million at June 30, 2006 if the proceeds from the sale of terminating equipment leases are zero. Consistent with past experience, management does not expect any payments will be required pursuant to these guarantees, and no amounts have been accrued at June 30, 2006.
We also have entered into stand-by letters of credit that total approximately $6.5 million as of June 30, 2006. The stand-by letters of credit relate to workers’ compensation and general liability insurance. Due to the nature of these arrangements and our historical experience, we do not expect to make any significant payments under these arrangements.
14
The credit agreement, the Notes, the Term Notes and operating leases all require compliance with the following financial covenants: minimum consolidated tangible net worth, maximum consolidated total debt to consolidated EBITDA ratio, a minimum consolidated fixed charge coverage ratio and a minimum asset coverage ratio. These and other covenants included in our financing agreements impose certain requirements with respect to our financial condition and results of operations, and place restrictions on, among other things, our ability to incur certain additional indebtedness, to create liens or other encumbrances on assets and capital expenditures. A failure by us to comply with the requirements of these covenants, if not waived or cured, could permit acceleration of the related indebtedness and acceleration of indebtedness under other instruments that include cross-acceleration or cross-default provisions. At June 30, 2006, we were not in violation of any of the covenants in our debt agreements.
We expect to continue to rely on cash generated from operations and other sources of available funds to make required principal payments under the Notes during 2006. We anticipate that our existing cash and cash equivalents, and amounts available under our credit agreement will be adequate to fund our working capital and capital requirements for at least the next twelve months. To the extent necessary, we may also satisfy capital requirements through additional bank borrowings, senior notes, term notes and capital and operating leases, if such resources are available on satisfactory terms. We have from time to time evaluated and continue to evaluate opportunities for acquisitions and expansion. Any such transactions, if consummated, may use a portion of our working capital or necessitate additional bank borrowings.
Off Balance Sheet Arrangements
Other than non-cancelable operating lease commitments, we do not have off-balance sheet arrangements, financings, or other relationships with unconsolidated entities or other persons, also known as “special purpose entities.”
Related Party Transactions
We have ongoing business relationships with certain affiliates of Wells Fargo & Company (“Wells Fargo”). Wells Fargo, together with certain of its affiliates, is our largest shareholder. During the three and six months ended June 30, 2006, we made payments to affiliates of Wells Fargo for operating lease payments, pursuant to which the Company leases certain equipment from such affiliates. During the three and six months ended June 30, 2005, we also made the following payments to affiliates of Wells Fargo: (i) payments of interest and fees pursuant to letters of credit originated by such affiliates, (ii) payments of principal and interest on an industrial development revenue bond, and (iii) payments of principal, interest and related fees in connection with loan agreements between the us and such affiliates. Payments made by us to Wells Fargo and its affiliates amounted to $87 and $225, respectively, for the three and six months ended June 30, 2006, and $2.3 million and $3.1 million, respectively, for the three and six months ended June 30, 2005. Balances due to Wells Fargo and its affiliates were $0 at June 30, 2006 and December 31, 2005.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
We use derivative financial instruments from time to time to reduce exposure associated with potential foreign currency rate changes occurring between the contract date and the date when the payments are received. These instruments are not used for trading or for speculative purposes. We have six Foreign Exchange Agreements (“Agreements”) at June 30, 2006, which were for an original amount of $13.0 million. The Agreements guarantee that the exchange rate does not go below the rate used in the contract bid amount. As of June 30, 2006, $5.6 million was still open. We believe our current risk exposure to exchange rate movements to be immaterial.
We are exposed to cash flow and fair value risk due to changes in interest rates with respect to certain portions of our debt. The debt subject to changes in interest rates is our $65.0 million revolving credit line ($35.5 million outstanding as of June 30, 2006). We believe our current risk exposure resulting from interest rate movements to be immaterial.
Additional information required by this item is set forth in “Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”
15
Item 4. Controls and Procedures
As of June 30, 2006, the end of the period covered by this report, our Chief Executive Officer and our Chief Financial Officer reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e) and 15d-15(e)), which are designed to ensure that material information we must disclose in our report filed or submitted under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized, and reported on a timely basis. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that as of such date, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is accumulated and communicated as appropriate to allow timely decisions regarding required disclosure.
In the three months ended June 30, 2006, there has been no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
Part II – Other Information
Item 1A. Risk Factors
There have been no material changes in the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.
Item 4. Submission of Matters to a Vote of Security Holders
The Company’s annual meeting of shareholders was held on May 9, 2006. The following matter was submitted to shareholders for their consideration:
With respect to the nomination for directors identified in the Company’s Proxy Statement; Brian W. Dunham received 5,333,783 votes and 927,396 votes were withheld, Richard A. Roman received 5,956,943 votes and 304,236 votes were withheld, and Wayne B. Kingsley received 5,591,661 votes and 669,518 votes were withheld.
The other directors whose terms of office continue after the annual meeting are: Neil R. Thornton and William R. Tagmyer.
Item 6. Exhibits
(a) The exhibits filed as part of this Report are listed below:
Exhibit
Number | | Description |
| 31.1 | | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| 31.2 | | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| 32.1 | | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
| 32.2 | | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
16
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.
By: /s/ BRIAN W. DUNHAM | |
Brian W. Dunham | |
President and Chief Executive Officer |
| | |
By: /s/ JOHN D. MURAKAMI | |
John D. Murakami | |
Vice President, Chief Financial Officer |
(Principal Financial Officer) | |
| | | |
17
