For the nine months ended September 30, 2004, the Company’s funded backlog, defined as orders placed for which funds have been appropriated or purchase orders received, increased $7,433,000 or 2.3%, including increases in the Defense and Energy segments of $4,577,000 and $2,856,000, respectively. The increase in funded backlog for the Defense segment was primarily due to the receipt of $115,454,000 of orders during the third quarter of 2004, the more significant of which were for continued logistical support for TUAV systems deployed in Operation Iraqi Freedom and for the C-17 Maintenance Training System program. In addition, this amount includes approximately $6,600,000 of orders awarded by the U.S. Defense Department under a new contract to provide logistical support for biological detection systems at U.S. facilities around the world.
In connection with the discontinued transportation operations, AAI owns a 35% share of Electric Transit, Inc. (“ETI”). Skoda a.s. (“Skoda”), a Czech company, owns the remaining 65% share of ETI. ETI’s one remaining production contract with the San Francisco Municipal Railway (“MUNI”) involves the design and manufacture of 273 electric trolley buses (“ETBs”). In executing its contract with MUNI, ETI has entered into subcontracts with AAI, certain Skoda operating affiliates and others. Both AAI and the Skoda operating affiliates have essentially completed their initial delivery requirements and are now subject to warranty requirements. As of April 13, 2004, ETI had delivered all 273 ETBs in discharge of its delivery obligations under the MUNI contract. By the end of 2004, it is anticipated that ETI will have substantially completed a retrofit program that incorporates final design changes for many of the previously delivered buses.
The ability of ETI to satisfy its remaining obligations is, in part, dependent on the performance of other parties, including AAI, the Skoda operating affiliates and other subcontractors. Thus, the ability to timely perform under the MUNI contract is, to a significant extent, outside of ETI’s control. Skoda’s operating affiliates have delivered products and services under their subcontracts with ETI through October 2004. Following Skoda’s bankruptcy declaration in 2001 in the Czech Republic, effective as of 2002, AAI began recording 100%, instead of 35%, of ETI’s losses in accordance with equity method accounting rules applicable to minority shareholders. Although AAI has substantially completed performance on its subcontract with ETI on the MUNI contract, AAI has continued to provide ETI with personnel in order to enable ETI to satisfy its remaining commitments to MUNI.
There were no sales in the discontinued transportation operations during the nine months ended September 30, 2004, as AAI’s subcontract with ETI was essentially complete. Sales were $3,870,000 and $12,013,000 for the three months and nine months ended September 30, 2003, respectively.
For the three months ended September 30, 2004, the loss before income taxes for the Company’s discontinued transportation operations was $421,000, a decrease of $25,345,000 compared to the corresponding period in the prior year. The results for the third quarter of the prior year include a pretax loss of $23,994,000 primarily for the loss estimated at that time to be incurred by ETI to complete the production and warranty phases of its one remaining contract to provide ETBs to MUNI, $1,392,000 of costs related to idle capacity at AAI’s leased transportation facility, and $376,000 of the Company’s general and administrative expenses related to the discontinued transportation operations. For the nine months ended September 30, 2004, the loss before income taxes was $1,444,000, a decrease of $27,799,000 compared to the corresponding period in the prior year. The results for the first nine months of the prior year include a pretax loss of $24,389,000 primarily related to the future contract losses estimated at that time to be incurred by ETI to complete the electric trolley bus contract with MUNI, $3,572,000 of costs related to idle capacity at AAI’s leased transportation facility, and $1,281,000 of the Company’s general and administrative expenses related to the discontinued transportation operations.
For additional information regarding the discontinued transportation operations, see Note L to the Consolidated Condensed Financial Statements included in this Quarterly Report on Form 10-Q.
Liquidity and Capital Resources
Cash and cash equivalents increased $78,363,000 during the nine months ended September 30, 2004 to $102,501,000. For the first nine months of 2004, net cash provided by operating activities of the Company’s continuing operations was $4,917,000, which was partially offset by net cash used in operating activities of the discontinued operations of $4,051,000. Net cash used in investing activities was $2,864,000, primarily for purchases of property and equipment. Net cash provided by financing activities for the nine months ended September 30, 2004 was $80,361,000, including approximately $92,044,000 of net proceeds from the issuance and sale of the 3.75% Convertible Senior Notes after the concurrent repurchase of 850,400 shares of Common Stock for $24,356,000 and deducting $3,600,000 of investment banking fees associated with the sale. Financing activities also included $3,352,000 of cash receipts from the exercise of stock options, partially offset by $10,486,000 of cash used for the repurchase of the Company’s Common Stock under its previously announced repurchase programs, $3,881,000 of cash used for the payment of dividends, and $668,000 used for the repayment of long-term debt related to the financing of AAI’s new enterprise resource planning information system (“ERP System”). Changes in operating assets and liabilities of the Company’s continuing operations used cash of $25,671,000 during the nine months ended September 30, 2004, including an increase in accounts receivable of $22,030,000 primarily due to significant billings at the end of the quarter, an increase in inventory of $19,501,000 due to higher production levels as well as a temporary deferral in certain billing milestones, an increase in prepaid expenses and other current assets of $754,000, and a net decrease in long-term liabilities and other assets - net of $487,000, partially offset by increases in accounts payable of $5,344,000, customer advances of $3,897,000, Federal income taxes payable of $3,551,000, employee compensation accruals of $3,215,000, and other current liabilities of $1,094,000.
The Company does not anticipate having to contribute cash to the UIC Retirement Pension Plan during 2004. However, the Company expects to contribute $36,000 to the union plan in the Energy segment during the remainder of 2004.
The Company currently has no significant fixed commitments for capital expenditures except for the implementation of a new ERP System. The Company expects to acquire approximately $5,300,000 of capital assets and incur approximately $3,000,000 of other costs related to this implementation. In connection with this project, the Company has entered into a three-year financing arrangement with Oracle Credit Corporation, which commenced on July 1, 2004, that covers the cost of software, hardware, certain consultants and maintenance fees, and will result in quarterly cash payments of approximately $330,000 during the period July 1, 2004 through April 1, 2007. As of September 30, 2004, the Company has capitalized approximately $2,600,000 related to this ERP System project. The cash required to completely exit the discontinued transportation operations subsequent to September 30, 2004, is expected to be approximately $9,000,000 through 2008, of which $3,000,000 is expected to be expended during the remainder of 2004. This amount includes AAI’s agreements with MUNI, but excludes legal fees to be incurred in connection with defending claims made against AAI by ALSTOM related to the sale of certain transportation contracts in 2002, as well as legal fees to be incurred related to claims made by AAI in pursuit of payment under a surety bond (see Note L to the Consolidated Condensed Financial Statements included in this Quarterly Report on Form 10-Q for a discussion of the ALSTOM claims). No assurances can be given, however, as to the actual amount of the Company’s liability to exit the discontinued transportation operations.
The Board of Directors of the Company authorized the repurchase of up to $20,000,000 of the Company’s Common Stock through November 11, 2005. The exact number of shares to be repurchased will depend on market conditions. During the first nine months of 2004, the Company repurchased 560,100 shares of Common Stock under the plan for an aggregate amount of $10,486,000, or $18.72 per share. Considering prior year purchases, approximately $3,478,000 remains available for future purchases under this authorization.
In September 2004, United Industrial issued and sold $120,000,000 aggregate principal amount of 3.75% Convertible Senior Notes. The Company intends to use the balance of the net proceeds for potential acquisitions and general corporate purposes. The Company is evaluating and expects to continue to evaluate and engage in discussions regarding potential acquisitions. However, the Company currently has not entered into any agreements or commitments to make any
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acquisitions. Pending such uses, the Company is investing the balance of the net proceeds in short-term, interest-bearing investments. As a result of the issuance and sale of the 3.75% Convertible Senior Notes, the Company anticipates that it will have to make additional interest payments of approximately $4,500,000 per year as long as the $120,000,000 aggregate principal amount remains outstanding. In addition, the Company incurred approximately $1,000,000 of professional and printing fees in connection with the issuance and sale that were not paid as of September 30, 2004.
On June 28, 2001, the Company and certain of its subsidiaries entered into a Loan and Security Agreement (the “Credit Agreement”) with Bank of America Business Capital (formerly Fleet Capital Corporation), secured by all of the assets of the Company and such subsidiaries. The Credit Agreement had an original term of three years and provides for letters of credit and cash borrowings, subject to a borrowing base. The Credit Agreement provides for up to $25,000,000 of credit advances, with a sub limit of $10,000,000 for cash borrowings. Credit advances may increase to $32,000,000 provided that amounts in excess of $25,000,000 are cash-collateralized. At September 30, 2004, there were no cash borrowings under the Credit Agreement. The letter of credit obligations outstanding at September 30, 2004 under the Credit Agreement were $6,654,000, which results in approximately $18,346,000 available for borrowings under the Credit Agreement. On May 18, 2004, the Credit Agreement was further amended to, among other things, extend its original term from a June 28, 2004 maturity date to March 31, 2005, eliminate a $6,000,000 borrowing base reserve, modify certain of the existing financial covenants, and establish a new covenant limiting the net cash payments relating to the Company’s discontinued transportation operations to $11,500,000 for the year ending December 31, 2004 and $6,000,000 for the year ending December 31, 2005. On August 16, 2004, the Credit Agreement was further amended to increase the amount of the Company’s Common Stock that may be repurchased from $20,000,000 to $30,000,000. On September 8, 2004, in connection with the issuance and sale of the 3.75% Convertible Senior Notes, the Credit Agreement was again amended to, among other things, (i) permit the Company to incur the additional indebtedness as a result of the sale of the 3.75% Convertible Senior Notes, (ii) increase the amount of the Company’s Common Stock that may be repurchased from $30,000,000 to $55,000,000, of which $25,000,000 may only be used from the net proceeds of the sale of the 3.75% Convertible Senior Notes, (iii) establish a new covenant prohibiting the Company from making certain cash payments under the 3.75% Convertible Senior Notes unless the Company is in compliance with certain financial covenants and maintains a liquidity measure as defined in the amendment of not less than $15,000,000, (iv) eliminate a reserve applied to the cash borrowing sub limit, and (v) modify certain of the financial covenants and change the definition of the Consolidated Fixed Charge Coverage Ratio (defined as the ratio of EBITDA divided by fixed charges, each as defined) to include certain voluntary principal payments and all interest payments under the 3.75% Convertible Senior Notes in the calculation of fixed charges. Management believes that the Company will be successful in its ability to negotiate a new financing arrangement in the future with Bank of America Business Capital or another party. However, no assurances can be given as to whether the Company will be able to obtain new financing.
Detroit Stoker also has a $2,000,000 unsecured line of credit with a bank that may be used for cash borrowings or letters of credit. The term of this financing arrangement, previously set to expire on July 1, 2004, was extended for one year and expires on July 1, 2005. At September 30, 2004, Detroit Stoker had no cash borrowings and $816,000 of letters of credit outstanding, which results in approximately $1,184,000 available for borrowings under the line of credit.
Based on the remaining net proceeds from the issuance and sale of the 3.75% Convertible Senior Notes, the existing Credit Agreement and current initiatives and operations, the Company expects that available cash and existing lines of credit will be sufficient to meet its cash requirements for the next twelve months.
On April 15, 2004, the Company entered into a contract to sell approximately 26 acres of undeveloped property adjacent to its Hunt Valley, Maryland facility for $8,000,000. Closing is expected to occur no later than January 14, 2005. However, the Company can elect to accelerate the closing. By contract, the Company has received a non-refundable $150,000 deposit. No assurances can be given, however, as to whether the contract will be closed or the timing of the sale.
In accordance with its previously disclosed strategic initiatives, the Company is exploring the sale of non-core assets, seeking to maximize efficiency, and considering select acquisitions to grow its core defense businesses. Accordingly, in October 2003 the Company engaged Imperial Capital LLC to assist the Company in a potential sale of the Detroit Stoker Energy segment. No assurances can be given regarding whether Detroit Stoker will be sold or the timing or proceeds from any such sale.
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Contingent Matters
Off-Balance Sheet Arrangements
In connection with certain contracts, United Industrial’s operating subsidiaries have committed to certain performance guarantees. The ability to perform under these guarantees may, in part, be dependent on the performance of other parties, including partners and subcontractors. If the United Industrial’s operating subsidiaries are unable to meet these performance obligations, the performance guarantees could have a material adverse effect on product margins and the Company’s results of operations, liquidity or financial position. United Industrial’s operating subsidiaries monitor the progress of their partners and subcontractors, and United Industrial does not believe that the performance of these partners and subcontractors will adversely affect these contracts as of September 30, 2004. No assurances can be given, however, as to the liability of United Industrial’s operating subsidiaries if partners or subcontractors are unable to perform their obligations.
Other Contingent Matters
The Company is involved in various lawsuits and claims, including asbestos-related litigation and one environmental matter. Except as set forth in Note L to the Consolidated Condensed Financial Statements included in this Quarterly Report on Form 10-Q, there have been no material changes in litigation since the Company filed its Annual Report on Form 10-K for the year ended December 31, 2003. For further information, refer to the Consolidated Financial Statements and Notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and to Note L to the Consolidated Condensed Financial Statements included in this Quarterly Report on Form 10-Q.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as reported amounts of revenues and expenses during the reporting period. Judgments and assessments of uncertainties are required in applying the Company’s accounting policies in many areas. Actual results could differ from these estimates.
There have been no revisions to the Critical Accounting Policies as filed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.
Recent Accounting Developments
See Note E to the Consolidated Condensed Financial Statements included in this Quarterly Report on Form 10-Q for a discussion of recent accounting developments.
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Item 3. - Quantitative and Qualitative Disclosures about Market Risk
A portion of the Company’s operations consists of manufacturing and sales activities in foreign jurisdictions, and some of these transactions are denominated in foreign currencies. As a result, the Company’s financial results could be affected by changes in foreign exchange rates. To mitigate the effect of changes in these rates, the Company has entered into foreign exchange contracts. There has been no material change in the firmly committed sales exposures and related derivative contracts from December 31, 2003 (see Item 7A in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003).
On September 15, 2004, the Company issued and sold $120,000,000 of 3.75% Convertible Senior Notes. Several features contained in the indenture governing the 3.75% Convertible Senior Notes are considered embedded derivative instruments, including the Conversion feature, Repurchase Event Make-Whole Premium, Contingent Interest, and the Make-Whole Interest Payment, each of which is discussed below and in Note G to the Consolidated Condensed Financial Statements included in this Quarterly Report on Form 10-Q. The Company is accounting for these embedded derivative instruments pursuant to Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and related amendments and guidance. The Contingent Interest and Make-Whole Interest Payment features were bifurcated from the 3.75% Convertible Senior Notes and are being accounted for separately as derivative instruments. The aggregate fair value assigned to these embedded derivatives initially and at September 30, 2004 was approximately $530,000. The Company will record gains or losses in its Consolidated Condensed Statements of Operations for changes in the fair value of each of these embedded derivatives. The Conversion feature and Repurchase Event Make-Whole Premium feature were not required to be bifurcated and separately accounted for as derivative instruments.
Each of the embedded derivatives may result in certain payments to the holders of the 3.75% Convertible Senior Notes, as described below:
Conversion Feature
The 3.75% Convertible Senior Notes are convertible into shares of the Company’s Common Stock prior to stated maturity at an initial conversion rate, subject to adjustment, of 25.4863 shares per $1,000 principal amount of the 3.75% Convertible Senior Notes (equal to an initial conversion price of approximately $39.24 per share) under certain circumstances. Upon conversion, the Company may choose to deliver, in lieu of shares of the Company’s Common Stock, cash or a combination of cash and shares of the Company’s Common Stock. If converted at the initial conversion price of $39.24, the Company could elect to issue to the holders of the 3.75% Convertible Senior Notes 3,058,356 shares of the Company’s Common Stock, $120,000,000, or a combination thereof.
Repurchase Event Make-Whole Premium
If any of the holders of the 3.75% Convertible Senior Notes elect to require the Company to repurchase any of their outstanding holdings as the result of a Repurchase Event that occurs prior to September 15, 2009, the Company will pay at its option in cash, in shares of Common Stock, or a combination thereof to such holders a Repurchase Event Make-Whole Premium. The amount of the Repurchase Event Make-Whole Premium is equal to the principal amount of the notes multiplied by a specified percentage. The maximum Repurchase Event Make-Whole Premium will occur if a Repurchase Event occurs during the first year the 3.75% Convertible Senior Notes are outstanding and the average of the closing sale prices of the Company’s Common Stock for a specified period is $40.00 per share. In this event, the Repurchase Event Make-Whole Premium would be $20,880,000.
Contingent Interest
The Company will pay Contingent Interest to the holders of the 3.75% Convertible Senior Notes during any six-month interest period from March 15 to September 14, and from September 15 to March 14, commencing with the six-month period starting September 15, 2009, if the average market price of the 3.75% Convertible Senior Notes for the five trading days ending on the third trading day immediately preceding the first day of the relevant six-month period equals 120% or more of the principal amount of the 3.75% Convertible Senior Notes. The amount of Contingent Interest payable in respect
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of any six-month period will equal 0.23% of the average market price of the 3.75% Convertible Senior Notes for the specified period referred to above. For example, if the average market price of the 3.75% Convertible Senior Notes is 120% of the principal amount for the specified period then the aggregate annual amount of Contingent Interest would be $552,000.
Make-Whole Interest Payment
The Company may also elect to automatically convert some or all of the outstanding 3.75% Convertible Senior Notes on or prior to maturity if the closing price of its Common Stock has exceeded 150% of the conversion price for a specified period prior to the notice of its election to automatically convert. If such an Automatic Conversion occurs on or prior to September 15, 2009, the Company will pay a Make-Whole Interest Payment at the time of conversion in cash or, at its option, in shares of Common Stock, equal to five full years of interest, less any interest actually paid or provided for prior to Automatic Conversion. For example, if the Company has the ability and elects to automatically convert the 3.75% Convertible Senior Notes after two interests payments have been made then the Make-Whole Interest Payment would be $18,000,000. At the Company’s option, the Make-Whole Interest Payment is payable in cash or the Company’s Common Stock valued at 95% of the average of the closing price of the Common Stock for a specified period.
The interest rate on the 3.75% Convertible Senior Notes is fixed and, accordingly, not affected by changes in interest rates. However, if interest rates decline, the interest paid by the Company on the 3.75% Convertible Senior Notes could be at above market rates. The Company has agreed to file a shelf registration statement with the Securities and Exchange Commission within 90 days of September 15, 2004, and to use its reasonable best efforts to cause such registration statement to become effective within 210 days of September 15, 2004. If such registration statement is not filed by December 15, 2004, or such registration statement does not become effective by April 15, 2005 (each a “Registration Default”), additional interest will be paid to the holders of the 3.75% Convertible Senior Notes at the annual rate of 0.25%, or up to $75,000 for the first 90 days after any such Registration Default, and thereafter at an annual rate of 0.50%, or $600,000 per year, until the events are satisfied.
Item 4. - Controls and Procedures
(a) | The Company’s management evaluated, with the participation of the Company’s principal executive and principal financial officers, the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of September 30, 2004. Based on their evaluation, the Company’s principal executive and principal financial officers concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2004. |
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(b) | There has been no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the Company’s fiscal quarter ended September 30, 2004, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. |
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PART II - OTHER INFORMATION
Item 1. - Legal Proceedings
Reference is made to the information contained in the section entitled “Contingent Matters” under Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” set forth above and to Note L to the Consolidated Condensed Financial Statements included herein, which information is incorporated herein by reference.
Item 2. - Unregistered Sales of Equity Securities and Use of Proceeds
For information regarding the Company’s purchases of its equity securities, please reference Note O to the Consolidated Condensed Financial Statements included herein, which information is incorporated herein by reference.
Item 6. - Exhibits
| 10.1 | Indenture dated as of September 15, 2004 by and among the Registrant, AAI Corporation and U.S. Bank National Association, as trustee. (1) |
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| 10.2 | Registration Rights Agreement dated as of September 15, 2004 by and among the Registrant and AAI Corporation, and UBS Securities LLC and the other initial purchaser named in the Purchase Agreement, dated September 9, 2004 among the Registrant, AAI Corporation and the initial purchasers, for whom UBS Securities LLC is acting as representative. (2) |
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| 10.3 | Tenth Amendment to the Loan Agreement dated as of September 8, 2004 among the Company and certain of its subsidiaries, as Borrowers, and Fleet Capital Corporation (currently known as Bank of America Business Capital), as Lender. (3) |
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| 10.4 | Employment Agreement, dated August 17, 2004, between the Registrant and Jonathan A. Greenberg. (4) |
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| 10.5 | Ninth Amendment to the Loan Agreement dated as of August 16, 2004 among the Company and certain of its subsidiaries, as Borrowers, and Fleet Capital Corporation (currently known as Bank of America Business Capital), as Lender. (5) |
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| 31.1 | Rule 13a - 14(a) Certification of Chief Executive Officer of the Company. |
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| 31.2 | Rule 13a - 14(a) Certification of Chief Financial Officer of the Company. |
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| 32.1 | Section 1350 Certification of the Chief Executive Officer of the Company. |
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| 32.2 | Section 1350 Certification of the Chief Financial Officer of the Company. |
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| (1) | Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 16, 2004. |
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| (2) | Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 16, 2004. |
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| (3) | Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 10, 2004. |
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| (4) | Incorporated by reference to Exhibit 99.2 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 8, 2004. |
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| (5) | Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 8, 2004. |
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SIGNATURE
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.
| UNITED INDUSTRIAL CORPORATION |
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Date: November 9, 2004 | By: | /s/ JAMES H. PERRY |
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| | James H. Perry
Chief Financial Officer,
Vice President and Treasurer
(as duly authorized officer
and principal accounting officer) |
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INDEX OF EXHIBITS FILED HEREWITH
Exhibit No. | |
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31.1 | Rule 13a - 14(a) Certification of the Chief Executive Officer of the Company. |
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31.2 | Rule 13a - 14(a) Certification of the Chief Financial Officer of the Company. |
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32.1 | Section 1350 Certification of the Chief Executive Officer of the Company. |
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32.2 | Section 1350 Certification of the Chief Financial Officer of the Company. |
