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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(Mark one) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1998
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: 000-23231
INNOVATIVE VALVE TECHNOLOGIES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 76-0530346
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
2 NORTHPOINT DRIVE, SUITE 300 77060
HOUSTON, TEXAS ZIP CODE
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE): (281) 925-0300
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
None Not applicable
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock, par value $.001 per share
(Title of class)
Rights to Purchase Series A Junior
Participating Preferred Stock
(Title of class)
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
As of March 29, 1999, there were 9,664,562 shares of common stock, par
value $.001 per share, of the Registrant issued and outstanding, 6,213,381 of
which, having an aggregate market value of $5,048,392, based on the closing
price per share of the common stock of the Registrant reported on the Nasdaq
National Market on that date, were held by non-affiliates of the Registrant. For
purposes of the above statement only, all directors and executive officers of
the Registrant are assumed to be affiliates.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement related to the Registrant's 1999 Annual
Stockholders Meeting are incorporated by reference into Part III of this report.
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TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business............................. 1
Item 2. Properties........................... 14
Item 3. Legal Proceedings.................... 14
Item 4. Submission of Matters to a Vote of
Security Holders................... 14
PART II
Item 5. Market for Registrant's Common Equity
and Related Stockholder Matters.... 15
Item 6. Selected Financial Data.............. 16
Item 7. Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 16
Item 7A. Quantitative and Qualitative
Disclosures About Market Risk...... 20
Item 8. Financial Statements and
Supplementary Data................. 21
Item 9. Changes in and Disagreements with
Accountants on Accounting and
Financial Disclosure............... 21
PART III
Item 10. Directors and Executive Officers of
the Registrant..................... 21
Item 11. Executive Compensation............... 21
Item 12. Security Ownership of Certain
Beneficial Owners and Management... 21
Item 13. Certain Relationships and Related
Transactions....................... 21
PART IV
Item 14. Exhibits, Financial Statement
Schedules, and Reports on Form
8-K................................ 21
( i )
PART I
ITEM 1. BUSINESS
GENERAL
Innovative Valve Technologies, Inc. ("Invatec," and collectively with its
operating subsidiaries, the "Company") was created to be the leading
single-source provider of comprehensive maintenance, repair, replacement and
value-added distribution services for industrial valves, piping systems and
other process-system components (collectively, "repair and distribution
services") throughout North America. To achieve this goal, Invatec conducted an
aggressive acquisition program through the first half of 1998 and began
implementing a national operating strategy it had designed to enhance internal
growth, market share and profitability.
Invatec was incorporated in Delaware on March 6, 1997. In October 1997,
Invatec closed its initial public offering (the "IPO") of its Common Stock and
simultaneously acquired seven established businesses (the "Initial Acquired
Businesses") providing various repair and distribution services. Since then and
through December 31, 1998, Invatec has acquired thirteen additional repair and
distribution services businesses (the "Additional Acquired Businesses" and,
together with the Initial Acquired Businesses, the "Acquired Businesses"). See
"Businesses Acquired in 1998" elsewhere in this Item 1. The consideration paid
for acquisitions made in 1998 consisted primarily of common stock of the Company
and cash borrowed under the Company's $90 million credit facility with its bank
lenders established in October 1997 (the "Old Credit Facility").
The Acquired Businesses have been in business an average of 24 years, and
the Company currently has 63 operating locations in the United States, two in
Europe and one in the Middle East. Its principal executive offices are located
at 2 Northpoint Drive, Suite 300, Houston, Texas 77060, and its telephone number
at that address is (281) 925-0300.
RECENT DEVELOPMENTS
The Company's customers consist primarily of refineries, chemical,
petrochemical, power and pulp and paper plants, the businesses of which tend to
be cyclical. Margins in those industries are highly sensitive to demand cycles,
and the Company's customers in those industries have historically tended to
delay capital projects, expensive turnarounds and other maintenance projects
during slow periods. Commencing with the second quarter of 1998 and continuing
into 1999, the Company's business was negatively impacted by significant
slowdowns experienced by its customers in the petroleum refining, petrochemical,
chemical, and pulp and paper industries.
As a result of the above-described downturns affecting the Company's
customers, the Company's level of business declined during 1998 and the
Company's earnings for the last three quarters of 1998 fell significantly short
of expectations. Consequently, this decline in earnings resulted in a severe
reduction in the market price of the Company's Common Stock. Declining earnings
also ultimately resulted in the Company defaulting on its Old Credit Facility as
a result of failing to meet certain financial covenants which required specific
levels of earnings in relation to debt. This default left the Company unable to
borrow funds for acquisitions thereunder. The Company remained in default under
the loan agreement from July 20, 1998 through March 25, 1999. The Company's
acquisition program has been effectively suspended since July 1998 as a result
of the low price of the Company's common stock and its inability to borrow funds
under the Old Credit Facility. Invatec is obligated under certain price
guarantee provisions of its acquisition agreements to issue a substantial number
of additional shares of its Common Stock on the anniversary dates of those
acquisitions. See "Businesses Acquired in 1998" elsewhere in this Item 1.
The Company amended its Old Credit Facility on March 26, 1999 (the "New
Credit Facility") to provide for a one year facility consisting of a $35
million stationary term component and up to a $45 million revolving line of
credit from its existing bank group. The New Credit Facility prohibits the
Company from making acquisitions and provides for increasingly high overall
borrowing costs if the facility is not substantially reduced or replaced prior
to July 1, 1999. As a result, the Company is currently seeking a
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significant equity infusion to enable it to reduce its debt, obtain a new credit
facility on better terms and potentially resume its acquisition program on a
scaled down, strategic basis. A significant equity infusion could have a
substantially dilutive effect on existing shareholders. It is uncertain whether
the Company's efforts to find new equity and debt financing will be successful
or that if such efforts are successful the Company will have sufficient
resources to resume its acquisition program. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources" in Item 7 of this Report.
Since the suspension of the Company's acquisition program, the Company has
focused on efforts to cut costs and otherwise improve profitability. During
1998, the Company eliminated in excess of $5 million in annualized costs,
including substantial corporate overhead. In 1999, the Company intends to
continue its cost cutting program. This program is expected to include
downsizing certain of its operations to fit the current level of business,
consolidation of certain locations, consolidating marketing efforts currently
conducted by different subsidiary companies and other potential improvements in
operational efficiency. See "Business Strategies" elsewhere in this Item 1.
Despite these cost cuts, the Company anticipates that it will be difficult
to improve overall profitability in 1999 due to the high cost of funds under the
New Credit Facility, unless it obtains a more favorable credit facility or
business improves dramatically. The Company has not experienced any significant
improvement in the level of its business during 1999. The Company cannot predict
when or whether its business level will rebound. In addition, there can be no
assurance that a further deterioration in the Company's business will not occur.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" in Item 7 of this Report.
FACTORS THAT MAY AFFECT FUTURE RESULTS
This report contains statements of management's plans and objectives and
other "forward-looking statements" that involve a number of risks,
uncertainties and assumptions. No assurance can be given that actual results
will not differ materially from these statements as a result of various factors,
including the factors set forth immediately above in "Recent Developments" and
the following:
The Company's ability to generate internal growth is dependent on its
ability to (i) integrate its businesses into a cohesive, efficient enterprise,
(ii) expand the range of repair services of its businesses, (iii) leverage its
relationships with customers in existing markets into work for those customers
in other markets where they currently use the services of competitors and (iv)
reduce overhead costs. The Company's ability to expand services will also depend
upon its ability to attract and retain qualified operating management, service
technicians and machinists in existing and new areas of operation.
The Company performs a significant portion of its repair services in
refineries, chemical plants and other industrial facilities that process,
produce, store, transport or handle potentially hazardous substances, including
highly corrosive, flammable or explosive substances kept at extremes of
temperature and pressure. These services (i) include sealing leaks and repairing
valves on process units operating under pressure, (ii) typically involve a
combination of individuals and machinery operating in restricted work areas and
(iii) are subject to the usual hazards associated with providing on-site
services in these types of facilities, such as pipeline leaks and ruptures,
explosions, fires, oil and chemical spills, discharges or releases of toxic
substances or gases. These hazards can cause personal injury and loss of life,
severe damage to or destruction of property and equipment and environmental
damage and may result in suspension of operations of all or part of the facility
being serviced. If a catastrophic event occurs at a plant to which the Company
provides services, the Company may have to defend itself against large claims.
It maintains insurance coverage in the amounts and against the risks it believes
accord with industry practice, but this insurance does not cover all types or
amounts of liabilities. No assurance can be given that either (i) this insurance
will be adequate to cover all losses or liabilities the Company may incur in its
operations or (ii) the Company will be able to maintain insurance of the types
or at levels it deems necessary or adequate or at rates it considers reasonable.
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The markets for the Company's repair and distribution services generally
are highly competitive. Some of its competitors may have lower overhead cost
structures and, consequently, may be able to provide their services at lower
rates than the Company or require the Company to lower its gross margins.
A wide range of federal, state and local regulations relating to health,
safety and environmental matters apply to the Company's business. See
"Governmental Regulation and Environmental Matters" elsewhere in this Item 1.
No assurance can be given the Company's compliance with current, amended, new or
more stringent laws or regulations, stricter interpretations of existing laws or
the future discovery of environmental conditions will not require additional,
material expenditures by the Company.
The success of the Company's operations will depend on the continuing
efforts of its executive officers and the senior management of the Acquired
Businesses. The business or prospects of the Company could be affected adversely
if any of these persons do not continue in their respective management roles.
The success of the Company's growth strategy generally, as well as the Company's
current operations, will depend on the extent to which it is able to retain,
recruit and train qualified sales personnel, service technicians and machinists
who meet the Company's standards of service to customers.
The success of the Company as a value-added distributor of new valves and
other process-system components depends, in part, on its relationships with the
Original Equipment Manufacturers ("OEMs") for which it distributes products.
In these relationships, the Company acts either as a sales representative on a
commission basis for direct sales by the OEM to the end user or purchases
products on a discounted basis for resale, generally on a value-added basis.
OEMs typically exercise a great deal of control over their distributors. An OEM
may assign a territory to a distributor on an exclusive or nonexclusive basis,
refuse to assign additional territories to its distributors and reserve the
right to sell directly to customers in an assigned territory. The typical
distribution agreement is terminable at will on relatively short prior notice
and restricts the ability of the distributor to offer similar products made by
another OEM. The Company's business strategy has caused concern by some OEMs and
could conflict with existing or future OEM distributor policies or programs.
Actions taken by OEMs to exploit their bargaining positions with the Company
could materially adversely affect the Company's ability to implement its growth
strategies and maintain its existing distribution services business. See
"Suppliers -- Relationships With OEMs" elsewhere in this Item 1.
The success of the Company as a value-added distributor also depends on the
extent to which its OEMs are able to create demand for their products in the
markets the Company serves. Factors affecting this demand include, in addition
to price, product quality and performance (including durability and safety) and
delivery time, the relative strengths of the brand names and the marketing
abilities of the OEMs. See "Competition" elsewhere in this Item 1.
INDUSTRY BACKGROUND
OVERVIEW. Petroleum refineries, petrochemical, chemical plants, pulp and
paper mills, electric and other utilities and other industrial process
facilities use industrial valves to direct and regulate the flow of feedstocks,
intermediates, products and fuels in their process piping systems. Industrial
valves serve as mechanical control, blocking and pressure-relief devices in
piping applications involving a myriad of liquids, gases, dry materials,
slurries and other substances. The service environments for industrial valves
range from relatively benign to severe, and the useful life of an industrial
valve can range from several hours to 30 years or more depending on the severity
of its service and other factors. These factors include the materials comprising
the valve, the quality of its manufacture and the frequency and quality of its
repair. Valves include rising stem valves ("RSVs"), such as globe, gate and
diaphragm valves, and pressure safety, relief and safety-relief valves
("PRVs"). Process industries use PRVs to relieve excess pressure in process
equipment, pressure vessels, boilers and pipelines in order to prevent
explosions or other system damage. PRVs typically are designed to contain
pressure up to a predetermined level (which is individually set for each valve)
and then to open and relieve excess pressure in a controlled manner. Standard
PRVs are self-operating and typically are spring loaded, while actuated PRVs
typically are operated by a pilot controller that actuates the valve.
3
Process systems consist of discrete units or trains of units which
generally operate continuously under pressure. In many process industries, these
systems handle corrosive substances and are subject to high cycling rates and
extremes of pressure and temperature. The process systems in the industries the
Company serves generally require emergency work and comprehensive scheduled
periodic off-line repairs (called "turnarounds"). Emergency work is performed,
if practicable, while the affected unit remains in operation and under pressure.
On-line repairs historically have consisted of sealing leaking pipes and flanges
with various enclosures and clamps and repacking leaking valves as interim
measures pending the next scheduled turnaround. Turnarounds typically involve
the shutdown of an entire process unit or trains of process units to permit the
disassembly, repair and/or replacement and reassembly of component parts
(including industrial valves), a process that can take from a few days to
several months.
OEMs of industrial valves generally sell their products through various
independent distribution channels. Value-added distribution services include the
assembly, testing, sealing and certification of PRVs and customizing original
equipment to meet the customer's specifications.
Repair services include "on-line" repairs of valves, piping systems and
other process-system components that continue to operate under pressure while
the repair is made and "off-line" repairs involving the repair of valves and
other process-system components that have been temporarily removed from a
process system. Off-line repairs are made either at the customer's facility (an
"on-site" repair) or in the repair service company's facility (an "in-shop"
repair).
In the United States, end users, distributors and repair companies perform
most repair and distribution services, while OEMs generally offer these services
only on a limited basis. The Company believes that, as part of an overall
emphasis on reducing operating costs, many end users are increasing their
outsourcing of various non-revenue-producing activities, such as plant
maintenance (including outsourcing of entire valve maintenance and management
programs).
MARKET ENVIRONMENT AND TRENDS. The Company provides service to end users
in primarily the following three categories of process industries in the United
States and Mexico: (i) petroleum refineries, petrochemical, chemical plants, and
pulp and paper mills (process manufacturers); (ii) conventional and nuclear
electric power plants and cogenerators and water and wastewater utilities
(utilities); and (iii) crude oil and natural gas producers, gas processing
plants and oil, gas and products pipelines (resource industries). These groups
are characterized by severe service applications in their processes which
require valves that can endure corrosive substances, flammable and explosive
materials, high cycling rates and extremes of pressure and temperature. The
Company believes economic conditions (generally and in these targeted groups),
technological developments and health, safety and environmental concerns drive
the markets for repair services and value-added distribution services in these
groups. The Company's customers consist of process manufacturers, the businesses
of which tend to be cyclical. Margins in those industries are highly sensitive
to demand cycles and the Company's customers in those industries have
historically tended to delay capital projects, expensive turnarounds and other
maintenance projects during slow periods.
Commencing with the second quarter of 1998 and continuing into 1999, the
Company's business was negatively impacted by significant slowdowns experienced
in the petroleum refining, petrochemical, chemical, and pulp and paper
industries. As a result of the above-described downturns affecting the Company's
customers, the Company's business declined during 1998. Although the power
utilities business was relatively strong, it was not significant enough to
offset the decline in other industries. In addition, the Company believes that
increasing deregulation of utilities has resulted in some uncertainty in that
business, which may temporarily adversely affect demand in that industry.
Although the downturn has adversely affected virtually all of the Company's
businesses, it has had a severe effect on the distribution side of the business
which is driven more by spending on capital projects and large turnarounds. The
Company has not yet experienced any significant improvement in the level of its
distribution business during 1999. The Company cannot predict when or whether
the level of its business will rebound. Any improvement will depend primarily on
a rebound in the underlying business of its petroleum refining, petrochemical,
chemical, and pulp and paper customers. Even prior to the downturn, the Company
believes that for a number of years, many companies in these industries
lengthened the period of
4
time between turnarounds to minimize the economic costs associated with
turnarounds and delayed construction of new plant facilities. In recent years,
various factors have led companies in these industries to undertake capital
expenditure programs to retool their existing process operations with newer and
more cost efficient processes. The Company believes this trend has strengthened
both the replacement market for industrial valves and the market for
independent, comprehensive repair services.
Since the Company's customers in targeted industries generally manufacture
or produce commodities, they compete generally on the basis of price with each
other and, in many cases, with overseas companies having lower-cost labor pools
or raw material or other competitive advantages. The downward pressure this
competition places on prices has led to the trend in these industries to attempt
to achieve operating efficiencies as a means of preserving or enhancing
operating margins while remaining competitive in their markets. Also
contributing to this trend are various technological developments that enable
these industries to reduce operating costs by modernizing existing process
systems and other plant operations or replacing existing process systems with
new, more efficient systems. For example, some industries have developed new
process technologies requiring equipment to operate under higher pressures and
thus entailing the replacement or pressure-resetting of installed PRVs.
Similarly, automation of valve and other process control devices and
computerized information management systems enable these industries to use a
smaller work force to perform essential non-revenue-producing services, while
the emergence of reliable independent service providers in areas such as valve
repair service, inventory management and turnaround planning enables these
industries increasingly to outsource these services, typically at a net savings.
The Company believes that many companies in these industries have eliminated or
severely reduced the size of their own maintenance crews and engineering staffs.
In addition, in order to reduce the size of their purchasing departments and the
costs of contract administration, these companies are trending towards using
fewer in-house administrators overseeing a reduced number of vendors performing
an increasing amount of services.
Another factor driving certain of the Company's targeted industries towards
spending for new valves and related products and new valve repair service
technologies is the mandate of the federal Clean Air Act, as amended in 1990,
that various process industries, including most of those the Company serves, (i)
to minimize the occurrences of fugitive emissions from their process systems of
certain volatile organic compounds or other hazardous air pollutants and (ii) to
control the emissions that do occur. To achieve compliance with the applicable
performance standards, federal and state regulations require the process
industries covered thereby to establish leak detection and repair programs
incorporating specified protocols.
BUSINESS STRATEGIES
As a result of the downturn in the Company's business and its limited
financial resources, the Company has focused on various short-term strategies to
reduce costs and improve profitability. One of these strategies includes
downsizing certain of its operations to fit its current level of business.
The Company has 66 operating locations. The Company believes that it can
decrease costs by combining certain locations and continue to service the
customers from other nearby Company facilities without significantly affecting
its business.
Additionally, many of the Company's operating subsidiaries service the same
customers using different sales and marketing staff. The Company believes there
are opportunities to consolidate such sales and marketing efforts and
significantly reduce related costs.
Although the Company believes that it would be beneficial to conduct
additional strategic acquisitions, it is unclear whether it will have the
resources to do so in the foreseeable future. The Company believes that the
downturn in its business has in most instances severely affected potential
acquisition candidates so that there are many attractive acquisition
opportunities. With the suspension of the Company's acquisition program,
executive management will, however, have the opportunity to increase its focus
on improving operations, including continued implementation of its national
operating strategy described below.
To enhance its market position as a leading national provider of repair and
distribution services, the Company continues to implement its national operating
strategy aimed at increasing internal growth and market share and enhancing
profitability. These strategies focus on capitalizing on certain trends in the
5
Company's targeted industries, including increased outsourcing, reducing the
number of vendors, and increasingly more stringent regulatory requirements
applicable to process-system facilities.
The principal elements of the Company's long-term national operating
strategy are: (i) cross-selling repair and distribution services; (ii)
capitalizing on the Company's geographic diversity to develop national and
regional customer and OEM relationships; and (iii) achieving cost efficiencies
and standardizing and implementing "best practices". See "Repair Services,"
"Distribution Services," "Operations" and "Sales and Marketing" elsewhere
in this Item 1. Various factors may affect the extent to which the Company is
able to implement this strategy successfully. See "Factors That May Affect
Future Results" elsewhere in this Item 1.
BUSINESSES ACQUIRED IN 1998
A description of the 1998 acquisition program follows.
On February 27, 1998, the Company acquired Cypress Industries, Inc.
("Cypress"). The total purchase price for Cypress was approximately $17.0
million in cash and assumed debt. Cypress, through its three operating
divisions, provides field machining, valve repair, specialized welding and
babbit bearing repair services to its customers, which include the power utility
industry, steel mills and other related industrial markets. Cypress is
headquartered in Schaumburg, Illinois and has operating locations in Cincinnati,
Ohio and Atlanta, Georgia.
On March 16, 1998, the Company acquired IPS Holding, Ltd., and its direct
and indirect subsidiaries, International Piping Services Company, IPSCO (U.K.)
Limited, Mid-America Energies, Corp. and IPSCO-Florida, Inc. (collectively,
"IPSCO"). The total purchase price for IPSCO was approximately $11.9 million
in cash and assumed debt and 807,828 shares of Common Stock. IPSCO, with its
headquarters in Downers Grove, Illinois and through its domestic operating
locations in Florida, Illinois, New Jersey, North Carolina and Texas and its
international operations in England, Germany and United Arab Emirates, provides
on-line piping and valve services, which include hot tapping, line stopping and
leak sealing. In addition, IPSCO manufactures certain small diameter hot tapping
and line stopping machinery for sale to industrial customers and service
companies that provide hot tapping and line stopping services.
During, 1998, the Company purchased an additional seven other businesses.
The total purchase price the Company paid for the seven businesses included
approximately $9.3 million in cash and assumed debt, $0.4 million of convertible
subordinated notes and 941,224 shares of Common Stock. See Notes 2 and 3 of the
Notes to Consolidated Financial Statements of the Company. As a result of these
acquisitions, the Company has expanded its business to include on-line hot
tapping and line stopping services both in the United States and abroad, repair
and replacement of steam turbines and other repair services.
Three of the acquisition agreements for the Additional Acquired Businesses
contain provisions requiring the Company to pay additional amounts (the "Makeup
Amount") to the former shareholders of each acquired business on the first
anniversary of that acquisition if the price of Invatec Common Stock on that
anniversary date is below a certain level. Two of those acquisition agreements
were entered into on July 9, 1998, and give Invatec the option of paying up to
one-half of the Makeup Amount in cash, with the remainder paid in Common Stock
valued at the market price on the anniversary date. The third agreement was
entered into on June 29, 1998 and gives Invatec the option of paying the entire
Makeup Amount in cash or Common Stock valued at the market price on the
anniversary date.
The Makeup Amount in each case is the difference between a set price, being
at or slightly above the market price of Invatec Common Stock on the closing
date of the acquisition, and the greater of (i) the market price of Invatec
Common Stock on the first anniversary of the closing date or (ii) $2.50. If the
price of Invatec Common Stock at the respective anniversary dates of each of
those acquisitions is not greater than $2.50 per share, the aggregate Makeup
Amount would be $6,516,104, of which $4,971,250 may be paid in cash instead of
Invatec Common Stock. The price of Invatec Common Stock was less than $2.50 per
share on March 29, 1999. See "Market for Registrant's Common Equity and Related
Stockholder Matters" in Item 5 of this Report. If the market price of Invatec
Common Stock on the anniversary dates of the acquisitions were the same as its
market price of $.8125 on March 29, 1999 and Invatec paid the maximum
6
of $4,971,251 of the Makeup Amount payable in cash, an additional 1,901,358
shares, or approximately 20% of its shares currently issued and outstanding,
would be due the former shareholders of those acquired businesses. The issuance
of those shares could have a substantial dilutive effect on existing
shareholders. It is impossible to determine with certainty what the ultimate
maximum cash portion of the Makeup Amount will be or whether the Company will
have sufficient cash available for such payments when they are due. See
"Liquidity and Capital Resources" in Item 7 of this Report. If the Company is
unable to pay the maximum cash portion of the Makeup Amount in cash and is
required to satisfy such obligation by delivery of additional shares, the
dilution to existing shareholders would be substantially greater than if cash is
available to satisfy the obligation.
In addition, one of the acquisition agreements requires Invatec to pay to
each former shareholder for each share of Invatec Common Stock sold by such
shareholder after six but before twelve months from the closing date of June 29,
1998, the amount by which $8.35 exceeds the greater of (i) the current market
price as of the date on which such share is sold or (ii) $7.35,which was the
current market price as of the closing date. At its current stock price levels,
Invatec would owe those former shareholders $1.00 per share sold by them before
June 29, 1999, payable at Invatec's option in cash or Common Stock valued at its
market price on the first anniversary of the closing. As of March 29, 1999, none
of the shares issued in that acquisition has been sold and an aggregate of
250,102 shares are available for sale by the former shareholders.
REPAIR SERVICES
The Company provides a variety of off-line repair services (including both
on-site and in-shop repair services) and on-line repair services for valves,
piping systems and other process-system components. These services vary by
industry and by process applications within each industry.
OFF-LINE SERVICES. The Company's off-line services include: diagnosis and
testing of valve performance, including nondestructive examination using dye
penetrants and mag-particle testing; repair, rebuilding and replacement of
valves; custom-designing, machining and plating of pressure-sealed gaskets;
repair and upgrading of standard valves of various types; repair and replacement
of actuators and positioners used with actuated valves; and cleaning of valves
used in hazardous and other service applications; inspection, repair and
replacement of steam turbine components; field machining and reconditioning and
casting babbitted bearings used as linings between stationary bearings and
rotating shafts. Valve repair services include: replacing broken stems and other
components with OEMs' parts or equivalent parts that the Company machines and
fabricates; blasting valve interiors with metal shot to remove process residue
and corroded material; welding overlays to refinish valve seats and other worn
areas; upgrading standard valves with actuators and related parts; and modifying
existing components to meet OEMs' specifications for repacking with new, pliable
packing materials. In some locations, the Company also reconditions its
customers' used valves, and remanufactures used valves (other than PRVs) it has
purchased, typically at scrap metal value, to equal or exceed the original OEMs'
specifications. It typically sells its remanufactured valves under a one-year
warranty at a discount from the price of a comparable new valve. As part of the
repair process, the Company uses high-pressure air, steam and liquid lines and
related instrumentation to test and certify the performance capabilities of the
valves and other equipment it repairs.
An important part of the Company's repair services is providing detailed
documentation of the sources and types of the materials and components used to
make repairs, the repair methods applied, the design specifications adhered to
and test results. Customers can use this information in connection with their
planning for future turnarounds and repairs. In addition, customers subject to
federal and state fugitive emissions control regulations are required to
maintain this information in their corrective action files.
ON-LINE SERVICES. The Company's on-line services include (i) hot tapping
and line stopping services; (ii) using conventional technologies to seal leaking
pipes, flanges and valves as interim measures pending the affected system's next
scheduled shutdown and turnaround and (iii) in the case of RSVs leaking as a
result of the deterioration of their stem-packing materials, using its
SafeSeal 2/5 system to restore the packing materials generally to their original
performance capabilities.
7
Hot tapping involves the use of special equipment to cut into a piping
system operating under pressure in order to connect a new pipe or other
process-system component. Line stopping is a means of stopping flow and
providing a shut-off in a piping system where none exists. This service enables
the customer to isolate piping system lines for repairs, alterations or
relocations. The Company provides these services to offshore pipelines as well
as to onshore plants and pipeline systems.
In performing interim on-line repairs, the Company designs line enclosures
and flange clamps to meet customer-specific technical and engineering objectives
and applicable industry and regulatory code requirements.
In SafeSeal [T] valve restorations, the Company uses a valveless injection
fitting and a combination of specialized tools to inject the appropriate pliable
(or "nonhardening") compound into the valve's packing gland. The compound
supplements the existing packing to stop the leak and restore the sealing
capability of the packing. The Company believes the SafeSeal system is safer,
more effective and more cost-efficient than conventional on-line valve-repacking
methods.
OPERATING HAZARDS. The Company performs a significant portion of its
repair services in refineries, chemical plants and other industrial facilities
that process, produce, store, transport or handle potentially hazardous
substances, including highly corrosive, flammable or explosive substances kept
at extremes of temperature and pressure. These services are subject to the usual
hazards associated with providing on-site services in these types of facilities.
See "Litigation and Insurance" and "Factors That May Affect Future Results"
elsewhere in this Item 1.
DISTRIBUTION SERVICES
The Company currently sells new valves and related instrumentation and
other process-system components directly to its process-industry customers from
a majority of its sales and service locations. In addition to purchasing valves
from OEMs for resale, the Company also acts as a sales representative for a
number of OEMs. In this capacity, it typically promotes the sale and
distribution of the OEMs' products in designated territories for direct factory
shipment to the customer and is compensated by the OEMs on a commission basis.
At each sales location, the Company maintains inventories of valves and other
equipment typically used by the process industries it serves from that location.
The Company's value-added valve distribution services primarily involve the
assembly, setting, testing and sealing of spring-loaded and pilot-operated PRVs
and also include: assembling other original valves with optional components
supplied by the same or different OEMs; customizing the original equipment for
installation in the customer's process unit; combining two or more valves in
configurations designed for specific process applications; and testing and
calibrating, as applicable, individual components and accessories and complete
equipment packages. As a part of its standard quality assurance program, the
Company supplements the positive material identification information OEMs
furnish to trace all materials they use in manufacturing their valves and other
equipment with its own material certifications, testing certificates and
full-assembly and test reports. Compiling this information (i) enables customers
to comply with applicable internal and regulatory recordkeeping requirements and
to demonstrate compliance with applicable industry and regulatory performance
standards, (ii) facilitates the repair or replacement of component parts and the
reconditioning of entire valve assemblies to the original design specifications
and (iii) provides the initial step in a predictive valve maintenance program
that uses actual operating histories to plan turnarounds and, by isolating the
reasons for equipment failures, spurs the use of different or new materials and
technologies.
OPERATIONS
The Company operates on a decentralized basis, and the management of each
operating company and each regional operating group is responsible for its
day-to-day operations, growth and profitability. The Company has centralized and
manages its cash management, auditing and internal control, employee benefits,
financing, financial reporting, and risk management at its corporate
headquarters. It coordinates the sharing among its operating locations of
financial resources for improved systems and expansion of
8
services, training programs, financial controls, purchasing information and
operating expertise. The Company's executive management team directs the
development of the Company's marketing strategies and programs and is
responsible for key national supplier and customer relationships. The Company
has established standard reporting mechanisms to enhance its ability to monitor
each local or regional operation and assimilate acquired businesses and has
implemented performance-based incentive plans keyed to defined operational and
productivity measurements and benchmarks. The Company periodically reviews the
operations of the Company and other repair and distribution services businesses
in order to identify the "best practices" the Company will implement
throughout its operations. In order to reduce traditional corporate headquarters
expenses (as a percentage of revenues) and increase efficiencies, the Company
outsources various functions, including various personnel management and other
human resource services, legal and tax services, risk management and management
information systems design and implementation.
The Company conducts its repair and distribution services operations
through its local sales and service centers. It typically staffs its service
centers with customer service and order entry personnel, repair coordinators and
inventory, shipping and receiving and office personnel. The Company currently
performs in-shop valve and other equipment assembly, testing and certification
at many of its operating facilities. Most of these locations are authorized by
various OEMs as centers for the assembly, sale and repair of their valves and
other products and maintain various professional certifications by organizations
such as the American Society of Mechanical Engineers ("ASME") and the National
Board of Boiler & Professional Vessel Inspectors.
The Company performs most of its on-site repair services on a scheduled
basis in response to the customer's call. The Company also offers 24-hour
emergency on-line and on-site repair services from many of its service
locations.
The Company operates mobile machine shops that allow its technicians to
perform repair and installation functions at the facilities of its customers.
These shops typically are self-contained trucks or trailers the Company equips
with various combinations of lathes, milling machines, grinders, welding
equipment, drill presses, test stands, work benches and hand tools. The Company
maintains its mobile shops at various locations, and from time to time it will
maintain a shop indefinitely at a customer's facility if the work so warrants.
The Company utilizes its repair and maintenance personnel to remanufacture
valves for sale at times of decreased demand for repair and maintenance
activities. This incremental activity enables the Company to maintain sufficient
staff to meet the high level of activity associated with turnarounds and to
produce a valuable product in times of decreased activity.
SALES AND MARKETING
The Company employs a direct sales force to conduct its marketing and sales
activities. Most product and service orders are awarded by plant maintenance
managers to a small number of pre-approved vendors, with little direct bidding
for each job. More recently, plant owners have begun establishing sole-source
relationships with large, well-insured vendors with reputations for efficient
response, safe technicians and comprehensive service. The Company's sales and
marketing efforts typically focus on one-on-one relationships with plant
maintenance managers and turnaround planners and include regular visits to
customer plants to ensure client satisfaction. Initial visits also typically
involve demonstration of the Company's technical abilities at the plant or the
Company's shop facilities. The Company regularly advertises in trade journals,
participates in trade shows and conducts customer appreciation functions.
Many of the Company's customers are regional and national companies in the
petroleum refining, chemical and pulp and paper industries and power utilities.
For 1998, none of the Company's customers accounted for 10% or more of the
Company's pro forma combined revenues. While the Company is not dependent on any
one customer, the loss of one of its significant customers could, at least on a
short-term basis, have an adverse effect on the Company's results of operations.
9
The Company generally seeks to enter into "blanket" contracts with its
large customers. These contracts function to designate the Company as an
approved service provider for a customer and establish certain standard terms
and conditions for providing service to plants or other facilities owned or
operated by that customer. Although these blanket contracts generally do not
establish the Company as an exclusive provider of repair and distribution
services, the Company believes they are an important consideration for plant
managers and other decision makers in the usual process of selecting a vendor of
the services the Company provides.
SUPPLIERS
VALVES, PARTS AND FITTINGS. The Company purchases substantially all the
new valves and other process-system components it distributes from OEMs. Its
principal suppliers include OEM's offering multiple product lines and OEM's
offering various specialized product lines. Invatec is not materially dependent
on any single OEM for the achievement of its growth strategies over the
long-term. The loss of one or more product lines could, however, have a material
adverse effect on the ability of the Company to achieve its expectations on a
short-term basis.
RELATIONSHIPS WITH OEMS. The success of the Company as a value-added
distributor of new valves and other process-system components and as a
factory-authorized repair service provider depends on its relationships with the
OEMs of these products. Except for its distribution agreements with OEMs, the
Company generally has no contractual repair services contracts with OEMs.
The typical distribution agreement in the Company's industry specifies the
territory or territories in which the distributor has the right and obligation
to sell the OEM's products and the services (sales, assembly or repair) the
distributor is authorized to, or must, perform. An OEM may (i) assign a
territory on an exclusive or a nonexclusive basis, (ii) limit the range of the
OEM's products the distributor may sell or service, (iii) authorize or restrict
sales or services by the distributor outside the assigned territory, (iv) refuse
to assign the distributor additional territories and (v) reserve to itself the
right to deal exclusively with specified customers or classes of customers (for
example, national accounts or engineering and construction companies) in the
assigned territory. The Company believes the current fragmentation of the
distribution sector of its industry reflects the traditional assignment by OEMs
of territories on generally a local basis to distributors operating from a
single facility.
The typical distribution agreement may limit the distributor's role to that
of sales representative acting on a commission basis or provide for purchases by
the distributor for resales to end users. It also may impose requirements on the
distributor concerning such matters as (i) minimum individual or annual purchase
orders, (ii) maintenance of minimum inventories, (iii) establishment and
maintenance of facilities and equipment to perform specified services and (iv)
training of sales personnel and service technicians. Many OEMs closely monitor
compliance with these requirements. The distribution agreement also typically
(i) grants the distributor the nonexclusive right to use and display the OEM's
trademarks and service marks in the form and manner approved by the OEM and (ii)
prohibits the distributor from offering products that compete with the OEM's
products the distributor is authorized to sell.
The Company's distribution agreements generally have indefinite terms and
are subject to termination by either party on prior notice generally ranging
from 30 to 90 days.
The Company's business strategy could conflict with existing or future OEM
distributor policies or programs. The Company believes, however, that it offers
attractive benefits to OEMs. For large OEMs, it offers a cost-effective
distribution alternative that promotes consistent quality and possesses
significant financial and human resources. For small and mid-sized OEMs, it
offers access to broader markets and expertise in marketing. In addition, the
Company offers to all OEMs (i) a central source of market and usage data,
including complete life histories of valves and other products, and (ii) a means
of reducing their own selling costs through additional outsourcing of their
assembly, testing, repair and certification services, reducing the number of
distributors they are required to monitor and eliminating transition problems
associated with local owner-operated distributorships. Although no assurance can
be given that OEMs will not take actions that could materially adversely affect
the Company's ability to implement its growth
10
strategies and maintain its existing distribution services business, the Company
believes that the combination of (i) the advantages it offers to OEMs and (ii)
the desire of end users to reduce the number of their vendors should result in
these issues being resolved on a mutually satisfactory basis.
HIRING, TRAINING AND SAFETY
The Company seeks to ensure through its hiring procedures and continuous
training programs and the training programs its OEMs offer that (i) its
product-assembly and service technicians and machinists meet the performance and
safety standards of the Company and its OEMs, professional and industry codes
and federal, state and local laws and regulations have established and possess
the required ASME, factory or other certifications and (ii) its sales personnel
are trained thoroughly in the selection, application, adaptation and
customization of the products it distributes and types of repair services it
offers.
Because on-line and on-site repair services often are performed in
emergency situations under dangerous circumstances, the Company provides its
technicians with extensive classroom and field training and supervision and
establishes and enforces strict safety and competency requirements, including
physical exams and periodic drug testing. The Company's training programs for
its on-site repair technicians must meet requirements of the Occupational Safety
and Health Administration ("OSHA") respecting, among other matters, release
detection procedures, appropriate work practices, emergency procedures and other
measures these technicians can take to protect themselves and the environment.
COMPETITION
The markets for the Company's repair and distribution services generally
are highly competitive. The Company believes the principal competitive factors
in a distributor's sale of new valves and other process-system components
directly to industries in the distributor's market include price and the ability
of the distributor to offer on a timely basis a wide selection of the new,
better-performing valves and components OEMs have designed to meet the needs of
these industries. Factors affecting delivery time include inventory size and
accessibility and whether, in the case of PRVs and certain other valves, the OEM
or the distributor assembles, sets, tests and seals, or otherwise customizes,
the valve. The Company believes its assembly and testing facilities enable it
generally to deliver valves ready for installation faster than the relevant OEM.
In the case of repair services, the Company believes the principal competitive
factors are quality and availability of service (including emergency service and
documentation of valve histories), price, use of OEM-approved replacement parts,
familiarity with the OEMs' products and local brand equity of the repair
business.
In its distribution operations, the Company competes with the direct sales
forces and distribution networks of OEMs offering the same or comparable lines
of products. The success of the Company as a provider of value-added
distribution services depends on the extent to which the OEMs with which it has
distribution arrangements are able to create a demand for their products in the
territories they assign the Company. Factors affecting this demand include, in
addition to price, product quality and performance (including durability and
safety), delivery time and the relative strengths of the brand name and
marketing ability of the OEM.
The Company competes for repair services business with other repair service
businesses and customers' in-house maintenance crews and, to a lesser extent,
with OEMs. Some of its competitors may have lower overhead cost structures and,
consequently, may be able to provide their services at lower rates than the
Company. The Company's competitors for on-line repairs include three national
competitors and several regional competitors. Competition in the market for
off-line repair services is highly fragmented, although certain competitors may
have dominant positions in some of the local markets they serve.
INTELLECTUAL PROPERTY
The Company holds various United States and foreign patents, including some
relating to the SafeSeal [T] system. It does not consider any individual patent
to be presently material to its consolidated business and believes its future
success will depend more on its technological capabilities and the
11
application of know-how in the conduct of that business. The Company enjoys
service and product name recognition, principally through various common law
trademarks.
EMPLOYEES
At December 31, 1998, the Company had approximately 1,200 full-time
employees. Approximately 14 are members of the United Steelworkers of America,
AFL/CIO union and 3 are members of Local Union 597 Pipefitters Association. None
of the Company's other employees are represented by a union. Management believes
the Company's relations with its employees are satisfactory. The Company's
future success will depend, in part, on its ability to attract, retain and
motivate highly qualified technical, marketing, engineering and management
personnel.
The Company has not experienced any strikes or work stoppages that have had
a material impact on the Company's operations and financial condition. The
Company seeks to attract and retain qualified service technicians and other
technical field personnel by providing competitive compensation packages. It has
never experienced a prolonged shortage of qualified technical personnel in any
of its operations (and does not currently anticipate any such shortage), but if
demand for the Company's services were to increase rapidly, retention of
qualified field personnel might become more difficult without significant
increases in compensation.
FACILITIES
The Company leases or owns 63 operating facilities in the United States,
two in Europe and one in the Middle East. It holds most of these facilities
under lease. The facilities consist principally of sales and services,
remanufacturing and administrative facilities. The Company believes its
facilities are adequately maintained and sufficient for its planned operations
at each location.
The Company's principal executive and administrative offices are located in
Houston, Texas.
GOVERNMENTAL REGULATION AND ENVIRONMENTAL MATTERS
A wide range of federal, state and local regulations relating to health,
safety and environmental matters apply to the Company's business. The Company's
in-shop reconditioning and remanufacturing of used valves infrequently involves
the use, handling, storage and contracting for the disposal or recycling of a
variety of substances or wastes considered hazardous or toxic. Environmental
laws are complex and subject to frequent change. These laws impose "strict
liability" in some cases without regard to negligence or fault. Sanctions for
noncompliance may include revocation of permits, corrective action orders,
administrative or civil penalties and criminal prosecution. Certain
environmental laws provide for joint and several strict liability for
remediation of spills and releases of hazardous substances. In addition,
businesses may be subject to claims alleging personal injury or property damage
as a result of alleged exposure to hazardous substances, as well as damage to
natural resources. These laws and regulations also may expose the Company to
liability for the conduct of or conditions caused by others, or for acts of the
Company which complied with all applicable laws when performed. No assurance can
be given the Company's compliance with amended, new or more stringent laws or
regulations, stricter interpretations of existing laws or the future discovery
of environmental conditions will not require additional, material expenditures
by the Company. OSHA regulations also apply to the Company's business, including
requirements the Company's training programs must meet. See "Hiring, Training
and Safety" elsewhere in this Item 1. Future acquisitions by the Company also
may be subject to regulation, including antitrust reviews.
The Company believes it has all material permits and licenses required to
conduct its operations and is in substantial compliance with applicable
regulatory requirements relating to its operations. The Company's capital
expenditures relating to environmental matters were not material on a pro forma
combined basis in 1998. The Company does not currently anticipate any material
adverse effect on its business or financial position as a result of its future
compliance with existing environmental laws and regulations controlling the
discharge of materials into the environment.
12
LITIGATION AND INSURANCE
The Company maintains insurance in such amounts and against such risks as
it deems prudent, although no assurance can be given that such insurance will be
sufficient under all circumstances to protect the Company against significant
claims for damages. The primary risks in the Company's operations are bodily
injury to third parties and workers' compensation. The Company maintains a broad
range of insurance coverage against these and other risks including general
liability, automobile liability, automobile physical damage, comprehensive
property damage, workers' compensation, employer's liability, directors and
officers liability and other coverage customary in the industry. The Company is
subject to per incident deductibles ranging from $500 to $100,000. The Company
also maintains excess insurance limits in amounts which management considers
sufficient to protect us against claims beyond the existing coverages. The
occurrence of a significant event not fully insured against could have a
material adverse effect on the Company's financial condition and results of
operations. Moreover, no assurance can be given that the Company will be able to
maintain adequate insurance in the future at commercially reasonable rates or on
acceptable terms.
YEAR 2000 ISSUE
The Company has assessed its Year 2000 issues and has developed a plan to
address both the information technology ("IT") and non-IT systems issues. The
plan involves the replacement or modification of some of the existing operating
and financial computer systems utilized by the Company's operating subsidiaries.
The Company has not developed any computer systems for use in its business;
consequently, it believes its Year 2000 issues relate to systems that different
vendors have developed and sold to the Company for which modifications are or
will be available.
The Company has contacted the vendors that provide its telephone systems
and computer systems, as well as its OEMs. The Company has received confirmation
from its major vendors of new valves and other process system components,
telephone systems, and computer systems that their products are Year 2000
compliant. Further, the Company has replaced many computer systems that are not
Year 2000 compliant in the normal course of updating various systems used at the
operating subsidiaries. At this time, the replacement of the systems which are
not Year 2000 compliant is over fifty percent complete and the amount expended
to date is approximately $100,000. The Company believes that the cost to replace
the remaining non-compliant systems or the cost to update the systems in 1999
should not exceed $350,000, which costs will be paid for with cash flows from
operations. The Company intends to complete all programming changes by June 30,
1999. The New Credit Facility requires that such programming be completed by
June 30, 1999. The new Credit Facility requires that such programming be
completed by September 30, 1999
The Company believes that any temporary disruptions would not be material
to its overall business or results of operations. As a contingency plan,
immediately prior to January 1, 2000, the Company intends to print all inventory
listings in its systems and take other reasonably necessary steps so that the
Company can operate "manually" until such time as any temporary Year 2000
problems related to its operations are cured.
13
EXECUTIVE OFFICERS
The following table sets forth certain information as of March 1, 1999
concerning each of the executive officers of Invatec:
NAME AGE POSITION
- - ------------------------------------- --- -----------------------------------------------------
William E. Haynes.................... 55 Chairman of the Board and Chief Executive Officer
Charles F. Schugart.................. 39 President
Pliny L. Olivier..................... 53 Senior Vice President -- Operations
Douglas R. Harrington, Jr............ 34 Vice President -- Chief Financial Officer, Treasurer
and Secretary
Invatec's executive officers are appointed annually by the Invatec Board of
Directors (the "Board of Directors") to serve for the ensuing year or until
their respective successors have been duly appointed.
ITEM 2. PROPERTIES
This item incorporates by this reference the information appearing under
the caption "Facilities" in Item 1 of this Report.
ITEM 3. LEGAL PROCEEDINGS
This Item incorporates by this reference the information appearing under
the caption "Litigation and Insurance" in Item 1 of this Report.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the Company's security holders during
the fourth quarter of 1998.
14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Since October 1997, the Common Stock of Invatec has been quoted on the
Nasdaq National Market under the symbol "IVTC." NASDAQ has notified the
Company of its intention to delist Invatec's Common Stock, as a result of the
Company's Common Stock failing to maintain a closing bid price of $5 per share
and the Company's failure to maintain the required levels of tangible net worth.
Company management has met with NASDAQ representatives in an effort to maintain
the listing, but no assurance can be given that the Company's Common Stock will
remain listed on the NASDAQ National Market. The Company anticipates that in the
event of delisting from NASDAQ's National Market, its Common Stock will be
eligible to be quoted and traded on the NASDAQ Small Cap Market or Bulletin
Board. As of March 29, 1999, there were 9,664,562 shares of Common Stock
outstanding, held by approximately 80 stockholders of record. The number of
record holders does not necessarily bear any relationship to the number of
beneficial owners of the Common Stock.
The following table sets forth the range of high and low sale prices for
the Common Stock on the Nasdaq National Market for the periods indicated:
HIGH LOW
--------- ---------
Year ended December 31, 1997
Fourth Quarter (October 23 to
December 31)...................... $ 20.25 $ 15.75
Year Ended December 31, 1998
First Quarter...................... 20.25 15.00
Second Quarter..................... 18.75 7.00
Third Quarter...................... 7.44 2.53
Fourth Quarter..................... 3.31 1.13
The last reported sale price of the Common Stock on the Nasdaq National
Market on March 29, 1999 was $.8125 per share.
In January 1998, Invatec issued shares of its Common Stock to eleven
employees who had been granted bonuses of The Safe Seal Company ("SSI") stock
in December 1995, to vest in two equal amounts on December 31, 1996 and 1997.
Giving effect to the merger of SSI and Invatec and the conversion of SSI shares
in connection therewith, rights to receive an aggregate of 1,812 shares of
Common Stock vested on December 31, 1997. The sales of those shares of Common
Stock were exempt from the registration requirements of the Securities Act by
virtue of Section 4(2) thereof as transactions not involving any public
offering.
Invatec has not paid or declared any dividends since its formation and
currently intends to retain earnings to fund working capital. Any future
dividends will be at the discretion of the Board of Directors after taking into
account various factors deemed relevant by the Board of Directors, including the
Company's financial condition and performance, cash needs, income tax
consequences and the restrictions Delaware and other applicable laws and its
credit facilities then impose. The New Credit Facility prohibits the payment of
dividends. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources" in Item 7 of this
Report and Note 7 of the Notes to Consolidated Financial Statements of the
Company in Item 8 of this Report.
15
ITEM 6. SELECTED FINANCIAL DATA
The Company's financial statements present SSI as the "accounting
acquirer" in the acquisitions Invatec effected through October 31, 1997.
Consequently, the Company's historical financial statements for periods ended on
or before that date are SSI's historical consolidated financial statements, and
in this Item 6 the term "Company" means (i) SSI and its consolidated
subsidiaries prior to that date and (ii) Invatec and its consolidated
subsidiaries on that date and thereafter. The following selected historical
financial information derives from the Company's audited financial statements
for each year in the five-year period ended December 31, 1998. See the
historical financial statements and notes thereto included elsewhere herein.
YEAR ENDED DECEMBER 31
-------------------------------------------------------
1994 1995 1996 1997(1) 1998
--------- --------- --------- ---------- ----------
(IN THOUSANDS)
HISTORICAL STATEMENT OF OPERATIONS
INFORMATION:
Revenues........................... $ 2,547 $ 2,852 $ 3,888 $ 58,621 $ 154,617
Gross profit(3).................... 1,276 1,268 1,512 17,634 47,049
Selling, general and administrative
expenses(3)...................... 1,268 1,853 1,917 15,639 40,480
Special compensation expense(1).... -- -- 38 7,614 --
Non-recurring costs(2)............. -- -- -- -- 2,190
Income (loss) from operations...... 8 (585) (443) (5,619) 4,379
Interest income (expense), net..... (7) 10 28 (2,901) (5,622)
Other income (expense), net........ (282) (930) -- (3) 247
Loss before income taxes........... (281) (1,505) (415) (8,523) (996)
Net loss........................... $ (281) $ (1,505) $ (415) $ (7,500) $ (1,416)
========= ========= ========= ========== ==========
HISTORICAL BALANCE SHEET INFORMATION:
Working capital (deficit).......... $ (202) $ 823 $ (13) $ 21,232 $ 42,545
Total assets....................... 668 23,109 2,228 105,432 183,700
Total debt, including current
portion.......................... 93 -- 589 29,527 83,220
Stockholders' equity (deficit)..... (75) (1,075) (1,394) 59,869 79,205
- - ------------
(1) Non-cash, non-recurring special compensation expenses of $7.6 million
attributable to certain awards of stock and stock options and certain stock
sales and financing fees of $1.0 million (included in interest expense)
related to guarantees by Philip Services, Inc. See Note 2 of the Notes to
Consolidated Financial Statements of the Company.
(2) Non-recurring costs reflect approximately $1.4 million in write-offs of
capitalized costs of abandoned projects, including a friction welding system
and $0.8 million of accrued severance costs.
(3) Certain 1997 amounts have been reclassified to conform with the current year
presentation.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company derives its revenues principally from its sales of industrial
valves and other process-system components, and its performance of comprehensive
maintenance, repair, replacement and value-added distribution services of
industrial valves and other process-system components. Cost of operations
consists principally of direct costs of valves and components sold, coupled with
labor and overhead costs connected with the performance of repair services.
Selling, general and administrative expenses consist principally of compensation
and benefits payable to owners and to sales, management and administrative
personnel and insurance, depreciation and amortization and other related
expenses.
16
Invatec, incorporated in March 1997, conducted no operations prior to
October 28, 1997 except in connection with the IPO and the acquisitions of the
seven Initial Acquired Businesses. Since the IPO, Invatec has acquired thirteen
businesses, nine of which were acquired in 1998. Each of the Additional Acquired
Businesses operated as a separate, independent business prior to its acquisition
by the Company.
The Company's customers consist primarily of petroleum refining,
petrochemical, chemical, power and pulp and paper plants, the businesses of
which tend to be cyclical. Margins in those industries are highly sensitive to
demand cycles and the Company's customers in those industries have historically
tended to delay capital projects, expensive turnarounds and other maintenance
projects during slow periods. Commencing with second quarter of 1998 and
continuing into 1999, the Company's business was negatively impacted by
significant slowdowns experience by its customers in the petroleum refining,
petrochemical, chemical, and pulp and paper industries.
As a result of the above-described downturns affecting the Company's
customers, the Company's level of business declined during 1998 and the
Company's earnings for the last three quarters of 1998 fell significantly short
of expectations. Consequently, this decline in earnings resulted in a severe
reduction in the market price of the Company's Common Stock. Declining earnings
also ultimately resulted in the Company defaulting on its Old Credit Facility as
a result of failing to meet certain financial covenants which required specific
levels of earnings in relation to debt. This default left the Company unable to
borrow funds for acquisitions thereunder. The Company remained in default under
the loan agreement from July 20, 1998 through March 25, 1999. The Company's
acquisition program has been effectively suspended since July 1998 as a result
of the low price of the Company's Common Stock and its inability to borrow funds
under the Old Credit Facility.
The Company amended its Old Credit Facility on March 26, 1999. As a result
the New Credit Facility, expiring on April 20, 2000, consists of a $35 million
stationary term component and up to a $45 million revolving line of credit from
its existing bank group. The New Credit Facility prohibits the Company from
making acquisitions and provides for increasingly high borrowing costs. As a
result, the Company is currently seeking a significant equity infusion to enable
it to reduce its debt, obtain a new credit facility on better terms and
potentially resume its acquisition program on a scaled down, strategic basis. A
significant equity infusion could have a substantially dilutive impact on
existing shareholders.
Since the suspension of the Company's acquisition program, the Company has
focused on efforts to cut costs and otherwise improve profitability. During
1998, the Company eliminated in excess of $5 million in annualized costs,
including substantial corporate overhead. In 1999, the Company intends to
continue its cost cutting program. This program is expected to include
downsizing certain of its operations to fit the current level of business,
consolidation of certain locations and consolidating the marketing efforts
currently conducted by different subsidiary companies and other potential
improvements in operational efficency.
Despite those cost cuts, the Company anticipates that it will be difficult
to improve overall profitability in 1999 due to the high cost of funds under the
New Credit Facility unless it obtains a more favorable credit facility or
business improves dramatically. The Company has not experienced any significant
improvement in its business during 1999. The Company cannot predict when or
whether its business will rebound. In addition, there can be no assurance that a
further deterioration in the Company's business will not occur. Any significant
additional erosion in the Company's business would further depress earnings and
likely result in a default under the New Credit Facility.
The Company's financial statements present SSI as the "accounting
acquirer" in the acquisitions Invatec effected through October 31, 1997.
Consequently, the Company's historical financial statements for periods ended on
or before that date are SSI's historical consolidated financial statements, and
in this discussion the term "Company" means (i) SSI and its consolidated
subsidiaries prior to that date and (ii) Invatec and its consolidated
subsidiaries on that date and thereafter.
17
RESULTS OF OPERATIONS
HISTORICAL
The following table sets forth selected financial information of the
Company and that information as a percentage of the Company's revenues for the
years indicated (dollars in thousands):
YEAR ENDED DECEMBER 31
-----------------------------------------------------------------
1996 1997 1998
-------------------- -------------------- ---------------------
Revenues............................. $ 3,888 100% $ 58,621 100% $ 154,617 100%
Cost of operations................... 2,376 61 40,987 70 107,568 70
--------- --- --------- --- ---------- ---
Gross profit......................... 1,512 39 17,634 30 47,049 30
Selling, general and administrative
expenses........................... 1,917 49 15,639 27 40,480 26
Special compensation expense......... 38 1 7,614 13 --
Nonrecurring costs................... -- -- -- -- 2,190 1
--------- --- --------- --- ---------- ---
Income (loss) from operations........ $ (443) (11) $ (5,619) (10) $ 4,379 3
========= === ========= === ========== ===
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
REVENUES -- Revenues increased $96.0 million, or 164%, from $58.6 million
in 1997 to $154.6 million in 1998. Approximately $60.6 million of this increase
resulted from the inclusion of revenues from the additional Acquired Businesses
purchased in 1997 and 1998 from their respective dates of acquisition. The
remaining $35.4 million increase is due to the inclusion of the results of the
Initial Acquired Businesses for the entire year of 1998.
GROSS PROFIT -- Gross profit increased $29.4 million, or 167%, from $17.6
million in 1997 to $47.0 million in 1998, of which $21.0 million was as a result
of the incremental gross margins generated by the Additional Acquired
Businesses. The remaining $8.4 million increase is due to the inclusion of the
gross margin of the Initial Acquired Businesses for the entire year of 1998. As
a percentage of revenues, gross profit remained relatively flat at 30%.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES -- Selling, general and
administrative expenses increased $24.8 million, or 159%, from $15.6 million in
1997 to $40.4 million in 1998, primarily due to the incremental selling, general
and administrative expenses of the businesses acquired in 1997 and 1998. As a
percentage of revenues, these expenses decreased from 27% in 1997 to 26% in 1998
as a result of the implementation of the Company's cost reduction strategies,
coupled with selling, general and administrative expenses of the corporate
headquarters being spread over a larger revenue base in 1998.
NONRECURRING COSTS -- Nonrecurring costs reflect approximately $1.4 million
in write-offs of capitalized costs of abandoned projects, including a friction
welding system and $0.8 million of accrued severance costs.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES -- Revenues increased $54.7 million, or 1,408%, from $3.9 million
in 1996 to $58.6 million in 1997. This increase resulted from the inclusion of
the results of the Acquired Businesses purchased in 1997 from their respective
dates of acquisition.
GROSS PROFIT -- Gross profit increased $16.1 million, or 1,066%, from $1.5
million in 1996 to $17.6 million in 1997, primarily as a result of the
incremental gross margins generated by the Acquired Businesses Invatec purchased
in 1997. As a percentage of revenues, gross profit decreased from 39% in 1996 to
30% in 1997. This decrease reflects the expansion of the Company's consolidated
operations to include the off-line distribution and related services operations
of the businesses purchased in 1997 which historically have generated lower
gross margins than SSI's gross margins attributable to its on-line repair
services operations.
18
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES -- Selling, general and
administrative expenses increased $13.7 million or 716% from $1.9 million in
1996 to $15.6 million in 1997. This increase primarily reflects the incremental
selling, general and administrative expenses of the businesses acquired in 1997
and the building of the Company's corporate management team. As a percentage of
revenues, these expenses decreased from 49% in 1996 to 27% in 1997 as a result
of being spread over a larger revenue base coupled with the implementation of
the Company's cost reduction strategies.
SPECIAL COMPENSATION EXPENSE -- Special compensation expense increased $7.6
million, or 19,937%, from $38,000 in 1996 to $7.6 million in 1997. In 1996,
these non-cash expenses related to the issuance by SSI of its common stock and
options to purchase its common stock under employee benefit programs. In 1997,
these non-cash expenses related to an SSI issuance of shares of its common
stock, sales by Invatec of Common Stock and certain options granted by Invatec
to purchase Common Stock. See Note 2 of the Notes to Consolidated Financial
Statements of the Company.
LIQUIDITY AND CAPITAL RESOURCES
The following table sets forth selected information from the Company's
statements of cash flows (in millions):
YEAR ENDED DECEMBER 31
-------------------------------
1996 1997 1998
--------- --------- ---------
Net cash used in operating
activities......................... $ (0.9) $ (0.3) (12.4)
Net cash used in investing
activities......................... (0.2) (52.6) (44.0)
Net cash provided by financing
activities......................... -- 55.0 53.8
--------- --------- ---------
Net change in cash................... $ (1.1) $ 2.1 $ (2.6)
========= ========= =========
For the period from January 1, 1996 through December 31, 1998, the
Company's operations used $13.6 million of cash primarily as a result of 1997
and 1998 increases in inventory and accounts receivable levels required to
support the Company's internal sales growth programs. Cash used in investing
activities of $96.8 million in the same period consisted primarily of $91.0
million used to purchase the Additional Acquired Businesses. Cash provided from
financing activities in the same period of $108.8 million primarily reflects net
proceeds from the Company's IPO of $44.0 million and net borrowings under credit
facilities of $70.6 million offset by repayments of debt to Philip Services,
Inc., an affiliate, of $3.0 million.
The Company's Old Credit Facility was a $90 million three-year revolving
credit facility the Company used for acquisitions and general corporate
purposes. Declining earnings during 1998 ultimately resulted in the Company
defaulting in July 1998 on its Old Credit Facility as a result of failing to
meet certain financial covenants requiring specific levels of earnings in
relation to debt. This default left the Company unable to borrow funds for
acquisitions. The Company remained in default under the loan agreement from July
20, 1998 through March 25, 1999. The Company's acquisition program has been
effectively suspended since July 1998 as a result of the low price of the
Company's Common Stock and its inability to borrow funds.
In March 1999, the Company and its syndicate of lenders agreed to amend the
Company's credit facility to put into place the New Credit Facility. The
Company's credit facility was reduced from $90 million to $80 million and
restructured to be comprised of a stationary term component of $35 million and a
revolving credit facility of up to $45 million, the proceeds of which may be
used only for general corporate and working capital purposes. The Company's
subsidiaries have guaranteed the repayment of all amounts due under the
facility, and repayment is secured by pledges of the capital stock, and all or
substantially all of the assets, of those subsidiaries. The New Credit Facility
prohibits acquisitions and the payment of cash dividends, restricts the ability
of the Company to incur other indebtedness and requires the Company to comply
with certain financial covenants. These financial covenants include provisions
for maintenance of certain levels of earnings before interest, taxes,
depreciation, amortization ("EBITDA") and other items specified in the loan
agreement. Additionally, the New Credit Facility requires that the Company
complete all required programming changes in connection with the Year 2000
compliance objective by September 30, 1999. The Company believes that it will be
able to meet this requirement. See Item 1 "Year 2000 Issue."
The amount of availability under the New Credit Facility is now governed by
a borrowing base which consists primarily of the accounts receivable and
inventory of the Company and its subsidiaries, although
19
the amount available under the revolving portion of the credit facility will
decrease over time and upon the occurrence of certain specified events, such as
a sale of assets outside the ordinary course of business. Interest accrues at
the prime rate as in effect from time to time, plus 2%, payable monthly. In
addition, fees accrue each quarter at the rate of 1.5% of the unpaid principal
balance under the New Credit Facility. If, however, the stationary term
component is repaid by July 1, 1999 and the revolving portfolio on that date
does not exceed the borrowing base, the aggregate amount of such fees will be
reduced to $100,000. If all obligations under the New Credit Facility are repaid
in full by June 30, 1999, no such fees will be payable. The entire New Credit
Facility matures on April 20, 2000.
In connection with the amendment to the New Credit Facility, the syndicate
of lenders were issued warrants to purchase up to 482,262 shares of the Common
Stock of the Company, exercisable at $0.73 per share (10% below the market price
of such Common Stock as of March 25, 1999), and granted certain registration
rights with respect to the shares issuable upon exercise of the warrants.
Due to (i) the high borrowing costs associated with the New Credit Facility
if it is not fully repaid prior to July 1, 1999, (ii) the Company's high level
of debt and (iii) the Company's belief that it would be advantageous to resume
its acquisition program on a scaled-down, strategic basis if it had sufficient
resources, the Company is currently seeking a significant equity infusion to
enable it to reduce its debt, obtain a new credit facility to reduce its
borrowing costs and potentially resume its acquisition program on a scaled down,
strategic basis. A significant equity infusion could have a substantially
dilutive impact on existing shareholders. It is uncertain whether the Company's
efforts to find new equity and debt financing will be successful or that, if
successful, the Company will have sufficient resources to resume its acquisition
program.
Although the Company believes that based upon current levels of business
that it can comply with the various financial covenants contained in the New
Credit Facility, a substantial adverse deviation of EBITDA would likely result
in a default by the Company of the EBITDA covenants. Therefore, if there is any
significant downward deviation in the Company's business or pressure on margins,
it is likely that the Company will be in default under the New Credit Facility.
At December 31, 1998, the Company's outstanding borrowings under the Old
Credit Facility were $70.6 million, bearing interest at 9.75%. At March 30,
1999, the Company's outstanding borrowings under the New Credit Facility were
$70.4 million, bearing interest at 9.75% per annum, excluding the effect of
contingent fees discussed above.
It is anticipated that cash flow from operations and funds available under
the New Credit Facility will provide sufficient cash for the Company's normal
working capital needs, debt service requirements and planned capital
expenditures for the next year.
FLUCTUATIONS IN OPERATING RESULTS
The Company's results of operations may fluctuate significantly from
quarter to quarter or year to year because of a number of factors, including
seasonal fluctuations in the demand for repair and distribution services
(particularly the demand attributable to scheduled turnarounds in the power
industry, which typically are scheduled for mild-weather months) and competitive
factors. Accordingly, quarterly comparisons of the Company's revenues and
operating results should not be relied on as an indication of future
performance, and the results of any quarterly period may not be indicative of
results to be expected for a full year.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Revolving credit borrowings under the Company's New Credit Facility contain
certain market risk exposure. The Company's outstanding borrowings under the Old
Credit Facility were $70.6 million at December 31, 1998. A change of one percent
in the interest rate would cause a change in interest expense of approximately
$700,000, or $0.04 per share, on an annual basis. The New Credit Facility was
not entered into for trading purposes and carries interest at a pre-agreed upon
percentage point spread from either the prime interest rate or 30-day Eurodollar
interest rate.
20
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of Invatec and certain of its
subsidiaries, together with the related report of independent public
accountants, are set forth on pages F-1 through F-19 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
For the information called for by Item 10 (other than the information
regarding Executive Officers, which is set forth in "Item 1.
Business -- Executive Officers") and Items 11, 12 and 13, reference is made to
the Company's definitive proxy statement for its 1999 Annual Meeting of
Stockholders, which will be filed with the Commission within 120 days after
December 31, 1998, and which is incorporated herein by reference (except for the
material included under the captions "Report on Compensation Committee" and
"Performance Graph").
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) Financial Statements.
INDEX TO FINANCIAL STATEMENTS
Report of Independent Public
Accountants........................ F-1
Consolidated Balance Sheets.......... F-2
Unaudited Pro Forma Combined
Statement of Operations............ F-3
Consolidated Statements of
Operations......................... F-4
Consolidated Statements of
Stockholders' Equity (Deficit)..... F-5
Consolidated Statements of Cash
Flows.............................. F-6
Notes to Consolidated Financial
Statements......................... F-7
(2) Financial Statement Schedules.
All financial statement schedules are omitted because they are not required
or the required information is shown in the Company's consolidated financial
statements or the notes thereto.
(3) Exhibits.
EXHIBIT
NUMBER DESCRIPTION
- - ------------------------ ------------------------------------------------------------------------------------------
2.1(a) -- Merger Agreement dated June 29, 1998 among Invatec, Plant Maintenance, Inc. and the former
shareholders thereof.
2.1(b) -- Amendment to Merger Agreement dated as of September 25, 1998 among Invatec, Plant
Maintenance, Inc. and the former shareholders thereof.
2.2(a) -- Merger Agreement dated July 9, 1998 among Invatec, Collier Equipment Corporation and the
former shareholders thereof.
2.2(b) -- Amendment to Merger Agreement dated as of August 20, 1998 among Invatec, Cecorp, Inc. (the
successor corporation to Collier Equipment Corporation), and the former shareholders
thereof.
21
2.3(a) -- Merger Agreement dated as of July 9, 1998 among Invatec, Colonial Process Equipment Co.,
Inc. and Colonial Service Company, Inc. and the former shareholders thereof.
2.3(b) -- Amendment to Merger Agreement dated as of September 22, 1998 among Invatec, Colonial
Process Service and Equipment Co., Inc. (the successor corporation to Colonial Process
Equipment Co. Inc. and Colonial Service Company, Inc.) and the former shareholders thereof.
3.1* -- Certificate of Incorporation of Invatec, as amended, (Form 10-Q for the quarterly period
ended September 30, 1998 (File No. 000-23231) Ex. 3.1).
3.2* -- Amended and Restated Bylaws of Invatec (Form 10-Q for the quarterly period ended September
30, 1998 (File No. 000-23231), Ex. 3.2).
4.1* -- Form of Certificate representing Common Stock (Form S-1 (Reg. No. 333-31617), Ex. 4.1).
4.2* -- Registration Rights Agreement dated as of June 9, 1997 by and among Invatec and the
stockholders listed on the signature pages thereto (Form S-1 (Reg. No. 333-31617), Ex.
4.2).
4.3* -- Registration Rights Agreement dated as of June 12, 1997 by and among Invatec and the
persons listed on the signature pages thereto (Form S-1 (Reg. No. 333-31617), Ex. 4.3).
4.4* -- Addendum to Registration Rights Agreement dated as of July 28, 1997 by and among Invatec
and the holders listed on the signature pages thereto (Form S-1 (Reg. No. 333-31617, Ex.
4.4).
4.5* -- Rights Agreement by and between the Company and ChaseMellon Shareholder Services, L.L.C.,
including form of Rights Certificate attached as Exhibit B thereto (Form 10-Q for the
quarterly period ended September 30, 1997 (File No. 000-23231), Ex. 4.5).
4.6(a)* -- Loan Agreement dated July 7, 1998 among Invatec, Chase Bank of Texas, National
Association, as Agent and as a lender, and the other lenders referred to therein. (Form
10-Q for the quarterly period ended September 30, 1998 (File No. 000-23231), Ex. 4.1).
4.6(b) -- Amendment to Loan Agreement dated March 26, 1999 among Invatec, Chase Bank of Texas,
National Association, as Agent and as a lender, and the other lenders referred to therein.
4.7* -- Form of Indenture dated June 1, 1998 from Invatec to U.S. Trust Company of Texas, N.A., as
trustee relating to the Convertible Debt Securities. (Form S-4 (Reg. No. 333-49283), Ex.
4.4)
4.8 -- Registration Rights Agreement dated as of March 26, 1999 by and among Invatec, Chase Bank
of Texas and the other lenders.
4.9 -- Form of Warrants dated as of March 26, 1999 to purchase an aggregate of 482,262 shares of
Invatec Common Stock issued by Invatec to Chase Bank of Texas, and the other lenders.
Invatec and certain of its subsidiaries are parties to certain debt instruments under
which the total amount of securities authorized does not exceed 10% of the total assets of
Invatec and its subsidiaries on a consolidated basis. Pursuant to paragraph 4(iii)(A) of
Item 601(b) of Regulation S-K, Invatec agrees to furnish a copy of those instruments to
the SEC on request.
10.1 -- 1997 Incentive Plan of Invatec, as amended.
10.2(a)* -- Form of Employment Agreement dated as of January 27, 1997, between SSI and William E.
Haynes (Form S-1 (Reg. No. 333-31617, Ex. 10.2).
10.2(b) -- Letter Agreement dated October 30, 1998 between the Company and William E. Haynes.
10.3(a)* -- Form of Employment Agreement dated as of January 27, 1997, between SSI and Charles F.
Schugart (Form S-1 (Reg. No. 333-31617), Ex. 10.3).
10.3(b) -- Letter Agreement dated October 30, 1998 between the Company and Charles F. Schugart.
10.4 -- Amended and Restated Employment Agreement dated as of January 1, 1998 between the Company
and Pliny L. Olivier.
22
10.5(a) -- Employment Agreement dated August 21, 1998 between the Company and Douglas R. Harrington,
Jr.
10.5(b) -- Letter Agreement dated October 30, 1998 between the Company and Douglas R. Harrington, Jr.
10.6* -- Form of Indemnification Agreement between Invatec and each of its directors and officers
(Form S-1 (Reg. No. 333-31617), Ex. 10.6).
21.1 -- List of Subsidiaries.
23.1 -- Consent of Arthur Andersen LLP.
27.1 -- Financial Data Schedule.
- - ------------
* Incorporated by reference.
Management contract or compensatory plan or arrangement required to be filed
as an exhibit to this form pursuant to Item 14(c) of this Form 10-K.
(b) Reports on Form 8-K.
None
23
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
INNOVATIVE VALVE TECHNOLOGIES, INC.
Date: March 30, 1999 By: /s/WILLIAM E. HAYNES
WILLIAM E. HAYNES
CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on March 30, 1999.
SIGNATURE TITLE
--------------- -------------
/s/WILLIAM E. HAYNES Chairman and Chief Executive Officer
WILLIAM E. HAYNES (Principal Executive Officer)
/s/CHARLES F. SCHUGART President and Director
CHARLES F. SCHUGART
/s/DOUGLAS R. HARRINGTON, JR. Vice President, Chief Financial
DOUGLAS R. HARRINGTON, JR. Officer, Treasurer and Secretary
(Principal Financial Officer and
Principal Accounting Officer)
/s/ROBERT M. CHISTE Director
ROBERT M. CHISTE
/s/ARTHUR L. FRENCH Director
ARTHUR L. FRENCH
/s/ROGER L. MILLER Director
ROGER L. MILLER
/s/FELIX PARDO Director
FELIX PARDO
/s/T. WAYNE WREN Director
T. WAYNE WREN
24
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Innovative Valve Technologies, Inc.:
We have audited the accompanying consolidated balance sheets of Innovative
Valve Technologies, Inc. and subsidiaries, (a Delaware corporation), as of
December 31, 1997 and 1998, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1998. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statements presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Innovative Valve Technologies, Inc. and Subsidiaries, as of December 31, 1997
and 1998, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Houston, Texas
March 26, 1999
F-1
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31
--------------------------------
1997 1998
--------------- ---------------
ASSETS
CURRENT ASSETS:
Cash............................... $ 2,544,450 $ --
Accounts receivable, net of
allowance of $1,079,857 and
$1,562,104....................... 17,680,697 29,634,167
Inventories, net................... 15,987,765 26,007,804
Prepaid expenses and other current
assets........................... 1,171,090 2,366,871
Deferred tax asset................. 3,723,448 4,481,256
--------------- ---------------
Total current assets..... 41,107,450 62,490,098
PROPERTY AND EQUIPMENT, net............. 11,474,701 19,469,804
GOODWILL, net........................... 48,387,981 96,175,294
PATENT COSTS, net....................... 682,436 490,552
OTHER NONCURRENT ASSETS, net............ 3,780,115 5,074,090
--------------- ---------------
$ 105,432,683 $ 183,699,838
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term debt.................... $ 4,660,924 $ --
Current maturities of long-term
debt............................. 304,310 580,140
Accounts payable and accrued
expenses......................... 14,910,638 19,364,587
--------------- ---------------
Total current
liabilities........... 19,875,872 19,944,727
CREDIT FACILITY......................... 11,750,000 70,570,584
LONG-TERM DEBT, net of current
maturities............................ 318,911 400,834
CONVERTIBLE SUBORDINATED DEBT........... 12,493,178 11,668,875
OTHER LONG-TERM LIABILITIES............. 1,125,417 1,909,774
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value,
30,000,000 shares authorized,
7,890,198 and 9,664,562 issued
and outstanding.................. 7,890 9,665
Additional paid-in capital......... 70,212,035 90,960,972
Retained deficit................... (10,350,620) (11,765,593)
--------------- ---------------
Total stockholders'
equity................ 59,869,305 79,205,044
--------------- ---------------
$ 105,432,683 $ 183,699,838
=============== ===============
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED
DECEMBER 31
------------------------
1997 1998
----------- ----------
(UNAUDITED)
REVENUES............................. $92,782 $ 154,617
COST OF OPERATIONS................... 63,835 107,568
----------- ----------
Gross profit.................... 28,947 47,049
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES........................... 24,169 40,480
NONRECURRING COSTS................... -- 2,190
----------- ----------
Income from operations.......... 4,778 4,379
OTHER INCOME (EXPENSE):
Interest, net................... (354) (5,622)
Other........................... 8 247
----------- ----------
INCOME (LOSS) BEFORE INCOME TAXES.... 4,432 (996)
PROVISION FOR INCOME TAXES........... 1,988 420
----------- ----------
INCOME (LOSS)........................ $ 2,444 $ (1,416)
=========== ==========
EARNINGS (LOSS) PER SHARE -- Basic... $ 0.31 $ (0.16)
=========== ==========
EARNINGS (LOSS) PER
SHARE -- Diluted................... $ 0.30 (0.16)
=========== ==========
WEIGHTED AVERAGE SHARES
OUTSTANDING -- Basic................. 7,825 9,025
=========== ==========
WEIGHTED AVERAGE SHARES
OUTSTANDING -- Diluted............. 8,088 9,025
=========== ==========
The accompanying notes are an integral part of these
unaudited pro forma combined financial statements.
F-3
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31
---------------------------------------------
1996 1997 1998
------------ -------------- ---------------
REVENUES............................. $ 3,887,761 $ 58,620,946 $ 154,616,945
COST OF OPERATIONS................... 2,375,245 40,987,435 107,568,111
------------ -------------- ---------------
Gross profit.................... 1,512,516 17,633,511 47,048,834
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES........................... 1,917,063 15,638,815 40,479,744
SPECIAL COMPENSATION EXPENSE......... 38,048 7,613,386 --
NONRECURRING COSTS................... -- -- 2,189,599
------------ -------------- ---------------
Income (loss) from operations........ (442,595) (5,618,690) 4,379,491
OTHER INCOME (EXPENSE):
Interest income (expense),
net........................... 27,703 (2,901,039) (5,621,182)
Other........................... 393 (2,957) 246,654
------------ -------------- ---------------
28,096 (2,903,996) (5,374,528)
------------ -------------- ---------------
LOSS BEFORE INCOME TAX............... (414,499) (8,522,686) (995,037)
PROVISION (BENEFIT) FOR INCOME TAX... -- (1,022,722) 419,936
------------ -------------- ---------------
NET LOSS............................. $ (414,499) $ (7,499,964) $ (1,414,973)
============ ============== ===============
NET LOSS BEFORE DIVIDENDS APPLICABLE
TO
PREFERRED STOCK.................... $ (414,499) $ (7,499,964) $ (1,414,973)
PREFERRED STOCK DIVIDENDS............ (191,854) (156,957) --
------------ -------------- ---------------
NET LOSS APPLICABLE TO COMMON
SHARES............................. $ (606,353) $ (7,656,921) $ (1,414,973)
============ ============== ===============
Loss per Share:
Basic and Diluted.......... $ (0.42) $ (2.25) $ (0.16)
============ ============== ===============
Weighted average common shares
outstanding:
Basic and Diluted.......... 1,441,135 3,397,980 9,024,915
============ ============== ===============
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
COMMON STOCK ADDITIONAL
------------------ PAID-IN RETAINED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
--------- ------ ----------- ------------ --------------
BALANCE, December 31, 1995........... 1,432,951 $1,433 $ 1,010,472 $ (2,087,346) $ (1,075,441)
SSI preferred stock dividends... -- -- -- (191,854) (191,854)
Issuances of SSI common stock... 60,868 61 357,987 -- 358,048
Retirement of SSI common
stock......................... (11,900) (12) (69,988) -- (70,000)
Net loss........................ -- -- -- (414,499) (414,499)
--------- ------ ----------- ------------ --------------
BALANCE, December 31, 1996........... 1,481,919 1,482 1,298,471 (2,693,699) (1,393,746)
SSI preferred stock dividends... -- -- -- (156,957) (156,957)
Issuance of SSI common stock.... 222,650 223 2,604,782 -- 2,605,005
Exercise of SSI common stock
warrant and options........... 714,769 715 4,554,141 -- 4,554,856
Issuance of common stock to
certain executives............ 242,839 243 5,008,675 -- 5,008,918
Public offering, net of offering
costs......................... 3,852,500 3,853 44,018,053 -- 44,021,906
Issuances of common stock in
acquisitions.................. 185,661 185 2,129,794 -- 2,129,979
Redemption of SSI redeemable
preferred stock and payment of
indebtedness to Philip........ 1,189,860 1,189 10,598,119 -- 10,599,308
Net loss........................ -- -- -- (7,499,964) (7,499,964)
--------- ------ ----------- ------------ --------------
BALANCE, December 31, 1997........... 7,890,198 7,890 70,212,035 (10,350,620) 59,869,305
Issuances of Common Stock in
acquisitions.................. 1,749,052 1,749 20,483,297 -- 20,485,046
Exercise of stock options....... 25,312 26 265,640 -- 265,666
Net loss........................ -- -- -- (1,414,973) (1,414,973)
--------- ------ ----------- ------------ --------------
BALANCE, December 31, 1998........... 9,664,562 $9,665 $90,960,972 $(11,765,593) $ 79,205,044
========= ====== =========== ============ ==============
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
----------------------------------------------
1996 1997 1998
-------------- -------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss........................... $ (414,499) $ (7,499,964) $ (1,414,973)
Adjustments to reconcile net loss
to net cash used in operating
activities --
Depreciation and amortization... 31,183 1,235,940 4,321,854
Deferred taxes.................. -- 4,982,917 (1,690,870)
Special compensation expense.... 38,048 7,613,386 --
Nonrecurring costs.............. -- -- 1,989,599
Gain on sale of property and
equipment..................... -- -- (18,345)
(Increase) decrease in --
Accounts receivable........... (49,736) (1,219,537) (3,600,442)
Inventories, net.............. (13,660) (4,187,410) (4,485,014)
Prepaid expenses and other
current assets............. (66,161) 424,535 (755,654)
Other noncurrent assets,
net........................ (324,246) 1,141,616 (1,208,550)
Increase (decrease) --
Accounts payable and accrued
expenses................... (91,195) (2,806,726) (5,518,177)
-------------- -------------- --------------
Net cash used in operating
activities................. (890,266) (315,243) (12,380,572)
-------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and
equipment....................... (128,309) (1,062,366) (4,707,457)
Additions to patent costs.......... (46,030) -- --
Proceeds from sale of property and
equipment....................... -- 17,137 168,619
Business acquisitions, net of cash
acquired of $499,436 and
$818,416........................ -- (51,555,833) (39,438,029)
-------------- -------------- --------------
Net cash used in investing
activities................. (174,339) (52,601,062) (43,976,867)
-------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings of debt................. 265,000 29,348,272 209,425
Repayments of debt................. -- (27,981,507) (5,209,853)
Net borrowings under Credit
Facility........................ -- 11,750,000 58,820,584
Repayments of convertible
subordinated debt............... -- -- (81,396)
Payments on non-compete
obligations..................... -- (152,662) (134,268)
Repayment of debt of Philip........ -- (2,981,789) --
Proceeds from sale/exercise of SSI
common stock warrant............ -- 1,216,855 --
Proceeds from exercise of Invatec
stock options................... -- -- 208,497
Proceeds from sale of common stock,
net of offering costs........... -- 44,021,906 --
SSI common stock repurchases....... (70,000) -- --
Preferred stock dividends.......... (191,854) (156,957) --
-------------- -------------- --------------
Net cash provided by financing
activities................. 3,146 55,064,118 53,812,989
-------------- -------------- --------------
NET INCREASE (DECREASE) IN CASH...... (1,061,459) 2,147,813 (2,544,450)
CASH, beginning of period............ 1,458,096 396,637 2,544,450
-------------- -------------- --------------
CASH, end of period.................. $ 396,637 $ 2,544,450 $ --
============== ============== ==============
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS AND ORGANIZATION:
General
Innovative Valve Technologies, Inc. ("Invatec" or the "Company") was
incorporated in Delaware in March 1997 to create the leading single-source
provider of comprehensive maintenance, repair, replacement and value-added
distribution services for industrial valves and related process-system
components throughout North America. Except for its purchase of Steam Supply &
Rubber Co., Inc. and three related entities (collectively, "Steam Supply") in
July 1997, Invatec conducted no operations of its own prior to the closing on
October 28, 1997 of (i) its initial public offering (the "IPO") of its common
stock, par value $.001 per share ("Common Stock"), (ii) its purchase of
Industrial Controls & Equipment, Inc. and three related entities (collectively,
"ICE/VARCO") and Southern Valve Services, Inc. and a related entity
(collectively, "SVS") and (iii) a merger (the "SSI Merger") in which The
Safe Seal Company, Inc. ("SSI") became its subsidiary. Earlier in 1997, SSI
had purchased Harley Industries, Inc. ("Harley"), GSV, Inc. ("GSV") and
Plant Specialities, Inc. ("PSI"). SSI and its subsidiaries were affiliates of
Invatec prior to the SSI Merger. Subsequent to the IPO, Invatec has acquired
thirteen businesses.
Recent Developments
The Company's customers consist primarily of petroleum refining, chemical,
petrochemical, power and pulp and paper plants, the businesses of which tend to
be cyclical. Margins in those industries are highly sensitive to demand cycles
and the Company's customers in those industries have historically tended to
delay capital projects, expensive turnarounds and other maintenance projects
during slow periods. Commencing with the second quarter of 1998 and continuing
into 1999, the Company's business was negatively impacted by significant
slowdowns experienced by its customers in the petroleum refining, petrochemical,
chemical, and pulp and paper industries.
As a result of the above-described downturns affecting the Company's
customers, the Company's level of business declined during 1998 and the
Company's earnings for the last three quarters of 1998 fell significantly short
of expectations. Consequently, this decline in earnings resulted in a severe
reduction in the market price of the Company's Common Stock. Declining earnings
also ultimately resulted in the Company defaulting on its credit facility (the
"Old Credit Facility") as a result of failing to meet certain financial
covenants which required specific levels of earnings in relation to debt. This
default left the Company unable to borrow funds for acquisitions thereunder. The
Company remained in default under the Old Credit Facility from July 20, 1998
through March 25, 1999. The Company's acquisition program has been effectively
suspended since July 1998 as a result of the low price of the Company's common
stock and its inability to borrow funds under the Old Credit Facility.
The Company amended its Old Credit Facility on March 26, 1999 to provide
for a new credit facility (the "New Credit Facility") expiring on April 20,
2000 and consisting of a $35 million stationary term component and up to a $45
million revolving line of credit from its existing bank group. The New Credit
Facility prohibits the Company from making acquisitions and provides for
increasingly high overall borrowing costs if the facility is not substantially
reduced or replaced prior to July 1, 1999. As a result, the Company is currently
seeking a significant equity infusion to enable it to reduce its debt, obtain a
new credit facility on better terms and potentially resume its acquisition
program on a scaled down, strategic basis. A significant equity infusion could
have a substantially dilutive impact on existing shareholders. It is uncertain
whether the Company's efforts to find new equity and debt financing will be
successful or that if such efforts are successful the Company will have
sufficient resources to resume its acquisition program.
F-7
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION
For financial reporting purposes, SSI is presented as the "accounting
acquirer" of Steam Supply, ICE/VARCO, SVS, Harley, GSV and PSI (collectively,
the "Initial Acquired Businesses"), and, as used herein, the term "Company"
means (i) SSI and its consolidated subsidiaries prior to October 31, 1997 and
(ii) Invatec and its consolidated subsidiaries (including SSI) on that date and
thereafter.
For accounting purposes, the effective dates of the acquisitions of the
Initial Acquired Businesses in 1997 are as follows: (i) Harley -- January 31;
(ii) GSV -- February 28; (iii) PSI -- May 31; (iv) Steam Supply -- July 31, and
(v) ICE/VARCO and SVS -- October 31. Following the IPO, the Company acquired
thirteen businesses (together with the Initial Acquired Businesses, the
"Acquired Businesses") in 1997 and 1998. The Company accounted for the
Acquired Businesses in accordance with the purchase method of accounting. The
allocation of the purchase prices paid to the assets acquired and the
liabilities assumed in the acquisitions of the Acquired Businesses has been
recorded initially on the basis of preliminary estimates of fair value and may
be revised as additional information concerning the valuation of those assets
and liabilities becomes available.
The financial statements include the accounts of the Company and its wholly
owned subsidiaries. All significant intercompany accounts and transactions have
been eliminated in consolidation.
UNAUDITED PRO FORMA COMBINED STATEMENTS OF OPERATIONS
The unaudited pro forma combined statements of operations give effect to
the following events and transactions as if they had occurred on January 1,
1997: (i) the formation and organizational financing of Invatec; (ii) the SSI
Merger; (iii) the acquisitions of the Initial Acquired Businesses and the
financing of those acquisitions; (iv) reverse stock splits of the outstanding
Common Stock and the SSI common stock effected in connection with the IPO; (v)
the IPO and Invatec's application of its net proceeds therefrom; and (vi) the
issuance of shares of Common Stock to repay indebtedness the Company owed to
subsidiaries of Philip Services Corp. (collectively with its subsidiaries,
"Philip"). These statements include the results of operations of the other
Acquired Businesses purchased in 1997 from their respective acquisition dates
and also include pro forma adjustments (i) to selling, general and
administrative expenses to reflect (a) the decrease in salaries and benefits
associated with certain owners and managers of the Acquired Businesses who
either were not employed by the Company after the acquisition of their Acquired
Businesses and will not be replaced or agreed prospectively to the decrease
prior to the acquisition of their Acquired Businesses and (b) the elimination of
certain excess administrative support service fees charged by ICE/VARCO's former
parent, (ii) to depreciation and amortization expense to reflect purchase price
allocations and (iii) to the provision for income taxes to provide for
incremental income taxes as if all Acquired Businesses had been subject to
federal and state income taxes during the periods presented. The per share
information in these statements has been calculated in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share."
RECLASSIFICATION
Certain prior year balances have been reclassified to conform with the
current year presentation.
INVENTORY
Inventories are valued at the lower of cost or market utilizing the
first-in, first-out method.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost, and depreciation is computed
using the straight-line method over the estimated useful lives of the assets.
The costs of major improvements are capitalized. Expenditures for maintenance,
repairs and minor improvements are expensed as incurred. When property
F-8
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and equipment are sold or retired, the cost and related accumulated depreciation
are removed and the resulting gain or loss is included in results of operations.
Included in property and equipment are certain assets subject to capital
leases. These assets are amortized using the straight-line method over the
lesser of the life of the leases or the estimated useful life of the assets.
GOODWILL
Goodwill represents the excess of the aggregate purchase price paid by the
Company in the acquisition of businesses accounted for as purchases over the
fair market value of the net assets acquired. Goodwill is amortized on a
straight-line basis over 40 years. Goodwill amortization expense was
approximately $467,000 and $2,163,000 for the years ended December 31, 1997 and
1998, respectively.
The Company periodically evaluates the recoverability of intangibles
resulting from business acquisitions and measures the amount of impairment, if
any, by assessing current and future levels of income and cash flows as well as
other factors, such as business trends and prospects and market and economic
conditions and assuming the acquired business continues to operate as a
consolidated subsidiary.
DEBT ISSUE COSTS
Debt issue costs related to the Company's Credit Facility (see Note 7) are
included in other noncurrent assets and are amortized to interest expense over
the scheduled maturity of the debt. Debt issue costs, net of accumulated
amortization were approximately $469,000 and $412,000 at December 31, 1997 and
1998, respectively.
EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income by the weighted
average common shares outstanding. Diluted earnings per share is computed by
dividing net income by the weighted average number of common shares and common
equivalent shares outstanding.
STOCK-BASED COMPENSATION
In accordance with SFAS No. 123, the Company has elected to use the method
APB Opinion No. 25 prescribes to measure its compensation costs attributable to
stock-based compensation and to include in Note 11 of these Notes the pro forma
effect on those costs using the fair value approach that SFAS No. 123 would
have.
INCOME TAXES
The Company follows the liability method of accounting for income taxes in
accordance with SFAS No. 109. Under this method, deferred income taxes are
recorded based upon differences between the financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the underlying assets or liabilities are recovered
or settled.
Prior to the Acquisitions, certain Acquired Businesses' stockholders were
taxed under the provisions of subchapter S of the Internal Revenue Code. Under
these provisions, the stockholders paid income taxes on their proportionate
share of their companies' earnings. Because the stockholders were taxed
directly, their businesses paid no federal income tax and only certain state
income taxes.
The Company intends to file a consolidated federal income tax return that
will include the operations of the Acquired Businesses for periods subsequent to
their respective acquisitions dates.
REVENUE RECOGNITION
Revenue is recognized as products are sold and as services are performed.
F-9
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CASH
Cash payments for interest during 1996, 1997 and 1998 were approximately
$4,000, $1,954,000 and $4,628,000 respectively. Cash payments for taxes during
1996, 1997 and 1998 were $0, $306,000, and $1,695,000 respectively. Noncash
activities for the year ended December 31, 1997 consisted of approximately $10.6
million of obligations and preferred stock owned by a related party which were
converted into Common Stock. Noncash activities for the year ended December 31,
1998 consisted of approximately $1.2 million reduction of convertible
subordinated debt in connection with finalization of the purchase consideration
of a 1997 acquisition.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
SPECIAL COMPENSATION EXPENSE
In 1996, SSI recorded a special non-cash compensation expense of $38,048
related to the issuance of 4,513 shares of its common stock, $0.01 par value
("SSI Common Stock"), and options to purchase 1,955 shares of that stock under
employee benefit programs.
In 1997, SSI recorded a special non-cash compensation expense of
approximately $2.6 million related to the issuance of 221,595 shares of Common
Stock to three members of executive management and to Computerized Accounting &
Tax Services, Inc. ("CATS"), a related party, to attract such individuals and
CATS to effect the IPO. For financial statement presentation purposes, these
shares were valued at approximately $11.70 per share.
During 1997, Invatec recorded a special non-cash compensation expense of
approximately $5.0 million related to (i) its issuance of 242,839 shares of
Common Stock to six members of executive management and CATS to attract them to
effect the IPO and (ii) its grant to certain of its officers of options to
purchase 202,589 shares of Common Stock at an exercise price of $1.00 per share.
For financial statement presentation purposes, the shares were valued at
approximately $11.70 per share and the options were valued at approximately
$10.70 per option share.
NONRECURRING COSTS
Nonrecurring costs reflect approximately $1.4 million in write-offs of
capitalized costs of abandoned projects, including a friction welding system,
and $0.8 million of accrued severance costs.
NEW ACCOUNTING PRONOUNCEMENTS
SFAS No. 130, "Reporting Comprehensive Income" issued in June 1997,
established standards for the reporting of comprehensive income in a company's
financial statements. Comprehensive income includes all changes in the equity of
a company during the period which result from the Company's transactions with
its stockholders. For the Company, SFAS No. 130 was effective for the year
beginning January 1, 1998. The adoption of this pronouncement did not have a
material effect on the Company's financial statements.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", requires that public business enterprises report certain
information about its operating segments in order to provide information about
the different types of business activities in which an enterprise engages. The
Company's industrial repair and distribution services are integral and any
separation of revenues or earning streams would
F-10
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
be arbitrary. As such, management does not view or conduct these activities as
distinct, separate segments. Therefore, the disclosures required by SFAS 131 are
not applicable.
3. ACQUISITIONS:
1996
In November 1996, the Company acquired The Spin Safe Corporation, Inc.
("Spin Safe") in exchange for 54,400 shares of Common Stock, valued at $5.88
per share, and noninterest-bearing notes payable of $400,000 and an agreement to
pay certain royalties. The notes are due in four equal annual installments
beginning January 15, 1998. Additionally, the Company entered into an agreement
with the former stockholders of Spin Safe [T], pursuant to which the Company
will make royalty payments to them based on the number of times in excess of a
specified base the Spin Safe [T] system is used by the Company through 2011. The
cost of this acquisition is recorded as patent costs.
1997
The aggregate consideration paid by the Company to purchase Acquired
Businesses in 1997 (as described in Note 1) was $52.2 million in cash and
assumed debt, $17.2 million in the form of short-term notes and subordinated
notes convertible into common shares and 185,661 shares of Common Stock.
Of the total purchase price paid for the Acquisitions, $23.2 million has
been allocated to net assets acquired, and the remaining $48.9 million has been
recorded as goodwill. On the basis of management's preliminary analysis, the
Company expects the historical carrying values of the Acquired Businesses'
assets and liabilities will approximate fair value, but this analysis is subject
to revision as more information regarding asset and liability valuations becomes
available.
1998
The aggregate consideration paid by the Company to purchase Acquired
Businesses in 1998 (as described in Note 1) was $38.2 million in cash and
assumed debt, $0.4 million in the form of subordinated notes convertible into
common shares and 1,749,052 shares of Common Stock.
Of the total purchase price paid for the Acquisitions, $13.4 million has
been allocated to net assets acquired, and the remaining $44.9 million has been
recorded as goodwill. On the basis of management's preliminary analysis, the
Company expects the historical carrying values of the Acquired Businesses'
assets and liabilities will approximate fair value, but this analysis is subject
to revision as more information regarding asset and liability valuations becomes
available.
Three of the acquisition agreements for the Additional Acquired Businesses
contain provisions requiring the Company to pay additional amounts (the "Makeup
Amount") to the former shareholders of each acquired business on the first
anniversary of that acquisition if the price of Invatec Common Stock on that
anniversary date is below a certain level. Two of those acquisition agreements
were entered into on July 9, 1998, and give Invatec the option of paying up to
one-half of the Makeup Amount in cash, with the remainder paid in Common Stock
valued at the market price on the anniversary date. The third agreement was
entered into on June 29, 1998 and gives Invatec the option of paying the entire
Makeup Amount in cash or Common Stock valued at the market price on the
anniversary date.
The Makeup Amount in each case is the difference between a set price, being
at or slightly above the market price of Invatec Common Stock on the closing
date of the acquisition, and the greater of (i) the market price of Invatec
Common Stock on the first anniversary of the closing date or (ii) $2.50. If the
price of Invatec Common Stock at the respective anniversary dates of each of
those acquisitions is not greater than $2.50 per share, the aggregate Makeup
Amount would be $6,516,104, of which $4,971,251 may be paid in cash instead of
Invatec Common Stock. The price of Invatec Common Stock was less than $2.50 per
share on March 26, 1999. If the market price of Invatec Common Stock on the
anniversary dates of the
F-11
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
acquisitions were the same as its market price of $.8125 on March 26, 1999 and
Invatec paid the maximum of $4,971,251 of the Makeup Amount payable in cash, an
additional 1,901,358 shares, or approximately 20% of its shares currently issued
and outstanding would be due the former shareholders of those acquired
businesses. The issuance of those shares could have a substantial dilutive
effect on existing shareholders. It is impossible to determine with certainty
what the ultimate maximum cash portion of the Makeup Amount will be or whether
the Company will have sufficient cash available for such payments when they are
due. If the Company is unable to pay the maximum cash portion of the Makeup
Amount in cash and is required to satisfy such obligation by delivery of
additional shares, the dilution to existing shareholders would be substantially
greater than if cash is available to satisfy the obligation.
In addition, one of the acquisition agreements requires Invatec to pay to
each former shareholder for each share of Invatec Common Stock sold by such
shareholder after six but before twelve months from the closing date of June 29,
1998, the amount by which $8.35 exceeds the greater of (i) the current market
price as of the date on which such share is sold or (ii) $7.35, which was the
current market price as of the closing date. At its current Common Stock price
levels, Invatec would owe those former shareholders $1.00 per share sold by them
before June 29, 1999, payable at Invatec's option in cash or Common Stock valued
at its market price on the first anniversary of the closing. As of March 26,
1999, none of the shares issued in that acquisition has been sold and an
aggregate of 250,102 shares are available for sale by the former shareholders.
The following table reflects, on an unaudited pro forma basis, the combined
operations of the Company as if the IPO, the SSI Merger, the Company's 1997 and
1998 acquisitions of Acquired Businesses and certain other events and
transactions discussed under "-- Unaudited Pro Forma Combined Statements of
Operations" in Note 2 also had taken place on January 1, 1997. These pro forma
results have been prepared for comparative purposes only and do not purport to
be indicative of the results of operations the Company would have obtained had
these events and transactions actually taken place when assumed, has obtained
since the dates of acquisition or may obtain in the future.
1997 1998
---------- ----------
(UNAUDITED AND
IN THOUSANDS)
Revenues............................. $ 183,449 $ 170,116
Income (loss) before income taxes.... 3,399 (2,076)
Net income(loss)..................... 1,937 (1,183)
Basic income (loss) per share........ $ 0.20 $ (0.12)
========== ==========
Diluted income (loss) per share...... $ 0.19 $ (0.12)
========== ==========
See discussion of the pro forma adjustments, reflected in the above amounts
in Note 2 under "Unaudited Pro Forma Combined Statements of Operations."
F-12
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. PROPERTY AND EQUIPMENT:
Property and equipment consist of the following:
DECEMBER 31,
ESTIMATED --------------------------------
USEFUL LIVES 1997 1998
------------- --------------- ---------------
Land................................. -- $ 1,616,660 $ 1,716,839
Buildings............................ 30 years 4,232,884 5,120,878
Leasehold improvements............... 30 years 988,561 4,425,874
Furniture and fixtures............... 3 - 5 years 3,175,375 4,443,392
Machinery and equipment.............. 5 years 16,632,340 23,690,367
--------------- ---------------
26,645,820 39,397,350
Less -- Accumulated
depreciation.................. (15,171,119) (19,927,546)
--------------- ---------------
Property and equipment, net..... $ 11,474,701 $ 19,469,804
=============== ===============
Depreciation expense was approximately $31,000, $692,000, and $2,094,000
for the years ended December 31, 1996, 1997 and 1998, respectively.
5. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS:
Activity in the Company's allowance for doubtful accounts consists of the
following:
DECEMBER 31
-------------------------------------
1996 1997 1998
--------- ------------ ------------
Balance, at beginning of year........ $ 25,000 $ 25,000 $ 1,079,857
Additions............................ -- 102,243 107,787
Deductions........................... -- (80,810) (413,151)
Allowance for doubtful accounts at
acquisition dates.................. -- 1,033,424 787,611
--------- ------------ ------------
Balance, at end of year.............. $ 25,000 $ 1,079,857 $ 1,562,104
========= ============ ============
Inventory consists of the following:
1997 1998
-------------- --------------
Finished goods....................... $ 14,358,776 $ 21,785,485
Work in process...................... 1,628,989 4,222,319
-------------- --------------
$ 15,987,765 $ 26,007,804
============== ==============
Accounts payable and accrued expenses consist of the following:
DECEMBER 31,
------------------------------
1997 1998
-------------- --------------
Accounts payable, trade.............. $ 8,553,604 $ 8,086,157
Accrued compensation and benefits.... 1,904,116 1,357,717
Accrued insurance.................... 1,277,637 1,733,133
Interest payable..................... 53,693 1,067,020
Other accrued expenses............... 3,121,588 7,120,560
-------------- --------------
$ 14,910,638 $ 19,364,587
============== ==============
F-13
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. SHORT-TERM DEBT:
In connection with the Company's purchase of Dalco, Inc., two short-term
notes totaling $4.7 million were issued to the former owners of Dalco, Inc. The
notes bore interest at a rate of 5.5% per annum, were unsecured and were repaid
on January 2, 1998.
7. CREDIT FACILITY:
The Company's Old Credit Facility was a $90 million three-year revolving
credit facility the Company used for acquisitions and general corporate
purposes. Declining earnings during 1998 ultimately resulted in the Company
defaulting in July 1998 on its Old Credit Facility as a result of failing to
meet certain financial covenants requiring specific levels of earnings in
relation to debt. This default left the Company unable to borrow funds for
acquisitions. The Company remained in default under the loan agreement from July
20, 1998 through March 25, 1999. The Company's acquisition program has been
effectively suspended since July 1998 as a result of the low price of the
Company's Common Stock and its inability to borrow funds.
In March 1999, the Company and its existing syndicate of lenders agreed to
amend the Company's credit facility to put into place the New Credit Facility.
The Company's credit facility was reduced from $90 million to $80 million and
restructured to be comprised of a stationary term component of $35 million and a
revolving credit facility of up to $45 million, the proceeds of which may be
used only for general corporate and working capital purposes. The Company's
subsidiaries have guaranteed the repayment of all amounts due under the
facility, and repayment is secured by pledges of the capital stock, and all or
substantially all of the assets, of those subsidiaries. The New Credit Facility
prohibits acquisitions and the payment of cash dividends, restricts the ability
of the Company to incur other indebtedness and requires the Company to comply
with certain financial covenants. These financial covenants include provisions
for maintenance of certain levels of earnings before interest, taxes,
depreciation, amortization, certain levels of cash flows as defined by the New
Credit Facility and other items specified in the loan agreement. Additionally,
the New Credit Facility requires that the Company complete all required
programming changes in connection with the Year 2000 compliance objective by
September 30, 1999. The Company believes that it will be able to meet this
requirement.
The amount of availability under the New Credit Facility is now governed by
a borrowing base which consists primarily of the accounts receivable and
inventory of the Company and its subsidiaries, although the amount available
under the revolving portion of the credit facility will decrease over time and
upon the occurrence of certain specified events, such as a sale of assets
outside the ordinary course of business. In addition, the Company and the
subsidiaries are now required to (i) meet substantially more stringent reporting
covenants, (ii) submit to collateral audits and (iii) deposit all revenues and
receipts into lockbox accounts. Interest accrues at the prime rate as in effect
from time to time, plus 2%, payable monthly. In addition, fees accrue each
quarter at the rate of 1.5% of the unpaid principal balance under the New Credit
Facility. If, however, the stationary term component is repaid by July 1, 1999
and the revolving portfolio on that date does not exceed the borrowing base, the
aggregate amount of such fees will be reduced to $100,000. If all obligations
under the New Credit Facility are repaid in full by June 30, 1999, no such fees
will be payable. The entire New Credit Facility matures on April 20, 2000. As of
March 26, 1999, the Company was in compliance with all covenants under the New
Credit Facility.
Although the Company believes that based upon current levels of business
that it can comply with the various financial covenants contained in the New
Credit Facility, a substantial adverse deviation of EBITDA would likely result
in a default by the Company of the EBITDA covenants. Therefore, if there is any
significant downward deviation in the Company's business or pressure on margins,
it is likely that the Company will be in default under the New Credit Facility.
In connection with the amendment to the New Credit Facility, the syndicate
of lenders were issued warrants to purchase up to 482,262 shares of the common
stock of the Company, exercisable at $0.73 per share (10% below the market price
of such common stock as of March 25, 1999), and granted certain registration
rights with respect to the shares issuable upon exercise of the warrants.
F-14
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1998 the Company's outstanding borrowings under the Old
Credit Facility were $70.6 million, bearing interest at 9.75%. At March 26,
1999, the Company's borrowings under the New Credit Facility were $70.6 million,
bearing interest at 9.75%.
8. LONG-TERM DEBT:
Long-term debt consists of the following:
DECEMBER 31,
----------------------
1997 1998
---------- ----------
Notes payable to former stockholders
of Spin Safe, with annual
installments of $100,000 beginning
January 15, 1998, non-interest
bearing, due January 15, 2001,
unsecured.......................... $ 358,125 $ 280,906
Installment notes payable; interest
ranging from 5.09% to 10%, payable
in monthly installments through
2006; secured by
certain assets..................... 265,096 700,068
---------- ----------
623,221 980,974
Less: current maturities............. 304,310 580,140
---------- ----------
$ 318,911 $ 400,834
========== ==========
9. CONVERTIBLE SUBORDINATED DEBT:
At December 31, 1998, outstanding convertible subordinated debt consisted
of approximately $5.1 million aggregate principal amount of 5.0% notes due in
2002, $1.6 million aggregate principal amount of 5.5% notes due in 2004, $4.6
million aggregate principal amount of 5.5% notes due in 2002 and $0.4 million
aggregate principal amount of 5.0% notes due 2003. These notes are convertible
at initial conversion prices ranging from $16.90 to $22.20 per share at the
option of the holder in whole at any time.
10. INCOME TAXES:
The provision (benefit) for income taxes consisted of:
YEAR ENDED DECEMBER 31,
-----------------------------------------
1996 1997 1998
--------- -------------- --------------
Current:
U.S. Federal................ $ -- $ (1,026,565) $ (1,089,396)
State....................... -- 513,854 661,728
--------- -------------- --------------
Total current benefit....... -- (512,711) (427,668)
Deferred:
U.S. Federal................ -- (478,127) 711,237
State....................... -- (31,884) 136,367
--------- -------------- --------------
Total deferred provision
(benefit)................. -- (510,011) 847,604
--------- -------------- --------------
Total income tax provision
(benefit)...................... $ -- $ (1,022,722) $ 419,936
========= ============== ==============
F-15
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Actual income tax expense differs from income tax expense computed by
applying the U.S. federal statutory corporate tax rate to income before income
taxes as follows:
YEAR ENDED DECEMBER 31
-------------------------------------
1996 1997 1998
----------- ----------- -----------
Statutory federal income tax
benefit............................ (34)% (34)% (34)%
Special compensation charge.......... -- 22% --
Nondeductible goodwill............... -- 2% 43%
Nondeductible expenses............... -- 3% --
State taxes, net of federal benefit
of 34%............................. -- 4% 33%
Other................................ -- 1% (1)%
Valuation allowance.................. 34% (10)% --
--- --- ---
Effective income tax rate............ 0% (12)% 41%
=== === ===
Net deferred tax assets consist of the following:
DECEMBER 31
--------------------------
1997 1998
------------ ------------
Current deferred tax assets:
Accrued liabilities and
valuation allowances not
currently deductible.......... $ 3,723,448 $ 4,481,256
------------ ------------
3,723,448 4,481,256
Noncurrent deferred tax assets:
Net operating losses............ 172,893 3,025,914
Special compensation charge..... 802,050 802,050
Amortization of intangibles..... 149,871 --
Other........................... 266,210 --
------------ ------------
1,391,024 3,827,964
Valuation allowance.................. -- --
------------ ------------
Total deferred tax assets............ $ 5,114,472 $ 8,309,220
============ ============
Noncurrent deferred tax liabilities:
Depreciation of property, plant
and equipment................. (131,555) (700,812)
Amortization of intangibles..... -- (206,734)
------------ ------------
(131,555) (907,546)
------------ ------------
Net deferred tax assets.............. $ 4,982,917 $ 7,401,674
============ ============
The Company records a valuation allowance for deferred tax assets when
management believes it is more likely than not the asset will not be realized.
Management believes that the Company's deferred tax asset will be fully realized
and therefore has not recorded a valuation allowance for this asset as of
December 31, 1997 and 1998.
F-16
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Deferred income tax provisions result from temporary differences in the
recognition of income and expenses for financial reporting purposes and for tax
purposes. The tax effects of these temporary differences representing deferred
tax assets and liabilities result principally from the following:
YEAR ENDED DECEMBER 31,
--------------------------------------
1996 1997 1998
------------ ------------ ----------
Deferred tax provision during the
year
Net operating loss.............. $ 107,301 $ 644,022 $ --
Special compensation charge..... -- (802,050) --
Depreciation.................... (2,520) 128,843 302,804
Accrued expenses not deductible
for tax....................... 25,168 366,400 544,800
Valuation allowance............. (129,949) (847,226) --
------------ ------------ ----------
Total...................... $ -- $ (510,011) $ 847,604
============ ============ ==========
Certain deferred tax assets and liabilities were recorded with respect to
purchase accounting for the Acquired Businesses during the year ended December
31, 1998.
11. STOCKHOLDERS' EQUITY:
SSI COMMON STOCK
In 1995, the Company implemented an employee benefit award program. Under
this program, the Company awarded 4,726 shares of Common Stock to employees. In
1996, employees forfeited 816 of these shares and the Company recorded non-cash
compensation expense of $11,500 with respect to the 1,955 of these shares that
had vested. The Company discontinued the program in 1997 and cancelled the
remaining unvested shares.
REVERSE STOCK SPLIT
Prior to the SSI Merger, SSI and Invatec each effected a 0.68-for-one
reverse stock split of its outstanding common stock. The accompanying financial
statements have been prepared as if these splits had been effected as of the
beginning of the earliest period presented.
SSI MERGER
As a result of the SSI Merger: (i) the shares of SSI Common Stock and
redeemable preferred stock outstanding as of October 31, 1997 were converted
into shares of Common Stock; (ii) outstanding options and a warrant to purchase
shares of SSI Common Stock were converted into options to purchase Common Stock;
and (iii) SSI's authorized capital stock became 1,000 shares of SSI Common
Stock, par value $1.00 per share, all of which have been issued and are
outstanding and owned by Invatec. All share and per share information for the
periods shown, except authorized shares, have been restated to reflect the
merger as of the beginning of the earliest period presented.
INVATEC COMMON STOCK
Invatec sold 3,852,500 shares of Common Stock in the IPO. The initial price
to the public in the IPO was $13.00, and Invatec's proceeds from the IPO, net of
an underwriting discount of $3.5 million and IPO expenses of $2.6 million,
including approximately $1.5 million of expenses which were initially funded
through advances obtained from Philip, totaled $44.0 million.
At December 31, 1998, the Company had reserved approximately 601,000 shares
of Common Stock for issuance on conversion of its outstanding convertible
subordinated notes described in Note 9, and 1,500,000 shares of Common Stock for
issuance on the exercise of stock options
F-17
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
under Invatec's 1997 Incentive Plan, of which options to purchase a total of
558,198 shares then were exercisable at exercise prices ranging from $1.00 per
share to $17.00 per share. The Company has not reserved a specific number of
shares of Common Stock for issuance in payment of any Makeup Amount that may be
due to certain former shareholders of the three 1998 Additional Acquired
Businesses discussed in Note 3 because it is unable to determine what amount, if
any, may be owing until the anniversary dates of the acquisitions and because of
the uncertainty of the availability of cash to pay the portion of the Makeup
Amount that may be paid in cash. The Company beleives it will have a sufficient
number of authorized but unissued shares to pay all of the Makeup Amount in
stock if necessary.
Invatec's certificate of incorporation authorizes the issuance of up to
30.0 million shares of Common Stock, of which 9,664,562 shares were issued and
outstanding as of December 31, 1998, and 5.0 million shares of preferred stock,
none of which has been issued.
STOCK OPTIONS
In 1996, the Company began a management stock option program that was
discontinued in 1997. Under this program, the Company granted both shares of
Common Stock and options to purchase shares of Common Stock to certain members
of management. The options vested monthly and were exercisable at any time
following the six-month period ending June 30 or December 31 in which the
options were earned. The Company had reserved 200,000 shares of Common Stock for
issuance in this program. During 1996, the Company granted 4,513 shares of
Common Stock and options to purchase 71,899 shares of Common Stock. The options
had an exercise price of $10.00 per share and are exercisable through July 1,
2001. In 1996, the Company recorded non-cash compensation expense of $26,548 for
the 4,513 shares issued with a fair market value of $5.88 per share. No
compensation expense was recorded for the options granted in 1996 because their
exercise price exceeded the fair market value of the underlying shares ($5.88
per share). Prior to 1996, the Company had, from time to time, granted options
to key employees at or above the market value of the Common Stock. The options
granted had exercise prices ranging from $5.00 to $20.00 per share. All but
50,000 options expired in 1996. The remaining options were exercised in June
1997.
1997 INCENTIVE PLAN
The Company has adopted an incentive plan (the "Incentive Plan") that
provides for the granting or awarding of stock options and other
performance-based awards to key employees, nonemployee directors and independent
contractors of the Company and its subsidiaries. The Incentive Plan aims to
attract and retain the services of key employees and qualified independent
directors and contractors by making stock option and other performance-based
awards tied to the growth and performance of the Company. At December 31, 1998,
Invatec had reserved 1,500,000 shares of Common Stock for use under the
Incentive Plan. Beginning in the second quarter of 1998, the number of shares
available for that use is the greater of 1,500,000 or 15% of the number of
shares of Common Stock outstanding on the last day of the preceding quarter.
F-18
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes the stock options outstanding at December
31, 1998 and changes during the three years then ended:
WEIGHTED-
SHARES UNDER AVERAGE
OPTION EXERCISE PRICE
------------ --------------
Balance at December 31, 1995......... 121,000 13.18
Granted......................... 71,899 10.00
Exercised....................... -- --
Cancelled....................... (71,000) 18.94
------------
Balance at December 31, 1996......... 121,899 7.94
Warrants converted to options... 15,000 10.00
Granted......................... 1,310,389 9.97
Exercised....................... (50,000) 5.00
Cancelled....................... (1,540) 10.00
------------
Balance at December 31, 1997......... 1,395,748 9.97
Granted......................... 586,236 3.40
Exercised....................... (23,500) 8.87
Cancelled....................... (502,500) 11.51
------------
Balance at December 31, 1998......... 1,455,984 6.81
============
Available for grant at December 31,
1998............................... 44,016
============
The options outstanding at December 31, 1998 have exercise prices from
$1.00 to $17.00 per share, and a weighted average remaining contractual life of
6.02 years.
At December 31, 1997 and 1998 the number of options exercisable was 533,873
and 558,198, respectively, and the weighted average exercise price of those
options was $9.97 and $ 7.96, respectively.
The Company accounts for options by applying APB Opinion No. 25, under
which no compensation expense (other than described in Note 2) has been
recognized. The Company's pro forma compensation expense for 1996 is zero as
options were determined to be without value under SFAS No. 123 using the minimum
value option method.
If the Company had recorded 1997 and 1998 compensation cost for option
grants consistent with SFAS No. 123, 1997 and 1998 net loss and loss per share
would have been increased by the following pro forma amounts:
YEAR ENDED DECEMBER 31,
------------------------------
1997 1998
-------------- --------------
Net Loss:
As Reported..................... $ (7,499,964) $ (1,414,973)
Pro forma....................... $ (8,350,661) $ (3,001,219)
Loss Per Share:
Basic
As Reported..................... $ (2.25) $ (0.16)
Pro forma....................... $ (2.50) $ (0.33)
The pro forma compensation cost may not be representative of that to be
expected in future years because options vest over several years and additional
awards may be made each year.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model, with the following weighted average
assumptions used for grants in 1997 and 1998,
F-19
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
respectively: dividend yield of 0% and 0%; expected volatility of 48.43% and
50.27%; risk-free interest rate of 6.09% and 4.94%; and expected lives of 6.92
years and 7.0 years.
WARRANTS
During 1997, Philip exercised warrants to purchase 680,768 shares of SSI
Common Stock at an exercise price of $6.32 per share. Consideration for the
exercise consisted of approximately $3.3 million of Philip promissory notes and
approximately $1.2 million in cash. The Company used the Philip notes as part of
the consideration it paid for Harley.
STOCK REPURCHASES
In December 1996, the Company purchased 11,900 shares of SSI Common Stock
from certain stockholders for $70,000 ($5.88 per share). It subsequently
canceled these shares.
12. EARNINGS PER SHARE:
The computation of earnings (loss) per share of Common Stock is presented
in accordance with SFAS No. 128, "Earnings Per Share," based on the following
shares of Common Stock outstanding:
1996 1997 1998
----------- ----------- -----------
Issued and outstanding at January
1.................................. 1,432,951 1,481,919 7,890,198
Issued to acquire businesses
(weighted)......................... -- 25,016 1,116,316
Issued in connection with the
Company's IPO (weighted)........... -- 726,445 --
Issued in redemption of SSI Preferred
Stock (weighted)................... -- 228,192 --
Issued in connection with SSI and
Invatec merger (weighted).......... -- 170,105 --
Issued for stock options exercised
and warrants exercised
(weighted)......................... 8,184 766,303 18,401
----------- ----------- -----------
Weighted average shares
outstanding -- Basic and Diluted... 1,441,135 3,397,980 9,024,915
=========== =========== ===========
Common share equivalents including options to purchase 10,301 shares of
Common Stock and $12.5 million of subordinated debt convertible into Common
Stock at prices ranging from $16.90 to $22.20 per share, outstanding at December
31, 1997, were not included in the computation of diluted EPS as their effect on
EPS was antidilutive.
Common share equivalents including options to purchase 258,583 shares of
Common Stock, approximately 2.5 million shares of Common Stock assumed to be
issued for guaranteed stock prices, and $11.7 million of subordinated debt
convertible into Common Shares at prices ranging between $16.90 and $22.20 per
share, outstanding at December 31, 1998, were not included in the computation of
diluted EPS as their effect on EPS was antidilutive.
13. REDEEMABLE PREFERRED STOCK:
In 1995, SSI issued and sold 20,000 shares of its redeemable preferred
stock to Philip for $2.0 million ($100 per share). In the SSI Merger in 1997,
these shares, together with accrued dividends thereon, converted into 154,958
shares of Common Stock.
F-20
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. COMMITMENTS AND CONTINGENCIES:
OPERATING LEASES
The Company leases warehouse space, office facilities and vehicles under
noncancelable leases. Rental expense for 1996, 1997 and 1998 was approximately
$162,400, $822,400, and $2,765,553, respectively. The following represents
future minimum rental payments under noncancelable operating leases:
Year ending December 31 --
1999............................ $ 3,010,999
2000............................ 2,804,987
2001............................ 2,040,896
2002............................ 1,273,234
2003............................ 542,135
Thereafter...................... 2,508,285
--------------
$ 12,180,536
==============
LITIGATION
In the ordinary course of its business, the Company has become involved in
various legal actions. Management, after consultation with legal counsel, does
not believe that the outcome of these legal actions will have a material effect
on the Company's financial position or results of operations.
15. CERTAIN TRANSACTIONS:
The Company had a management agreement with CATS, an entity then related by
common ownership. Management fee expense for 1996 and 1997 was approximately
$108,000 and $353,000, respectively. This agreement terminated in 1997.
16. EMPLOYEE BENEFIT PLANS:
The Company maintains certain 401(k) plans which allow eligible employees
to defer a portion of their income through contributions to the plans. No
contributions were required or made to these plans during 1996. The Company
contributed approximately $59,000 and $596,000 to its plans during the years
ended December 31, 1997 and 1998, respectively.
17. RELATIONSHIP WITH PHILIP:
In 1996, Philip agreed to make certain advances to SSI to enable SSI, or
its successors, to pursue a possible initial public offering. As a result of
Philip's financial support of SSI's acquisition of Harley, Philip became a
related party of the Company for financial statement presentation purposes
effective January 31, 1997. In June 1997, Invatec entered into a funding
arrangement with Philip pursuant to which Philip advanced funds to Invatec to
pay costs related to the IPO and Invatec assumed SSI's obligation to repay the
Philip advances and the related deferred offering costs funded with these
advances.
In connection with the IPO, Invatec issued 1,036,013 shares of Common Stock
to Philip as payment of $8.6 million of indebtedness owed to Philip. Immediately
after the IPO, Invatec repaid the remaining $3.0 million of indebtedness owed to
Philip in cash.
18. SERVICE AND DISTRIBUTION AGREEMENTS:
The Company purchases, sells and services various products under service
and distribution agreements with its major suppliers. In general, these
agreements are cancelable by the suppliers upon 30 to 60 days' notice.
Management does not anticipate cancellation of these agreements.
F-21