UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED March 31, 1999
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
------------------------
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 [ ]
The number of shares of Common Stock of the Registrant, par value $.001
per share, outstanding at May 14, 1999 was 9,664,562.
=============================================================================
INNOVATIVE VALVE TECHNOLOGIES, INC.
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 1999
INDEX
PAGE
----
Part I -- Financial Information...................................... 2
Item 1 -- Financial Statements..................................... 2
Consolidated Balance Sheets as of December 31, 1998 and
March 31, 1999 (Unaudited)...................................... 2
Consolidated Statements of Operations for the Three Months
Ended March 31, 1998 and 1999 (Unaudited)...................... 3
Consolidated Statements of Cash Flows for the Three Months
Ended March 31, 1998 and 1999 (Unaudited)....................... 4
Notes to Consolidated Financial Statements (Unaudited)............ 5
Item 2 -- Management's Discussion and Analysis of Financial
Condition and Results of Operations............................ 10
Item 3 -- Quantitative and Qualitative Disclosures About Market
Risk............................................................ 15
Part II -- Other Information........................................ 15
Item 2 -- Changes in Securities and Use of Proceeds................ 15
Item 6 -- Exhibits and Reports on Form 8-K......................... 16
1
PART I - FINANCIAL INFORMATION
ITEM 1 -- FINANCIAL STATEMENTS
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, MARCH 31,
1998 1999
------------- -------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash ...................................... $ -- $ --
Accounts receivable, net of allowance
of $1,562,104 and $1,474,442 ............ 29,634,167 31,324,112
Inventories, net .......................... 26,007,804 27,367,943
Prepaid expenses and other current
assets .................................. 2,366,871 2,311,434
Deferred tax asset ........................ 4,481,256 4,481,256
------------- -------------
Total current assets ................ 62,490,098 65,484,745
PROPERTY AND EQUIPMENT, net .................. 19,469,804 19,306,229
GOODWILL, net ................................ 96,175,294 95,559,329
OTHER NONCURRENT ASSETS, net ................. 5,564,642 5,764,223
------------- -------------
TOTAL ASSETS ........................ $ 183,699,838 $ 186,114,526
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt ...... $ 580,140 $ 299,335
Accounts payable and accrued expenses ..... 19,364,587 22,386,157
------------- -------------
Total current liabilities ........... 19,944,727 22,685,492
CREDIT FACILITY .............................. 70,570,584 70,325,181
LONG-TERM DEBT, net .......................... 400,834 266,673
CONVERTIBLE SUBORDINATED DEBT ................ 11,668,875 11,668,875
OTHER LONG-TERM OBLIGATIONS .................. 1,909,774 1,899,234
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value,
30,000,000 shares authorized,
9,664,562 shares issued
and outstanding ...................... 9,665 9,665
Additional paid-in capital ............. 90,960,972 91,067,070
Retained deficit ....................... (11,765,593) (11,807,664)
------------- -------------
Total stockholders' equity ......... 79,205,044 79,269,071
------------- -------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY ............. $ 183,699,838 $ 186,114,526
============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
2
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
--------------------------------
1998 1999
------------ ------------
REVENUES ............................... $ 33,504,037 $ 43,930,553
COST OF OPERATIONS ..................... 22,621,985 30,802,636
------------ ------------
Gross profit ........................ 10,882,052 13,127,917
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES .............. 7,985,005 11,004,868
------------ ------------
Income from operations .............. 2,897,047 2,123,049
OTHER INCOME (EXPENSE):
Interest expense, net ............... (709,490) (1,931,991)
Other ............................... 12,983 37,907
------------ ------------
INCOME BEFORE INCOME TAXES ............. 2,200,540 228,965
PROVISION FOR INCOME TAXES ............. 946,232 271,036
------------ ------------
NET INCOME (LOSS) ...................... $ 1,254,308 $ (42,071)
============ ============
EARNINGS (LOSS) PER SHARE -
BASIC ............................... $ 0.16 $ --
============ ============
EARNINGS (LOSS)PER SHARE -
DILUTED ............................. $ 0.15 $ --
============ ============
WEIGHTED AVERAGE SHARES
OUTSTANDING - BASIC .................. 8,029,092 9,664,562
============ ============
WEIGHTED AVERAGE SHARES
OUTSTANDING - DILUTED ................ 8,684,764 9,664,562
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
3
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
----------------------------
1998 1999
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ........................... $ 1,254,308 $ (42,071)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities -
Depreciation and amortization ............... 736,916 1,224,001
Loss on sale of property and equipment ...... -- 3,595
Deferred taxes .............................. 241,778 (16,373)
(Increase) decrease in -
Accounts receivable ...................... (3,651,014) (1,689,945)
Inventories .............................. (1,732,334) (1,360,139)
Prepaid expenses and other
current assets ........................ (653,373) 55,437
Other noncurrent assets .................. 766,418 (187,392)
Increase (decrease) in -
Accounts payable and accrued
expenses ........................... (1,249,657) 3,085,803
------------ ------------
Net cash provided by (used in)
operating activities ............... (4,286,958) 1,072,916
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of equipment ............. -- 17,281
Additions to property and
equipment ................................ (746,162) (415,158)
Business acquisitions, net of cash
acquired of $185,094 and $-- ............. (30,674,244) --
------------ ------------
Net cash used in investing
activities ......................... (31,420,406) (397,877)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term debt ................ (151,208) (420,661)
Repayments of short-term debt ............... (4,660,924) --
Net borrowings (repayments) under Credit
Facility ................................. 38,377,800 (245,403)
Payments on noncompete obligations .......... (65,160) (8,975)
Proceeds from exercise of stock
options .................................. 27,500 --
------------ ------------
Net cash provided by (used in)
financing activities ............... 33,528,008 (675,039)
NET DECREASE IN CASH .............................. (2,179,356) --
CASH, beginning of period ......................... 2,544,450 --
------------ ------------
CASH, end of period ............................... $ 365,094 $ --
============ ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest ...................... $ 397,244 $ 1,219,470
Cash paid for income taxes .................. $ 333,111 $ 104,566
The accompanying notes are an integral part of these consolidated financial
statements.
4
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION:
Innovative Valve Technologies, Inc. ("Invatec") 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 an established business 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 ("Common
Stock"), (ii) its purchase of two established businesses and (iii) a merger (the
"SSI Merger") in which The Safe Seal Company, Inc. ("SSI") became its
subsidiary. Earlier in 1997, SSI had purchased three established businesses. SSI
and its subsidiaries were affiliates of Invatec prior to the SSI Merger.
For financial reporting purposes, SSI is presented as the "accounting
acquirer" of the seven businesses it and Invatec purchased through the IPO
closing date (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.
Following the IPO, the Company purchased thirteen businesses (these
businesses, together with the Initial Acquired Businesses, are referred to
herein as the "Acquired Businesses"). The Company is accounting for the
acquisitions of 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 accompanying historical
consolidated financial statements of operations present historical information
of the Company, which gives effect to the acquisitions as of their respective
acquisition dates.
The consolidated financial statements herein have been prepared by the
Company without audit, pursuant to rules and regulations of the Securities and
Exchange Commission which permit certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles to be condensed or omitted. The Company believes
the presentation and disclosures herein are adequate to make the information not
materially misleading, and the financial statements reflect all elimination
entries and normal adjustments that are necessary for a fair presentation of the
results for the interim periods ended March 31, 1998 and 1999. Certain
reclassifications have been made to 1998 amounts to conform with 1999
presentation.
Operating results for interim periods are not necessarily indicative of
the results for full years. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Fluctuations in Operating
Results" in Item 2 of this Part I. Invatec's Annual Report on Form 10-K for the
year ended December 31, 1998, as amended (the "1998 10-K Report"), includes the
Company's consolidated financial statements and related notes for 1998.
RECENT DEVELOPMENTS
The Company's customers consist primarily of petroleum refining, chemical,
petrochemical, power and pulp and paper plants, the businesses of
5
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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'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 discussed below.
2. GOODWILL
Goodwill represents the excess of the aggregate purchase price paid by the
Company in the acquisition of businesses accounted for using the purchase method
of accounting over the fair market value of the net assets acquired. Goodwill is
amortized on a straight-line basis over 40 years.
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, business
trends and prospects and market and economic conditions, assuming the acquired
business continues to operate as a consolidated subsidiary. Management is
currently evaluating various alternatives, including the potential sale of
certain Company assets, which could result in a potential impairment of the
recorded asset value.
3. 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.
In March 1999, the Company and its existing syndicate of lenders agreed to
amend the Company's Old 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
6
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
covenants. These financial covenants include provisions for maintenance of
certain levels of earnings before interest, taxes, depreciation, and
amortization ("EBITDA"), 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 New 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 portion on that date does not exceed the borrowing base, the
aggregate amount of such contingent 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. There is no accrual for these fees at March 31,
1999. The entire New Credit Facility matures on April 20, 2000. As of May 14,
1999, the Company was in compliance with all covenants under the New Credit
Facility.
Although the Company believes, based upon current levels of business, that
it can comply with the various financial covenants contained in the New Credit
Facility, a substantial adverse decline in 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.
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. The Company
recently retained an investment banking firm to assist the Company in reviewing
financial restructuring alternatives, including raising additional equity which
would likely 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.
In connection with the amendment to the New Credit Facility, the syndicate
of lenders was 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. The
warrants do not have an expiration date. The estimated fair value of the
warrants at the date issued was $0.21 per share using a Black-Scholes option
pricing model.
At May 14, 1999, the Company's borrowings under the New Credit Facility were
$74.3 million bearing interest at 9.75%, excluding the effect of contingent fees
discussed above.
7
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
4. INCOME TAXES:
Certain of the Acquired Businesses were subject to the provisions of
Subchapter S of the Internal Revenue Code prior to their acquisition by the
Company. Under these provisions, their former stockholders paid income taxes on
their proportionate share of the earnings of these businesses. Because the
stockholders were taxed directly, their businesses paid no federal income tax
and only certain state income taxes.
The Company files a consolidated federal income tax return that includes the
operations of the Acquired Businesses for periods subsequent to their respective
acquisition dates.
5. EARNINGS (LOSS) PER SHARE:
The computation of earnings (loss) per share of Common Stock for the
interim periods is presented in accordance with SFAS No. 128, "Earnings Per
Share," based on the following shares of Common Stock outstanding:
THREE MONTHS ENDED
MARCH 31
-----------------------
1998 1999
--------- ---------
Issued and outstanding at January 1 ........ 7,890,198 9,664,562
Issued to acquire businesses in 1998
(weighted) .............................. 134,638 --
Issued for stock options exercised
and warrants exercised ................. 4,256 --
--------- ---------
Weighted average shares outstanding -
Basic .................................. 8,029,092 9,664,562
Dilutive effect of shares issuable on
conversion of convertible notes ........ 363,502 --
Dilutive effect of shares issuable
on exercise of stock options ........... 292,170 --
--------- ---------
Weighted average shares outstanding -
Diluted ................................ 8,684,764 9,664,562
========= =========
Diluted weighted average shares outstanding for 1999 does not reflect the
effect of certain options and warrants to purchase common stock, convertible
subordinated notes which were outstanding during the period, and contingent
shares provided in connection with certain acquisition agreements as these items
were anti-dilutive.
6. CONTINGENT CONSIDERATION
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
8
INNOVATIVE VALVE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 May 12, 1999. If the market price of Invatec Common Stock on the
anniversary dates of the acquisitions were the same as its market price of $0.81
on May 12, 1999 and Invatec paid the maximum of $4,971,251 of the Makeup Amount
payable in cash, an additional 1,900,188 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 would likely 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 May 14, 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.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion should be read in conjunction with the
consolidated financial statements and the notes thereto which are included in
Item 1 of this Part I. This report contains "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. See "Factors That May Affect Future Results" in Item
1 of the Company's Annual Report on Form 10-K for the year ended December 31,
1998.
OVERVIEW
The Company derives its revenues principally from (i) sales of industrial
valves and related process-system components to its process-industry customers
and commissions paid by the manufacturers of these products in connection with
the Company's direct sales of these products and (ii) performance of
comprehensive maintenance repair services of industrial valves and related
process-system components for its customers. Costs of operations consist
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 sales, management and administrative personnel, insurance,
depreciation and amortization and other related expenses.
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 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.
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,
10
strategic basis. A significant equity infusion would likely 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 profitabilty. During 1998,
the Company eliminated in excess of $5 million in annualized costs, including
substantial corporate overhead. In 1999, the Company is continuing its cost
cutting program. This program includes 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 efficiency.
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 recently
retained an investment banking firm to assist the Company in reviewing financial
restructuring alternatives, including raising additional equity, which would
likely have a substantially dilutive impact on the existing shareholders.
RESULTS OF OPERATIONS -- HISTORICAL (Unaudited)
The following table sets forth for the Company certain selected
consolidated financial data and that data as a percentage of consolidated
revenues for the periods indicated:
THREE MONTHS ENDED
MARCH 31
------------------------------------------
1998 1999
------------------------------------------
(IN THOUSANDS)
Revenues ................. $33,504 100% $43,931 100%
Cost of operations ....... 22,622 68 30,803 70
------- ------- ------- -------
Gross profit ............. 10,882 32 13,128 30
Selling, general and
administrative
expenses .............. 7,985 24 11,005 25
------- ------- ------- -------
Income from
operations ............ $ 2,897 8% $ 2,123 5%
======= ======= ======= =======
THREE MONTHS ENDED MARCH 31
REVENUES -- Revenues increased $10.4 million, or 31%, from $33.5 million
in the three months ended March 31, 1998 to $43.9 million in the corresponding
period in 1999. This increase primarily resulted from the inclusion in the 1999
period of the results of the businesses acquired during 1998.
GROSS PROFIT -- Gross profit increased $2.2 million, or 21%, from $10.9
million in the three months ended March 31, 1998 to $13.1 million in the
corresponding period in 1999. This increase occurred principally as a result of
the inclusion in the 1999 period of the incremental gross profit of the
businesses acquired during 1998. Gross margin as a percentage of revenues
decreased from 32% to 30%, primarily resulting from lower sales volumes
associated with the downturns previously described.
11
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES -- Selling, general and
administrative expenses increased $3.0 million, or 38%, from $8.0 million in the
three months ended March 31, 1998 to $11.0 million in the corresponding period
in 1999. This increase primarily reflected the incremental selling, general and
administrative expenses in the 1999 period of the businesses acquired during
1998. As a percentage of revenues, these expenses increased from 24% in the
three months ended March 31, 1998 to 25% in the same period in 1999, primarily
due to the inclusion of the results of certain businesses acquired during 1998.
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 the
timing of acquisitions, seasonal fluctuations in the demand for the Company's
services 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.
LIQUIDITY AND CAPITAL RESOURCES
For the three months ended March 31, 1999, the Company's operations
generated $1.1 million in cash. Capital expenditures totaled $0.4 million and
net repayment of debt amounted to $0.7 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 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 "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 the amount available
under the revolving portion of the New 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
12
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 portion on that date
does not exceed the borrowing base, the aggregate amount of such contingent 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. There is no
accrual for such fees at March 31, 1999. The entire New Credit Facility matures
on April 20, 2000.
In connection with the amendment to the New Credit Facility, the syndicate
of lenders was 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. The
warrants do not have an expiration date. The estimated fair value of the
warrants at the date issued was $0.21 per share, using a Black-Scholes option
pricing model.
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 recently retained an investment banking firm
to assist the Company in 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 would likely have a substantially dilutive impact on
existing shareholders. It is uncertain whether those 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 decrease in 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 March 31, 1999, the Company's outstanding borrowings under the New
Credit Facility were $70.3 million, bearing interest at 9.75%. At May 14, 1999,
the Company's outstanding borrowings under the New Credit Facility were $74.3
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.
At March 31, 1999, the Company's capitalization included approximately
$11.7 million aggregate principal amount of convertible subordinated notes due
2002-04 that bore a weighted average interest rate of 5.3%. The Company issued
these notes as partial consideration in acquisitions of certain Acquired
Businesses. These notes are convertible into Common Stock at initial conversion
prices ranging from $16.90 to $22.20 per share.
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
13
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 May 12, 1999. If the market price of Invatec Common Stock on the
anniversary dates of the acquisitions were the same as its market price of $0.81
on May 12, 1999 and Invatec paid the maximum of $4,971,251 of the Makeup Amount
payable in cash, an additional 1,900,188 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 May 14, 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.
In the event additional cash is needed to support the Company's working
capital requirements, the Company may need to seek additional financing by
increasing the borrowing capacity under the New Credit Facility or the public or
private sale of equity or debt securities. There can be no assurance that the
Company could secure such financing if and when it is needed or on terms the
Company deems acceptable.
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
14
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 sixty 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 July
31, 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.
ITEM 3. 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 New Credit Facility were $70.3 million at March 31, 1999. 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.
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In connection with the amendment to the New Credit Facility, Invatec's
syndicate of lenders was issued, on March 21, 1999, 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 given certain registration rights with respect to the shares issuable upon
exercise of the warrants. The warrants may be exercised by the holder thereof at
any time by surrender of the warrant to the Company and payment of the exercise
price, either in cash or by the delivery of warrant shares valued at the fair
market price per share. The warrants are subject to certain antidilution
provisions. The sale of the warrants (and the underlying rights to shares of
common stock) was exempt from the registration requirements of the Securities
Act by virtue of Section 4(2) thereof as a transaction not involving any public
offering. The issuance of shares of common stock on exercise of those warrants
will be exempt from those requirements pursuant to Section 3(a)(9) of the
Securities Act.
15
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION
-------------------------------------------------------------------------------
2.1(a)* -- Merger Agreement dated June 29, 1998 among Invatec,
Plant Maintenance, Inc. and the former shareholders thereof
(Form 10-K for the year ended December 31, 1998 (File No.
000-23231) Ex. 2.1(a)).
2.1(b)* -- Amendment to Merger Agreement dated as of September 25,
1998 among Invatec, Plant Maintenance, Inc. and the former
shareholders thereof (Form 10-K for the year ended December
31, 1998 (File No. 000-23231) Ex. 2.1(b)).
2.2(a)* -- Merger Agreement dated July 9, 1998 among Invatec,
Collier Equipment Corporation and the former shareholders
thereof (Form 10-K for the year ended December 31, 1998
(File No. 000-23231) Ex. 2.2(a))
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 (Form 10-K for the year ended December
31, 1998 (File No. 000-23231) Ex. 2.2(b)).
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 (Form
10-K for the year ended December 31, 1998 (File No.
000-23231) Ex. 2.3(a)).
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 (Form 10-K for the year
ended December 31, 1998 (File No. 000-23231) Ex. 2.3(b)).
3.1* -- Certificate of Incorporation of Invatec, as amended
(Form 10-Q for the quarterly period ended September 31,
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(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).
4.1(b)* -- Amendment to Loan Agreement dated March 21, 1999 among
Invatec, Chase Bank of Texas and the other lenders (Form
10-K for the year ended December 31, 1998 (File No.
000-23231) Ex. 4.6(b)).
16
4.2* -- Registration Rights Agreement dated as of March 21, 1999
by and among Invatec, Chase Bank of Texas and the other
lenders (Form 10-K for the year ended December 31, 1998
(File No. 000-23231) Ex. 4.8).
4.3* -- Form of Warrants dated as of March 21, 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 (Form 10-K for the year ended December 31, 1998
(File No. 000-23231) Ex. 4.9). 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 (Form 10-K
for the year ended December 31, 1998 (File No. 000-23231)
Ex. 10.1).
27.1 -- Financial Data Schedule.
- ----------------
* Incorporated by reference to the filing indicated.
(b) Reports on Form 8-K.
None.
17
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant, Innovative Valve Technologies, Inc., has duly caused this Report to
be signed on its behalf by the undersigned, thereunto duly authorized.
INNOVATIVE VALVE TECHNOLOGIES, INC.
DOUGLAS R. HARRINGTON, JR.
VICE PRESIDENT
CHIEF FINANCIAL OFFICER
Dated: May 14, 1999
18