UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 1999
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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 0-23454
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Total Containment, Inc.
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(Exact name of registrant as specified in its charter)
Pennsylvania 23-2394872
- ------------------------------- -------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
422 Business Center, A130 North Dr., Oaks, PA 19456
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(Address of principal executive offices) (Zip Code)
(610) 666-7777
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(Registrant's telephone number, including area code)
N/A
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(Former name, former address and former fiscal year,
if changed since last report)
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
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date: 4,672,600 shares of
Common Stock, par value $0.01 per share were outstanding at October 29, 1999.
1
Total Containment, Inc.
Index
Page
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Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheet -
December 31, 1998 and September 30, 1999 3
Condensed Consolidated Statement of Operations - Three and nine months
ended September 30, 1998 and 1999 4
Condensed Consolidated Statement of Cash Flows -
Nine months ended September 30, 1998 and 1999 5
Notes to Condensed Consolidated Financial Statements -September 30, 1999 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Part II. Other Information
Item 1. Legal Proceedings 16
Item 5. Other Information 16
Item 6. Exhibits and Reports on Form 8-K 17
Signatures 18
2
Part I. Financial Information
Item 1. Financial Statements
TOTAL CONTAINMENT, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
December 31, Sept. 30
1998 1999
------------ --------
(Unaudited)
(In thousands)
ASSETS
Current Assets:
Cash and cash equivalents $ 132 $ 261
Accounts receivable, net 13,329 5,977
Inventories 7,623 6,593
Deferred income taxes 2,851 2,147
Other assets 767 1,244
-------- --------
Total current assets 24,702 16,222
Molds and tooling, net 438 328
Property and equipment, net 4,386 5,393
Patents, patent rights and licenses, net 310 265
Goodwill, net 5,792 5,606
Deferred income taxes 1,527 3,949
-------- --------
Total Assets $ 37,155 $ 31,763
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Line of credit borrowings and short term demand note $ 3,388 $ 5,756
Current portion of long-term debt 668 649
Accounts payable, trade and accrued expenses 6,412 4,703
Other payable 4,020 4,020
Warranty reserve 5,452 970
-------- --------
Total current liabilities 19,940 16,098
Long-term debt 1,727 2,362
Warranty reserve 667 2,576
-------- --------
Total liabilities 22,334 21,036
-------- --------
Shareholders' Equity:
Preferred stock - $10,000 stated value; authorized 400 shares;
400 shares issued and outstanding 4,000 4,000
Common stock - $0.01 par value;
authorized 20,000,000 shares;
4,652,600 and 4,672,600 shares issued and outstanding 47 47
Capital in excess of par value 13,756 13,808
Retained earnings (accumulated deficit) (2,816) (6,943)
Equity adjustment from foreign
currency translation (166) (185)
-------- --------
Total shareholders' equity 14,821 10,727
-------- --------
Total Liabilities & Shareholders' Equity $ 37,155 $ 31,763
======== ========
See notes to condensed consolidated financial statements.
3
TOTAL CONTAINMENT, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
--------------------------- ---------------------------
1998 1999 1998 1999
-------- -------- -------- --------
(In thousands, except per share data) (In thousands, except per share data)
Net sales $ 14,984 $ 5,742 $ 39,464 $ 20,648
Cost of sales (excluding warranty provision) 8,031 4,610 21,933 16,554
-------- -------- -------- --------
6,953 1,132 17,531 4,094
Warranty Provision 453 164 1,183 600
Special pipe warranty charge (reversal) (3,347) -- (3,347) --
-------- -------- -------- --------
Gross profit 9,847 968 19,695 3,494
Selling, general and administrative 3,397 3,244 9,796 9,137
Amortization of patents, licenses and goodwill 123 61 367 184
Loss on write-off of patent and patent license 3,727 -- 3,727 --
-------- -------- -------- --------
Income (loss) from operations 2,600 (2,337) 5,805 (5,827)
Interest expense 210 157 474 459
-------- -------- -------- --------
Income (loss) before income taxes 2,390 (2,494) 5,331 (6,286)
Income tax expense (benefit) 898 (951) 2,026 (2,389)
-------- -------- -------- --------
Net income (loss) 1,492 (1,543) 3,305 (3,897)
Preferred stock dividends 87 76 189 230
-------- -------- -------- --------
Net Income (loss) applicable to common
shareholders $ 1,405 $ (1,619) $ 3,116 $ (4,127)
======== ======== ======== ========
Earnings (loss) per common share - basic $ 0.30 $ (0.35) $ 0.67 $ (0.88)
======== ======== ======== ========
Weighted average shares used in computation
of net income (loss) per share - basic 4,650 4,673 4,645 4,666
======== ======== ======== ========
Earnings (loss) per common share - diluted $ 0.29 $ (0.35) $ 0.64 $ (0.88)
======== ======== ======== ========
Weighted average shares used in computation
of net income (loss) per share - diluted 4,920 4,673 4,850 4,666
======== ======== ======== ========
See notes to condensed consolidated financial statements.
4
TOTAL CONTAINMENT, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
Nine months ended
September 30,
----------------------------
1998 1999
-------- --------
(In thousands)
Cash flows from operating activities:
Net income (loss) 3,305 (3,897)
Adjustment to reconcile net income (loss) to
net cash provided by operating activities:
Loss on write-off of patent license 3,727 --
Depreciation and amortization 1,489 1,221
Change in assets and liabilities (3,228) 4,240
Change in operating warranty reserve (8,642) (2,573)
-------- --------
Net cash used in operating activities $ (3,349) $ (1,009)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment (1,286) (1,898)
-------- --------
Net cash used in investing activities (1,286) (1,898)
-------- --------
Cash flows from financing activities:
Proceeds from the sale of preferred stock 4,000 --
Proceeds from the sale of common stock 20 52
Repayments on long-term debt (502) (384)
Net borrowings under bank line of credit and short term demand note 959 3,368
-------- --------
Net cash provided by financing activities 4,477 3,036
-------- --------
Net increase (decrease) in cash and cash equivalents $ (158) $ 129
======== ========
See notes to condensed consolidated financial statements.
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(Unaudited)
Note 1 - Basis of Presentation
The unaudited Condensed Consolidated Financial Statements of Total Containment,
Inc. and its wholly owned subsidiaries (the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information. Accordingly, they do not include all of the information and
disclosures required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included. The results of operations of the Company for the three and
nine months ended September 30, 1999 are not necessarily indicative of the
results that may be expected for any other interim period or for a full year.
For further information, refer to the Consolidated Financial Statements and
notes thereto included in the Registrant Company's Annual Report and Form 10-K
for the year ended December 31, 1998.
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.
Significant estimates made by management that are reasonably subject to change
include the warranty reserve, inventory reserves, allowance for doubtful
accounts and deferred tax assets. Realization of deferred tax assets,
associated, in part, with both federal and state net operating loss (NOL)
carryforwards, is dependent upon generating sufficient taxable income prior to
their expiration. The Company has incurred a net operating loss during 1999,
which management believes is temporary in nature and has elected to record an
increase in the deferred tax assets as of September 30, 1999. Although
realization is not assured for the deferred tax assets, the Company believes it
is more likely than not, that they will be realized through future taxable
earnings.
New Accounting Pronouncements. On January 1, 1998, the Company adopted
Statement of Financial Accounting Standards (SFAS) No. 130, Reporting
Comprehensive Income. SFAS No. 130 establishes standards to provide prominent
disclosure of comprehensive income items. Comprehensive income is the change in
equity of a business enterprise during a period from transactions and other
events and circumstances from non-owner sources. Prior period presentations have
been restated to conform to the provisions of SFAS No. 130. The adoption of SFAS
130 had no impact on the Company's financial position or results of operations.
The Company's total Comprehensive Income (loss) applicable to common
shareholders for the quarters ended September 30, 1998 and 1999 was $1,533,000
and $(1,632,000), respectively, and for the nine months ended September 30, 1998
and 1999 was $3,315,000 and $(4,146,000), respectively.
The AICPA's Accounting Standards Executive Committee has issued SOP 98-1,
Accounting for the Costs of Computer Software Developed or Obtained for Internal
Use. The SOP segments an internal use software project into stages and the
accounting is based on the stage in which a cost is incurred. SOP 98-1 is
effective for fiscal years beginning after December 15, 1998 for costs incurred
in those fiscal years for all projects, including projects in progress when the
SOP is adopted. The adoption of SOP 98-1 did not have a material impact on the
Company's financial position or results of operations.
6
Note 2 - Inventories
The components of inventory consist of the following:
Dec. 31, September 30,
1998 1999
-------- -------------
(In thousands)
Raw Materials $ 785 $ 476
Finished Goods 6,838 6,117
------ ------
$7,623 $6,593
====== ======
Note 3 - Addition to Existing Manufacturing Line
In the third and fourth quarter of 1999, the Company completed the installation
of an addition to the existing pipe manufacturing line (the "Corrugator") at its
Oaks, Pennsylvania facility. Prior to such completion, the Company had purchased
the base tube for all of its piping products from a vendor. The cost of this
manufacturing equipment was approximately $2 million and was financed through
the Company's new long term debt facility (see Note 5 - Long Term Debt).
Note 4 - Line of Credit
In April 1998, the Company established an overall working capital line of credit
with its bank in an amount of $10.0 million. Subsequently, the overall line
availability was reduced to $5 million as of September 30, 1999. At September
30, 1999 the unpaid principal balance under the line of credit was approximately
$4.3 million. This facility provides for financing of working capital needs and
equipment purchases and is secured by the Company's receivables, inventory and
other assets. As of June 30, 1998, the Company met certain financial covenants
contained in the line of credit agreement and therefore received a reduction in
the interest rate effective September 1, 1998, down to the prime rate. As of
November 1, 1999, the line availability was again reduced to $4 million. At
November 1, 1999 the unpaid principle balance under this line of credit was
approximately $3.4 million.
Due to the losses the Company has sustained in the first, second and third
quarters of 1999, the Company is in technical default of certain financial
covenants of the line of credit agreement regarding required earnings before
interest, income taxes, depreciation and amortization levels (EBITDA) and
warranty spending (primarily the pipe replacement program) in excess of EBITDA.
The Company and the bank operate under a temporary forbearance agreement which
terminates on December 15, 1999. Currently, the Company is negotiating with
other financial institutions to replace the current short term line of credit
with its existing bank. Through December 15, 1999, the bank will continue to
allow the Company to borrow on and repay the line as it did previously and has
waived its rights to currently exercise certain remedies as a result of the
default, including among other things, charging an increased rate of interest or
demanding payment on the balance of the loan as long as the Company maintains
certain collateral and borrowing criteria. If the Company is required to repay
all or a significant amount of the outstanding balance of the line of credit,
and the Company is unable to find an alternate source of financing, the
Company's financial condition and results of operations could be materially
adversely affected. See Part II, Item 5. Other Information.
7
Note 5 - Long Term Debt
In September 1999, the Company refinanced its long term debt of approximately
$1.9 million with a new five-year, $4 million facility with Finloc Inc., an
affiliate of The Canam Manac Group. Finloc Inc. is currently the holder of
approximately 57% of the Company's common stock. The facility charges interest
at the rate of LIBOR plus 4.00% which as of September 30, 1999, was
approximately 9.4%. The loan is in the form of a six month promissory note which
requires payment of the entire principal and related interest at its term.
Finloc has provided written notice of its intent to renew this note every six
months for a five year period with a reduction of principal of approximately
$400,000 from the principal of the previous note. As of September 30, 1999 the
proceeds from this facility were used to repay approximately $1.9 million of the
existing long term debt and reduce the short term line of credit by $1 million.
In the beginning of October 1999, the remaining proceeds of approximately $1.1
million were used to pay vendors who supplied various components in connection
with the Company's installation of its Corrugator.
Note 6 - Short Term Demand Note
In September 1999, the Company obtained the use of up to $2 million through a
demand note with Canam Steel Corporation, a subsidiary of The Canam Manac Group,
and the current sole owner of the Company's $4 million in Preferred Stock. The
note bears interest at the rate of prime plus 1%, which as of September 30,
1999, was approximately 9.25%, and can be used for normal operating working
capital needs. As of September 30, 1999, approximately $1.3 million of this
facility was outstanding. Canam Steel Corporation has communicated to the
Company that it would like to convert this loan into an additional $2 million in
Preferred Stock under the same terms and conditions as the previous placement
(see Note 7). The Company expects to authorize the additional shares and
complete that transaction during the fourth quarter of 1999. However, the terms
of any future sale of preferred stock has not been determined and there can be
no assurances that the Company will complete any future sales of preferred
stock.
Note 7 - Sale of Preferred Stock
On March 17, 1998, the Company issued 400 shares of authorized perpetual Class A
Floating Rate Preferred Stock of the Company at $10,000 cash per share (the
"Preferred Stock"), or $4 million in the aggregate. The perpetual Preferred
Stock is entitled to receive, as and if declared by the Company's Board,
dividends at a floating rate equal to the rate payable by the Company on its
line of credit with its commercial bank. Dividends are paid quarterly in
arrears, and if not declared or paid would cumulate at the line of credit rate,
plus 50 basis points. The preferred stock: (i) does not possess voting rights,
(ii) is not convertible into common stock, and (iii) is not redeemable at the
option of the holder. The Preferred Stock is redeemable at the option of the
Company, but only (i) if and to the extent the Company's net tangible assets at
the end of any fiscal quarter and after such dividend exceeds $4.5 million, or
(ii) if at least a majority of the independent and disinterested members of the
audit committee of the Company's Board of Directors approve such redemption. The
preceding provision relating to redemption constitutes a covenant between the
Company, the Company's principal shareholder and its remaining shareholders and
may not be changed without the approval of at least a majority of the
independent and disinterested members of the audit committee of the Company's
Board of Directors.
8
As part of the Company's line of credit agreement, the bank has the right to
charge a default rate of interest which is 2% above the current prime rate. If
the bank elects this right to increase the rate of interest charged on the line
of credit, the interest rate experienced on the preferred stock would also
increase by 2%. The bank has waived its right to charge the default rate of
interest through December 15, 1999.
Note 8 - Warranty Reserves
The Company's Tank Jacket(R) product line carries a warranty of one year for
workmanship and materials. The Enviroflex(R) product line carries a ten-year
warranty for workmanship and materials. The Tank Jacket product line also
carries a thirty-year warranty for corrosion from certain specified materials.
The Company's warranties are limited to replacement of defective material; they
do not cover by their terms costs associated with leaks or spillage of tank or
pipe contents. Management has accrued a reserve for anticipated warranty and
other product liability claims and associated legal fees based upon its industry
knowledge and actual claims experience.
As a result of a review of piping problems initiated in 1996, the Company,
during the third quarter of 1997, increased its warranty reserve by
approximately $18.6 million primarily to cover the Company's estimate of the
cost, anticipated to be incurred over a two to three year period, of inspecting
and replacing pipe that had deteriorating cover material on the retractable
inner pipe portion of the Company's double-wall underground fuel dispensing and
containment systems installed between 1990 and 1994 at approximately 3,000
remaining sites. The deterioration results from a microbiological fungus, which,
under certain conditions, affects the outer layers of the system's primary
(inner) retractable pipe. The Company has instituted litigation against the
supplier of the pipe to recover the cost the Company has sustained and will
sustain to replace such pipe, as well as other damages.
As a result of a review performed during the third quarter of 1998 of the
progress made regarding this replacement pipe program, as well as the costs then
expected to be incurred to complete this process, the Company recorded, during
the third quarter of 1998, a reduction of the warranty reserve of approximately
$3.3 million. The Company has been able to significantly reduce the cost of
performing the pipe replacement program by managing more efficiently the use of
outside contractors as well as controlling the costs incurred by the Company's
service crews.
Due to the decrease in the results of its operations during the first,
second and third quarters of 1999, the Company has significantly slowed its pipe
replacement program starting in May 1999. The Company expects that it will
continue to replace the deteriorating pipe as results of operations allow it to
provide funds for such activities. Through September 30, 1999, the Company
estimates that it has replaced at least 70 to 75% of all of the potential
problem sites. Due to the current unavailability of excess funds, the Company
cannot predict at this time when the pipe replacement program will be completed.
9
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Company is a Pennsylvania corporation organized in 1986. The Company is
a leading manufacturer and distributor of underground systems and products for
the conveyance and containment of petroleum and alcohol based motor vehicle
fuels from underground storage tanks to aboveground fuel dispensers. The
principal end users of the Company's products are service stations, convenience
stores and other retail sellers of gasoline, gasohol and other motor vehicle
fuels, government bodies, utilities and other fleet vehicle operators.
In addition to historical information, this Form 10-Q contains forward-looking
information. The forward-looking information contained herein is subject to
certain risks and uncertainties that could cause actual results to differ
materially from those projected. For example, risks and uncertainties can arise
with changes in: general economic conditions, including their impact on capital
expenditures; business conditions in the manufacturing and distribution
industry; the regulatory environment; rapidly changing technology and industry
standards; competitive factors, including increased competition with both
national and international companies, new services and products offered by
competitors; and price pressures. Readers are cautioned not to place undue
reliance on the forward-looking information included within, which reflects
management's analysis only as of the date hereof. The Company undertakes no
obligation to publicly revise or update this forward-looking information to
reflect events or circumstances that arise after the date hereof. Readers should
carefully review the risk factors described in other documents the Company files
from time to time with the Securities and Exchange Commission.
RESULTS OF OPERATIONS - Third Quarter of 1999 compared to Third Quarter of 1998
Net Sales
The Company's net sales for the quarter ended September 30, 1999 were $5.7
million compared to $15.0 million for the corresponding quarter in 1998, a
decrease of 61.7%. The decrease was attributable to a decrease in revenues from
our field operations at our American Containment, Inc. subsidiary, as well as a
decrease of product sales, primarily attributable to a general slowdown in new
construction and renovation of petroleum service stations despite the large
number of service stations still not in compliance with the federally mandated
regulations. The recently announced merger plans of several large oil companies
has resulted in a decrease in their capital expenditure plans which has also had
a negative impact on the Company's revenues.
Gross Profit (Loss)
The primary component of the Company's cost of sales is the product
manufacturing costs incurred by the Company as well as costs paid to various
third party manufacturers. Other components are the variable and fixed costs of
operating the Company's manufacturing and warehousing operations, depreciation
of molds, tools and equipment, and warranty expense. The Company's gross profit,
after the warranty provision for the quarter ended September 30, 1999, was $1.0
million compared to $9.8 million for the corresponding quarter in 1998. As a
result of a review performed during the third quarter of 1998 of the progress
made regarding the replacement pipe program, as well as the costs then expected
to be incurred to complete this process, the Company recorded, during the third
quarter of 1998, a reduction of the warranty reserve of approximately $3.3
million. Through the use of managing outside contractors as well as controlling
the costs incurred by the Company's service crews, the Company has been able to
significantly reduce the cost of performing the pipe replacement program. The
remaining decrease resulted primarily from a decrease in product sales volume as
well as a decrease in the field operation sales volume.
10
Comparing margins before the effect of the warranty provision, the Company
experienced a decrease in gross profit margin primarily from the decreased sales
and unabsorbed manufacturing and warehousing costs.
The Company's gross profit percentage after the effect of the warranty
provision decreased to 16.9% for the quarter ended September 30, 1999 compared
to a gross profit percentage of 65.7% for the corresponding quarter in 1998. The
gross margin for the 1998 period experienced a benefit from the previously
mentioned $3.3 million reduction of the warranty reserve. The Company's gross
profit percentage before the effect of the warranty provision decreased to 24.7%
compared to 46.4% for the corresponding quarter in 1998. The decrease in the
gross profit margin is due to unabsorbed manufacturing costs attributable to
lower than expected manufacturing activity, increased scrap levels due to
production problems experienced by our standard pipe vendor and higher freight
costs.
Operating Expense
Selling, general and administrative expenses consist primarily of salaries
and related benefits, payroll taxes, commissions, royalties, legal expenses and
other general, administrative and overhead costs. Selling, general and
administrative expenses for the quarter ended September 30, 1999 were $3.2
million compared to $3.4 million for the corresponding quarter in 1998. The
decrease for the quarter resulted mainly from a decrease in personnel headcount
and activity levels due to cost reductions initiated by the Company during the
second quarter offset by approximately $900,000 of one-time charges for
reductions in operations or shutdown of certain activities, including severance
costs, truck lease termination expenses, bank line of credit renegotiation legal
and administrative costs and insurance coverage adjustments. The effects of
these reductions on operating expenses are expected to be more evident during
the fourth quarter of 1999.
Amortization of Intangibles
Amortization of intangibles consists of the amortization of goodwill over a
period of 40 years and the amortization of various patents and licenses that are
amortized on a straight-line basis over the estimated lives of the patents
(which range from 13 to 17 years) at the acquisition date or subsequent issuance
date. The decrease in amortization expense to $61,000 for the quarter ended
September 30, 1999 from $123,000 in 1998 is due to the write off of a patent
license in the third quarter of 1998.
Interest Expense
Interest expense for the quarter ended September 30, 1999 was $157,000
compared to $210,000 for the corresponding quarter in 1998. Interest expense is
incurred on term loans that were used for purchasing equipment and under the
Company's working capital line of credit. The decrease for the quarter is due to
the inclusion of loan administrative and legal fees in the 1998 amount related
to the Company's closing in April 1998 of its $10 million new debt facility.
Income Taxes
Income tax benefit for the quarter ended September 30, 1999 was $951,000
compared to an income tax expense of $898,000 for the corresponding quarter in
1998. The Company recorded income taxes utilizing an effective tax rate of
approximately 38% during the 1998 and 1999 periods. In recognizing this benefit
in the 1999 period, the Company increased its deferred tax asset on its balance
sheet. The Company currently believes that it is more likely than not that this
asset will be realized in future years as a result of taxable income to be
generated by its operations, but will continue to monitor the valuation of this
asset on a quarterly basis.
11
Net Income (Loss)
The Company's net loss for the quarter ended September 30, 1999 was $1.5
million compared to net income of $1.5 million for the corresponding quarter in
1998. The decrease of $ 3.0 million in net income (loss) for the quarter
resulted from decreased sales and a decrease in gross margin percentage. The
Company has reduced its spending and staffing levels and will continue to
monitor the industry and its short term capital expenditure plans.
Preferred Stock Dividends
The preferred stock dividend, approved by the Company's Board of Directors,
relates to the Company's sale, on March 17, 1998, of 400 shares of authorized
perpetual Class A Floating Rate Preferred Stock (the "Preferred Stock") at
$10,000 cash per share, or $4.0 million in the aggregate. For the nine months
ended September 30, 1999 the Company has accrued, but not paid this dividend.
The preferred Shareholder has waived any penalties related to non-payment of the
dividend.
RESULTS OF OPERATIONS - Nine Months Ended September 30, 1999 vs. Nine Months
Ended September 30, 1998
Net Sales
The Company's net sales for the quarter ended September 30, 1999 were $5.7
million compared to $15.0 million for the corresponding quarter in 1998, a
decrease of 61.7%. The decrease was attributable to a decrease in revenues from
our field operations at our American Containment, Inc. subsidiary, as well as a
decrease of product sales, primarily attributable to a general slowdown in new
construction and renovation of petroleum service stations despite the large
number of service stations still not in compliance with the federally mandated
regulations. The recently announced merger plans of several large oil companies
has resulted in a decrease in their capital expenditure plans which has also had
a negative impact on the Company's revenues.
Gross Profit (Loss)
The Company's gross profit after the warranty provision for the nine months
ended September 30, 1999, was $3.5 million compared to $19.7 million for the
corresponding nine months in 1998. As a result of a review performed during the
third quarter of 1998 of the progress made regarding the replacement pipe
program, as well as the costs then expected to be incurred to complete this
process, the Company recorded, during the third period of 1998, a reduction of
the warranty reserve of approximately $3.3 million. Through the use of managing
outside contractors as well as controlling the costs incurred by the Company's
service crews, the Company has been able to significantly reduce the cost of
performing the pipe replacement program. The remaining decrease resulted
primarily from a decrease in product sales volume as well as a decrease in the
field operation sales volume.
Comparing margins before the effect of the warranty provision, the Company
experienced a decrease in gross profit margin primarily from the decreased sales
and unabsorbed manufacturing and warehousing costs.
12
The Company's gross profit percentage after the effect of the warranty
provision decreased to 16.9% for the nine months ended September 30, 1999
compared to a gross profit margin of 49.9% for the corresponding nine months in
1998. The gross margin for the 1998 period experienced a benefit from the
previously mentioned $3.3 million reduction of the warranty reserve. The
Company's gross profit percentage before effect of the warranty provision
decreased to 21.2% compared to 44.4% for the corresponding period in 1998. The
remaining decrease in the gross profit margin is due to unabsorbed manufacturing
costs attributable to lower than expected manufacturing activity, increased
scrap levels due to production problems experienced by our standard pipe vendor
and higher freight costs.
Operating Expense
Selling, general and administrative expenses for the nine months ended
September 30, 1999 were $9.1 million compared to $9.8 million for the
corresponding nine months in 1998. The decrease for the nine months ended
September 30, 1999 resulted mainly from a decrease in personnel headcount and
activity levels due to cost reductions initiated by the Company. Included in the
nine months ended September 30, 1999 are one-time charges of approximately $1.1
million for reductions in operations or shutdown of certain activities,
including severance costs, truck lease termination expenses, bank line of credit
renegotiation legal and administration costs and insurance coverage adjustments.
Amortization of Intangibles
The decrease in amortization expense to $ 184,000 for the nine months ended
September 30, 1999 from $367,000 in 1998 is due to the write off of a patent
license in the third quarter of 1998.
Interest Expense
Interest expense for the nine months ended September 30, 1999 was $459,000
compared to $474,000 for the corresponding nine months in 1998. Interest expense
is incurred on term loans that were used for purchasing equipment and under the
Company's working capital line of credit. The decrease is due to the inclusion
of loan origination fees in the 1998 amount related to the Company's closing in
April 1998 of its $10 million new debt facility.
Income Taxes
Income tax benefit for the nine months ended September 30, 1999 was $2.4
million compared to an income tax expense of $2.0 million for the corresponding
nine months in 1998. The Company recorded income taxes utilizing an effective
tax rate of approximately 38% during the 1998 and 1999 periods. In recognizing
this benefit in the 1999 period, the Company increased its deferred tax asset on
its balance sheet. The Company currently believes that it is more likely than
not that this asset will be realized in future years as a result of taxable
income to be generated by its operations, but will continue to monitor the
valuation of this asset on a quarterly basis.
Net Income (Loss)
The Company's net loss for the nine months ended September 30, 1999 was
$3.9 million compared to net income of $3.3 million for the corresponding nine
months in 1998. The decrease of $7.2 million in net income for the nine month
periods resulted from decreased sales and a decrease in gross margin percentage.
The Company has reduced its spending and staffing levels and will continue to
monitor the industry and its short term capital expenditure plans.
13
Preferred Stock Dividends
The preferred stock dividend, approved by the Company's Board of Directors,
relates to the Company's sale of the Preferred Stock.
Seasonality and Economic Conditions
The Company's sales are affected by the timing of planned construction of
new service stations and the retrofitting of existing service stations by the
end users, both of which are influenced by inclement weather and general
economic conditions. During the quarter ended March 31, 1999, the Company
experienced adverse sales and operating results due to inclement weather. The
Company's sales have been adversely affected to a slight extent due to the
recent Asian economic crisis and political changes in certain Latin American
countries.
The recently announced merger plans of several large oil companies have
created short term uncertainty regarding their retail operation capital
expenditure plans. During the quarter ended March 31, and more significantly in
the quarters ended June 30 and September 30, 1999, the Company experienced
adverse sales and operating results due to a reduction in capital expenditures
by the large oil companies related to their retail operations. The Company
believes that once these mergers receive U.S. Justice Department approvals, the
major oil Companies will reinitiate their related capital expenditures. The
Company's sales slightly benefited during the first quarter of 1999 from the
increased order volume associated with the activity related to upgrading to the
Federally mandated compliance regulations. The Company believes that a fair
number of sites have not yet been upgraded but cannot currently predict when
this compliance will be performed.
Financial Condition
On March 17, 1998, the Company sold 400 shares of the Preferred Stock to
the Company's principal shareholder at $10,000, cash, per share or $4.0 million
in the aggregate. For more information, see "Part II. Item 5. Other
Information."
The decrease in the Company's inventory to $6.6 million as of September
30, 1999, as compared to $7.6 million as of December 31, 1998, is attributable
to the Company aggressively attempting to reduce the overall levels of inventory
it is carrying during the depressed market conditions.
Liquidity and Capital Resources
The Company had working capital of $124,000 and $4.8 million at September
30, 1999 and December 31, 1998, respectively. During the first and second
quarters of 1999, the Company utilized its line of credit to fund its pre-tax
loss and make purchases of equipment of approximately $1 million. During the
third quarter of 1999, the Company was able to obtain a new $4 million long term
loan facility (see Note 5 - Long Term Debt) and a $2 million short term working
capital loan (see Note 6 - Short Term Demand Note) that it used to complete its
purchase of the additional manufacturing equipment (see Note 3 - Addition to
Existing Manufacturing Line) and to fund its operating needs. If authorized by
the Company, the $2 million short term working capital loan may be converted to
$2 million of Preferred Stock. This lender has also indicated that, if
authorized by the Company, it could make an additional $2 million investment in
Preferred Stock during the fourth quarter of 1999. The terms of any future sale
of preferred stock has not been determined and there can be no assurances that
the Company will complete any future sales of preferred stock. The holder of the
currently outstanding Preferred Stock has waived both payment of dividends and
non payment penalties related to the dividends for the forseeable future.
14
The Company satisfies its working capital needs primarily through funds
generated by operations, by borrowings under its existing $4.0 million secured
credit facility with a commercial bank and through the loans obtained in
September 1999. The Company is currently in default of its credit facility
arrangement but is working with this bank and other financial institutions in
order to continue to have available operating financing. If the Company was
unable to satisfactorily arrange continued financing with its current bank, or
replace the existing financing arrangement with a satisfactory arrangement with
another financing source, the Company could experience adverse operating
results. See Notes 4,5 and 6 of Notes to Condensed Consolidated Financial
Statements and Part II, Item 5., Other Information.
The Company believes that its presently available funds, existing credit
facility, the above mentioned loans, the additional planned $2 million of
Preferred Stock investment and the cash flow expected to be generated from
operations, will be adequate to satisfy its anticipated working capital
requirements for the foreseeable future.
Year 2000 Disclosure
Management initiated, early in 1998, an enterprise-wide program to identify
areas where Company owned or operated computer hardware, software,
electronically operated manufacturing and support equipment, and any other
application, could be adversely impacted by the problems presented by the year
2000, and prepare these computer systems, applications, and other equipment for
continuing use through the year 2000. Assessment and testing of all computer
hardware and software and manufacturing hardware and software is complete. The
Company has identified where a small amount of remediation must be performed
where a few older personal computers will be replaced. Substantially all of its
internal remediation was completed by June 1999; however, despite its best
efforts, business may be interrupted with potentially material impact on its
financial position or results of operations if any of the following occur:
external supply of raw materials or utilities is delayed or unavailable for an
extended period; manufacturing systems fail; or, central corporate computer
systems fail. To limit the effects of these potential failures, the Company has
completed corporate contingency planning guidelines and will prepare contingency
plans for potential disruptions of critical systems or processes. Examples of
contingency plans include modifications to computer systems, ensuring
availability of additional information technology personnel during the critical
time period, backing-up systems at off-site facilities, making alternate raw
material supply arrangements, and preparing for temporary shut-downs of certain
plants and facilities. In addition, the Company has standard operating
procedures in place for a safe and orderly shutdown of systems and facilities
should this be necessary.
The Company has incurred or expects to incur internal staff costs as well
as consulting and other expenses related to infrastructure and facilities
enhancements necessary to prepare the systems for the year 2000. Testing and
conversion of system applications has cost approximately $350,000, substantially
all of which has already been incurred as part of the acquisition of the
Company's new information system.
In the opinion of management, the Company believes that all of its
important business resources, either currently or in the near future, are
expected allow the Company to continue operating through the year 2000 and that
there will be no disruption of any material business operation or capability.
15
Part II. Other Information
Item 1. Legal Proceedings
The legal action that is pending against Dayco Products, Inc., in the
United States District Court for the Eastern District of Pennsylvania, which was
reported in the Company's Annual Report and Form 10-K for the fiscal year ended
December 31, 1998, was proposed to go to trial in July 1999. However, the trial
of this case was rescheduled for January 2000. A new judge for this case was
appointed in August 1999. This judge has now rescheduled the trial date for
April 2000. Dayco Products, Inc. initiated a separate legal action against the
Company in February 1999 in the United States District Court for the Western
District of Missouri, alleging that the Company is infringing certain patents
held by Dayco relating to hose couplings and is seeking, among other things, a
determination of infringement, damages and injunctive relief. The Company
believes that it has meritorious defenses to this action. It has filed a motion
to have this case dismissed on the basis that it makes claims that are already
being litigated in the Eastern District of Pennsylvania. In the alternative, the
Company has moved that the action be transferred to the Eastern District of
Pennsylvania.
A description of the Company's other pending legal proceedings has been
previously reported in the Company's Annual Report and Form 10-K for the fiscal
year ended December 31, 1998.
Item 5. Other Information
Due to the losses the Company has sustained in the first, second and third
quarters of 1999, the Company is in technical default of certain financial
covenants of the line of credit agreement regarding required earnings before
interest, income taxes, depreciation and amortization levels (EBITDA) and
warranty spending (primarily the pipe replacement program) in excess of EBITDA.
The Company and the bank operate under a temporary forbearance agreement which
terminates on December 15, 1999. Currently, the Company is negotiating with
other financial institutions to replace the current short term line of credit
with its existing bank. Through December 15, 1999, the bank will continue to
allow the Company to borrow on and repay the line as it did previously and has
waived its rights to currently exercise certain remedies as a result of the
default, including among other things, charging an increased rate of interest or
demanding payment on the balance of the loan as long as the Company maintains
certain collateral and borrowing criteria. If the Company is required to repay
all or a significant amount of the outstanding balance of the line of credit,
and the Company is unable to find an alternate source of financing, the
Company's financial condition and results of operations could be materially
adversely affected.
16
Item 6. Exhibits and Reports of Form 8-K
(a) Exhibits
3.1 Articles of Incorporation of the Company (Incorporated herein by
reference to Exhibit 3.1 to the Company's Quarterly Report of
Form 10-Q for the quarter ended June 30, 1997).
3.2 Bylaws of the Company (Incorporated herein by reference to
Exhibit 3.2 to the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1997).
11 Statement re: Computation of Earnings Per Share (unaudited)
27 Financial Data Schedule
(b) Reports on form 8-K
None.
17
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Total Containment, Inc.
Date November ____, 1999 By_________________________________
Pierre Desjardins
Chief Executive Officer
Date November ____, 1999 By_________________________________
Keith R. Ruck
Vice President Finance & Chief
Financial Officer
18
Exhibit Index
Exhibit No. Description
- ----------- -----------
3.1 Articles of Incorporation of the Company
(Incorporated herein by reference to Exhibit 3.1 to
the Company's Quarterly Report of Form 10-Q for the
quarter ended June 30, 1997).
3.2 Bylaws of the company (Incorporated herein by
reference to Exhibit 3.2 to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30,
1997).
11 Statement re: computation of Earnings Per Share (unaudited)
27 Financial Data Schedule
19