Item 1. Business. 1 Item 2.
Item 2. Properties. 12 Item 3.
Item 3. Legal Proceedings. 12 Item 4.
Item 4. Submission of Matters to a Vote of Security Holders. 12
PART II. Item 5.
Item 5. Market For Registrant's Common Equity and Related Stockholder Matters. 12 Item 6.
Item 6. Selected Financial Data. 14 Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. 15 Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk. 27 Item 8
Item 8 Financial Statements and Supplementary Data. 27 Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. 27 Item 9A.
Item 9A. Controls and Procedures. 27
PART III. Item 10.
Item 10. Directors and Executive Officers of the Registrant. 28 Item 11.
Item 11. Executive Compensation. 28 Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. 28 Item 13.
Item 13. Certain Relationships and Related Transactions. 28 Item 14.
Item 14. Principal Accountant Fees and Services. 28
PART IV. Item 15.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. 28
Signatures 31 Index to Financial Statements
THIS ANNUAL REPORT ON FORM 10-K, INCLUDING "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," CONTAINS FORWARD-LOOKING STATEMENTS REGARDING FUTURE EVENTS AND OUR FUTURE RESULTS THAT ARE BASED ON CURRENT EXPECTATIONS, ESTIMATES, FORECASTS, AND PROJECTIONS ABOUT THE INDUSTRY IN WHICH WE OPERATE AND THE BELIEFS AND ASSUMPTIONS OF OUR MANAGEMENT. WORDS SUCH AS "EXPECTS," "ANTICIPATES," "TARGETS," "GOALS," "PROJECTS," "INTENDS," "PLANS," "BELIEVES," "SEEKS," "ESTIMATES," VARIATIONS OF SUCH WORDS, AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. IN ADDITION, ANY STATEMENTS THAT REFER TO PROJECTIONS OF OUR FUTURE FINANCIAL PERFORMANCE, OUR ANTICIPATED GROWTH AND TRENDS IN OUR BUSINESS, AND OTHER CHARACTERIZATIONS OF FUTURE EVENTS OR CIRCUMSTANCES, ARE FORWARD-LOOKING STATEMENTS. READERS ARE CAUTIONED THAT THESE FORWARD-LOOKING STATEMENTS ARE ONLY PREDICTIONS AND ARE SUBJECT TO RISKS, UNCERTAINTIES, AND ASSUMPTIONS THAT ARE DIFFICULT TO PREDICT. THEREFORE, ACTUAL RESULTS MAY DIFFER MATERIALLY AND ADVERSELY FROM THOSE EXPRESSED IN ANY FORWARD-LOOKING STATEMENTS. READERS ARE REFERRED TO THE RISKS AND UNCERTAINTIES IDENTIFIED BELOW, UNDER "RISK FACTORS," AND ELSEWHERE. WE UNDERTAKE NO OBLIGATION TO REVISE OR UPDATE ANY FORWARD-LOOKING STATEMENTS FOR ANY REASON.
1. BUSINESS. ---------
GENERAL
NuCO2 Inc. is, we believe, the largest supplier in the United States of bulk CO2 systems and bulk CO2 for carbonating fountain beverages based on the number of bulk CO2 systems leased to customers. We believe that we are the first and only company in our industry to operate a national network of bulk CO2 service locations with over 99% of fountain beverage users in the continental United States within our current service area. Our website is www.nuco2.com. Through a link on our Investor Relations section of our website, we make available the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the U.S. Securities and Exchange Commission ("SEC"): our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. All such filings are available free of charge.
Bulk CO2 involves use of a cryogenic vessel delivered to a customer's site, which preserves CO2 in its liquid form and then converts the liquid product to gaseous CO2, the necessary ingredient for beverage carbonation. This is a relatively new technology with clear advantages over high pressure CO2. Some of these advantages are:
o consistent and improved beverage quality, o increased product yields, o reduced employee handling and cylinder storage requirements, o greater productivity, o elimination of downtime and product waste during high pressure cylinder changeovers, and o enhanced safety.
Presently, CO2 is supplied in most instances to fountain beverage users in the form of gas, which is transported and stored in high pressure cylinders. High pressure cylinders have been the predominant method of carbonating fountain beverages for almost 100 years. High pressure cylinders may be less expensive than bulk CO2 systems for low volume users of CO2.
Among our customers are many of the major national and regional restaurant and convenience store chains (based on U.S. systemwide foodservice sales), movie theater operators, theme parks, resorts and sports venues, including:
QUICK SERVE RESTAURANTS CASUAL/DINNER HOUSES Arby's McDonald's Applebee's Official All Star Cafe Bumpers Drive-In Panera Bread Company Bahama Breeze Outback Steakhouse Burger King Papa Gino's Bertucci's Perkins Family Restaurants Captain D's Pizza Hut Cheesecake Factory Pizzeria Uno Carl's Jr. Quizno's Classic Subs Chevy's Ponderosa Steak House Checker's Drive-In Rubios Chili's Red Lobster/Olive Garden Chick-Fil-A Sbarro Cooker Bar & Grill Rio Bravo Cantina Chipotle Grill Schlotzsky's Deli Don Pablo's Roadhouse Grill Churchs Chicken Sonic Drive-In Friendly's Restaurant Ruby Tuesday D'Angelo's Sandwich Shop Steak'n Shake Hard Rock Cafe Ryan's Family Steak House Dunkin' Donuts Taco Bell Landry's Shoney's El Pollo Loco Wendy's Longhorn Steakhouse Spaghetti Warehouse Hardee's White Castle Macaroni Grill KFC Krystal
CONTRACT FEEDERS WHOLESALE CLUBS CONVENIENCE/PETROLEUM ARAmark BJ's Wholesale 7-Eleven Golden Pantry Compass Group Costco AM/PM Phillips 66 Host Marriott Sam's Club BP/Amoco Racetrac Petroleum Sodexho Circle K Shell ETD Coastal Mark Spectrum Stores SPORTS VENUES THEME/AMUSEMENT Conoco Sunshine Jr. AMF Bowling Centers Six Flags Exxon Tom Thumb Brunswick Recreation Centers Universal Studios Florida E-Z Serve Derby Lane Walt Disney World Farm Stores Georgia Dome Wet n Wild Madison Square Garden White Waters MOVIE THEATRES Pro Player Stadium Litchfield Cinemas Regal Cinemas Raymond James Stadium Loew's Cineplex Wallace Theatres Staples Center
We are a Florida corporation, incorporated in 1990. Through a combination of internal growth and over 30 asset acquisitions, we have expanded our service area from one service location and 19 customers in Florida to 101 service locations and approximately 75,000 bulk and high pressure CO2 customers in 45 states as of June 30, 2003. Since our initial public offering in December 1995, this growth has been achieved, in large part, with the proceeds of our initial public offering of common stock as well as a secondary offering of common stock in June 1996, borrowings under our senior credit facilities, the issuance in 1997 and 1999 of our 12% senior subordinated notes due 2004 and 2005, respectively, the sale of our Series A 8% Cumulative Convertible Preferred Stock in May 2000 and Series B 8% Cumulative Convertible Preferred Stock in November 2001, and the private placement of our common stock in August 2002. Today, the majority of our growth is driven by the conversion of high pressure CO2 users to bulk CO2 systems. Our ability to grow is dependent on the success of our marketing efforts to acquire new customers and their acceptance of bulk CO2 systems as a replacement for high pressure cylinders.
Service Locations
[MAP]
Our bulk CO2 customer base is highest in Florida, Texas, Georgia, New York and California. Substantially all of our revenues have been derived from the rental of bulk CO2 systems installed at customers' sites, the sale of CO2 and high pressure cylinder revenues. Revenues have grown from $812,000 in fiscal 1991 to $74.4 million in fiscal 2003.
Net Sales (in millions) [GRAPH]
OPPORTUNITY FOR GROWTH
CO2 is universally used for carbonating fountain beverages. Bulk CO2 systems are permanently installed at the customer's site and are filled by the supplier from a specialized bulk CO2 truck, unlike high pressure cylinders which are typically changed out when empty and transported to the supplier's depot for refilling. Advantages to users of bulk CO2 systems over high pressure cylinders include consistent and improved beverage quality, increased product yields, reduced employee handling and cylinder storage requirements, greater productivity, elimination of downtime and product waste during high pressure cylinder changeovers and enhanced safety. Consequently, we believe that bulk CO2 systems will eventually displace most high pressure cylinders in the fountain beverage market.
We estimate there are currently approximately 150,000 bulk CO2 beverage users in the United States. Of these, approximately 74,000 are already our customers. We also currently service approximately 800 stand alone high pressure CO2 customers. There are an estimated 600,000 fountain beverage users
in the continental United States. Therefore, the bulk CO2 industry presents substantial opportunity for growth. We plan on increasing the number of our bulk CO2 customers through sales and marketing initiatives aimed at bulk CO2 users who are serviced by our competitors as well as the conversion of current users of high pressure cylinders to bulk CO2. In addition, we may seek to increase our customer base through carefully selected acquisitions of customer accounts and bulk CO2 equipment.
TOTAL BEVERAGE CO2 USERS
[CHART]
PRODUCTS AND SERVICES
We offer our customers two principal services: (1) a stationary bulk CO2 system installed on the customer's site and (2) routine filling of the bulk CO2 system with bulk CO2. The bulk CO2 system installed at a customer's site consists of a cryogenic vessel for the storage of bulk CO2 and related valves, regulators and gas lines. The cryogenic vessel preserves CO2 in its liquid form and then converts the liquid product to gaseous CO2, the necessary ingredient for beverage carbonation. Presently, we offer bulk CO2 systems ranging from 300 to 600 lbs. of CO2 capacity. This range of bulk CO2 system sizes permits us to market our services to a range of potential customers.
We typically enter into a six-year bulk CO2 system lease and CO2 supply agreement with our customers. Generally, these agreements are classified as one of two types: (1) "budget plan" service contracts or (2) "rental plus per pound charge" contracts. Under budget plan contracts, customers pay a fixed monthly charge for the lease of a bulk CO2 system installed on the customer's site and refills of bulk CO2. The bulk CO2 is included in the monthly rental charge up to a predetermined maximum annual volume. This arrangement is appealing to the customer since we bear the initial cost of the equipment and installation, with the customer paying a predictable and modest monthly usage fee. If the maximum annual volume of CO2 is exceeded, the customer is charged on a per pound basis for additional bulk CO2 delivered. Under rental plus per pound charge contracts, we also lease a bulk CO2 system to the customer, but the customer is charged on a per pound basis for all bulk CO2 delivered. Although the bulk CO2 system is typically owned by us and leased to the customer, some customers own their own bulk CO2 systems. Even with customers that own their own bulk CO2 systems, we seek to arrange for long-term bulk CO2 supply contracts.
We believe that the use of long-term contracts provides benefits to both us and our customers. Customers are able to largely eliminate CO2 supply interruptions and the need to operate CO2 equipment themselves, while the contract adds stability to our revenue base. Service termination is typically caused by restaurant closure. After the expiration of the initial term of a contract, the contract generally renews unless we or the customer notifies the other of intent to cancel. To date, our experience has been that contracts generally "roll-over" without a significant portion terminating in any one year.
We also supply high pressure gases in cylinder form, including CO2, helium and nitrogen. We estimate that we currently service approximately 800 stand-alone high pressure CO2 customers, most of whom are very low volume users. Helium and nitrogen are supplied mostly to existing customers in connection with filling balloons and dispensing beer, respectively.
We have an agreement with The Coca-Cola Company ("Coca-Cola") that establishes a framework to develop a strategic alliance between us for providing Coca-Cola's fountain customers in the United States with quality CO2 and CO2 dispensing systems, technology and services that are superior to that which have
thus far been available. While Coca-Cola will not be a customer of ours, it is anticipated that by working together, both we and Coca-Cola will benefit by offering superior products and services to current and potential customers, many of whom are the same.
The framework for the strategic alliance was established in March 2000. During the fiscal year ended June 30, 2003, we continued to develop the strategic alliance and Coca-Cola assisted us in securing several key new customer contracts. We plan to jointly develop a differentiated CO2 marketing program to be used exclusively for Coca-Cola's customers.
MARKETING AND CUSTOMERS
At June 30, 2003, we serviced approximately 75,000 bulk and high pressure CO2 customers, none of which accounted for more than 3% of our fiscal 2003 net sales. We market our bulk CO2 products and services to large customers such as restaurant and convenience store chains, movie theater operators, theme parks, resorts and sports venues. Our customers include most of the major national and regional chains throughout the United States. We approach large chains on a corporate or regional level for approval to become the exclusive supplier of bulk CO2 products and services on a national basis or within a designated territory. We then direct our sales efforts to the managers or owners of the individual or franchised operating units. Our relationships with chain customers in one geographic market frequently help us to establish service with these same chains when we expand into new markets. After accessing the chain accounts in a new market, we attempt to rapidly build route density by leasing bulk CO2 systems to independent restaurants, convenience stores and theaters. Our products and services are sold by a sales force of 34 commission only independent sales representatives and 26 salaried sales personnel. As of June 30, 2002 and 2003, we had backlogs of 534 and almost 4,400 new locations, respectively, awaiting activation. During fiscal 2004, we expect to place into service a substantial number of these locations and to maintain a similar backlog throughout the year. New activations are dependent upon a number of factors, including the expiration of any existing agreements the customer may have with its current CO2 supplier.
COMPETITION
We believe that we are the largest and the sole national supplier of bulk CO2 systems and bulk CO2 for carbonating fountain beverages. In many of our markets, we are a leading or the dominant supplier of bulk CO2 services.
Major restaurant and convenience store chains continue to adopt bulk CO2 technology and search for qualified suppliers to install and service bulk CO2 systems. With the exception of us, we believe that qualified suppliers of bulk CO2 services do not presently exist in many regions of the United States. Unlike many of our competitors for whom bulk CO2 is a secondary service line, we have no material lines of business at present other than the provision of bulk CO2 services. All aspects of our operations are guided by our focus on the bulk CO2 business, including our selection of operating equipment, design of delivery routes, location of service locations, structure of customer contracts, content of employee training programs and design of management information and accounting systems. By restricting the scope of our activities to the bulk CO2 business, and largely avoiding the dilution of management time and resources that would be required by other service lines, we believe that we are able to maximize the level of service we provide to our bulk CO2 customers.
We offer a wide range of innovative sales, marketing and billing programs. We believe that our ability to compete depends on a number of factors, including product quality, availability and reliability, price, name recognition, delivery time and post-sale service and support. Despite the customer-level advantages of bulk CO2 systems over high pressure cylinders, we generally price our services comparably to the price of high pressure cylinders. This has proved an effective inducement to cause customers to convert from high pressure cylinders to bulk CO2 systems. We believe that we enjoy advantages over our competitors due to the density of our route structure and a lower average time and distance traveled between stops. Each bulk CO2 system serviced by us has a label with a toll-free help line for the customer's use. The experience level of our personnel aids in the resolution of equipment failures or other service interruptions, whether or not caused by our equipment. Recognizing the public visibility of our customers, we carefully maintain the appearance of our vehicles and the professional image of our employees.
Many types of businesses compete in the fountain beverage CO2 business and market share is fragmented. High pressure cylinders and bulk CO2 services are most frequently provided by distributors of industrial gases. These companies generally provide a number of products and services in addition to CO2 and often view bulk CO2 systems as high-service adjuncts to their core business. Industrial gas distributors generally have been reluctant to attempt to convert their high pressure cylinder customers to bulk CO2 systems for several reasons including the capital outlays required to purchase bulk CO2 systems and the idling of existing high pressure cylinders and associated equipment. Other
competitors in the fountain beverage CO2 business include fountain supply companies and distributors of restaurant supplies and groceries, which vary greatly in size. There are also a number of small companies that provide bulk CO2 services that operate on a local or regional geographic scope. While many of these suppliers lack the capital necessary to offer bulk CO2 systems to customers on lease, suppliers vary widely in size and some of our competitors may have significantly greater financial, technical or marketing resources than we do.
OPERATIONS
At June 30, 2003, we operated 101 service locations (91 stationary depots and 10 mobile depots) located throughout our 45 state service area and operated 168 specialized bulk CO2 trucks and 73 technical service vehicles. Each specialized bulk CO2 truck refills bulk CO2 systems at customers' sites on a regular cycle and CO2 delivery quantities are measured by flow meters installed on the bulk CO2 trucks. Each stationary depot is equipped with a storage tank (up to 40 tons) which receives bulk CO2 from large capacity tanker trucks and from which our specialized bulk CO2 trucks are filled with bulk CO2 for delivery to customers. In most instances, the bulk CO2 system at a customer's site is accessible from the outside of the establishment and delivery of bulk CO2 does not cause any interference with the operations of the customer. All dispatch and billing functions are conducted from our corporate headquarters in Stuart, Florida, with route drivers, installers and service personnel operating from our service locations.
Implementation of our Intelligent Distribution System, AccuRoute(R), continued during the year. AccuRoute(R) includes these core components:
Portable Account Link (PAL)
This is our mobile information system for use in our delivery operation. The system utilizes a hand held device to provide field personnel with up to date delivery route and customer account information and also serves as an input source to record all delivery transaction information. PAL has been operational since the spring of 2000.
Scheduling System
In order to ensure reliability and consistent service levels to the customer, deliveries are made at a fixed interval. Information from the scheduling system is used to determine the proper frequency. Accounts are closely monitored by our field and corporate personnel. Each account is placed into the correct frequency grouping based on delivery history, seasonality, and promotions reported to us by the customer. The scheduling system analyzes a customer's CO2 usage and determines the optimal next delivery date, considering both maximum payload delivery and safety stock held in the customer's tank. The foundation of the scheduling system is the delivery information gathered by the PAL system. The scheduling system utilizes sophisticated computer algorithms that consider:
1. Tank size 2. Delivery history 3. Seasonal factors 4. Safety margins
Based on delivered quantities over time, the scheduling system determines a daily usage rate. Usage, combined with tank size and last delivery date, is used to determine how often a customer's tank must be filled. The scheduling system was first deployed during the fall of 2000 and is continually refined and enhanced.
Route Optimization
The route optimization system will produce efficient delivery routes to minimize time and distance traveled between deliveries. We expect that this will significantly improve the levels of service to our customers by enabling our drivers to deliver more stops in less time. Testing of a potential third-party solution has taken place and we expect that additional solutions will be evaluated in the near future.
Mobile Fleet Communication
We have implemented two-way voice communication and text messaging primarily using the Nextel(R) wireless communication system. This system allows for real-time, voice communication or two-way text messaging with delivery and service personnel, regardless of their location, virtually anywhere in the country. This capability has greatly increased our ability to maximize the utilization of our resources and to provide the highest level of customer service.
Customer Extranet
Customers will be able to log on to a secure Web site and among other things, maintain their accounts, review account balances and delivery history, as well as scheduled deliveries, and place orders or request special service. The Customer Extranet is expected to be deployed during fiscal 2004.
BULK CO2 SUPPLY
Bulk CO2 is currently a readily available commodity product, which is processed and sold by various sources. In May 1997, we entered into a ten-year exclusive bulk CO2 requirements contract with The BOC Group, Inc., a multinational industrial gases company, that provides a stable supply of high quality CO2 at competitive prices. In addition, the agreement provides that if sufficient quantities of bulk CO2 become unavailable for any reason, we will receive treatment as a preferred customer. For example, in the event of a CO2 shortage, many CO2 suppliers reduce deliveries of CO2 to all customers. Our agreement with BOC provides that we will continue to receive deliveries in full, along with BOC's other large customers, prior to deliveries to other customers.
BULK CO2 SYSTEMS
We purchase new bulk CO2 systems from the two major manufacturers of such systems and we believe that we are the largest purchaser of bulk CO2 systems from these manufacturers combined. We currently purchase bulk CO2 systems in four sizes (300, 400, 450 or 600 lbs. of bulk CO2 capacity) depending on the needs of our customers. Bulk CO2 systems are vacuum insulated containers with extremely high insulation characteristics allowing the storage of CO2, in its liquid form, at very low temperatures. Bulk CO2 systems operate under low pressure, are fully automatic, and require no electricity. Based upon manufacturers' estimates, the service life of a bulk CO2 system is expected to exceed 20 years. We maintain an adequate inventory of bulk CO2 systems to meet expected customer demand.
EMPLOYEES
At June 30, 2003, we employed 503 full-time employees, 172 of whom were involved in management, sales or customer support, 251 of whom were route drivers and 80 of whom were in technical service functions. We consider our relationship with our employees to be good.
TRADEMARKS
We market our services using the NuCO2(R) and AccuRoute(R) trademarks which have been registered by us with the U.S. Patent and Trademark Office. The current registrations for these trademarks expire in 2007 and 2013, respectively.
SEASONALITY
At June 30, 2003, approximately 20,000 of our bulk CO2 customers were billed under rental plus per pound charge contracts or by the pound for all bulk CO2 delivered. Customers who purchase bulk CO2 by the pound tend to consume less CO2 in the winter months and our revenues to such customers will be correspondingly lower in times of cold or inclement weather.
REGULATORY MATTERS
Our business is subject to various federal, state and local laws and regulations adopted for the protection of the environment, the health and safety of employees and users of our products. For example, the transportation of bulk CO2 is subject to regulation by various federal, state and local agencies, including the U.S. Department of Transportation. Regulatory authorities have broad powers and we are subject to regulatory and legislative changes that can affect the economics of the industry by requiring changes in operating practices or by influencing the demand for, and the costs of, providing services. We believe that we are in compliance in all material respects with all such laws, regulations and standards currently in effect and that the cost of compliance with such laws, regulations and standards has not and is not anticipated to materially adversely effect us.
RISK FACTORS
Set forth below and elsewhere in this Annual Report on Form 10-K and in other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Annual Report on Form 10-K.
WE HAVE INCURRED LOSSES SINCE OUR INCEPTION AND FACE UNCERTAINTY IN OUR ABILITY TO BECOME A PROFITABLE COMPANY.
We have incurred substantial losses since our inception in 1990. Our net loss was $15.5 million for fiscal 2001, $11.0 million for fiscal 2002 and $4.9 million for fiscal 2003. We are uncertain whether we will install a sufficient number of our bulk CO2 systems or obtain sufficient market acceptance to allow us to achieve or sustain profitability. Our losses to date have resulted primarily from expenses we incurred in building a sales and marketing organization, adding administrative personnel and developing a national infrastructure to support the rapid growth in the number of our installed base of bulk CO2 systems. The cost of this expansion and the significant depreciation expense of our installed base of bulk CO2 systems have resulted in significant operating losses to date and accumulated net losses of $57.9 million at June 30, 2003.
WE HAVE SUBSTANTIAL INDEBTEDNESS AND OUR OBLIGATION TO SERVICE THAT INDEBTEDNESS COULD DIVERT FUNDS FROM OPERATIONS AND LIMIT OUR ABILITY TO OBTAIN ADDITIONAL FUNDING TO EXPAND OUR BUSINESS.
As of September 19, 2003, we had outstanding indebtedness of $73.0 million, which included $43.0 million under our credit facility and $30.0 million of our 16.3% senior subordinated notes due 2009.
If we are unable to generate sufficient cash flow to service our indebtedness, we will have to:
o reduce or delay planned capital expenditures, o sell assets, o restructure or refinance our indebtedness, or o seek additional equity capital.
We are uncertain whether any of these strategies can be effected on satisfactory terms, if at all, particularly in light of our high levels of indebtedness. In addition, the extent to which we continue to have substantial indebtedness could have significant consequences, including:
o our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions and other general corporate purposes may be materially limited or impaired,
o a substantial portion of our cash flow from operations may need to be dedicated to the payment of principal and interest on our indebtedness and therefore not available to finance our business, and
o our high degree of indebtedness may make us more vulnerable to economic downturns, limit our ability to withstand competitive pressures or reduce our flexibility in responding to changing business and economic conditions.
Also, our lenders require that we comply with financial and business covenants. If we fail to maintain these covenants, our lenders could declare us in default. They could demand the repayment of our indebtedness to them if this default were not cured or waived. At various times in the past we have been unable to meet certain covenants and have had to obtain waivers or modifications of terms from our lenders. Although we believe that we will be able to comply with the current provisions of our borrowing arrangements, circumstances may result in our having to obtain waivers or further modifications in the future.
OUR FUTURE OPERATING RESULTS REMAIN UNCERTAIN DESPITE THE GROWTH RATE IN OUR REVENUE.
You should not consider growth rates in our revenue to be indicative of growth rates in our operating results. In addition, you should not consider prior growth rates in our revenue to be indicative of future growth rates in our revenue. The timing and amount of future revenues will depend almost entirely on our ability to obtain agreements with new customers to install bulk CO2 systems and use our services. Our future operating results will depend on many factors, including:
o the level of product and price competition, o the ability to manage our growth, o the ability to hire additional employees, and o the ability to control costs.
WE LACK PRODUCT DIVERSITY, AND OUR BUSINESS DEPENDS ON CONTINUED MARKET ACCEPTANCE BY THE FOOD AND BEVERAGE INDUSTRY OF OUR PRODUCT AND CONSUMER PREFERENCE FOR CARBONATED BEVERAGES.
We depend on continued market acceptance of our bulk CO2 systems by the food and beverage industry, which accounts for approximately 95% of our revenues. Unlike many of our competitors for whom bulk CO2 is a secondary business, we have no material lines of business other than the leasing of bulk
CO2 systems and the sale of CO2. We do not anticipate diversifying into other product or service lines in the future. The retail beverage CO2 industry is mature, with only limited growth in total demand for CO2 foreseen. Our ability to grow is dependent upon the success of our marketing efforts to acquire new customers and their acceptance of bulk CO2 systems as a replacement for high pressure CO2 cylinders. While the food and beverage industry to date has been receptive to bulk CO2 systems, we cannot be certain that the operating results of our installed base of bulk CO2 systems will continue to be favorable or that past results will be indicative of future market acceptance of our service. In addition, any recession experienced by the food and beverage industry or any significant shift in consumer preferences away from carbonated beverages to other types of beverages would result in a loss of revenues, which would adversely affect our financial condition and results of operations and our ability to service our indebtedness.
OUR MARKET IS HIGHLY COMPETITIVE AND OUR INABILITY TO RESPOND TO VARIOUS COMPETITIVE FACTORS MAY RESULT IN A LOSS OF CURRENT CUSTOMERS AND A FAILURE TO ATTRACT NEW CUSTOMERS.
The industry in which we operate is highly competitive. We compete regionally with several direct competitors. We cannot be certain that these competitors will not substantially increase their installed base of bulk CO2 systems and expand their service nationwide. Because there are no major barriers to entry, we also face the risk of a well-capitalized competitor's entry into our existing or future markets. In addition, we compete with numerous distributors of bulk and high pressure CO2, including:
o industrial gas and welding supply companies, o specialty gas companies, o restaurant and grocery supply companies, and o fountain supply companies.
These suppliers vary widely in size. Some of our competitors may have significantly greater financial, technical or marketing resources than we do. Our competitors might succeed in developing technologies, products or services that are superior, less costly or more widely used than those that have or are being developed by us or that would render our technologies or products obsolete or noncompetitive. In addition, competitors may have an advantage over us with customers who prefer dealing with one company that can supply bulk CO2 as well as fountain syrup. We cannot be certain that we will be able to compete effectively with current or future competitors.
OUR INABILITY TO MANAGE GROWTH MAY OVEREXTEND OUR MANAGEMENT AND OTHER RESOURCES, CAUSING INEFFICIENCIES, WHICH MAY ADVERSELY AFFECT OUR OPERATING RESULTS.
We have experienced rapid growth and intend to continue to expand our operations aggressively. Because of our limited product line, we must expand operations to become profitable. We may be unable to:
o manage effectively the expansion of our operations, o implement and develop our systems, procedures or controls, o adequately support our operations, or o achieve and manage the currently projected installations of bulk CO2 systems.
If we are unable to manage growth effectively, our business, financial condition and results of operations and our ability to service our indebtedness could be seriously harmed. The growth in the size and scale of our business has placed, and we expect it will continue to place, significant demands on our personnel and operating systems. Our additional planned expansion may further strain management and other resources. Our ability to manage growth effectively will depend on our ability to:
o improve our operating systems, o expand, train and manage our employee base, and o develop additional service capacity.
WE ARE DEPENDENT ON THIRD-PARTY SUPPLIERS AND IF THESE SUPPLIERS CEASE DOING BUSINESS WITH US, WE MAY HAVE DIFFICULTY FINDING SUITABLE REPLACEMENTS TO MEET OUR NEEDS.
We do not conduct manufacturing operations and depend, and will continue to depend, on outside parties for the manufacture of bulk CO2 systems and components. We intend to significantly expand our installed base of bulk CO2 systems. Our expansion may be limited by the manufacturing capacity of our third-party manufacturers. Manufacturers may not be able to meet our manufacturing needs in a satisfactory and timely manner. If there is an unanticipated increase in demand for bulk CO2 systems, we may be unable to meet such demand due to manufacturing constraints. We purchase bulk CO2 systems from Chart, Inc. and Harsco Corporation, the two major manufacturers of bulk CO2 systems. Should either manufacturer cease manufacturing bulk CO2 systems, we would be required to locate additional suppliers. We may be unable to locate
alternate manufacturers on a timely basis. A delay in the supply of bulk CO2 systems could cause potential customers to delay their decision to purchase our services or to choose not to purchase our services. This would result in delays in or loss of future revenues.
In addition, we purchase CO2 for resale to our customers. In May 1997, we entered into a ten-year exclusive bulk CO2 requirements contract with The BOC Group, Inc. In the event that BOC is unable to fulfill our requirements, we would have to locate additional suppliers. A delay in locating additional suppliers or our inability to locate additional suppliers would result in loss of revenues, which would adversely affect our financial condition and results of operations and our ability to service our indebtedness.
YOU MAY NOT BE ABLE TO SELL OUR STOCK ON TERMS FAVORABLE TO YOU BECAUSE OUR COMMON STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE.
Our common stock price has fluctuated substantially since our initial public offering in December 1995. The market price of our common stock could decline from current levels or continue to fluctuate. The market price of our common stock may be significantly affected by the following factors:
o announcements of technological innovations or new products or services by us or our competitors, o trends and fluctuations in the use of bulk CO2 systems, o timing of bulk CO2 systems installations relative to financial reporting periods, o release of reports, o operating results below expectations, o changes in, or our failure to meet, financial estimates by securities analysts, o industry developments, o market acceptance of bulk CO2 systems, o economic and other external factors, and o period-to-period fluctuations in our financial results.
In addition, the securities markets have from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our common stock. Also, daily trading volume in our common stock has from time to time been light and you may not be able to sell our common stock on terms favorable to you in the volume and at the times you desire.
OUR OPERATING RESULTS MAY FLUCTUATE DUE TO SEASONALITY SINCE CONSUMERS TEND TO DRINK FEWER QUANTITIES OF CARBONATED BEVERAGES DURING THE WINTER MONTHS.
Approximately 12% of our bulk CO2 customers lease our bulk CO2 systems and, in addition, are billed by the pound for bulk CO2 delivered. Approximately 15% of our bulk CO2 customers own their own bulk CO2 systems and are billed by the pound for all CO2 delivered. We believe that, on a relative basis, customers purchasing bulk CO2 by the pound tend to consume less CO2 in the winter months. Our sales to such customers will be correspondingly lower in times of cold or inclement weather. We cannot be certain, however, that these seasonal trends will continue. Consequently, we are unable to predict revenues for any future quarter with any significant degree of accuracy.
FOR THE FORESEEABLE FUTURE, YOUR ONLY RETURN ON INVESTMENT, IF ANY, WILL OCCUR ON THE SALE OF OUR STOCK BECAUSE WE DO NOT INTEND TO PAY DIVIDENDS.
We have never declared or paid any cash dividends on our common stock. We currently intend to retain any future earnings for funding growth. Therefore, we do not expect to pay any dividends in the foreseeable future. In addition, the payment of cash dividends is restricted by financial covenants in our loan agreements.
OUR OPERATING RESULTS ARE AFFECTED BY RISING INTEREST RATES SINCE MORE OF OUR CASH FLOW WILL BE NEEDED TO SERVICE OUR INDEBTEDNESS.
The interest rate on our credit facility fluctuates with market interest rates resulting in greater interest costs in times of rising interest rates. Consequently, our profitability is sensitive to changes in interest rates.
OUR INSURANCE POLICIES MAY NOT COVER ALL OPERATING RISKS AND A CASUALTY LOSS BEYOND OUR COVERAGE COULD NEGATIVELY IMPACT OUR BUSINESS.
Our operations are subject to all of the operating hazards and risks normally incidental to handling, storing and transporting CO2. As a compressed gas, CO2 is classified as a hazardous material. We maintain insurance policies
in such amounts and with such coverages and deductibles that we believe are reasonable and prudent. We cannot assure you that our insurance will be adequate to protect us from all liabilities and expenses that may arise from claims for personal and property damage arising in the ordinary course of business or that current levels of insurance will be maintained or available at economical prices. If a significant liability claim is brought against us that is not covered by insurance, we may have to pay the claim with our own funds and our financial condition and ability to service our indebtedness could be seriously harmed.
OUR BUSINESS IS SUBJECT TO EXTENSIVE GOVERNMENTAL REGULATION, WHICH MAY INCREASE OUR COST OF DOING BUSINESS. IN ADDITION, FAILURE TO COMPLY WITH THESE REGULATIONS MAY SUBJECT US TO FINES, PENALTIES AND/OR INJUNCTIONS THAT MAY ADVERSELY AFFECT OUR OPERATING RESULTS.
Our business is subject to federal and state laws and regulations adopted for the protection of the environment, the health and safety of our employees and users of our products and services. The transportation of bulk CO2 is subject to regulation by various federal, state and local agencies, including the U.S. Department of Transportation. These regulatory authorities have broad powers, and we are subject to regulatory and legislative changes that can affect the economics of our industry by requiring changes in operating practices or influencing the demand for and the cost of providing services. A significant increase in the cost of our operations could adversely affect our chances for profitability.
OUR OFFICERS AND DIRECTORS ARE ABLE TO EXERT SIGNIFICANT CONTROL OVER MATTERS REQUIRING SHAREHOLDER APPROVAL, WHICH MAY ADVERSELY AFFECT THE PRICE THAT INVESTORS ARE WILLING TO PAY FOR OUR COMMON STOCK.
Executive officers, directors and entities affiliated with them beneficially own, in the aggregate, approximately 28% of our outstanding shares of common stock (including shares of common stock issuable upon conversion of preferred stock). These shareholders, if acting together, would be able to significantly influence all matters requiring approval by our shareholders, including the election of directors and the approval of significant corporate transactions, such as mergers or other business combination transactions. This concentration of ownership may also have the effect of delaying or preventing an acquisition or change in control of our company, which could have a material adverse effect on our common stock price.
OUR PREFERRED STOCK AND PROVISIONS OF OUR CHARTER AND FLORIDA LAW MAY NEGATIVELY AFFECT THE ABILITY OF A POTENTIAL BUYER TO PURCHASE ALL OR SOME OF OUR STOCK AT AN OTHERWISE ADVANTAGEOUS PRICE, WHICH MAY LIMIT THE PRICE INVESTORS ARE WILLING TO PAY FOR OUR COMMON STOCK.
Our common stock is subordinate to all outstanding classes of preferred stock in the payment of dividends and other distributions on our stock, including distributions upon liquidation or dissolution of NuCO2. We have outstanding two series of preferred stock, the Series A 8% Cumulative Convertible Preferred Stock and the Series B 8% Cumulative Convertible Preferred Stock. Our board of directors has the authority to issue up to an additional 4,992,500 shares of preferred stock. If we designate or issue other series of preferred stock, it will create additional securities that will have dividend and liquidation preferences over the common shares. If we issue convertible preferred stock, a subsequent conversion may dilute the current shareholders' interest. Without any further vote or action on the part of the shareholders, our board of directors will have the authority to determine the price, rights, preferences, privileges and restrictions of the preferred stock. Although the issuance of preferred stock will provide us with flexibility in connection with possible acquisitions and other corporate purposes, the issuance of preferred stock may make it more difficult for a third party to acquire a majority of our outstanding voting stock. We are subject to several anti-takeover provisions that apply to a public corporation organized under Florida law. These provisions generally require that an "affiliated transaction" (certain transactions between a corporation and a holder of more than 10% of its outstanding voting securities) must be approved by a majority of disinterested directors or the holders of two-thirds of the voting shares not beneficially owned by an "interested shareholder." Additionally, "control shares" (shares acquired in excess of certain specified thresholds) acquired in specified control share acquisitions have voting rights only to the extent conferred by resolution approved by shareholders, excluding holders of shares defined as "interested shares."
A Florida corporation may opt out of the Florida anti-takeover laws if its articles of incorporation or, depending on the provision in question, its bylaws so provide. We have not opted out of the provisions of the anti-takeover laws. Consequently, these laws could prohibit or delay a merger or other takeover or change of control and may discourage attempts by other companies to acquire us.
FUTURE SALES OF SHARES MAY ADVERSELY AFFECT OUR STOCK PRICE SINCE ANY INCREASE IN THE AMOUNT OF OUTSTANDING SHARES MAY HAVE A DILUTIVE EFFECT ON OUR STOCK.
If our shareholders sell substantial amounts of our common stock in the public market, the market price of our common stock could fall. These sales could be due to shares issued upon exercise of outstanding options and warrants
and upon conversion of preferred stock. These sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate. We have outstanding options under our 1995 stock option plan, directors' stock option plan and options granted to directors to purchase an aggregate of 1,496,520 common shares at an average exercise price of $8.80 per share and outstanding warrants to purchase an aggregate of 1,841,462 common shares at an average exercise price of $9.76 per share. In addition, we also have outstanding Series A 8% Cumulative Convertible Preferred Stock and Series B 8% Cumulative Convertible Preferred Stock that is currently convertible at $9.28 and $12.92 per share, respectively, into 694,709 and 222,269 common shares, respectively.
2. PROPERTIES. ----------
Our corporate headquarters are located in a 32,000 square foot rented facility in Stuart, Florida that accommodates corporate, administrative, marketing, sales and warehouse space. At June 30, 2003, we also rented 91 stationary service locations throughout 45 states. These facilities are rented on terms consistent with market conditions prevailing in the area. We believe that our existing facilities are suitable for our current needs and that additional or replacement facilities, if needed, are available to meet future needs.
3. LEGAL PROCEEDINGS. ------------------
We are involved from time to time in litigation arising in the ordinary course of business, none of which is expected to have a material adverse effect on our financial condition or results of operations.
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. ----------------------------------------------------
Not applicable.
5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. ----------------------------------------------------------------------
Our common stock trades on the Nasdaq National Market under the symbol "NUCO". The following table indicates the high and low sale prices for our common stock for each quarterly period during fiscal 2002 and 2003, as reported by the Nasdaq National Market.
High Low ---- --- CALENDAR 2001 ------------- Third Quarter $ 13.200 $ 7.940 Fourth Quarter 12.850 9.820
CALENDAR 2002 ------------- First Quarter $ 13.050 $11.120 Second Quarter 14.000 10.900 Third Quarter 13.850 7.000 Fourth Quarter 10.560 7.000
CALENDAR 2003 ------------- First Quarter $ 8.210 $ 3.900 Second Quarter 9.780 4.990
At September 19, 2003, there were approximately 200 holders of record of our common stock, although there is a much larger number of beneficial owners.
We have never paid cash dividends on our common stock and we do not anticipate declaring any cash dividends on our common stock in the foreseeable future. We intend to retain all future earnings for use in the development of our business. In addition, the payment of cash dividends is restricted by financial covenants in our loan agreements.
The following table sets forth certain information regarding equity compensation plans as of June 30, 2003.
EQUITY COMPENSATION PLAN INFORMATION
Number of securities to be Weighted-average exercise price Number of securities remaining issued upon exercise of price of outstanding available for future issuance under outstanding options, options, warrants and equity compensation plans (excluding Plan Category warrants and rights rights securities reflected in column (a)) ------------- ------------------- ------ ----------------------------------- (a) (b) (c)
Equity compensation plans 1,354,420 $9.13 186,322 approved by security shares of Common Stock shares of Common Stock holders ...
Equity compensation plans 117,500(1) $8.68 0 not approved by security shares of Common Stock holders ...
Total... 1,471,920 $9.09 186,322 shares of Common Stock shares of Common Stock
------------------------------ (1) Represents (i) 50,000 options to purchase common stock exercisable at $7.82 per share granted to five Directors in January 2001, (ii) 30,000 warrants to purchase common stock exercisable at $14.64 per share issued to a placement agent in October 1997, (iii) 1,500 options to purchase common stock exercisable at $10.25 per share granted to a consultant in December 1997, and (iv) 36,000 options to purchase common stock exercisable at $4.85 per share granted to six Directors in March 2003.
On August 22, 2002, we sold 1,663,846 shares of our common stock without registration under the Securities Act of 1933, as amended ("Securities Act") to 24 "accredited investors" at a price of $9.75 per share for aggregate cash proceeds of $16,222,499 in reliance upon the exemption from registration provided by Section 4(2) of the Securities Act and Regulation D thereunder. Commissions in the amount of $920,138 were paid.
6. SELECTED FINANCIAL DATA. -----------------------
The Selected Financial Data set forth below reflect our historical results of operations, financial condition and operating data for the periods indicated and should be read in conjunction with the consolidated financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Annual Report on Form 10-K.
Fiscal Year Ended June 30, -------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- (in thousands, except per share amounts and Operating Data) Income Statement Data: Net sales .................................................... $ 74,409 $ 72,312 $ 67,633 $ 57,951 $ 47,098 Cost of products sold, excluding depreciation and amortization 35,538 35,491 33,177 28,565 24,548 Selling, general and administrative expenses ................. 17,485 17,614 17,368 12,352 10,121 Depreciation and amortization ................................ 17,167 16,319 17,475 15,501 12,763 Loss on asset disposal ....................................... 1,671 4,661 4,891 901 1,110 --------- --------- --------- --------- ---------
Operating income (loss) ...................................... 2,548 (1,773) (5,278) 632 (1,444) Interest expense ............................................. 7,487 8,402 10,207 10,015 7,489 Loss on early extinguishment of debt ......................... -- 796 -- -- -- --------- --------- --------- --------- ---------
Net (loss) ................................................... $ (4,939) $ (10,971) $ (15,485) $ (9,383) $ (8,933) ========= ========= ========= ========= =========
Net (loss) per common share .................................. $ (0.54) $ (1.32) $ (2.01) $ (1.30) $ (1.24)
Weighted average shares outstanding .......................... 10,396 8,742 7,926 7,238 7,217
Other Data: EBITDA (1) ................................................... $ 19,715 $ 14,546 $ 12,197 $ 16,133 $ 11,319
Operating Data: Company owned bulk CO2 systems serviced Beginning of period ..................................... 61,000 60,000 58,000 50,395 39,295 New installations, net .................................. 1,877 1,000 2,000 7,605 11,100 --------- --------- --------- --------- --------- Total company owned bulk CO2 systems serviced ................ 62,877 61,000 60,000 58,000 50,395 Customer owned bulk CO2 systems serviced ..................... 11,088 9,000 9,000 10,000 8,605 --------- --------- --------- --------- --------- Total bulk CO2 systems serviced .............................. 73,965 70,000 69,000 68,000 59,000 Total high pressure CO2 customers ............................ 833 1,000 2,000 5,000 6,000 --------- --------- --------- --------- --------- Total customers .............................................. 74,798 71,000 71,000 73,000 65,000 Stationary depots ............................................ 91 76 74 70 69 Mobile depots ................................................ 10 22 19 21 15 Bulk CO2 trucks .............................................. 168 161 157 158 166 Technical service vehicles ................................... 73 76 87 95 86 High pressure cylinder delivery trucks ....................... -- -- 2 7 7
Balance Sheet Data: Cash and cash equivalents .................................... $ 455 $ 1,562 $ 626 $ 279 $ 1,579 Total assets ................................................. 125,846 132,638 138,016 148,549 141,630 Total debt (including short-term debt) ....................... 70,529 87,660 87,346 92,082 82,461 Redeemable preferred stock ................................... 9,258 8,552 5,466 5,050 -- Total shareholders' equity ................................... 34,936 25,219 33,982 38,240 47,733
(1) RECONCILIATION OF GAAP AND EBITDA
Fiscal Year Ended June 30, --------------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Net loss $ (4,939) $(10,971) $(15,485) $ (9,383) $ (8,933) Interest expense 7,487 8,402 10,207 10,015 7,489 Depreciation and amortization 17,167 16,319 17,475 15,501 12,763 Loss on early extinguishment of debt -- 796 -- -- -- -------- -------- -------- -------- --------
EBITDA $ 19,715 $ 14,546 $ 12,197 $ 16,133 $ 11,319 ======== ======== ======== ======== ========
Cash flows provided by (used in): Operating activities $ 15,826 $ 10,858 $ 5,213 $ 6,559 $ 4,249 Investing activities $(13,891) $(12,817) $(11,761) $(20,694) $(25,620) Financing activities $ (3,042) $ 2,895 $ 6,895 $ 12,835 $ 22,614
Earnings before interest, taxes, depreciation and amortization ("EBITDA") is one of the principal financial measures by which we measure our financial performance. EBITDA is a widely accepted financial indicator used by many investors, lenders and analysts to analyze and compare companies on the basis of operating performance, and we believe that EBITDA provides useful information regarding our ability to service our debt and other obligations. However, EBITDA does not represent cash flow from operations, nor has it been presented as a substitute to operating income or net income as indicators of our operating performance. EBITDA excludes significant costs of doing business and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with accounting principles generally accepted in the United States of America. In addition, our calculation of EBITDA may be different from the calculation used by our competitors, and therefore comparability may be affected. In addition, our lenders also use EBITDA to assess our compliance with debt covenants. These financial covenants are based on a measure that is not consistent with accounting principles generally accepted in the United States of America. Such measure is EBITDA (as defined) as modified by certain defined adjustments.
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. ---------------------------------------------------------------
OVERVIEW
We believe that we are the largest supplier in the United States of bulk CO2 systems and bulk CO2 for carbonating fountain beverages based on the number of bulk CO2 systems leased to customers. As of June 30, 2003, we operated a national network of 101 service locations in 45 states servicing approximately 75,000 bulk and high pressure customers. Currently, 99% of fountain beverage users in the continental United States are within our present service area. Historically, due to a combination of internal growth and acquisitions, we have experienced high levels of growth in terms of number of customers and net sales, averaging 20% to 50% per year from 1995 through 2000. Today, the majority of our growth is internal resulting from the conversion of high pressure CO2 users to bulk CO2 systems.
During fiscal 2001 and continuing through the early stages of fiscal 2003, we initiated several actions that have improved our ability to contract and retain customers, while maintaining a superior level of customer service. These actions had a significant positive impact on our operating effectiveness during the later stages of fiscal 2003 and should provide a strong base for profitable growth in fiscal 2004. During fiscal 2001 and 2002, we deliberately slowed new customer contract signings and the related installation rate of bulk CO2 systems. This decision was made to enable us to focus on improving our operating effectiveness in order to better position us for future growth. We decentralized service location management from our headquarters in Stuart, Florida to the depot locations themselves and in connection with this decision hired new full-time depot and regional managers. This slowed our gross margin improvement plan in fiscal 2001 and 2002, although it is anticipated to enhance it in the future. The result of this decision was that our revenue growth slowed from prior years although revenue still grew at 16.7%, 6.9% and 2.9% in fiscal 2001, 2002 and 2003, respectively. The ramp down in growth enabled our sales force to concentrate on signing higher margin new customers and re-signing existing customers at increased rates.
We believe that our future revenue growth, gains in gross margin and profitability will be dependent upon (i) increases in route density in existing markets and the expansion and penetration of bulk CO2 system installations in new market regions, both resulting from successful ongoing marketing, (ii) improved operating efficiencies and (iii) price increases. New multi-unit placement agreements combined with single-unit placements will drive
improvements in achieving route density. Our success in reaching multi-placement agreements is due in part to our national delivery system. We maintain a "hub and spoke" route structure and establish additional stationary bulk CO2 service locations as service areas expand through geographic growth. Our entry into many states was accomplished largely through the acquisition of businesses having thinly developed route networks. We expect to benefit from route efficiencies and other economies of scale as we build our customer base in these states through intensive regional and local marketing initiatives. Greater density should also lead to enhanced utilization of vehicles and other fixed assets and the ability to spread fixed marketing and administrative costs over a broader revenue base.
Generally, our experience has been that as our service locations mature their gross profit margins improve as a result of their volume growing while fixed costs remain essentially unchanged. New service locations typically operate at low or negative gross margins in the early stages and detract from our highly profitable service locations in more mature markets. Fiscal 2001 and 2002 and the early stages of fiscal 2003 were periods of transition for us in which we achieved significant progress in better positioning ourselves for the next phase of growth. Accordingly, we believe that we are in position to build our customer base in fiscal 2004 while maintaining and improving upon our superior levels of customer service. In addition, we will continue to focus on improving operating effectiveness, increasing prices and strengthening management. We anticipate that these initiatives will contribute positively to all areas of our company.
GENERAL
Substantially all of our revenues have been derived from the rental of bulk CO2 systems installed at customers' sites, the sale of CO2 and high pressure cylinder revenues. Revenues have grown from $47.1 million in fiscal 1999 to $74.4 million in fiscal 2003. We believe that our revenue base is stable due to the existence of long-term contracts with our customers which generally rollover with a limited number expiring without renewal in any one year. Revenue growth is largely dependent on (1) the rate of new bulk CO2 system installations, (2) the growth in bulk CO2 sales at (i) customers having rental plus per pound charge contracts and (ii) customers who own their own bulk CO2 systems, and (3) price increases.
Cost of products sold is comprised of purchased CO2, vehicle and service location costs associated with the storage and delivery of CO2. Selling, general and administrative expenses consist of wages and benefits, dispatch and communications costs, as well as expenses associated with marketing, administration, accounting and employee training. Consistent with the capital intensive nature of our business, we incur significant depreciation and amortization expenses. These stem from the depreciation of our bulk CO2 systems and related installation costs, amortization of deferred lease acquisition costs, and amortization of deferred financing costs and other intangible assets.
With respect to bulk CO2 systems, we capitalize costs that are associated with specific installations of such systems with customers under non-cancelable contracts and which would not be incurred but for a successful placement. All other service, marketing and administrative costs are expensed as incurred.
Since 1990, we have devoted significant resources to building a sales and marketing organization, adding administrative personnel and developing a national infrastructure to support the rapid growth in the number of our installed base of bulk CO2 systems. The costs of this expansion and the significant depreciation expense recognized on our installed network have resulted in accumulated net losses of $57.9 million at June 30, 2003.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage relationship which the various items bear to net sales:
Fiscal Year Ended June 30, --------------------------- 2003 2002 2001 ---- ---- ---- Income Statement Data:
Net sales 100.0 % 100.0 % 100.0 % Cost of products sold, excluding depreciation and amortization 47.8 49.1 49.1 Selling, general and administrative expenses 23.5 24.4 25.7 Depreciation and amortization 23.1 22.6 25.8 Loss on asset disposal 2.2 6.4 7.2 ---- ---- ---- Operating income (loss) 3.4 (2.5) (7.8) Loss on early extinguishment of debt -- 1.1 -- Interest expense 10.1 11.6 15.1 ---- ---- ----
Net (loss) (6.6)% (15.2)% (22.9)% ==== ==== ====
FISCAL YEAR ENDED JUNE 30, 2003 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2002
NET SALES
Net sales increased by $2.1 million, or 2.9%, from $72.3 million in 2002 to $74.4 million in 2003. Sales derived from our service plans increased by $3.3 million, or 4.6%, due to an increase in the number of accounts, partially offset by the net impact of a $0.6 million decrease in revenue derived from changes in the amount of CO2 sold to the average customer under our variable product purchase plans, which includes our equipment lease and product purchase plans, and a $0.6 million decrease from rental of high pressure cylinders and the sale of gases other than CO2.
While our bulk CO2 customer base increased by 4.7%, the amount of CO2 sold to the average customer decreased by 1.2%, from 2,311 lbs. in 2002 to 2,283 lbs. in 2003. As part of our pricing initiatives, we were able to obtain an average price increase of 2.1% on tank rentals from approximately 80% of our customers under contract. In addition, while we were able to achieve significant price increases from 4,200 of our renewal customers, these improvements were offset by incentive pricing provided to a national restaurant organization.
The following table sets forth, for the periods indicated, the percentage relationship which our service plans bear to net sales:
Fiscal Year Ended June 30, -------------------------- Service Plan 2003 2002 ------ ----- Bulk budget plan(1) 65.5% 65.6% Equipment lease/product purchase plan(2) 8.7 7.1 Product purchase plan(3) 8.4 8.6 High pressure cylinder(4) 6.1 7.1 Other revenues(5) 11.3 11.6 ----- ----- 100.0% 100.0% ===== =====
(1) Combined fee for bulk CO2 tank and bulk CO2. (2) Fee for bulk CO2 tank and, separately, bulk CO2 usage. (3) Bulk CO2 only. (4) High pressure CO2 cylinders and non CO2 gases (5) Surcharges and other charges.
During fiscal 2002, we adopted a plan to phase out those customers that use only high pressure cylinders and who do not utilize one of our bulk CO2 service plans. Revenues derived from our stand-alone high pressure cylinder
customers may not be fully eliminated from our ongoing revenues inasmuch as our goal is to convert these customers to a bulk CO2 service plan. Accordingly, the expected declining revenues derived from stand-alone high pressure cylinder customers is not expected to have a material impact on our results of operations.
COST OF PRODUCTS SOLD
Costs of products sold remained constant at $35.5 million in both 2002 and 2003, while decreasing as a percentage of net sales from 49.1% to 47.8%. Product costs increased by $0.1 million, from $10.8 million in 2002 to $10.9 million in 2003, while decreasing as a percentage of net sales from 15.0% to 14.6%. The base price with our CO2 primary supplier decreased by 2.0%, while the volume of CO2 sold by us increased by 3.5%.
Operational wages and benefits decreased from $15.0 million in 2002 to $13.9 million in 2003, primarily due to a $0.5 million reduction in headcount and a $0.6 million reduction in installation costs due to greater operating efficiencies.
Truck delivery expenses increased by $0.3 million from $5.3 million in 2002 to $5.6 million in 2003. Increases in fuel costs and insurance were partially offset by a reduction in net lease costs. We have been able to minimize the impact of increased fuel costs and variable lease costs associated with truck usage by reducing the overall miles driven by 14% compared to 2002.
Other operational costs increased by $0.7 million from $4.4 million in 2002 to $5.1 million in 2003 due to a $0.4 million increase in occupancy costs attributable to an increase in the number of service depots, and a $0.4 million increase in tank repair expenses, due in part to an increase in the number of refurbished tanks placed into service.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased by $0.1 million, or 0.7%, from $17.6 million in 2002 to $17.5 million in 2003, while decreasing as a percentage of net sales from 24.4% in 2001 to 23.5% in 2003.
Selling expenses increased by $0.5 million, from $3.0 million in 2002 to $3.5 million in 2003. Wages and related benefits increased by $0.4 million; however, we reduced the headcount of our sales organization in February 2003, which we believe will result in improvements to our selling, wage and related expenses on a going-forward basis, while not hindering our ability to generate account bookings.
General and administrative expenses decreased by $0.6 million, or 4.6%, from $14.6 million in 2002 to $14.0 million in 2003. This improvement is due to a $1.9 million reduction of expense related to uncollectible accounts receivable. During fiscal 2003, we initiated numerous procedures to improve our review and collection of our outstanding receivable accounts. This improvement was partially offset by an increase in wages and benefits of $0.5 million, which is primarily attributable to severance and accrued incentives. Professional and consulting fees also increased by $0.6 million, primarily due to non-recurring fees incurred during the first six months of fiscal 2003 for repairs of certain software, improvements in our processes to track and collect customer receivables, and other process improvements. Finally, other general and administrative expenses increased $0.2 million, the result of increased insurance costs and other general expenses.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization increased from $16.3 million in 2002 to $17.2 million in 2003. As a percentage of net sales, depreciation and amortization expense increased from 22.6% in 2002 to 23.1% in 2003. Depreciation expense increased from $12.6 million in 2002 to $13.8 million in 2003 due in part to our plan to replace all 50 and 100 lb. tanks over the next three years, resulting in accelerated depreciation expense of $1.0 million in 2003 related to the shortened lives of these assets. Amortization expense decreased from $3.7 million in 2002 to $3.4 million in 2003, primarily due a decrease in amortization related to the acquisition of customer lists, many of which were almost fully amortized as of March 31, 2003, partially offset by an increase in the amortization of financing charges primarily related to amendments to our loan agreements in February 2003.
LOSS ON ASSET DISPOSAL
Loss on asset disposal decreased from $4.7 million in 2003 to $1.7 million in 2003, while decreasing as a percentage of net sales from 6.4% to 2.2%. During 2002, we adopted a plan to replace all 50 and 100 lb. tanks still in service at customer sites over a three to four year period (see Note 2 to the Financial Statements). The decision to replace these tanks was based on an evaluation of the general economic viability of the asset class. Such conclusion was achieved by examining undiscounted cash flow generation, contribution to depot fixed overhead, pricing and targeted margins. As a result of our decision, the 50 and 100 lb. tanks at customer sites as of June 30, 2002 were written down by $1.8 million to their estimated net realizable value of $2.8 million, and the
useful lives of these assets were shortened to not exceed a period of four years. In connection with the decision to replace the 50 and 100 lb. asset class, we recognized an additional loss of $1.1 million during the year ended June 30, 2002 relating to the 50 and 100 lb. tanks removed from service during the year, all of which were subsequently disposed of in the first quarter of fiscal 2003.
OPERATING INCOME
For the reasons previously discussed, operating income increased by $4.3 million from an operating loss of $1.8 million in 2002 to an operating income of $2.5 million in 2003. As a percentage of net sales, operating income (loss) improved from (2.5)% in 2002 to 3.4% in 2003.
LOSS ON EARLY EXTINGUISHMENT OF DEBT
We accelerated the recognition of $0.8 million in deferred financing costs in 2002 associated with the refinancing of our long-term debt.
INTEREST EXPENSE
Interest expense decreased by $0.9 million, from $8.4 million in 2002 to $7.5 million in 2003, and decreased as a percentage of net sales from 11.6% in 2002 to 10.1% in 2003, due to a decrease in the average level of outstanding debt. This reduction of debt is primarily due to $15.1 million generated from the private placement of 1,663,846 shares of our common stock in August 2002, which was used to reduce the outstanding balance of our senior facility. The effective interest rate of all debt outstanding during 2003 was 9.6%, as compared to 9.7% in 2002.
NET (LOSS)
For the reasons described above, net (loss) improved from $(11.0) million in 2002 to $(4.9) million in 2003. No provision for income tax expense has been made due to historical net losses. At June 30, 2003, we had net operating loss carryforwards for federal income tax purposes of $99.0 million, which are available to offset future federal taxable income, if any, in varying amounts through June 2023.
EBITDA
Earnings before interest, taxes, depreciation and amortization ("EBITDA") is one of the principal financial measures by which we measure our financial performance. EBITDA is a widely accepted financial indicator used by many investors, lenders and analysts to analyze and compare companies on the basis of operating performance, and we believe that EBITDA provides useful information regarding our ability to service our debt and other obligations. However, EBITDA does not represent cash flow from operations, nor has it been presented as a substitute to operating income or net income as indicators of our operating performance. EBITDA excludes significant costs of doing business and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with accounting principles generally accepted in the United States of America. In addition, our calculation of EBITDA may be different from the calculation used by our competitors, and therefore comparability may be affected. In addition, our lenders also use EBITDA to assess our compliance with debt covenants. These financial covenants are based on a measure that is not consistent with accounting principles generally accepted in the United States of America. Such measure is EBITDA (as defined) as modified by certain defined adjustments.
EBITDA, as set forth in the table below, increased by $5.2 million, or 35.5%, from $14.5 million in 2002 to $19.7 million in 2003 and increased as a percentage of net sales from 20.1% to 26.5%.
Fiscal Year Ended June 30, -------------------------- 2003 2002 ---- ----
Net (loss) $ (4,939) $ (10,971) Interest expense 7,487 8,402 Depreciation and amortization 17,167 16,319 Early Extinguishment of Debt - 796 -------- --------- EBITDA $ 19,715 $ 14,546 ======== =========
Cash flows provided by (used in): Operating activities $ 15,826 $ 10,858 Investing activities $(13,891) $ (12,817) Financing activities $ (3,042) $ 2,895
FISCAL YEAR ENDED JUNE 30, 2002 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2001
NET SALES
Net sales increased $4.7 million, or 6.9%, from $67.6 million in 2001 to $72.3 million in 2002. Sales increased by $5.0 million, or 7.5%, primarily due to pricing initiatives on both new and renewal customers. Such increase was offset by a $0.3 million decrease in revenues from stand-alone high pressure cylinder customers, a result of the planned phase-out of such customers.
The following table sets forth, for the periods indicated, the percentage relationship which our service plans bear to net sales:
Fiscal Year Ended June 30, -------------------------- 2002 2001 ---- ---- Bulk budget plan(1) 65.6% 64.2% Equipment lease/product purchase plan(2) 7.1 7.8 Product purchase plan(3) 8.6 8.7 High pressure cylinder(4) 7.1 7.9 Other revenues(5) 11.6 11.4 ----- ----- 100.0% 100.0% ====== ======
(1) Combined fee for bulk CO2 tank and bulk CO2. (2) Fee for bulk CO2 tank and, separately, bulk CO2 usage. (3) Bulk CO2 only. (4) High pressure CO2 cylinders and non C02 gases. (5) Surcharges and other charges.
During fiscal 2002, we adopted a plan to phase out those customers that use only high pressure cylinders and who do not utilize one of our bulk CO2 service plans. Revenues derived from our stand-alone high pressure cylinder customers may not be fully eliminated from our ongoing revenues inasmuch as our goal is to convert these customers to a bulk CO2 service plan. Accordingly, the expected declining revenues derived from stand-alone high pressure cylinder customers is not expected to have a material impact on our results of operations.
COST OF PRODUCTS SOLD
Costs of products sold increased by $2.3 million, or 7.0%, from $33.2 million in 2001 to $35.5 million in 2002, and as a percentage of net sales, equaled 49.1% in both fiscal years. Operational wages and benefits increased by $1.5 million from $13.5 million in 2001 to $15.0 million in 2002, and as a percentage of net sales, increased from 20.0% in 2001 to 20.8% in 2002. The increases are primarily attributable to increased field management personnel to enhance the operational effectiveness of our depots locally. Product purchases increased by $1.1 million from $9.7 million in 2001 to $10.8 million in 2002, and as a percentage of net sales, increased from 14.3% in 2001 to 15.0% in 2002. The dollar increase is attributable to increased purchases of CO2, partially offset by lower per pound costs, based on volume incentive pricing. Truck expenses decreased $0.7 million from $6.0 million in 2001 to $5.3 million in 2002 while decreasing as a percentage of sales from 8.8% in 2001 to 7.4% in 2002. The dollar decrease is primarily attributable to decreased fuel and truck repair costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased by $0.2 million, or 1.4%, from $17.4 million in 2001 to $17.6 million in 2002, and as a percentage of net sales decreased from 25.7% in 2001 to 24.4% in 2002. The increase is primarily attributable to increases in selling, executive and administrative wages and benefits and other general expenses, offset by a decrease in bad debt expense.
Selling and administrative wages and benefits increased by $0.2 million from $9.7 million in 2001 to $9.9 million in 2002. These costs include wages and benefits associated with the hiring of incremental sales and corporate management.
Other general expenses increased $0.3 million from $4.6 million in 2001 to $4.9 million in 2002. Bad debt expense decreased $0.3 million from $3.1 million in 2001 to $2.8 million in 2002. As a percentage of net sales, bad debt
expense decreased from 4.5% in 2001 to 3.8% in 2002. The decrease is primarily attributable to corrective action taken on the potential uncollectability of certain accounts receivable that came to light as a result of several issues in the billing and cash application areas noted in the prior year. We believe that the factors that gave rise to these issues have been addressed in order to prevent their reoccurrence in the future. Although there was a decrease in bad debt expense for 2002 compared to 2001, a charge of $1.9 million was recorded in the fourth quarter to increase reserves due to the unusually high closure rate among independent operators who have gone out of business in recent periods because of unfavorable economic conditions.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization decreased from $17.5 million in 2001 to $16.3 million in 2002. As a percentage of net sales, depreciation and amortization expense decreased from 25.8% in 2001 to 22.6% in 2002. Depreciation expense increased from $12.3 million in 2001 to $12.6 million in 2002 primarily as a result of new asset additions. Amortization expense decreased by $1.4 million from $5.1 million in 2001 to $3.7 million in 2002.
The decrease in amortization expense is a result of our adoption of Statement of Financial Accounting Standard No. 142, "GOODWILL AND OTHER INTANGIBLE ASSETS." This accounting standard requires that goodwill be separately disclosed from other intangible assets in the balance sheet, and no longer be amortized, but tested for impairment on a periodic basis. In accordance with this standard we discontinued the amortization of goodwill effective July 1, 2001. For fiscal 2002, we were not required to recognize an impairment of goodwill.
LOSS ON ASSET DISPOSAL
Loss on asset disposal decreased $0.2 million from $4.9 million in 2001 to $4.7 million in 2002, while decreasing as a percentage of net sales from 7.2% in 2001 to 6.4% in 2002.
In June 2001, we decided to discontinue further installation of 50 and 100 lb. tanks. As a result of this decision, a loss of $1.2 million was recognized for 50 and 100 lb tanks held in inventory as of June 30, 2001. In addition, during 2001 we recognized a loss of $1.8 million as a result of adopting a conservative approach to recognizing a loss associated with unamortized tank costs at lost customer sites.
During 2002, we adopted a plan to replace all 50 and 100 lb. tanks still in service at customer sites over a three to four year period. The decision to replace these tanks was based on an evaluation of the general economic viability of the asset class. Such conclusion was achieved by examining undiscounted cash flow generation, contribution to depot fixed overhead, pricing and targeted margins. As a result of our decision, the 50 and 100 lb. tanks at customer sites as of June 30, 2002 were written down by $1.8 million to the estimated net realizable value of $2.8 million, and the useful lives of these assets were shortened to not to exceed a period of four years. In connection with the decision to replace the 50 and 100 lb asset class, we recognized an additional loss of $1.1 million relating to the 50 and 100 lb. tanks removed from service during the year, all of which were subsequently disposed of in the first quarter of fiscal 2003.
OPERATING INCOME (LOSS)
Operating loss decreased by $3.5 million from $5.3 million in 2001 to $1.8 million in 2002. As a percentage of net sales, operating loss decreased from 7.8% in 2001 to 2.5% in 2002.
LOSS ON EARLY EXTINGUISHMENT OF DEBT
We accelerated the recognition of $0.8 million in deferred financing costs in 2002 associated with the refinancing of our long-term debt.
INTEREST EXPENSE
Interest expense, net, decreased by $1.8 million, from $10.2 million in 2001 to $8.4 million in 2002, and decreased as a percentage of net sales from 15.1% in 2001 to 11.6% in 2002. The dollar decrease is primarily attributable to an overall decline in interest rates as well as lower average debt levels. The effective interest rate of all debt outstanding during 2002 was 9.7% as compared to 11.2% in 2001.
NET LOSS
Net loss decreased by $4.5 million, or 29.2%, from $15.5 million in 2001 to $11.0 million in 2002. No provision for income tax expense in either 2001 or 2002 has been made due to historical net losses. At June 30, 2002, we
had net operating loss carryforwards for federal income tax purposes of $94.0 million, which are available to offset future federal taxable income, if any, in varying amounts through June 2022.
EBITDA
Earnings before interest, taxes, depreciation and amortization ("EBITDA") is one of the principal financial measures by which we measure our financial performance. EBITDA is a widely accepted financial indicator used by many investors, lenders and analysts to analyze and compare companies on the basis of operating performance, and we believe that EBITDA provides useful information regarding our ability to service our debt and other obligations. However, EBITDA does not represent cash flow from operations, nor has it been presented as a substitute to operating income or net income as indicators of our operating performance. EBITDA excludes significant costs of doing business and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with accounting principles generally accepted in the United States of America. In addition, our calculation of EBITDA may be different from the calculation used by our competitors, and therefore comparability may be affected. In addition, our lenders also use EBITDA to assess our compliance with debt covenants. These financial covenants are based on a measure that is not consistent with accounting principles generally accepted in the United States of America. Such measure is EBITDA (as defined) as modified by certain defined adjustments.
EBITDA, as set forth in the table below, increased by approximately $2.3 million, or 19.3%, from $12.2 million in 2001 to $14.5 million in 2002 and increased as a percentage of net sales from 18.0% to 20.1%.
Fiscal Year Ended June 30, -------------------------- 2002 2001 --------- --------- Net (loss) $(10,971) $(15,485) Interest expense 8,402 10,207 Depreciation and amortization 16,319 17,475 Loss on early extinguishment of debt 796 -- -------- -------- EBITDA $ 14,546 $ 12,197 ======== ========
Cash flows provided by (used in): Operating activities $ 10,858 $ 5,213 Investing activities $(12,817) $(11,761) Financing activities $ 2,895 $ 6,895
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board (the "FASB") issued SFAS No. 145, "RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB STATEMENT NO. 13, AND TECHNICAL CORRECTIONS" ("SFAS 145"). Among other things, SFAS 145 rescinds the provisions of SFAS No. 4 that require companies to classify certain gains and losses from debt extinguishments as extraordinary items. The provisions of SFAS 145 related to classification of debt extinguishments are effective for fiscal years beginning after May 15, 2002. Gains and losses from extinguishment of debt will be classified as extraordinary items only if they meet the criteria in APB Opinion No. 30 ("APB 30"); otherwise such losses will be classified as a component of continuing operations. We adopted SFAS 145 during the quarter ended September 30, 2002. In accordance with APB 30 and SFAS 145, we have reclassified the $796,000 extraordinary loss on the early extinguishment of debt for fiscal 2002 to a component of continuing operations.
In June 2002, the FASB issued SFAS 146, "ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES" ("SFAS 146") which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3 "LIABILITY RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS AND OTHER COSTS TO EXIT AN ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A RESTRUCTURING)" ("EITF 94-3"). The principal difference between SFAS 146 and EITF 94-3 relates to SFAS 146's requirements for recognition of a liability for a cost associated with an exit or disposal activity. SFAS 146 requires that a liability be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost was recognized at the date of an entity's commitment to an exit plan. SFAS 146 also establishes that fair value is the objective for initial measurement of the liability. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002, but early application is encouraged. The adoption of SFAS 146 during the first quarter of fiscal 2003 had no impact on our financial position, results of operations or cash flow for the period presented.
In December 2002, FASB issued SFAS No. 148, "ACCOUNTING FOR STOCK-BASED COMPENSATION - TRANSITION AND DISCLOSURE" ("SFAS 148"). SFAS 148 amends SFAS No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION" ("SFAS 123"), to
provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on the reported results. The provisions of SFAS 148 are effective for financial statements for fiscal years ending after December 15, 2002. The adoption of SFAS 148 had no impact our financial position, results of operations or cash flows for the periods presented.
In the first quarter of fiscal 2003, we adopted SOP 01-06, "ACCOUNTING BY CERTAIN ENTITIES (INCLUDING ENTITIES WITH TRADE RECEIVABLES) THAT LEND TO OR FINANCE THE ACTIVITIES OF OTHERS" ("SOP 01-06"). SOP 01-06 addresses disclosures on accounting policies relating to trade accounts receivable and is effective prospectively for financial statements issued for fiscal years beginning after December 15, 2001. The adoption of SOP 01-06 had no impact our financial position, results of operations or cash flows for the periods presented.
In April 2003, the FASB issued SFAS No. 149, "AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" ("SFAS 149"). SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, and hedging relations designated after June 30, 2003, except for those provisions of SFAS 149 which relate to SFAS No. 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003. For those issues, the provisions that are currently in effect should continue to be applied in accordance with their respective effective dates. In addition, certain provisions of SFAS 149, which relate to forward purchases or sales of when-issued securities or other securities that do not yet exist, should be applied to both existing contracts and new contracts entered into after June 30, 2003. The adoption of SFAS 149 is not expected to have a material effect on our financial position, results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, "ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY" ("SFAS 150"). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS 150 requires that an issuer classify a financial instrument that is within the scope of SFAS No. 150 as a liability. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective beginning September 1, 2003. The adoption of SFAS 150 is not expected to have a material effect on our financial position, results of operations or cash flows.
In May 2003, the EITF reached a consensus on Issue No. 00-21, "REVENUE ARRANGEMENTS WITH MULTIPLE DELIVERABLES" ("EITF 00-21"). EITF 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which the vendor will perform multiple revenue generating activities. Currently, we as lessor, recognize revenue from leasing CO2 systems on straight-line basis over the life of the related leases. As discussed in Note 1(i) to the Financial Statements, the majority of CO2 system leases generally include payments for leasing the equipment and a continuous supply of CO2. For periods beginning after June 15, 2003, EITF 00-21 will require us to segregate the recognition of revenues derived from the lease portion of these agreements from the revenues, net income and EBITDA derived from CO2 usage. Such segregation may impact the recognition of revenues on a quarterly basis as CO2 usage by the average customer fluctuates during a fiscal year based on factors such as weather, traditional summer and holiday periods. We are currently evaluating the potential impact of the implementation of EITF 00-21 on our financial position and results of operations.
LIQUIDITY AND CAPITAL RESOURCES
Our cash requirements consist principally of (1) capital expenditures associated with purchasing and placing new bulk CO2 systems into service at customers' sites; (2) payments of principal and interest on outstanding indebtedness; and (3) working capital. Whenever possible, we seek to obtain the use of vehicles, land, buildings, and other office and service equipment under operating leases as a means of conserving capital. As of June 30, 2003, we anticipated making cash capital expenditures of approximately $15.0 million in fiscal 2004, primarily for purchases of bulk CO2 systems for new customers, the replacement with larger bulk CO2 systems of 50 and 100 lb. systems in service at existing customers, as appropriate, and replacement CO2 tanks for our bulk truck fleet. In June 2002, we adopted a plan to replace all 50 and 100 lb. bulk CO2 systems in service at customers over a three to four year period. While this decision may not increase revenues from these customers, it is expected to improve operating efficiencies, gross margins and profitability. Once bulk CO2 systems are placed into service, we generally experience positive cash flows on a per-unit basis, as there are minimal additional capital expenditures required for ordinary operations. In addition to capital expenditures related to internal growth, we review opportunities to acquire bulk CO2 service accounts, and may require cash in an amount dictated by the scale and terms of any such transactions successfully concluded.
On September 24, 2001, we entered into a $60.0 million second amended and restated revolving credit facility with a syndicate of banks (the "Amended Credit Facility"). Prior to June 30, 2002, the Amended Credit Facility was amended to adjust certain financial covenants for the quarter ended June 30, 2002 and prospectively, and non-compliance with the minimum EBITDA covenant for the three months ended March 31, 2002 was waived. As of June 30, 2002, we were not in compliance with certain of our financial covenants. On September 30, 2002, the Amended Credit Facility was amended to adjust certain financial covenants for the quarter ended September 30, 2002 and prospectively, non-compliance with financial covenants for the three months ended June 30, 2002 was waived, and the maturity of the Amended Credit Facility was extended to November 17, 2003. On August 22, 2002, we completed the private placement of 1,663,846 shares of our common stock to 24 accredited investors at a price of $9.75 per share realizing net cash proceeds of approximately $15.1 million after $1.1 million of issuance costs. Pursuant to the requirements of the Amended Credit Facility, we used $14.5 million of the proceeds to pay down outstanding debt under the Amended Credit Facility. As of September 30, 2002, we were in compliance with all of the financial covenants under the Amended Credit Facility. On February 7, 2003, the Amended Credit Facility was amended to adjust certain financial covenants prospectively, non-compliance with the minimum EBITDA covenant for the three months ended December 31, 2002 was waived, the maturity of the Amended Credit Facility was extended to April 29, 2004, and the Amended Credit Facility was reduced to $45.0 million. As of March 31, 2003 and June 30, 2003, we were in compliance with all of the financial covenants under the Amended Credit Facility.
On August 25, 2003, we terminated the Amended Credit Facility and entered into a $50.0 million senior credit facility with a syndicate of banks (the "Senior Credit Facility"). The Senior Credit Facility consists of a $30.0 million A term loan facility (the "A Term Loan"), a $10.0 million B term loan facility (the "B Term Loan"), and a $10.0 million revolving loan facility (the "Revolving Loan Facility"). The A Term Loan matures on August 25, 2007, the B Term Loan matures on August 25, 2008 and the Revolving Loan Facility matures on August 25, 2007. The B Term Loan is subordinate in right of payment to the A Term Loan and borrowings under the Revolving Loan Facility. We are entitled to select either Eurodollar Loans (as defined) or Base Rate Loans (as defined), plus applicable margin, for principal borrowings under the Senior Credit Facility. The applicable Eurodollar Loan margin for A Term Loans and borrowings pursuant to the Revolving Loan Facility ranges from 3.5% to 4.0%, and the applicable Base Rate Loan margin for A Term Loans and borrowings pursuant to the Revolving Loan Facility ranges from 2.5% to 3.0%, provided that until delivery to the lenders of our financial statements for the quarter ending June 30, 2004, the margin on Eurodollar Loans is 4.0% and the margin for Base Rate Loans is 3.0%. The applicable Eurodollar Loan margin and Base Rate Loan margin for B Term Loans is 7.5% and 6.5%, respectively. Applicable margin is determined by a pricing grid based on our Consolidated Total Leverage Ratio (as defined). At closing, we borrowed the A Term Loan, the B Term Loan and $3.0 million under the Revolving Loan Facility. Interest is payable periodically on borrowings under the Senior Credit Facility. In addition, commencing on December 31, 2003 and on the last day of each quarter thereafter, we are required to make principal repayments on the A Term Loan in increasing amounts. The Senior Credit Facility is collateralized by all of our assets. Additionally, we are precluded from declaring or paying any cash dividends, except we may accrue and accumulate, but not pay, cash dividends on our outstanding redeemable preferred stock. We are also required to meet certain affirmative and negative covenants, including but not limited to financial covenants.
We are required to assess our compliance with financial covenants under the Senior Credit Facility on a quarterly basis. These financial covenants are based on a measure that is not consistent with accounting principles generally accepted in the United States of America. Such measure is EBITDA (as defined), which represents earnings before interest, taxes, depreciation and amortization, as further modified by certain defined adjustments. The failure to meet these covenants, absent a waiver or amendment, would place us in default and cause the debt outstanding under the Senior Credit Facility to immediately become due and payable. The Senior Credit Facility also includes certain cross-default provisions to our 16.3% Senior Subordinated Notes Due February 27, 2009.
In October 1997, we issued $30.0 million of our 12% Senior Subordinated Promissory Notes ("1997 Notes") with interest only payable semi-annually on April 30 and October 31, due October 31, 2004. On May 4, 1999, we sold an additional $10.0 million of our 12% Senior Subordinated Promissory Notes ("1999 Notes"). Except for their October 31, 2005 maturity date, the 1999 Notes were substantially identical to the 1997 Notes. As of June 30, 2002 and at various dates in the past we have been unable to meet certain covenants under the 1997 Notes and 1999 Notes and have had to obtain waivers or modifications. On September 27, 2002, concurrently with the amendment to the Amended Credit Facility, certain financial covenants of the 1997 Notes and 1999 Notes were amended to adjust certain financial covenants for the quarter ended June 30, 2002, and prospectively. As of September 30, 2002, December 31, 2002 and March 31, 2003, we were in compliance with all of the financial covenants under the 1997 Notes and 1999 Notes. On February 7, 2003, the interest coverage ratio governing the 1997 Notes and 1999 Notes was amended for the quarter ended March 31, 2003 and prospectively. As of June 30, 2003, we were in compliance with all of the financial covenants under the 1997 Notes and 1999 Notes.
On August 25, 2003, concurrently with the closing of the Senior Credit Facility, we prepaid the 1997 Notes and 1999 Notes and issued $30.0 million of our 16.3% Senior Subordinated Notes Due February 27, 2009 (the "New Notes") with interest only payable quarterly in arrears on February 28, May 31, August 31 and November 30 of each year, commencing November 30, 2003. Interest on the New Notes is 12% per annum payable in cash and 4.3% per annum payable "in kind" by adding the amount of such interest to the principal amount of the New Notes then outstanding. Ten year warrants to purchase an aggregate of 425,000 shares of our common stock at an exercise price of $8.79 per share were issued in connection with the New Notes. As with the Senior Credit Facility, we are required to meet certain affirmative and negative covenants under the New Notes, including but not limited to financial covenants.
Although we believe that we will be able to comply with the current provisions of our borrowing arrangements, circumstances may result in our having to obtain waivers or further modifications in the future.
During fiscal 2003, our capital resources included cash flows from operations, proceeds from the private placement of our common stock and available borrowing capacity under the Amended Credit Facility. As of June 30, 2003, a total of $30.7 million was outstanding under the Amended Credit Facility. As of September 19, 2003, a total of $43.0 million was outstanding under the Senior Credit Facility with a weighted average interest rate of 6.04%.
We believe that cash flows from operations and available borrowings under the Senior Credit Facility will be sufficient to fund proposed operations for at least the next twelve months.
The table below sets forth our obligations (in thousands) as of June 30, 2003, reflecting the payoff of our Amended Credit Facility, 1997 Notes and 1999 Notes in August 2003:
Less than 1 Contractual obligations Total Year 2-3 Years 4-5 Years Thereafter -------------------------------------------------------- Senior Credit Facility $43,253 $ 2,294 $15,350 $15,609 $10,000 Subordinated debt 30,000 -- -- -- 30,000 Non-competition agreements 80 80 -- -- -- Employment Agreements 1,960 758 1,142 60 Operating leases 12,934 3,915 5,240 2,776 1,002 ------- ------- ------- ------- ------- Total obligations $88,227 $ 7,047 $21,732 $18,445 $41,002 ======= ======= ======= ======= =======
In addition, in May 1997 we entered into a ten-year exclusive bulk CO2 requirements contract with The BOC Group, Inc.
WORKING CAPITAL. At June 30, 2003 and June 30, 2002, we had working capital of $(1.7) million and $2.3 million, respectively. While working capital decreased from 2002 to 2003, we used excess funds generated by operations offset by capital needs, as discussed below, along with $14.5 million generated by the private placement of our common stock, to reduce the outstanding amounts under our Amended Credit Facility.
CASH FLOWS FROM OPERATING ACTIVITIES. Cash flows provided by operations increased by $4.9 million from $10.9 million in 2002 to $15.8 million in 2003. The improvement is primarily due to our improvement in net income (excluding non-cash charges) of $3.1 million and a $1.9 million improvement in the working capital components of our balance sheet.
CASH FLOWS FROM INVESTING ACTIVITIES. During 2003 and 2002, net cash used in investing activities was $13.9 million and $12.8 million, respectively. These investing activities were primarily attributable to the acquisition, installation and direct placement costs of bulk CO2 systems.
CASH FLOWS FROM FINANCING ACTIVITIES. During 2003 cash flows used in financing activities was $3.0 million compared to $2.9 million provided by operations in 2002. During fiscal 2003, we completed the private placement of 1,663,846 shares of our common stock to 24 accredited investors at a price of $9.75 per share realizing net cash proceeds of approximately $15.1 million after $1.1 million of issuance costs. Pursuant to the requirements of the Amended Credit Facility, we used $14.5 million of the proceeds to pay down outstanding debt under the Amended Credit Facility. In addition, during a significant portion of 2003, our cash flows generated from operations exceeded our growth capital needs, thus allowing us to use the remaining portion to apply towards our outstanding debt levels.
In 2002, cash flows from financing activities included $5.4 million from the issuance of 2,500 shares of Series B 8% Cumulative Convertible Preferred Stock and the exercise of stock options, offset principally by an increase in deferred financing costs under the Amended Credit Facility. As a result of amending the Amended Credit Facility in August 2001, we simultaneously paid down the existing facility and received funding, from net proceeds from the issuance of long-term debt of $0.1 million.
INFLATION
The modest levels of inflation in the general economy have not affected our results of operations. Additionally, our customer contracts generally provide for annual increases in the monthly rental rate based on increases in the consumer price index. We believe that inflation will not have a material adverse effect on our future results of operations.
Our bulk CO2 supply contract with The BOC Group, Inc. ("BOC") provides for annual adjustments in the purchase price for bulk CO2 based upon increases or decreases in the Producer Price Index for Chemical and Allied Products or the average percentage increase in the selling price of bulk merchant carbon dioxide purchased by BOC's large, multi-location beverage customers in the United States.
CRITICAL ACCOUNTING POLICIES
In preparing our financial statements, we make estimates, assumptions and judgments that can have a significant impact on our revenue, operating income and net income, as well as on the reported amounts of certain assets and liabilities on our balance sheet. We believe that the estimates, assumptions and judgments involved in the accounting policies described below have the greatest potential impact on our financial statements, so we consider these to be our critical accounting policies. Estimates in each of these areas are based on historical experience and a variety of assumptions that we believe are appropriate. Actual results may differ from these estimates.
VALUATION OF LONG-LIVED ASSETS
We review our long-lived assets for impairment, principally property and equipment, whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. To determine recoverability of our long-lived assets, we evaluate the probability that future undiscounted net cash flows will be greater than the carrying amount of our assets. Impairment is measured based on the difference between the carrying amount of our assets and their estimated fair value. See Note 2 of the financial statements for more information regarding asset write-downs recognized during the years ended June 30, 2002 and 2001.
Certain events may occur that would materially effect our estimates and assumptions related to depreciation. Unforeseen changes in operations or technology could substantially alter management's assumptions regarding our ability to realize the return of our investment in operating assets and therefore affect the amount of depreciation expense to charge against both current and future revenues. Because depreciation expense is a function of historical experiences, analytical studies and professional judgments made of property, plant and equipment, subsequent studies could result in different estimates of useful lives and net salvage values. If future depreciation studies yield results indicating that our assets have shorter lives as a result of obsolescence, physical condition, changes in technology or changes in net salvage values, the estimate of depreciation expense could increase. Likewise, if studies indicate that assets have longer lives, the estimate of depreciation expense could decrease. For the year ended June 30, 2003, depreciation expense was $13,836,983 representing 19.3% of operating expenses. If the estimated lives of all assets being depreciated were increased by one year, depreciation expense would have decreased by approximately $1,100,000 or 8.0%. Conversely, if the estimated lives of all assets decreased by one year, depreciation expense would have increased by $1,400,000 or 10.1%.
Goodwill represents the cost in excess of the fair value of the tangible and identifiable intangible not assets of businesses acquired and, prior to July 1, 2001, was amortized on a straight-line method over 20 years. Effective July 1, 2001, we adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets ", pursuant to which, goodwill and indefinite life intangible assets are no longer amortized but are subject to annual impairment tests. Other intangible assets with finite lives continue to be amortized on a straight-line method over the periods of expected benefit. Other intangible assets consist of customer lists and non-competition agreements, principally acquired in 1995 through 1998 in connection with certain asset acquisitions. Customer lists are being amortized on a straight line method over five years, the average life of customer leases, and non-competition agreements. Which generally preclude the other party from competing with the us in a designated geographical area for a stated period of time, are being amortized on a straight line method over their contractual lives which range from thirty to one hundred and twenty months.
RESERVES FOR UNCOLLECTIBLE ACCOUNTS RECEIVABLE
We make ongoing assumptions relating to the collectability of our accounts receivable. The accounts receivable amount on our balance sheet includes a reserve for accounts that might not be paid. Such reserve is evaluated and adjusted on a monthly basis by examining our historical losses, aging of our trade receivables, the credit worthiness of significant customers based on ongoing evaluations, and current economic trends that might impact the level of credit losses in the future. The composition of receivables consists of on-time payers, "slow" payers, and at risk receivables, such as receivables from customers who no longer do business with us, are bankrupt, or are out of business. Substantially all at risk receivables greater than 120 days outstanding are fully reserved, with the reserve of all receivables at risk, regardless of days outstanding, exceeding 93% of the total amount as of June 30, 2003. While we believe that our current reserves are adequate to cover potential credit losses, we cannot predict future changes in the financial stability of
our customers and we cannot guarantee that our reserves will continue to be adequate. If actual credit losses are significantly greater than the reserve we have established, that would increase our general and administrative expenses and reduce our reported net income. Conversely, if actual credit losses are significantly less than our reserve, this would eventually decrease our general and administrative expenses and increase our reported net income.
DEFERRED INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment and record a valuation allowance to reduce our deferred tax assets to the amount that is expected to be realized in future periods.
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. -----------------------------------------------------------
As discussed under "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" above, as of June 30, 2003, a total of $30.7 million was outstanding under the Amended Credit Facility with a weighted average interest rate of 4.7%. As discussed in "Liquidity and Capital Resources," we terminated the Amended Credit Facility and entered into the Senior Facility as of August 25, 2003. Based upon $43.0 million outstanding under the Senior Credit Facility at September 19, 2003, our annual interest cost under the Senior Credit Facility would increase by approximately $0.4 million for each 1% increase in interest rates.
In order to reduce our exposure to increases in LIBOR, and consequently to increases in interest payments, we entered into an interest rate swap transaction (the "Prior Swap") in the amount of $12.5 million (the "Prior Notional Amount"). Pursuant to the Swap, we paid a fixed interest rate of 5.23% per annum and received a LIBOR-based floating rate. The effect of the Prior Swap was to neutralize any changes in LIBOR on the Prior Notional Amount. The Swap was terminated on August 25, 2003. In connection with the Senior Credit Facility, we are required to enter into an interest rate Swap agreement in a notional amount equal at least 50% of the aggregate of the A Term Loan and the B Term Loan prior to November 24, 2003.
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. -------------------------------------------
See page.
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. --------------------------------------------------------------------
None.
9A. CONTROLS AND PROCEDURES -----------------------
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Based on our management's evaluation (with the participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the "Exchange Act") are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING. There was no change in our internal control over financial reporting during our fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. ---------------------------------------------------
The information required by Item 10 is incorporated by reference to our definitive proxy statement to be filed with the SEC no later than October 28, 2003 pursuant to Regulation 14A.
11. EXECUTIVE COMPENSATION. -----------------------
The information required by Item 11 is incorporated by reference to our definitive proxy statement to be filed with the SEC no later than October 28, 2003 pursuant to Regulation 14A.
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. --------------------------------------------------------------------
The information required by Item 12 is incorporated by reference to our definitive proxy statement to be filed with the SEC no later than October 28, 2003 pursuant to Regulation 14A.
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. -----------------------------------------------
The information required by Item 13 is incorporated by reference to our definitive proxy statement to be filed with the SEC no later than October 28, 2003 pursuant to Regulation 14A.
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES. ---------------------------------------
Not applicable.
15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. -----------------------------------------------------------------
(a) The following documents are filed as part of this report.
(1) Financial statements. See Index to Financial Statements which appears on page herein.
(2) Financial Statement Schedules
II - Valuation and Qualifying Accounts.
(3) Exhibits:
Exhibit No. Exhibit
3.1 -- Amended and Restated Articles of Incorporation of the Company. (2)
3.2 -- Articles of Amendment to the Articles of Incorporation of the Company, dated December 18, 1995. (3)
3.3 -- Articles of Amendment to the Articles of Incorporation of the Company, dated December 17, 1996. (3)
3.4 -- Articles of Amendment to the Articles of Incorporation of the Company, dated May 10, 2000. (5)
3.5 -- Articles of Amendment to the Articles of Incorporation of the Company, dated November 1, 2001. (7)
3.6 -- Articles of Amendment to the Articles of Incorporation of the Company, dated March 31, 2003. (1)
3.7 -- Bylaws of the Company. (2)
4 -- Rights Agreement, dated as of March 27, 2003, between the Company and Continental Stock Transfer & Trust Company, as Rights Agent. (10)
10.1* -- 1995 Stock Option Plan of the Company. (5)
10.2* -- Directors' Stock Option Plan of the Company. (2)
10.3 -- Credit Agreement among the Company, various lenders and BNP Paribas, as Administration Agent, dated as of August 25, 2003. (1)
10.4 -- Senior Subordinated Note Purchase Agreement, dated as of August 25, 2003 between the Company and the Investors. (1)
10.5 -- Warrant Agreement dated as of August 25, 2003 among the Company and the Initial Holders. (1)
10.6 -- Special Warrant Agreement dated as of August 25, 2003 among the Company and the Initial Holders. (1)
10.7 -- Special Warrant Agreement dated as of August 25, 2003 among the Company and the Initial Holder. (1)
10.8 -- Preferred Stock Purchase Agreement, dated as of May 15, 2000, by and between the Company and Chase Capital Investments, L.P. (5)
10.9 -- Preferred Stock Purchase Agreement, dated as of November 1, 2001, by and between the Company and Paribas North America, Inc. (7)
10.10 -- Warrant Agreement ("Warrant Agreement") dated as of October 31, 1997 among the Company and the Initial Holders. (3)
10.11 -- Amendment No. 1 to Warrant Agreement dated as of November 14, 1997. (3)
10.12 -- Amendment No. 2 to Warrant Agreement dated as of May 4, 1999. (4)
10.13 -- Stock Purchase Agreement, dated as of December 7, 2000 by and between The BOC Group, Inc., a Delaware corporation and the Company. (6)
10.14 -- Stock Purchase Agreement, dated as of August 22, 2002, by and between the Company and the purchasers named therein. (9)
10.15 -- Registration Right Agreement, dated as of August 22, 2002, by and between the Company and the selling shareholders named therein. (8)
10.16* -- Employment Agreement between the Company and Michael E. DeDomenico, dated as of June 2, 2000. (5)
10.17* -- Employment Agreement between the Company and William Scott Wade, dated as of May 13, 2002. (9)
10.18* -- Employment Agreement between the Company and Robert R. Galvin, dated as of October 21, 2002. (1)
10.19* -- Stock Option Agreement between the Company and Craig L. Burr dated March 21, 2003. (1)
10.20* -- Stock Option Agreement between the Company and Robert L. Frome dated March 21, 2003. (1)
10.21* -- Stock Option Agreement between the Company and Daniel Raynor dated March 21, 2003. (1)
10.22* -- Stock Option Agreement between the Company and Richard D. Waters, Jr. dated March 21, 2003. (1)
10.23* -- Stock Option Agreement between the Company and John E. Wilson dated March 21, 2003. (1)
10.24* -- Stock Option Agreement between the Company and Craig L. Burr dated March 21, 2003. (1)
10.25* -- Stock Option Agreement between the Company and Robert L. Frome dated March 21, 2003. (1)
10.26* -- Stock Option Agreement between the Company and Daniel Raynor dated March 21, 2003. (1)
10.27* -- Stock Option Agreement between the Company and John Walsh dated March 21, 2003. (1)
10.28* -- Stock Option Agreement between the Company and Richard D. Waters, Jr. dated March 21, 2003. (1)
10.29* -- Stock Option Agreement between the Company and John E. Wilson dated March 21, 2003. (1)
14 -- Code of Ethics. (1)
23 -- Consent of Margolin, Winer & Evens LLP to the incorporation by reference to the Company's Registration Statements on Form S-8 (Nos. 333-06705, 333- 30042 and 333-89096) and Form S-3 (No. 333-99201) of the independent auditors' report included herein. (1)
31.1 -- Section 302 Certification of Principal Executive Officer. (1)
31.2 -- Section 302 Certification of Principal Financial Officer. (1)
32.1 -- Section 906 Certification of Principal Executive Officer. (1)
32.2 -- Section 906 Certification of Principal Financial Officer. (1)
* Indicates a management contract or compensation plan or arrangement.
(b) Reports on Form 8-K -------------------
A report on From 8-K dated May 6, 2003 reporting an Item 12 event was filed during the quarter ended June 30, 2003.
---------------------------
(1) Included herein. (2) Incorporated by reference to the Company's Registration Statement on Form SB-2, filed with the Commission on November 7, 1995 (Commission File No. 33-99078), as amended. (3) Incorporated by reference to the Company's Form 10-K for the year ended June 30, 1998. (4) Incorporated by reference to the Company's Form 10-K for the year ended June 30, 1999. (5) Incorporated by reference to the Company's Form 10-K for the year ended June 30, 2000. (6) Incorporated by reference to the Company's Form 10-Q for the quarter ended December 31, 2000. (7) Incorporated by reference to the Company's Form 10-Q for the quarter ended December 31, 2001. (8) Incorporated by reference to the Company's Registration Statement on From S-3, filed with the Commission on September 5, 2002 (Commission File No. 333- 99201). (9) Incorporated by reference to the Company's Form 10-K for the year ended June 30, 2002. (10) Incorporated by reference to the Company's Registration Statement on Form 8-A, filed on March 31, 2003.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NUCO2 INC.
Dated: September 26, 2003 /s/ Michael E. DeDomenico ------------------------- Michael E. DeDomenico Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date --------- ----- ----
/s/ Craig L. Burr Director September 26, 2003 ---------------------------- Craig L. Burr
/s/ Michael E. DeDomenico Director, September 26, 2003 --------------------------- Chief Executive Officer Michael E. DeDomenico
/s/ Robert L. Frome Director September 26, 2003 ------------------------ Robert L. Frome
/s/ Daniel Raynor Director September 26, 2003 ----------------- Daniel Raynor
____________________ Director John Walsh
/s/ Richard D. Waters, Jr. Director September 26, 2003 -------------------------- Richard D. Waters, Jr.
Director ------------------------ John E. Wilson
/s/ Robert R. Galvin Chief Financial Officer September 26, 2003 -------------------- Robert R. Galvin
Page No. --------
NUCO2 INC.
Independent Auditors' Report .............................................F-2
Financial Statements:
Balance Sheets as of June 30, 2003 and 2002.......................F-3
Statements of Operations for the Fiscal Years Ended June 30, 2003, 2002 and 2001 ..........................F-4
Statements of Shareholders' Equity for the Fiscal Years Ended June 30, 2003, 2002 and 2001......................F-5
Statements of Cash Flows for the Fiscal Years Ended June 30, 2003, 2002 and 2001.......................................F-6
Notes to Financial Statements.............................................F-8
Schedule II - Valuation and Qualifying Accounts for the Fiscal Years Ended June 30, 2003, 2002 and 2001 ...........................F-24
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders NuCO2 Inc. Stuart, Florida
We have audited the accompanying balance sheets of NuCO2 Inc. as of June 30, 2003 and 2002, and the related statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended June 30, 2003. We have also audited the financial statement schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of NuCO2 Inc. as of June 30, 2003 and 2002, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2003 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth herein.
As discussed in Note 1 to the financial statements, effective July 1, 2001 the Company adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," which changed the method of accounting for goodwill.
/s/ MARGOLIN, WINER & EVENS LLP ---------------------------------------- MARGOLIN, WINER & EVENS LLP
Garden City, New York August 8, 2003, except for Notes 5 and 6 as to which the date is August 25, 2003
NUCO2 INC. BALANCE SHEETS (In thousands, except share amounts) ASSETS June 30, ------------------------
2003 2002 --------- -------- Current assets: Cash and cash equivalents $ 455 $ 1,562 Trade accounts receivable; net of allowance for doubtful accounts of $2,299 and $3,085, respectively 6,217 7,171 Inventories 210 235 Prepaid expenses and other current assets 1,605 1,966 --------- --------- Total current assets 8,487 10,934 --------- ---------
Property and equipment, net 92,448 95,084 --------- ---------
Other assets: Goodwill, net 19,222 19,222 Deferred financing costs, net 1,593 2,524 Customer lists, net 25 281 Non-competition agreements, net 985 1,282 Deferred lease acquisition costs, net 2,892 2,991 Other assets 194 320 --------- --------- 24,911 26,620 --------- --------- Total assets $ 125,846 $ 132,638 ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt $ 2,294 $ 40 Accounts payable 4,095 3,512 Accrued expenses 1,315 2,304 Accrued interest 981 1,479 Accrued payroll 1,212 897 Other current liabilities 329 371 --------- --------- Total current liabilities 10,226 8,603
Long-term debt, excluding current maturities 28,659 48,254 Subordinated debt 39,576 39,366 Customer deposits 3,191 2,644 --------- --------- Total liabilities 81,652 98,867 --------- ---------
Commitments and contingencies Redeemable preferred stock 9,258 8,552 --------- ---------
Shareholders' equity: Preferred stock; no par value; 5,000,000 shares authorized; issued and outstanding 7,500 shares at June 30, 2003 and 2002 -- -- Common stock; par value $.001 per share; 30,000,000 shares authorized; issued and outstanding 10,633,405 shares at June 30, 2003 and 8,969,059 at June 30, 2002 11 9 Additional paid-in capital 92,938 78,584 Accumulated deficit (57,884) (52,945) Accumulated other comprehensive loss (129) (429) --------- --------- Total shareholders' equity 34,936 25,219 --------- --------- Total liabilities and shareholders' equity $ 125,846 $ 132,638 ========= =========
See accompanying notes to financial statements.
NUCO2 INC. STATEMENTS OF OPERATIONS (In thousands, except per share amounts)
Years Ended June 30, --------------------------------- 2003 2002 2001 -------- -------- ---------
Net sales $ 74,409 $ 72,312 $ 67,633 -------- -------- --------
Costs and expenses: Cost of products sold, excluding depreciation and amortization 35,538 35,491 33,177 Selling, general and administrative expenses 17,485 17,614 17,368 Depreciation and amortization 17,167 16,319 17,475 Loss on asset disposal 1,671 4,661 4,891 -------- -------- -------- 71,861 74,085 72,911 -------- -------- --------
Operating income (loss) 2,548 (1,773) (5,278)
Interest expense 7,487 8,402 10,207
Loss on early extinguishment of debt -- 796 -- -------- -------- --------
Net (loss) $ (4,939) $(10,971) $(15,485) ======== ======== ========
Basic and diluted earnings per common share
Net (loss) $ (0.54) $ (1.32) $ (2.01) ======== ======== ========
Weighted average number of common and common equivalent shares outstanding, basic and diluted 10,396 8,742 7,926 ======== ======== ========
See accompanying notes to financial statements.
NUCO2 INC. STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands, except share amounts)
Accumulated Additional Other Total Paid-In Accumulated Comprehensive Shareholders' Common Stock Capital Deficit Loss Equity ------------ ------- ------- ---- ------ Shares Amount ------ ------ Balance, June 30, 2000 7,275,015 $ 7 $ 64,722 $ (26,489) $ -- $ 38,240 Comprehensive (loss): Net (loss) -- -- -- (15,485) -- (15,485) Other comprehensive expense: Interest rate swap transaction -- -- -- -- (343) (343) ---------- Total comprehensive (loss) (15,828) Redeemable preferred stock dividend -- -- (416) -- -- (416) Issuance of 1,111,111 shares of common stock 1,111,111 1 9,918 -- -- 9,919 Issuance of 264,999 shares of common stock- exercise of options 264,999 1 2,066 -- -- 2,067 ----------- ----------- ----------- ----------- ----------- ---------- Balance, June 30, 2001 8,651,125 9 76,290 (41,974) (343) 33,982 ----------- ----------- ----------- ----------- ----------- ----------
Comprehensive (loss): Net (loss) -- -- -- (10,971) -- (10,971) Other comprehensive expense: Interest rate swap transaction -- -- -- -- (86) (86) ---------- Total comprehensive (loss) (11,057) Redeemable preferred stock dividend -- -- (586) -- -- (586) Issuance of 65,574 shares of common stock - exercise of warrants 65,574 -- 436 -- -- 436 Issuance of 252,360 shares of common stock - exercise of options 252,360 -- 2,444 -- -- 2,444 ----------- ----------- ----------- ----------- ----------- ---------- Balance, June 30, 2002 8,969,059 9 78,584 (52,945) (429) 25,219 ----------- ----------- ----------- ----------- ----------- ----------
Comprehensive (loss): Net (loss) -- -- -- (4,939) -- (4,939) Other comprehensive income: Interest rate swap transaction -- -- -- -- 300 300 ---------- Total comprehensive (loss) (4,639) Redeemable preferred stock dividend -- -- (706) -- -- (706) Issuance of 500 shares of common stock - exercise of options 500 -- 6 -- -- 6 Issuance of 1,663,846 shares of common stock 1,663,846 2 15,054 -- -- 15,056 ----------- ----------- ----------- ----------- ----------- ---------- Balance, June 30, 2003 10,633,405 $ 11 $ 92,938 $ (57,884) $ (129) $ 34,936 =========== =========== =========== =========== =========== ==========
See accompanying notes to financial statements.
NUCO2 INC. STATEMENTS OF CASH FLOWS (In thousands)
Years Ended June 30, -------------------- 2003 2002 2001 ---- ---- ----
Cash flows from operating activities: Net (loss) $ (4,939) $(10,971) $(15,485) Adjustments to reconcile net (loss) to net cash provided by operating activities: Depreciation and amortization of property and equipment 13,836 12,604 12,349 Amortization of other assets 3,331 3,715 5,126 Amortization of original issue discount 210 201 197 Loss on asset disposal 1,671 4,661 4,891 Loss on early extinguishment of debt -- 796 -- Changes in operating assets and liabilities: Decrease (increase) in: Trade accounts receivable 954 575 1,116 Inventories 25 (36) 23 Prepaid expenses and other current assets 361 (747) (306) Increase (decrease) in: Accounts payable 743 714 (5,562) Accrued expenses (989) (634) 2,356 Accrued payroll 316 17 504 Accrued interest (198) 51 (485) Other current liabilities (42) (43) 151 Customer deposits 547 (45) 338 -------- -------- --------
Net cash provided by operating activities 15,826 10,858 5,213 -------- -------- --------
Cash flows from investing activities: Proceeds from disposal of property and equipment 19 91 31 Purchase of property and equipment (12,752) (11,675) (10,509) Increase in non-competition agreements (160) (160) (80) Acquisition of businesses -- -- (36) Increase in deferred lease acquisition costs (1,125) (928) (1,164) Decrease (increase) in other assets 127 (145) (3) -------- -------- --------
Net cash used in investing activities $(13,891) $(12,817) $(11,761) -------- -------- --------
See accompanying notes to financial statements.
NUCO2 INC. STATEMENTS OF CASH FLOWS (In thousands) (Continued)
Years Ended June 30, -------------------- 2003 2002 2001 ---- ---- ----
Cash flows from financing activities: Proceeds from issuance of common stock $ 16,222 $ -- $ 9,919 Issuance costs - common stock (1,168) -- -- Proceeds from issuance of redeemable preferred stock -- 2,500 -- Net proceeds from issuance of long-term debt and subordinated debt -- 50,000 5,900 Repayment of long-term debt (17,340) (49,887) (10,833) Increase in deferred financing costs (762) (2,598) (158) Exercise of options and warrants 6 2,880 2,067 -------- -------- --------
Net cash (used in) provided by financing activities (3,042) 2,895 6,895 -------- -------- --------
(Decrease) increase in cash and cash equivalents (1,107) 936 347 Cash and cash equivalents, beginning of year 1,562 626 279 -------- -------- --------
Cash and cash equivalents, end of year $ 455 $ 1,562 $ 626 ======== ======== ========
Supplemental disclosure of cash flow information: Cash paid during the year for:
Interest $ 7,475 $ 8,066 $ 10,497 ======== ======== ========
Income taxes $ -- $ -- $ -- ======== ======== ========
Supplemental disclosure of non-cash investing and financing activities:
In 2003, 2002 and 2001, the Company increased the carrying amount of the redeemable preferred stock by $706, $586, and $416, respectively, for dividends that have not been paid and accordingly reduced additional paid-in capital by a like amount.
In 2001, the Company transferred the net realizable value of certain fixed assets held for sale in the amount of $237 to other assets.
In 2001, the Company entered into a non-competition agreement with a former executive officer in the amount of $480. At June 30, 2003, 2002 and 2001, the unpaid portion of the agreement totaled $80, $240 and $400, respectively, and is included in accounts payable.
See accompanying notes to financial statements.
NUCO2 INC. NOTES TO FINANCIAL STATEMENTS (In thousands, except per share amounts)
NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) BASIS OF PRESENTATION
The financial statements include the accounts of NuCO2 Inc. and its wholly-owned subsidiary, NuCO2 Acquisition Corp., which was merged into the Company during the fiscal year ended June 30, 2002. All material intercompany accounts and transactions have been eliminated.
(b) DESCRIPTION OF BUSINESS
The Company is a supplier of bulk CO2 dispensing systems to customers in the food, beverage, lodging and recreational industries in the United States.
(c) CASH AND CASH EQUIVALENTS
The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
(d) INVENTORIES
Inventories, consisting primarily of carbon dioxide gas, are stated at the lower of cost or market. Cost is determined by the first-in, first-out method.
(e) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. The Company does not depreciate bulk systems held for installation until the systems are in service and leased to customers. Upon installation, the systems, component parts and direct costs associated with the installation are transferred to the leased equipment account. These direct costs are associated with successful placements of such systems with customers under noncancelable contracts and which would not be incurred by the Company but for a successful placement. Upon early service termination, the unamortized portion of direct costs associated with the installation are expensed. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the respective assets or the lease terms for leasehold improvements, whichever is shorter.
The depreciable lives of property and equipment are as follows:
Estimated Life -------------- Leased equipment 5-20 years Equipment and cylinders 3-20 years Vehicles 3-5 years Computer equipment 3-7 years Office furniture and fixtures 5-7 years Leasehold improvements lease term
(f) GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill, net of accumulated amortization of $5,006, represents the cost in excess of the fair value of the tangible and identifiable intangible net assets of businesses acquired and, prior to July 1, 2001, was amortized on a straight-line method over 20 years. Effective July 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 142, "GOODWILL AND OTHER INTANGIBLE ASSETS," pursuant to which, goodwill and indefinite life intangible assets are no longer amortized but are subject to annual impairment tests. Other intangible assets with finite lives continue to be amortized on a straight-line method over the periods of expected benefit. The Company's other intangible assets consist of customer lists and non-competition agreements, principally acquired in 1995 through 1998 in connection with certain asset acquisitions. Customer lists are being amortized on a straight line method over five years, the average life of customer leases, and non-competition agreements, which generally preclude the other party from competing with the Company in a designated geographical area for a stated period of time, are being amortized on a straight line method over their contractual lives which range from thirty to
NUCO2 INC. NOTES TO FINANCIAL STATEMENTS (In thousands, except per share amounts)
one hundred and twenty months. Non-competition agreements also include an agreement entered into in January 2001, for $480, with the Company's former Chief Executive Officer and Chairman of the Board of Directors, precluding this former officer from competing with the Company for a period of five years.
(g) DEFERRED FINANCING COST, NET
Financing costs are being amortized on a straight-line method over the term of the related indebtedness, ranging from fifteen to eighty-four months. Accumulated amortization of financing costs was $4,007 and $2,313 at June 30, 2003 and 2002, respectively.
(h) DEFERRED LEASE ACQUISITION COSTS, NET
Deferred lease acquisition costs, net, consist of commissions associated with the acquisition of new leases and are being amortized over the life of the related leases, generally five to six years on a straight-line method. Accumulated amortization of deferred lease acquisition costs was $5,508 and $4,687 at June 30, 2003 and 2002, respectively. Upon early service termination, the unamortized portion of deferred lease acquisition costs are expensed.
(i) REVENUE RECOGNITION
The Company earns its revenues from the leasing of CO2 systems and related gas sales. The Company, as lessor, recognizes revenue from leasing of CO2 systems on a straight-line basis over the life of the related leases. The majority of CO2 system leases generally include payments for leasing of equipment and a continuous supply of CO2 until usage reaches a pre-determined maximum annual level, beyond which the customer pays for CO2 on a per pound basis. Other CO2 and gas sales are recorded upon delivery to the customer.
(j) INCOME TAXES
Income taxes are accounted for under Financial Accounting Standards Board Statement No. 109, Accounting for Income Taxes. Statement No. 109 requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Under Statement No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
(k) NET LOSS PER COMMON SHARE
Net loss per common share is presented in accordance with SFAS No. 128, "Earnings per Share." Basic earnings per common share is computed using the weighted average number of common shares outstanding during the period. Diluted earnings per common share incorporate the incremental shares issuable upon the assumed exercise of stock options and warrants to the extent they are not anti-dilutive.
(l) 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. Estimates used when accounting for items such as allowances for doubtful accounts, depreciation and amortization periods, valuation of long-lived assets and income taxes are regarded by management as being particularly significant. These estimates and assumptions are evaluated on an on-going basis and may require adjustment in the near term. Actual results could differ from those estimates.
(m) IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets, other than goodwill, consist of property and equipment, customer lists, and non-competition agreements. Long-lived assets being retained for use by the Company are tested for recoverability whenever events or changes in circumstances indicate that their carrying values may not be recoverable by comparing the carrying value of the assets with the estimated future undiscounted cash flows that are directly associated with and that are expected to arise as a direct result of the use and eventual disposition of the
NUCO2 INC. NOTES TO FINANCIAL STATEMENTS (In thousands, except per share amounts)
asset. Impairment losses are recognized only if the carrying amount of a long-lived asset is not recoverable and exceeds the asset's fair value. The impairment loss would be calculated as the difference between asset carrying values and the fair value of the asset with fair value generally estimated based on the present value of the estimated future net cash flows.
Long-lived assets to be disposed of by abandonment continue to be classified as held and used until they cease to be used. If the Company commits to a plan to abandon a long-lived asset before the end of its previously estimated useful life, depreciation estimates are revised to reflect the use of the asset over its shortened useful life. Long-lived assets to be disposed of by sale that meet certain criteria are classified as held for sale and are reported at the lower of their carrying amounts or fair values less cost to sell.
(n) EMPLOYEE BENEFIT PLAN
On June 1, 1996, the Company adopted a deferred compensation plan under Section 401(k) of the Internal Revenue Code, which covers all eligible employees. Under the provisions of the plan, eligible employees may defer a percentage of their compensation subject to the Internal Revenue Service limits. Contributions to the plan are made only by employees.
(o) STOCK-BASED COMPENSATION
At June 30, 2003, the Company had two stock-based compensation plans which are more fully described in Note 8. The Company accounts for these plans under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. No stock-based compensation cost is reflected in net income (loss), as all options granted under these plans had an exercise price equal to the market value of the underlying Common Stock on the date of grant. The following table illustrates the effect on net income (loss) and earnings (loss) per share if the Company had applied the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," to stock-based compensation.
2003 2002 2001 ---- ---- ---- Net (loss), as reported $ (4,939) $(10,971) $(15,485) Less: Stock-based compensation - fair value measurement (1,085) (985) (544) -------- -------- -------- Net (loss), pro forma (6,024) (11,956) (16,029) Preferred stock dividends (706) (586) (416) -------- -------- -------- Net (loss) available to common shareholders - pro forma $ (6,730) $(12,542) $(16,445) ======== ======== ========
Basic and diluted loss per share - reported $ (0.54) $ (1.32) $ (2.01) ======== ======== ======== Basic and diluted loss per share - pro forma $ (0.64) $ (1.43) $ (2.07) ======== ======== ========
Expected volatility 40% 40% 40% Risk free interest rate 2.6% - 3.2% 3.7% - 4.8% 4.6% - 6.0% Expected dividend yield 0% 0% 0% Expected lives 3-4 years 1-5 years 1-5 years
(p) INTERNAL USE SOFTWARE
Computer software developed or obtained for internal use is included in property and equipment and is accounted for in accordance with Statement of Position 98-1, "ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE". The Company expenses all costs related to the development of internal-use software other than those incurred during the application development stage. Costs incurred during the application development stage are capitalized and amortized on a straight-line method over the estimated useful life of the software, three to five years.
NUCO2 INC. NOTES TO FINANCIAL STATEMENTS (In thousands, except per share amounts)
(q) VENDOR REBATES
Pursuant to EITF 02-16, "ACCOUNTING BY A CUSTOMER (INCLUDING A RESELLER) FOR CERTAIN CONSIDERATION RECEIVED FROM A VENDOR," the Company recognizes rebates received from its supplier of bulk CO2 tanks as a reduction of capitalizable cost. The Company received rebates of $393 during the fiscal year ended June 30, 2003.
(r) TRADE RECEIVABLES AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company invoices its customers on a monthly basis, with payment due within 30 days of the invoice date. The Company does not provide discounts for early payment, or add financing charges to late payments.
In conjunction with its trade receivables, the Company has established a reserve for accounts that might not be collectable. Such reserve is evaluated and adjusted on a monthly basis by examining the Company's historical losses, aging of its trade receivables, the credit worthiness of significant customers based on ongoing evaluations, and current economic trends that might impact the level of credit losses in the future. The composition of receivables consists of on-time payers, "slow" payers, and at risk receivables, such as receivables from customers who no longer do business with the Company, are bankrupt, or out of business. Substantially all at risk receivables greater than 120 days outstanding are fully reserved, with the reserve of all receivables at risk, regardless of days outstanding, exceeding 93% of the total amount at risk as of June 30, 2003.
(s) RECENT ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 145, "RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB STATEMENT NO. 13, AND TECHNICAL CORRECTIONS" ("SFAS 145"). Among other things, SFAS 145 rescinds the provisions of SFAS No. 4 that require companies to classify certain gains and losses from debt extinguishments as extraordinary items. The provisions of SFAS 145 related to classification of debt extinguishments are effective for fiscal years beginning after May 15, 2002. Gains and losses from extinguishment of debt will be classified as extraordinary items only if they meet the criteria in APB Opinion No. 30 ("APB 30"); otherwise such losses will be classified as a component of continuing operations. The Company adopted SFAS 145 during the quarter ended September 30, 2002. In accordance with APB 30 and SFAS 145, the Company reclassified the $796 extraordinary loss on the early extinguishment of debt for fiscal 2002 to a component of continuing operations.
In June 2002, the FASB issued SFAS 146, "ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES" ("SFAS 146") which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3 "LIABILITY RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS AND OTHER COSTS TO EXIT AN ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A RESTRUCTURING)" ("EITF 94-3"). The principal difference between SFAS 146 and EITF 94-3 relates to SFAS 146's requirements for recognition of a liability for a cost associated with an exit or disposal activity. SFAS 146 requires that a liability be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost was recognized at the date of an entity's commitment to an exit plan. SFAS 146 also establishes that fair value is the objective for initial measurement of the liability. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002, but early application is encouraged. The adoption of SFAS 146 during the first quarter of fiscal 2003 had no impact on the Company's financial position, results of operations or cash flows for the periods presented.
In December 2002, the FASB issued SFAS No. 148, "ACCOUNTING FOR STOCK-BASED COMPENSATION - TRANSITION AND DISCLOSURE" ("SFAS 148"). SFAS 148 amends SFAS No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION" ("SFAS 123"), to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on the reported results. The provisions of SFAS 148 are effective for financial statements for fiscal years ending after December 15, 2002. The adoption of SFAS 148 had no impact on the Company's financial position, results of operations or cash flows for the periods presented.
In the first quarter of fiscal 2003, the Company adopted SOP 01-06, "ACCOUNTING BY CERTAIN ENTITIES (INCLUDING ENTITIES WITH TRADE RECEIVABLES) THAT LEND TO OR FINANCE THE ACTIVITIES OF OTHERS" ("SOP 01-06"). SOP 01-06 addresses disclosures on accounting policies relating to trade accounts receivable and is effective prospectively for financial statements issued for fiscal years beginning after December 15, 2001. The adoption of SOP 01-06 had no impact on the Company's financial position, results of operations or cash flows for the periods presented.
NUCO2 INC. NOTES TO FINANCIAL STATEMENTS (In thousands, except per share amounts)
In April 2003, the FASB issued SFAS No. 149, "AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" ("SFAS 149"). SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, and hedging relations designated after June 30, 2003, except for those provisions of SFAS No. 149 which relate to SFAS No. 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003. For those issues, the provisions that are currently in effect should continue to be applied in accordance with their respective effective dates. In addition, certain provisions of SFAS No. 149, which relate to forward purchases or sales of when-issued securities or other securities that do not yet exist, should be applied to both existing contracts and new contracts entered into after June 30, 2003. The adoption of SFAS No. 149 is not expected to have a material effect on the Company's financial position, results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, "ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY" ("SFAS 150"). SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer classify a financial instrument that is within the scope of SFAS No. 150 as a liability. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective beginning September 1, 2003. The adoption of SFAS No. 150 is not expected to have a material effect on the Company's financial position, results of operations or cash flows.
In May 2003, the EITF reached a consensus on Issue No. 00-21, "REVENUE ARRANGEMENTS WITH MULTIPLE DELIVERABLES" ("EITF 00-21"). EITF 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which the vendor will perform multiple revenue generating activities. Currently, the Company, as lessor, recognizes revenue from leasing CO2 systems on straight-line basis over the life of the related leases. As discussed in Note 1(i) , the majority of CO2 system leases generally include payments for leasing the equipment and a continuous supply of CO2. For periods beginning after June 15, 2003, EITF 00-21 will require the Company to segregate the recognition of revenues derived from the lease portion of these agreements from the revenues derived from CO2 usage. Such segregation may impact the recognition of revenues on a quarterly basis as CO2 usage by the average customer fluctuates during a fiscal year based on factors such as weather, traditional summer and holiday periods. The Company is currently evaluating the potential impact of the implementation of EITF 00-21 on its financial position and results of operations.
NOTE 2 - PROPERTY AND EQUIPMENT, NET
Property and equipment, net consists of the following:
As of June 30, -------------------- 2003 2002 ---- ---- Leased equipment $127,463 $119,773 Equipment and cylinders 16,405 15,357 Tanks held for installation 4,808 4,868 Vehicles 300 325 Computer equipment and software 4,356 3,897 Office furniture and fixtures 1,643 1,406 Leasehold improvements 1,846 1,674 -------- -------- 156,821 147,300 Less accumulated depreciation and amortization 64,373 52,216 -------- --------
$ 92,448 $ 95,084 ======== ========
Capitalized component parts and direct costs associated with installation of equipment leased to others included in leased equipment was $36,683 and $32,406 at June 30, 2003 and 2002, respectively. Accumulated depreciation and amortization of these costs was $22,450 and $18,258 at June 30, 2003 and 2002, respectively. Upon early service termination, the Company writes off the remaining net book value of direct costs associated with the installation of equipment.
Depreciation and amortization of property and equipment was $13,836, $12,604 and $12,349 for the years ended June 30, 2003, 2002, and 2001, respectively.
In June 2001, the Company adopted a plan to discontinue installation of 50 and 100 pound tanks and to dispose of the 50 and 100 pound tanks held for installation. The Company's supply of uninstalled 50 and 100 pound tanks was written down to estimated fair value of $163, and a loss of $1,155 was reflected
NUCO2 INC. NOTES TO FINANCIAL STATEMENTS (In thousands, except per share amounts)
in the statement of operations within the caption, loss on asset disposal. These tanks were disposed of in fiscal 2002. During fiscal 2002, an additional loss in the amount of $1,125 was recognized relating to 50 and 100 pound tanks that were removed from service during the year. Management continued to review the recoverability of the remaining 50 and 100 pound tanks in service and in June 2002, adopted a plan to replace all 50 and 100 pound tanks in service at customers over a three to four year period. The Company's decision to replace these small tanks was based on an evaluation of undiscounted cash flows, contribution to fixed depot overhead, pricing and targeted margins. As a result of the Company's decision, the remaining 50 and 100 pound tanks were written down to their estimated fair value and a loss on impairment of $1,809 was recorded in June 2002. As of June 30, 2003 and 2002, the net book value of the 50 and 100 pound tanks still in service was $1,313 and $2,765, respectively, which is being depreciated over the remaining period of time that these tanks are expected to be utilized.
NOTE 3 - GOODWILL AND OTHER INTANGIBLE ASSETS
The Company adopted SFAS 142 as of July 1, 2001, resulting in no goodwill amortization expense for the years ended June 30, 2003 and 2002. Goodwill and indefinite life intangible assets are no longer amortized but are subject to annual impairment tests. The Company was not required to recognize an impairment of goodwill. If the guidance of the statement had been applied retroactively, prior year results would have been different than previously reported. A reconciliation of net income as reported to adjusted net income for the exclusion of goodwill amortization is as follows:
Fiscal Year Ended June 30, ------------------------------------------ 2003 2002 2001 ---- ---- ---- Net (loss) - as reported $ (4,939) $ (10,971) $ (15,485) Goodwill amortization -- -- 1,212 --------- ---------- ---------- Net (loss) - as adjusted $ (4,939) $ (10,971) $ (14,273) ========= ========== ==========
Based and diluted (loss) per share - as reported $ (0.54) $ (1.32) $ (2.01) Goodwill amortization -- -- 0.15 --------- ---------- ---------- Based and diluted (loss) per share - as adjusted $ (0.54) $ (1.32) $ (1.86) ========= ========== ==========
Information regarding the Company's goodwill and other intangible assets is as follows:
Accumulated Net Book As of June 30, 2003: Cost Amortization Value -------- ------------ --------- Goodwill $ 24,228 $ 5,006 $ 19,222 Non-competition agreements 3,110 2,125 985 Customer lists 5,370 5,345 25 -------- ------- -------- $ 32,708 $12,476 $ 20,232 ======== ======= ========
As of June 30, 2002: Goodwill $ 24,228 $ 5,006 $ 19,222 Non-competition agreements 3,110 1,828 1,282 Customer lists 5,370 5,089 281 -------- ------- -------- $ 32,708 $11,923 $ 20,785 ======== ======= =======
Amortization expense for other intangible assets was $552, $1,155 and $1,235 for the years ended June 30, 2003, 2002 and 2001, respectively. There were no adjustments or changes in amortization periods of other intangible assets as a result of the initial application of SFAS 142.
Estimated amortization expense for each of the next five years is $307, $279, $226, $161, and $37 for fiscal years ending June 30, 2004, 2005, 2006, 2007, and 2008, respectively.
NUCO2 INC. NOTES TO FINANCIAL STATEMENTS (In thousands, except per share amounts)
NOTE 4 -LEASES
The Company leases equipment to its customers generally pursuant to five-year or six-year non-cancelable operating leases which expire on varying dates through June 2009. At June 30, 2003, future minimum rentals due from customers which includes, where applicable, a continuous supply of CO2 (see Note 1(i)), are approximately as follows:
Year Ending June 30, -------------------- 2004 $ 41,273 2005 37,530 2006 27,751 2007 18,075 2008 11,769 Thereafter 4,296 --------- $ 140,694 =========
As discussed in Note 1(s), the Company is currently evaluating the potential impact of EITF 00-21 on its financial position and results of operations.
NOTE 5 - LONG-TERM DEBT
Long-term debt consists of the following:
As of June 30, -------------- 2003 2002 ---- ---- Note payable to bank under credit facility. Drawings at June 30, 2003 and 2002 are at a weighted average interest rate of 4.70% and 5.39%, respectively. $ 30,700 $ 48,000 Various notes payable 253 294 ---------- --------- 30,953 48,294 Less current maturities of long-term debt 2,294 40 ---------- --------- Long-term debt, excluding current maturities $ 28,659 $ 48,254 ========== =========
(a) FACILITIES AS OF JUNE 30, 2003
In September 2001, the Company entered into a $60.0 million second amended and restated revolving credit facility with a syndicate of banks ("Amended Credit Facility"). This facility replaced the Company's former facility, which was due to expire in May 2002. The Amended Credit Facility contains interest rates and an unused commitment fee based on a pricing grid calculated quarterly on total debt to annualized EBITDA (as defined). The Company is entitled to select the Base Rate or LIBOR, plus applicable margin, for principal drawings under the Amended Credit Facility. The applicable LIBOR margin pursuant to the pricing grid currently ranges from 2.50% to 4.75%, the applicable unused commitment fee pursuant to the pricing grid ranges from 0.375% to 0.50% and the applicable Base Rate margin pursuant to the pricing grid currently ranges from 1.50% to 3.75%. Interest only is payable periodically until the expiration of the Amended Credit Facility. The Amended Credit Facility is collateralized by substantially all of the Company's assets. Additionally, the Company is precluded from declaring or paying any cash dividends, except the Company may accrue and accumulate, but not pay, cash dividends on the redeemable preferred stock. The Company is also required to meet certain affirmative and negative covenants including, but not limited to, financial covenants.
The Company is required to assess compliance with its debt covenants under the Amended Credit Facility on a quarterly basis. These financial covenants are based on a measure that is not consistent with accounting principles generally accepted in the United States of America. Such measure is EBITDA (as defined), which represents earnings before interest, taxes, depreciation and amortization, as modified by certain defined adjustments. The failure to meet these covenants, absent a waiver or amendment, would place the Company in default and cause the debt outstanding under the Amended Credit Facility to become immediately due and payable. The Amended Credit Facility also includes certain cross-default provisions to the Company's 12% Senior Subordinated Promissory Notes (see Note 6).
Prior to June 30, 2002, the Amended Credit Facility was amended to adjust certain financial covenants for the quarter ended March 31, 2002 and prospectively, and non-compliance with the minimum EBITDA covenant for the three months ended March 31, 2002 was waived. As of June 30, 2002 the Company was not in compliance with certain of its financial covenants. On September 27, 2002, the Amended Credit Facility was amended to adjust certain financial covenants for the quarter ended June 30, 2002, and prospectively, non-compliance with its financial covenants for the three months ended June 30, 2002 was waived, and the maturity of the Amended Credit Facility was extended to November 17, 2003. As of September 30, 2002, the Company was in compliance with
NUCO2 INC. NOTES TO FINANCIAL STATEMENTS (In thousands, except per share amounts)
all of the financial covenants under the Amended Credit Facility. On February 7, 2003, the Amended Credit Facility was amended to adjust certain financial covenants for the quarter ended December 31, 2002 and prospectively, non-compliance with the minimum EBITDA covenant for the three months ended December 31, 2002 was waived, the maturity of the Amended Credit Facility was extended to April 29, 2004, and the Amended Credit Facility was reduced to $45.0 million. As of March 31, 2003 and June 30, 2003, the Company was in compliance with all of the financial covenants under the Amended Credit Facility.
On August 22, 2002, the Company completed the private placement of 1,663,846 shares of its common stock to 24 accredited investors at a price of $9.75 per share realizing net cash proceeds of approximately $15.1 million after issuance costs of $1.1 million. Pursuant to the requirements of the Amended Credit Facility, the Company used $14.5 million of the proceeds to pay down outstanding debt under the Amended Credit Facility.
Effective July 1, 2000, the Company adopted SFAS No. 133 "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES," which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value. For a derivative designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in other comprehensive income and are recognized in the income statement when the hedged item affects earnings. Ineffective portions of changes in the fair value of cash flow hedges are recognized in earnings.
The Company uses derivative instruments to manage exposure to interest rate risks. The Company's objectives for holding derivatives are to minimize the risks using the most effective methods to eliminate or reduce the impacts of this exposure. As of June 30, 2003, the Company was a party to an interest rate swap agreement (the "Prior Swap") with a notional amount of $12.5 million and a scheduled termination date of September 28, 2003. Under the Prior Swap, the Company pays a fixed interest rate of 5.23% per annum and receives a LIBOR-based floating rate.
The Prior Swap, which is designated as a cash flow hedge, is deemed to be a highly effective transaction, and accordingly, the gain/(loss) on the derivative instrument is reported as a component of other comprehensive income/(loss). For the years ended June 30, 2003, 2002 and 2001, the Company recorded a gain/(loss) of $300, $(86) and $(343), respectively, representing the change in fair value of the Prior Swap, as other comprehensive income.
(b) REFINANCING EFFECTIVE AUGUST 25, 2003
On August 25, 2003, the Company terminated the Amended Credit Facility and entered into a $50.0 million senior credit facility with a syndicate of banks (the "Senior Credit Facility"). The Senior Credit Facility consists of a $30.0 million A term loan facility (the "A Term Loan"), a $10.0 million B term loan facility (the "B Term Loan"), and a $10.0 million revolving loan facility (the "Revolving Loan Facility"). The A Term Loan matures on August 25, 2007, the B Term Loan matures on August 25, 2008 and the Revolving Loan Facility matures on August 25, 2007. The B Term Loan is subordinate in right of payment to the A Term Loan and borrowings under the Revolving Loan Facility. The Company is entitled to select either Eurodollar Loans (as defined) or Base Rate Loans (as defined), plus applicable margin, for principal borrowings under the Senior Credit Facility. The applicable Eurodollar Loan margin for A Term Loans and borrowings pursuant to the Revolving Loan Facility ranges from 3.5% to 4.0%, and the applicable Base Rate Loan margin ranges from 2.5% to 3.0%, provided that until delivery to the lenders of our financial statements for the quarter ending June 30, 2004, the margin on Eurodollar Loans is 4.0% and the margin for Base Rate Loans is 3.0%. The applicable Eurodollar Loan margin and Base Rate Loan margin for B Term Loans is 7.5% and 6.5%, respectively. Applicable margin is determined by a pricing grid based on the Company's Consolidated Total Leverage Ratio (as defined). At closing, the Company borrowed the A Term Loan, the B Term Loan and $3.0 million under the Revolving Loan Facility. Interest is payable periodically on borrowings under the Senior Credit Facility. In addition, commencing on December 31, 2003 and on the last day of each quarter thereafter, the Company is required to make principal repayments of the A Term Loan in increasing amounts. The Senior Credit Facility is collateralized by all of the Company's assets. Additionally, the Company is precluded from declaring or paying any cash dividends, except it may accrue and accumulate, but not pay, cash dividends on its outstanding redeemable preferred stock. The Company is also required to meet certain affirmative and negative covenants, including but not limited to financial covenants.
The Company will be required to assess its compliance with financial covenants under the Senior Credit Facility on a quarterly basis. These financial covenants are based on a measure that is not consistent with accounting principles generally accepted in the United States of America. Such measure is EBITDA (as defined), which represents earnings before interest, taxes, depreciation and amortization, as further modified by certain defined
NUCO2 INC. NOTES TO FINANCIAL STATEMENTS (In thousands, except per share amounts)
adjustments. The failure to meet these covenants, absent a waiver or amendment, would place the Company in default and cause the debt outstanding under the Senior Credit Facility to immediately become due and payable. The Senior Credit Facility also includes certain cross-default provisions to our 16.3% Senior Subordinated Notes Due February 27, 2009.
The $43.0 million drawn under the Senior Credit Facility has a weighted average interest rate of 6.04%. Pursuant to SFAS No. 6, "CLASSIFICATION OF SHORT-TERM OBLIGATIONS EXPECTED TO BE REFINANCED," the amounts due under the Amended Credit Facility as of June 30, 2003 were classified on the Company's balance sheet as long-term debt.
In connection with the refinancing, during the first quarter of fiscal 2004 the Company will recognize a loss from the write-off of unamortized financing costs associated with the Amended Credit Facility and record $2,203 in financing costs associated with the Senior Credit Facility. Such costs will be amortized over the life of the Senior Credit Facility. Based on outstanding borrowings as of August 25, 2003, the weighted average effective interest rate of the Senior Credit Facility, including the amortization of deferred financing costs, is 7.06%. As of June 30, 2003, unamortized costs associated with the Amended Credit Facility were $935.
The aggregate maturities of long-term debt for each of the five years subsequent to June 30, 2003, based on the August 25, 2003 refinancing, are as follows:
Year Ending June 30, -------------------- 2004 $ 2,294 2005 6,048 2006 9,302 2007 11,557 2008 4,052
The Prior Swap was terminated on August 25, 2003. In connection with the termination of the Prior Swap prior to maturity, the Company paid $129. In connection with the Senior Credit Facility, the Company is required to enter into an interest rate Swap agreement in a notional amount equal to at least 50% of the aggregate of the A Term Loan and the B Term Loan prior to November 24, 2003.
NOTE 6 - SUBORDINATED DEBT
(a) FACILITIES AS OF JUNE 30, 2003
In October 1997, the Company issued $30.0 million of its 12% Senior Subordinated Promissory Notes (the "1997 Notes") with interest only payable semi-annually on April 30 and October 31, due October 31, 2004. The 1997 Notes were sold with detachable seven year warrants to purchase an aggregate of 655,738 shares of common stock at an exercise price of $16.40 per share. At the date of issuance, in accordance with APB 14, "ACCOUNTING FOR CONVERTIBLE DEBT AND DEBT ISSUED WITH PURCHASE WARRANTS," the Company allocated proceeds of $29.7 million to the debt and $0.3 million to warrants, with the resulting discount on the debt referred to as the Original Issue Discount. The Original Issue Discount is being amortized as interest expense over the life of the debt, resulting in an effective interest rate on the 1997 Notes of 12.1% per annum. The amount allocated to the warrants was credited to Additional Paid-In Capital. In conjunction with the issuance of the 1997 Notes, the Company is required to meet certain affirmative and negative covenants. In addition, NationsBanc Montgomery Securities, Inc., the placement agent, received a warrant to purchase an aggregate of 30,000 shares of common stock at an exercise price of $14.64 per share which expires on October 31, 2004.
On May 4, 1999, the Company sold an additional $10.0 million of its 12% Senior Subordinated Promissory Notes (the "1999 Notes"). Except for their October 31, 2005 maturity date, the 1999 Notes are substantially identical to the 1997 Notes described above. The 1999 Notes were sold with detachable 6-1/2 year warrants to purchase an aggregate of 372,892 shares of common stock at an exercise price of $6.65 per share, of which 65,574 were exercised and converted to shares of common stock during the year ended June 30, 2002.
In return for modifying certain financial covenants governing the 1997 Notes, the exercise price of 612,053 of the warrants issued in connection with the 1997 Notes was reduced to $6.65 per share. On May 4, 1999, the trading range of the Company's common stock was $6.44 to $6.88 per share. To assist with the valuation of the newly issued warrants and the repriced warrants, the Company hired an outside consultant. Utilizing the Black-Scholes Model, the warrants issued with the 1997 Notes were valued at $1.26 per warrant, or an aggregate value of $773,702, and the warrants issued with the 1999 Notes
NUCO2 INC. NOTES TO FINANCIAL STATEMENTS (In thousands, except per share amounts)
at $1.47 per warrant, or an aggregate value of $549,032. Both amounts are reflected as Additional Paid-In Capital, offset by the Original Issue Discount, which is netted against the outstanding balance of the 1997 Notes and 1999 Notes. On August 22, 2002, in conjunction with the private placement of 1,663,846 shares of the Company's Common Stock (see Note 5(a)), the warrants issued in conjunction with the 1997 Notes and 1999 Notes were adjusted pursuant to anti-dilution provisions to provide for the purchase of an additional 21,906 shares of the Company's Common Stock. After giving effect to the amortization of the Original Issue Discount, the effective interest rate on the 1999 Notes is 13.57% per annum.
As of June 30, 2003, the Company was in compliance with all of the financial covenants under the 1997 Notes and 1999 Notes. On February 7, 2003, the interest coverage ratio governing the 1997 Notes and 1999 Notes was amended for the quarter ending March 31, 2003 and prospectively.
(b) REFINANCING EFFECTIVE AUGUST 25, 2003
On August 25, 2003, concurrently with the closing of the Senior Credit Facility, the Company prepaid the 1997 Notes and 1999 Notes and issued $30.0 million of the Company's 16.3% Senior Subordinated Notes Due February 27, 2009 (the "New Notes") with interest only payable quarterly in arrears on February 28, May 31, August 31 and November 30 of each year, commencing November 30, 2003. Interest on the New Notes is 12% per annum payable in cash and 4.3% per annum payable "in kind" by adding the amount of such interest to the principal amount of the New Notes then outstanding. Ten year warrants to purchase an aggregate of 425,000 shares of the Company's Common Stock at an exercise price of $8.79 per share were issued in connection with the New Notes. Utilzing the Black-Scholes Model, the warrants issued in connection with the New Notes were valued at $3.70 per warrant, or an aggregate value of $1,573. In addition, the maturity date of 665,403 existing warrants, 335,101 due to expire in 2004 and 330,302 due to expire in 2005, was exstended to February 2009, resulting in additional value of $1.31 and $0.97 per warrant, respectively, or an aggregate value of $760. At the date of issuance, in accordance with APB 14, "ACCOUNTING FOR CONVERTIBLE DEBT AND DEBT ISSUED WITH PURCHASE WARRANTS," the Company allocated proceeds of $27.7 million to the debt and $2.3 million to the warrants, with the resulting discount on the debt referred to as the Original Issue Discount. The Original Issue Discount is being amortized as interest expense over the life of the debt. As with the Senior Credit Facility, the Company is required to meet certain affirmative and negative covenants under the New Notes, including but not limited to financial covenants.
In connection with the refinancing, during the first quarter of fiscal 2004 the Company will recognize a loss attributable to the unamortized financing costs and Original Issue Discount associated with the 1997 Notes and 1999 Notes, and record $450 of financing costs and Origninal Issue Discount associated with New Notes. Such fees will be amortized over the life of the New Notes. The weighted average effective interest rate of the New Notes, including the amortization of deferred financing costs and Original Issue Discount, is 18.0%. As of June 30, 2003, unamortized costs associated with the 1997 Notes and 1999 Notes were $658 and the unamortized Original Issue Discount was $424.
NOTE 7 - PREFERRED STOCK
In May 2000, the Company sold 5,000 shares of its Series A 8% Cumulative Convertible Preferred Stock, no par value (the "Series A Preferred Stock"), for $1,000 per share (the initial "Liquidation Preference"). Cumulative dividends are payable quarterly in arrears at the rate of 8% per annum on the Liquidation Preference, and, to the extent not paid in cash, are added to the Liquidation Preference. Shares of the Series A Preferred Stock may be converted into shares of common stock at any time at a current conversion price of $9.28 per share. In connection with the sale, costs in the amount of $65 were charged to paid-in capital.
In November 2001, the Company sold 2,500 shares of its Series B 8% Cumulative Convertible Preferred Stock, no par value (the "Series B Preferred Stock"), for $1,000 per share (the initial "Liquidation Preference"). Cumulative dividends are payable quarterly in arrears at the rate of 8% per annum on the Liquidation Preference, and, to the extent not paid in cash, are added to the Liquidation Preference. Shares of the Series B Preferred Stock may be converted into shares of common stock at any time at a current conversion price of $12.92 per share.
During the fiscal years ended June 30, 2003, 2002 and 2001, the carrying amount (and Liquidation Preferences) of the Series A Preferred Stock and Series B Preferred Stock ("Preferred Stock") was increased by $706, $586 and $416, respectively, for dividends accrued. The Preferred Stock shall be mandatorily redeemed by the Company within 30 days after a Change in Control (as defined) of the Company (the date of such redemption being the "Mandatory Redemption Date") at an amount equal to the then effective Liquidation Preference plus accrued and unpaid dividends thereon from the last dividend payment date to the Mandatory Redemption Date, plus if the Mandatory Redemption Date is on or prior to the fourth anniversary of the issuance of the Preferred Stock, the amount of any dividends that would have accrued and been payable on the Preferred Stock from the Mandatory Redemption Date through the fourth anniversary date.
NUCO2 INC. NOTES TO FINANCIAL STATEMENTS (In thousands, except per share amounts)
In addition, outstanding shares of Preferred Stock vote on an "as converted basis" with the holders of the common stock as a single class on all matters that the holders of the common stock are entitled to vote upon.
NOTE 8 - SHAREHOLDERS' EQUITY
(a) NON-QUALIFIED STOCK OPTIONS AND WARRANTS
In May 1997, the Company entered into a ten-year supply agreement with the BOC Group, Inc. ("BOC") by which BOC committed to provide the Company with 100% of its CO2 requirements at competitive prices. In connection with this agreement, the Company granted BOC a warrant to purchase 1,000,000 shares of its Common Stock. The warrant was exercisable at $17 per share from May 1, 1999 to May 1, 2002 and thereafter at $20 per share until April 30, 2007. In May 2000, the Company solicited BOC to purchase 1,111,111 shares of its Common Stock at $9.00 per share. In connection with this purchase of Common Stock, the outstanding warrant was reduced to 400,000 shares, with an exercise price of $17 per share. On the date of issuance of the Common Stock, the closing price of the Common Stock on the Nasdaq National Market was $8.00 per share.
In January 2001, the Company granted to each non-employee director options for 10,000 shares of Common Stock. An aggregate of 50,000 options were granted at an exercise price equal to the average closing price of the Common Stock on the Nasdaq National Market for the 20 trading days prior to January 2, 2001, or $7.82. In March 2003, the Company granted to each non-employee director options for 6,000 shares of Common Stock. An aggregate of 36,000 options were granted at an exercise price equal to the average closing price of the Common Stock on the Nasdaq National Market for the 20 trading days prior to March 12, 2003, or $4.85. All options vest in five equal annual installments commencing upon issuance, and have a ten-year term. As of June 30, 2003 and 2002, options for 36,000 and 20,000 shares, respectively, were exercisable.
(b) STOCK OPTION PLANS
The Board of Directors of the Company adopted the 1995 Option Plan (the "1995 Plan"). Under the 1995 Plan, the Company has reserved 1,950,000 shares of Common Stock for employees of the Company. Under the terms of the 1995 Plan, options granted may be either incentive stock options or non-qualified stock options. The exercise price of incentive options shall be at least equal to 100% of the fair market value of the Company's Common Stock at the date of the grant, and the exercise price of non-qualified stock options issued to employees may not be less than 75% of the fair market value of the Company's Common Stock at the date of the grant. The maximum term for all options is ten years. Options granted to date generally vest in equal annual installments from one to five years, though a limited number of grants were partially vested at the grant date. The weighted-average fair value per share of options granted during the years ended June 30, 2003, 2002 and 2001 was $2.41, $4.78 and $4.30, respectively.
The following summarizes the transactions pursuant to the 1995 Plan:
Weighted Average Options Exercise Price Per Outstanding Option Options Exercisable ----------- ------------------ ------------------- Outstanding at June 30, 2000 1,091,734 $ 8.58 481,808 Granted 372,000 10.39 Expired or canceled (30,400) 6.95 Exercised (262,999) 7.79 --------- Outstanding at June 30, 2001 1,170,335 9.38 581,499 Granted 429,100 12.15 Expired or canceled (184,625) 10.55 Exercised (252,360) 9.69 --------- Outstanding at June 30, 2002 1,162,450 10.15 503,072 Granted 326,350 6.87 Expired or canceled (199,880) 11.36 Exercised (500) 11.25 --------- Outstanding at June 30, 2003 1,288,420 9.13 640,373 =========
NUCO2 INC. NOTES TO FINANCIAL STATEMENTS (In thousands, except per share amounts)
The following table sets forth certain information as of June 30, 2003:
Options Outstanding Options Exercisable ---------------------------------------------------- --------------------------------------- Range of Exercise Options Weighted Average Weighted Average Weighted Average Prices Outstanding Remaining Life Exercise Price Options Exercisable Exercise Price ------ ----------- -------------- -------------- ------------------- -------------- $ 0.00 - $ 5.00 151,350 9.02 $ 4.82 46,667 $ 4.85 $ 5.01 - $10.00 547,145 7.59 7.37 269,888 7.03 $10.01 - $15.00 589,925 7.82 11.86 323,819 11.69 --------- ---- ------ -------- ----- 1,288,420 7.86 $ 9.13 640,373 $ 9.23 ========= ==== ======= ======== ======
The Board of Directors of the Company adopted the Directors' Stock Option Plan (the "Directors' Plan"). Under the Directors' Plan, each non-employee director will receive options for 6,000 shares of Common Stock on the date of his or her first election to the board of directors. In addition, on the third anniversary of each director's first election to the Board, and on each three year anniversary thereafter, each non-employee director will receive an additional option to purchase 6,000 shares of Common Stock. The exercise price per share for all options granted under the Directors' Plan will be equal to the fair market value of the Common Stock as of the date of grant. All options vest in three equal annual installments beginning on the first anniversary of the date of grant. The maximum term for all options is ten years. The weighted-average fair value per share of options granted during the years ended June 30, 2003, 2002 and 2001 was $1.82, $3.55 and $3.87, respectively.
The following summarizes the transactions pursuant to the Directors' Plan:
Weighted Average Options Exercise Price Per Outstanding Option Options Exercisable ----------- ------ ------------------- Outstanding at June 30, 2000 32,000 $ 8.28 16,000 Granted 24,000 8.97 Expired or canceled (6,000) 7.75 Exercised (2,000) 8.94 ------- Outstanding at June 30, 2001 48,000 8.66 22,000 Granted 12,000 11.10 ------- Outstanding at June 30, 2002 60,000 9.15 34,000 Granted 6,000 8.69 ------- Outstanding at June 30, 2003 66,000 9.11 45,997 =======
The following table sets forth certain information as of June 30, 2003:
Options Outstanding Options Exercisable ----------------------------------------------------- --------------------------------------- Range of Exercise Options Weighted Average Weighted Average Weighted Average Prices Outstanding Remaining Life Exercise Price Options Exercisable Exercise Price ------ ----------- -------------- -------------- ------------------- -------------- $ 5.01 - $10.00 42,000 6.25 $ 7.46 32,000 $ 7.24 $10.01 - $15.00 24,000 6.81 11.99 13,996 12.31 ------- ----- ------ ------- ------ 66,000 6.46 $ 9.11 45,997 $ 8.78 ======= ===== ======= ======= ======
NOTE 9 - EARNINGS PER SHARE
Basic (loss) per common share has been computed by dividing the net (loss), after giving effect to preferred stock dividends, by the weighted
NUCO2 INC. NOTES TO FINANCIAL STATEMENTS (In thousands, except per share amounts)
average number of common shares outstanding during the period. Common equivalent shares for stock options and warrants are calculated pursuant to the treasury stock method. During the years ended June 30, 2003, 2002 and 2001, respectively, the Company excluded the equivalent of 287,915, 671,155 and 411,238 shares of Common Stock in the computation of loss per share as these options and warrants to purchase common stock were anti-dilutive.
The following table lists options and warrants outstanding as of the periods shown which were not included in the computation of diluted EPS because the options and warrants exercise price was greater than the average market price of the common shares:
For the Year Ended June 30, ------------------------------------------- Range of Exercise Prices 2003 2002 2001 ------------------------ ---- ---- ---- $ 5.01 - $10.00 136,000 0 0 $10.01 - $15.00 570,962 159,064 36,000 $15.01 - $20.00 444,679 443,715 443,715 --------- -------- --------- 1,151,641 602,779 479,715 ========= ======== =========
Also, not included in the computation of diluted EPS for the years ended June 30, 2003, 2002 and 2001 were 910,983, 841,609 and 577,191 shares, respectively, of Common Stock issuable upon conversion of 7,500 shares of Convertible Preferred Stock because the effect would be anti-dilutive.
For the Year Ended June 30, ------------------------------------ 2003 2002 2001 ---- ---- ---- Net (loss) $ (4,939) $(10,971) $(15,485) Preferred stock dividends (706) (586) (416) -------- -------- -------- Net (loss) available to common shareholders $ (5,645) $(11,557) $(15,901) ======== ======== ======== Weighted average outstanding shares of common stock 10,396 8,742 7,926 ======== ======== ========
Net (loss) per share - basic and diluted $ (0.54) $ (1.32) $ (2.01) ======== ======== ========
NOTE 10 -INCOME TAXES
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities are as follows:
As of June 30, ----------------------- 2003 2002 -------- ------- Deferred tax assets: Allowance for doubtful accounts $ 805 $ 1,080 Amortization expense 1,585 933 Other 4 5 Net operating loss carryforwards 34,658 36,716 -------- -------- Total gross deferred tax assets 37,052 38,734 Less valuation allowance (21,249) (18,845) -------- -------- Net deferred tax assets 15,803 19,889 -------- -------- Deferred tax liabilities: Depreciation expense (15,803) (19,889) -------- -------- Total gross deferred tax liabilities (15,803) (19,889) -------- -------- Net deferred taxes $ -- $ -- ======== ========
The net change in the total valuation allowance for the years ended June 30, 2003 and 2002 was an increase of $2,404 and $4,358, respectively.
NUCO2 INC. NOTES TO FINANCIAL STATEMENTS (In thousands, except per share amounts)
At June 30, 2003, the Company had net operating loss carryforwards for Federal income tax purposes of approximately $99.0 million, which expire in varying amounts between 2007 through 2023 as follows:
Year of Expiration ---------- 2007-2011 $ 7,843 2012-2016 18,732 2017-2021 58,929 Thereafter 13,520 ------- $99,024 =======
NOTE 11 - LEASE COMMITMENTS
The Company leases office equipment, trucks and warehouse/depot and office facilities under operating leases that expire at various dates through June 2012. Primarily all of the leases contain renewal options and escalations for real estate taxes, common charges, etc. Future minimum lease payments under noncancelable operating leases (that have initial noncancelable lease terms in excess of one year) are as follows:
Year Ending June 30, -------------------- 2004 $ 3,915 2005 2,935 2006 2,305 2007 1,743 2008 1,033 Thereafter 1,003 ------------ $ 12,934 ============
Total rental costs under non-cancelable operating leases were approximately $5,344, $5,130 and $4,856 in 2003, 2002 and 2001, respectively.
NOTE 12 - CONCENTRATION OF CREDIT AND BUSINESS RISKS
The Company's business activity is with customers located within the United States. For each of the years ended June 30, 2003, 2002 and 2001 the Company's sales to customers in the food and beverage industry were approximately 95%.
There were no customers that accounted for greater than 3% of total sales for each of the three years ended June 30, 2003, nor were there any customers that accounted for greater than 5% of total accounts receivable at June 30, 2003 or 2002.
The Company purchases new bulk CO2 systems from the two major manufacturers of such systems. The inability of either or both of these manufacturers to deliver new systems to the Company could cause a delay in the Company's ability to fulfill the demand for its services and a possible loss of sales, which could adversely affect operating results.
NUCO2 INC. NOTES TO FINANCIAL STATEMENTS (In thousands, except per share amounts)
NOTE 13 - COMMITMENTS AND CONTINGENCIES
In May 1997, the Company entered into an exclusive ten-year carbon dioxide supply agreement with The BOC Group, Inc. ("BOC") (See Note 8). The agreement ensures readily available high quality CO2 as well as relatively stable liquid carbon dioxide prices. Pursuant to the agreement, the Company purchases virtually all of its liquid CO2 requirements from BOC. The agreement contains annual adjustments over the prior contract year for an increase or decrease in the Producer Price Index for Chemical and Allied Products ("PPI") or the average percentage increase in the selling price of bulk merchant carbon dioxide purchased by BOC's large, multi-location beverage customers in the United States.
The Company is a defendant in legal actions which arise in the normal course of business. In the opinion of management, the outcome of these matters will not have a material effect on the Company's financial position or results of operations.
NOTE 14 - RELATED PARTY TRANSACTION
Robert L. Frome, a Director of the Company, is a member of the law firm of Olshan Grundman Frome Rosenzweig & Wolosky LLP, which law firm has been retained by the Company. Fees paid by the Company to such law firm during fiscal 2003, 2002 and 2001, were $184, $140, and $281, respectively.
In conection with the Refinancing described in Note6(b), 25,000 of the ten year warrants to purchase an aggregate of 425,000 shares of the Company's Common Stock Stock at an exercise price of $8.79 per share were issued to Craig L. Burr, a Director of the Company and an affiliate of one of the purchasers of the New Notes.
In connection with the Refinancing described in Note 6(b), 100,000 of the ten year warrants to purchase an aggregate of 425,000 shares of the Company's Common Stock at an exercise price of $8.79 per share were issued to affiliates of J.P. Morgan Partners (BHCA), L.P., purchasers of a portion of the New Notes. In addition, the expiration date of warrants to purchase an aggregate of 665,403 shares of the Company's Common Stock at an exercise price of $6.65 per share previously issued to J.P. Morgan Partners (BHCA), L.P. in connection with the 1997 Notes and 1999 Notes was extended until February 27, 2009 (See Note 6(a)). Richard D. Waters, Jr., a Director of the Company, is an affiliate of J.P. Morgan Partners (BHCA), L.P.
NUCO2 INC. NOTES TO FINANCIAL STATEMENTS (In thousands, except per share amounts)
NOTE 15 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of each class of financial instruments.
(a) Cash and cash equivalents, accounts receivable and accounts payable and accrued expenses
The carrying amounts approximate fair value due to the short maturity of these instruments.
(b) Long-term and subordinated debt
The fair value of the Company's long-term and subordinated debt has been estimated based on the current rates offered to the Company for debt of the same remaining maturities.
The carrying amounts and fair values of the Company's financial instruments are as follows:
As of June 30, -------------- 2003 2002 ---- ---- Cash and cash equivalents $ 455 $ 1,562 Accounts receivable 6,217 7,171 Accounts payable and accrued expenses 7,604 8,193 Long-term debt, including current maturities 30,953 48,294 Subordinated debt 39,576 39,366
NOTE 16 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter ----------- ----------- ----------- ----------- 2003 2002 2003 2002 2003 2002 2003 2002 ---- ---- ---- ---- ---- ---- ---- ---- Net sales $ 18,678 $ 18,089 $ 18,101 $ 18,607 $ 18,340 $ 17,743 $ 19,290 $ 17,873 Gross profit 9,539 9,275 9,399 9,626 9,597 8,779 10,336 9,141 Net (loss) income (a) (2,110) (1,913) (2,314) (789) (777) (1,813) 262 (6,456)
Basic and diluted (loss) earnings per common share (a)(b) $ (0.24) $ (0.23) $ (0.23) $ (0.11) $ (0.09) $ (0.23) $ 0.01 $ (0.74)
(a) During the fourth quarter of fiscal 2002, the Company's management continued to monitor and evaluate the collectibility and potential impairment of its accounts receivable and certain fixed assets. In connection therewith, an additional allowance for doubtful accounts of $1,862 and write-downs of fixed assets of $1,809 were recorded in the fourth quarter. The potential uncollectibility of certain accounts receivable and the related increase in the allowance for doubtful accounts came to light as a result of the Company having experienced several problems relating to unusually high closure rates among independent operators who have gone out of business in recent periods due to unfavorable economic conditions. The write-downs of fixed assets were due to the Company's decision, reached during the fourth quarter of 2002, to replace all 50 and 100 pound tanks in service at customer locations over a three to four year period (Note 2). It is management's opinion that these adjustments are properly recorded in the fourth quarter based upon facts and circumstances that became available in that period.
(b) Per common share amounts for the quarters have each been calculated separately. Accordingly, quarterly amounts may not add to total year earnings per share because of differences in the average common shares outstanding during each period.
NUCO2 INC. Schedule II Valuation and Qualifying Accounts In Thousands
Column B Column C - Additions Column D Column E -------- -------------------- -------- -------- Balance at Charge beginning of costs and Charged to Balance at period expenses other accounts Deductions end of period ------ -------- -------------- ---------- ------------- Year ended June 30, 2001 Allowance for doubtful accounts $ 622 $3,061 $ -- $1,177 $2,506 Year ended June 30, 2002 Allowance for doubtful accounts $2,506 $2,753 $ -- $2,174 $3,085 Year ended June 30, 2003 Allowance for doubtful accounts $3,085 $ 860 $ -- $1,646 $2,299