Item 1. Business. 1 Item 2.
Item 2. Properties. 13 Item 3.
Item 3. Legal Proceedings. 13 Item 4.
Item 4. Submission of Matters to a Vote of Security Holders. 13
PART II. Item 5.
Item 5. Market For Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. 13 Item 6.
Item 6. Selected Financial Data. 15 Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. 16 Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk. 31 Item 8
Item 8 Financial Statements and Supplementary Data. 32 Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. 32 Item 9A.
Item 9A. Controls and Procedures. 32 Item 9B.
Item 9B. Other Information. 32
PART III. Item 10.
Item 10. Directors and Executive Officers of the Registrant. 32 Item 11.
Item 11. Executive Compensation. 32 Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. 32 Item 13.
Item 13. Certain Relationships and Related Transactions. 32 Item 14.
Item 14. Principal Accountant Fees and Services. 33
PART IV. Item 15.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. 33
Signatures 36 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 On the Border Boston Market Panera Bread Company Bahama Breeze Outback Steakhouse Bumpers Drive-In Papa Gino's Bertucci's Perkins Family Restaurants Burger King Pizza Hut Cheesecake Factory Pizzeria Uno Captain D's Pizza Inn Chevy's Ponderosa Steak House Carl's Jr. Quizno's Classic Subs Chili's Red Lobster/Olive Garden Checker's Drive-In Rubios Corner Bakery Rio Bravo Cantina Chick-Fil-A Sbarro Don Pablo's Roadhouse Grill Chipotle Grill Schlotzsky's Deli Friendly's Restaurant Rockfish Church's Chicken Sonic Drive-In Hard Rock Cafe Romano's Macaroni Grill D'Angelo's Sandwich Shop Steak'n Shake Hooters Ruby Tuesday Dunkin' Donuts Subway Landry's Ryan's Family Steak House El Pollo Loco Taco Bell Longhorn Steakhouse Shoney's Hardee's Wendy's Maggiano's Little Italy Spaghetti Warehouse KFC White Castle Official All Star Cafe Krystal CONTRACT FEEDERS WHOLESALE CLUBS CONVENIENCE/PETROLEUM ARAmark BJ's Wholesale 7-Eleven Golden Pantry Compass Group Costco AM/PM Phillips 66 Fine Host Sam's Club BP/Amoco Pilot Travel Host Marriott Circle K Racetrac Petroleum Sodexho Operations Coastal Market Shell ETD Conoco Spectrum Stores SPORTS VENUES THEME/AMUSEMENT Exxon Thornton Oil AMF Bowling Centers Six Flags Farm Stores Tom Thumb Brunswick Recreation Centers Universal Studios Florida Derby Lane Walt Disney World Georgia Dome Wet n Wild Madison Square Garden White Waters MOVIE THEATRES Pro Player Stadium Carmike Cinemas Regal Entertainment 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 108 service locations and approximately 82,000 bulk and high pressure CO2 customers in 45 states as of June 30, 2004. 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 (prepaid in August 2003), the sale of our Series A 8% Cumulative Convertible Preferred Stock in May 2000 (converted into 754,982 shares of common stock in August 2004) and Series B 8% Cumulative Convertible Preferred Stock in November 2001, the private placement of our common stock in August 2002 and the issuance in August 2003 of our 16.3% senior subordinated notes due 2009. 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
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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 $80.8 million in fiscal 2004.
REVENUES (in millions)
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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 155,000 bulk CO2 beverage users in the United States. Of these, approximately 81,000 are already our customers. We also currently service approximately 600 stand alone high pressure CO2 customers. We believe 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.
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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 600 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, 2004, 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, 2004, we serviced approximately 82,000 bulk and high pressure CO2 customers, none of which accounted for more than 3% of our fiscal 2004 revenues. 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 42 commission only independent sales representatives and 26 salaried sales personnel. As of June 30, 2003 and 2004, we had backlogs of almost 4,400 and 3,900 new locations, respectively, awaiting activation. During fiscal 2005, 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.
We have entered into master service agreements with 31 of the largest 100 restaurant and convenience store chains. These master service agreements generally provide for a commitment on the part of the operator for all of its currently owned locations and may also include future locations. In addition, the agreements generally provide that the operator's franchisees may participate in the program and the franchisor undertakes to promote our services to its franchisees. We currently service approximately 28,000 locations pursuant to existing master service agreements and these agreements represent an opportunity to service an additional 35,000 locations. We are actively working on expanding the number of master service agreements with numerous restaurant chains, including some of the largest operators.
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, 2004, we operated 108 service locations (97 stationary depots and 11 mobile depots) located throughout our 45 state service area and operated 173 specialized bulk CO2 trucks and 83 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:
o Tank size o Delivery history o Seasonal factors, and o 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. Initial testing of a potential third-party solution has taken place and we will be conducting a more extensive test within the near future. We expect to select and implement the route optimization system by the end of fiscal 2005.
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.
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 an 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, 2004, we employed 530 full-time employees, 175 of whom were involved in management, sales or customer support, 270 of whom were route drivers and 85 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
Demand for CO2 in times of cold or inclement weather is lower than at other times. Consequently, based on historical data and expected trends, we anticipate that revenue from the delivery of CO2 will be highest in our first quarter and lowest in our third quarter.
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 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 1, 2004, we had outstanding indebtedness of $67.7 million, which included $37.7 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. 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 an 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.
Demand for CO2 in times of cold or inclement weather is lower than at other times. Consequently, based on historical data and expected trends, we anticipate that revenue from the delivery of CO2 will be highest in our first quarter and lowest in our third quarter. 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 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 from currently exercisable options and warrants). 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 one series of preferred stock, 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 have adopted a shareholder rights plan that may prevent a change in control or sale of NuCO2 in a manner or on terms not approved by the board of directors. In addition, our articles of incorporation provide for a classified board of directors. A classified board of directors may significantly extend the time required to effect a change in control of the board of directors and may discourage hostile takeover bids for NuCO2. It could take at least two annual meetings for even a majority of shareholders to make a change in control of the board of directors because only a minority of the directors is scheduled to be elected at each meeting. Without the ability to easily obtain immediate control of the board of directors, a takeover bidder may not be able to take action to remove other impediments to its acquisition of NuCO2.
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 1,713,438 common shares at an average exercise price of $10.33 per share and outstanding warrants to purchase an aggregate of 1,683,484 common shares at an average exercise price of $9.81 per share. In addition, we also have outstanding 2,500 shares of Series B 8% Cumulative Convertible Preferred Stock that are currently convertible at $12.92 per share into 240,591 common shares.
SECURITIES ANALYSTS MAY NOT CONTINUE OR INITIATE COVERAGE OF OUR COMMON STOCK OR MAY ISSUE NEGATIVE REPORTS, AND THIS MAY HAVE A NEGATIVE IMPACT ON OUR COMMON STOCK'S MARKET PRICE.
There is no assurance that securities analysts will continue to publish research reports on us. If securities analysts do not, this lack of research coverage may adversely affect the market price of our common stock. Recently adopted rules mandated by the Sarbanes-Oxley Act of 2002, and a global settlement reached between the SEC, other regulatory agencies and a number of investment banks in April 2003, will lead to a number of fundamental changes in how analysts are reviewed and compensated. In particular, many investment banking firms will now be required to contract with independent financial analysts for their stock research. It may be difficult for companies with smaller market capitalizations, including us, to attract independent financial analysts who will cover our common stock, which could have a negative effect on our market price.
The trading market for our common stock will rely in part on the research and reports that industry or financial analysts publish about us or our business. If one or more of the analysts who cover us downgrades our stock, our stock price could decline rapidly. If one or more of these analysts ceases coverage of us, we could lose visibility in the market, which in turn could cause our stock price to decline.
COMPLIANCE WITH CHANGING REGULATION OF CORPORATE GOVERNANCE AND PUBLIC DISCLOSURE MAY RESULT IN ADDITIONAL EXPENSES.
Keeping abreast of, and in compliance with, changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq Stock Market rules, will require an increased amount of management attention and external resources. We intend to invest all reasonably necessary resources to comply with evolving standards, which may result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities.
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, 2004, we also rented 97 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, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
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 2003 and 2004, as reported by the Nasdaq National Market.
HIGH LOW CALENDAR 2002 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 Third Quarter 11.480 8.500 Fourth Quarter 13.200 11.000
CALENDAR 2004 First Quarter $ 18.700 $ 11.803 Second Quarter 20.170 16.700
At September 10, 2004, 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, 2004.
EQUITY COMPENSATION PLAN INFORMATION
Number of securities to be Weighted-average exercise Number of securities remaining issued upon exercise of price of outstanding and available for future issuance under outstanding options, options, equity compensation plans (excluding Plan Category warrants and rights warrants and rights securities reflected in column (a)) ------------- ------------------- ------------------- ----------------------------------- (a) (b) (c)
Equity compensation plans 1,584,437 $10.55 306,210 approved by security shares of common stock shares of common stock holders ...
Equity compensation plans 136,000 (1) $7.76 0 not approved by security shares of common stock holders ...
Total ... 1,720,437 $10.33 306,210 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) 36,000 options to purchase common stock exercisable at $4.85 per share granted to six directors in March 2003, (iii) 44,000 options to purchase common stock exercisable at $8.91 per share granted to two directors in September 2003, and (iv) 6,000 options to purchase common stock exercisisable at $16.25 per share granted to a director in March 2004.
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, -------------------------- 2004 2003* 2002* 2001* 2000* ---- ---- ---- ---- ---- (in thousands, except per share amounts and Operating Data) INCOME STATEMENT DATA: Product sales ...................................... $ 49,900 $ 45,833 $ 46,209 $ 43,909 $ 38,344 Equipment rentals .................................. 30,936 28,576 26,103 23,724 19,607 --------- --------- --------- --------- ---------
Total revenues ..................................... 80,836 74,409 72,312 67,633 57,951 --------- --------- --------- --------- ---------
Cost of products sold, excluding depreciation and amortization ................................... 33,859 32,047 31,903 28,921 26,457 Cost of equipment rentals, excluding depreciation and amortization ...................... 2,369 3,513 3,595 4,270 2,138 Selling, general and administrative expenses ....... 15,722 17,484 17,614 17,368 12,352 Depreciation and amortization ...................... 15,234 17,167 16,319 17,475 15,501 Loss on asset disposal ............................. 1,242 1,650 4,654 4,877 871 --------- --------- --------- --------- ---------
Operating income (loss) ............................ 12,410 2,548 (1,773) (5,278) 632 Loss on early extinguishment of debt ............... 1,964 -- 796 -- -- Unrealized loss on financial instrument ............ 177 -- -- -- -- Interest expense ................................... 7,947 7,487 8,402 10,207 10,015 --------- --------- --------- --------- ---------
Net income (loss) before income taxes .............. 2,322 (4,939) (10,971) (15,485) (9,383) Provision for income taxes ......................... 142 -- -- -- -- --------- --------- --------- --------- --------- Net income (loss) .................................. $ 2,180 $ (4,939) $ (10,971) $ (15,485) $ (9,383) ========= ========= ========= ========= =========
Net income (loss) per basic common share ........... $ 0.13 $ (0.54) $ (1.32) $ (2.01) $ (1.30) Net income (loss) per diluted common share ......... $ 0.12 $ (0.54) $ (1.32) $ (2.01) $ (1.30)
Weighted average shares outstanding - basic ........ 10,689 10,396 8,742 7,926 7,238 Weighted average shares outstanding - diluted ...... 11,822 10,396 8,742 7,926 7,238
OTHER DATA: EBITDA (1) ......................................... $ 27,644 $ 19,715 $ 14,546 $ 12,197 $ 16,133
OPERATING DATA: Company owned bulk CO2 systems serviced Beginning of period ........................... 62,877 61,000 60,000 58,000 50,395 New installations, net ........................ 5,767 1,877 1,000 2,000 7,605 --------- --------- --------- --------- --------- Total company owned bulk CO2 systems serviced ...... 68,644 62,877 61,000 60,000 58,000 Customer owned bulk CO2 systems serviced ........... 12,269 11,088 9,000 9,000 10,000 --------- --------- --------- --------- --------- Total bulk CO2 systems serviced .................... 80,913 73,965 70,000 69,000 68,000 Total high pressure CO2 customers .................. 613 833 1,000 2,000 5,000 --------- --------- --------- --------- --------- Total customers .................................... 81,526 74,798 71,000 71,000 73,000 Stationary depots .................................. 97 91 76 74 70 Mobile depots ...................................... 11 10 22 19 21 Bulk CO2 trucks .................................... 173 168 161 157 158 Technical service vehicles ......................... 83 73 76 87 95 High pressure cylinder delivery trucks ............. -- -- -- 2 7
BALANCE SHEET DATA: Cash and cash equivalents .......................... $ 505 $ 455 $ 1,562 $ 626 $ 279 Total assets ....................................... 128,536 125,846 132,638 138,016 148,549 Total debt (including short-term debt) ............. 66,173 70,529 87,660 87,346 92,082 Redeemable preferred stock ......................... 10,021 9,258 8,552 5,466 5,050 Total shareholders' equity ......................... 40,756 34,936 25,219 33,982 38,240
* Restated to conform to current year presentation.
(1) RECONCILIATION OF GAAP AND EBITDA
FISCAL YEAR ENDED JUNE 30, -------------------------- 2004 2003 2002 2001 2000 ---- ---- ---- ---- ---- Net income (loss) $ 2,180 $ (4,939) $ (10,971) $ (15,485) $ (9,383) Interest expense 7,947 7,487 8,402 10,207 10,015 Depreciation and amortization 15,234 17,167 16,319 17,475 15,501 Provision for income taxes 142 -- -- -- -- Unrealized loss on financial instrument 177 -- -- -- -- Loss on early extinguishment of debt 1,964 -- 796 -- -- --------- --------- --------- --------- ---------
EBITDA $ 27,644 $ 19,715 $ 14,546 $ 12,197 $ 16,133 ========= ========= ========= ========= =========
Cash flows provided by (used in): Operating activities $ 21,657 $ 15,826 $ 10,858 $ 5,213 $ 6,559 Investing activities $ (16,595) $ (13,891) $ (12,817) $ (11,761) $ (20,694) Financing activities $ (5,012) $ (3,042) $ 2,895 $ 6,895 $ 12,835
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, 2004, we operated a national network of 108 service locations in 45 states servicing approximately 82,000 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, virtually all of our growth is internal resulting from the conversion of high pressure CO2 users to bulk CO2 systems and conversions of competitive bulk CO2 system users.
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.
We have entered into master service agreements with 31 of the largest 100 restaurant and convenience store chains. These master service agreements generally provide for a commitment on the part of the operator for all of its currently owned locations and may also include future locations. In addition, the agreements generally provide that the operator's franchisees may participate in the program and the franchisor undertakes to promote our services to its franchisees. We currently service approximately 28,000 locations pursuant
to existing master service agreements and these agreements represent an opportunity to service an additional 35,000 locations. We are actively working on expanding the number of master service agreements with numerous restaurant chains, including some of the largest operators.
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. During the last two years, we have experienced a significant improvement in gross margin due to net new customer activations and operating improvements, including efficiencies in delivery of product to our customers, such as reductions in unscheduled deliveries, total miles driven, and miles driven between stops and improvements to our safety record. Accordingly, we believe that we are in position to build our customer base while maintaining and improving upon our superior levels of customer service, with minimal changes required to our support infrastructure. We continue to be focused on improving operating effectiveness, increasing prices for our services and strengthening our workforce, and 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 $58.0 million in fiscal 2000 to $80.8 million in fiscal 2004. 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 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. Cost of equipment rentals is comprised of costs associated with customer equipment leases. Selling, general and administrative expenses consist of wages and benefits, dispatch and communications costs, as well as expenses associated with marketing, administration, accounting and administrative 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 based on a standard amount per installation that is associated with specific installations of such systems with customers under non-cancelable contracts and which would not be incurred but for a successful placement. Costs incurred in excess of the standard amount per installation, if any, are expensed in the statement of operations. 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 $55.7 million at June 30, 2004.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage relationship which the various items bear to total revenues:
Fiscal Year Ended June 30, -------------------------- Income Statement Data: 2004 2003 2002 ---- ---- ----
Product sales 61.7% 61.6% 63.9% Equipment rentals 38.3 38.4 36.1 ----- ----- ----- Total revenues 100.0 100.0 100.0
Cost of products sold, excluding depreciation and amortization 41.9 43.1 44.1 Cost of equipment rentals, excluding depreciation and amortization 2.9 4.7 5.0 Selling, general and administrative expenses 19.4 23.5 24.4 Depreciation and amortization 18.8 23.1 22.6 Loss on asset disposal 1.6 2.2 6.4 ----- ----- ----- Operating income (loss) 15.4 3.4 (2.5) Loss on early extinguishment of debt 2.5 -- 1.1 Unrealized loss on financial instrument 0.2 -- -- Interest expense 9.8 10.0 11.6 ----- ----- -----
Income (loss) before income taxes 2.9 (6.6) (15.2) Provision for income taxes 0.2 -- -- ----- ----- ----- Net income (loss) 2.7% (6.6)% (15.2)% ===== ===== =====
FISCAL YEAR ENDED JUNE 30, 2004 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2003
TOTAL REVENUES
Total revenues increased by $6.4 million, or 8.6%, from $74.4 million in 2003 to $80.8 million in 2004. Revenues derived from our bulk service plans increased by $7.2 million, or 9.7%, of which $5.8 million was due to an increase in the number of accounts and $1.4 million was due to an increase in the sale of gases and services other than CO2. These increases were partially offset by the net impact of a $0.8 million decrease in revenue derived from a slight decrease in pricing of CO2. This decrease in pricing was due in large part to incentive pricing provided to multiple national restaurant organizations utilizing both our equipment lease/product purchase, and product only purchase plans.
The following table sets forth, for the periods indicated, the percentage relationship which our service plans bear to total revenues:
Fiscal Year Ended June 30, -------------------------- Service Plan 2004 2003 ------ ------ Bulk budget plan(1) 61.5% 65.5% Equipment lease/product purchase plan(2) 12.0 8.7 Product purchase plan(3) 8.8 8.4 High pressure cylinder(4) 6.0 6.1 Other revenues(5) 11.7 11.3 ----- ----- 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.
PRODUCT SALES - Revenues derived from the product sales portion of our service contracts increased by $4.1 million, or 8.9%, from $45.8 million in 2003 to $49.9 million in 2004. The increase in revenues is due to an 8.2% increase in the average number of customer locations serviced and a 1.0% increase in CO2 used by the average customer. In addition, sales of gases and services other than CO2, increased by $1.4 million or 11.0% compared to last year. All of this was partially offset by a 1.7% decrease in pricing of CO2. This decrease in pricing was due in large part to incentive pricing provided to multiple national restaurant organizations utilizing both our equipment lease/product purchase, and product only purchase plans.
EQUIPMENT RENTALS - Revenues derived from the lease portion of our service contracts increased by $2.3 million, or 8.3%, from $28.6 million in 2003 to $30.9 million in 2004, primarily due to a 7.3% increase in the average number of customers leasing equipment from us and price increases to a significant number of our customers, consistent with the Consumer Price Index, partially offset by incentive pricing provided to multiple national restaurant organizations utilizing our equipment under the equipment lease/product purchase plan.
COST OF PRODUCTS SOLD, EXCLUDING DEPRECIATION AND AMORTIZATION
Cost of products sold, excluding depreciation and amortization, increased from $32.0 million in 2003 to $33.9 million in 2004, while decreasing as a percentage of product sales from 69.9% to 67.9%. Product costs increased by $1.4 million from $10.9 million in 2003 to $12.3 million in 2004. The base price with our primary supplier of CO2 increased by the Producer Price Index, while the volume of CO2 sold by us increased by 10.2%, primarily due to an 8.2% increase in our average customer base.
Operational costs, primarily wages and benefits related to cost of products sold, increased from $12.4 million in 2003 to $13.3 million in 2004, primarily due to an increase in route driver costs. As of June 30, 2004, we had 270 drivers as compared to 249 last year, primarily representing the filling of open positions. However, some of the headcount increase in drivers was offset by a reduction in depot and regional management headcount. In addition, while we have realized a substantial savings in workers' compensation costs due to a reduction in claims and severity, we continue to experience higher health care costs, generally due to market conditions.
Truck delivery expenses decreased from $5.5 million in 2003 to $5.2 million in 2004. Increases in lease related costs were more than offset by a decrease in insurance and repair costs. In addition, we have been able to minimize the impact of increased fuel costs and variable lease costs associated with truck usage by continuing to improve efficiencies in the timing and routing of deliveries. Unscheduled deliveries in 2004 improved over the same period in 2003 by 16.3% while total miles driven increased by just 1.4% on an average customer base that increased by 8.2%. In addition, improvements in our safety record during 2004 have resulted in a significant reduction in the amount of workers' compensation and vehicle accident claims expense.
Occupancy and shop costs related to cost of products sold decreased from $3.2 million in 2003 to $3.1 million in 2004. The improvement is primarily the result of strategic relocation of targeted depots, improved insurance and communication costs.
COST OF EQUIPMENT RENTALS, EXCLUDING DEPRECIATION AND AMORTIZATION
Cost of equipment rentals, excluding depreciation and amortization, decreased by $1.1 million from $3.5 million in 2003 to $2.4 million in 2004, while deceasing as a percentage of equipment rental revenue from 12.3% to 7.7%. The reduction in cost of equipment rentals reflected in expense is primarily attributable to a greater percentage of costs being capitalized in connection with our bulk CO2 systems due to increased efficiency of our technical installers and the number of new activations. In addition, occupancy and shop costs related to cost of equipment rentals decreased from $2.0 million in 2003 to $1.6 million in 2004, as we continue to realize savings in tank refurbishment and repair costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased by $1.8 million from $17.5 million in 2003 to $15.7 million in 2004, while decreasing as a percentage of total revenues from 23.5% in 2003 to 19.4% in 2004.
Selling related expenses decreased by $0.2 million, from $3.5 million in 2003 to $3.3 million in 2004, primarily the result of a decrease in wages and related benefits due to a reduction in the headcount of our sales organization in February 2003. During the fourth quarter of 2004, we have begun to increase our sales force, primarily by adding independent sales representatives, to take advantage of opportunities for growth in the market place.
General and administrative expenses decreased by $1.6 million, or 10.8%, from $14.0 million in 2003 to $12.4 million in 2004. This improvement is due to a $0.8 million reduction in executive wages, a $0.5 million reduction in expenses related to uncollectible accounts receivable, a $0.2 million reduction in outside contract labor, and a $0.7 million reduction in consulting and professional fees. These were offset by a $0.3 million increase in administrative wages, primarily related to achieving incentive related targets, and $0.3 million in other general expenses. During fiscal 2003, we initiated numerous procedures to improve our review and collection of outstanding accounts receivable. Consulting fees decreased, primarily due to non-recurring fees incurred during the first seven months of fiscal 2003 for repairs of certain systems, improvements in our processes to track and collect customer receivables, and other process improvements.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization decreased from $17.2 million in 2003 to $15.2 million in 2004. As a percentage of total revenues, depreciation and amortization expense decreased from 23.1% in 2003 to 18.8% in 2004.
Depreciation expense decreased from $13.8 million in 2003 to $13.2 million in 2004. As we continue with our plan to replace all 50 and 100 lb. tanks over the next two years, depreciation expense from these tanks, whose expected useful lives were shortened to coincide with the replacement plan, resulted in depreciation expense of $0.9 million in 2004, down from $1.2 million in 2003. In addition, certain costs associated with the initial direct placement of bulk CO2 customer sites, which are capitalized, are fully depreciated upon the completion of the initial contract term, and upon contract renewal, no such costs are incurred.
Amortization expense decreased from $3.4 million in 2003 to $2.0 million in 2004. This decrease is due to a reduction in the amortization of deferred charges from our current financing arrangements effective August 25, 2003 as compared to the amortization of fees related to our previous financing arrangements, and to the amortization of customer lists, many of which were fully amortized as of March 31, 2003.
LOSS ON ASSET DISPOSAL
Loss on asset disposal decreased from $1.7 million in 2003 to $1.2 million in 2004, while decreasing as a percentage of total revenues from 2.2% to 1.6%.
OPERATING INCOME
For the reasons previously discussed, operating income increased by $9.9 million from $2.5 million in 2003 to $12.4 million in 2004. As a percentage of total revenues, operating income improved from 3.4% in 2003 to 15.4% in 2004.
LOSS ON EARLY EXTINGUISHMENT OF DEBT
In the first quarter of fiscal 2004, we accelerated the recognition of $1.5 million in deferred financing costs associated with the refinancing of our long-term debt. In addition, we accelerated the recognition of the unamortized portion of the Original Issue Discount associated with our 12% Senior Subordinated Promissory Notes, $0.4 million, and paid $0.1 million in conjunction with the early termination of an interest rate swap agreement.
UNREALIZED LOSS ON FINANCIAL INSTRUMENT
In order to reduce our exposure to increases in Eurodollar interest rates, and consequently to increases in interest payments, on October 2, 2003, we entered into an interest rate swap transaction (the "Swap") in the amount of $20.0 million (the "Notional Amount") with an effective date of March 15, 2004. Pursuant to the Swap, we pay a fixed interest rate of 2.12% per annum and receive a Eurodollar-based floating rate. The effect of the Swap is to neutralize any changes in Eurodollar rates on the Notional Amount. As the Swap was not effective until March 15, 2004 and no cash flows were exchanged prior to that date, the Swap did not meet the requirements to be designated as a cash flow hedge. As such, an unrealized loss of $177,000 was recognized in our results of operations during the nine months ended March 31, 2004, reflecting the change in fair value of the Swap from inception to the effective date. As of March 15, 2004, the Swap met the requirements to be designated as a cash-flow hedge and is deemed a highly effective transaction.
INTEREST EXPENSE
Interest expense increased from $7.5 million in 2003 to $7.9 million in 2004, while decreasing as a percentage of total revenues from 10.0% in 2003 to 9.8% in 2004. The effective interest rate of our debt increased from 9.8% to 11.4% per annum, primarily due to the terms of our refinancing in August 2003.
INCOME (LOSS) BEFORE INCOME TAXES
See discussion of Net Income (Loss).
PROVISION FOR INCOME TAXES
As of June 30, 2004, we had net operating loss carryforwards for federal income tax purposes of approximately $96 million and for state purposes in varying amounts, which are available to offset future federal taxable income, if any, in varying amounts through June 2024. However, a portion of our taxable income is subject to the alternative minimum tax ("AMT"), which is reflected in our statements of operations for 2004 along with a provision for state income taxes. Our provision for income taxes in 2004 was $0.1 million. No provision was made for income tax expense in 2003 due to our net loss.
NET INCOME (LOSS)
For the reasons described above, net income (loss) improved by $7.1 from a $4.9 million net loss in 2003 to net income of $2.2 million in 2004.
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 (in thousands), increased by $7.9 million, or 40.2%, from $19.7 million in 2003 to $27.6 million in 2004 and increased as a percentage of total revenues from 26.5% to 34.2%.
Fiscal Year Ended June 30, -------------------------- 2004 2003 -------- -------- Net income (loss) $ 2,180 $ (4,939) Interest expense 7,947 7,487 Depreciation and amortization 15,234 17,167 Provision for income taxes 142 -- Unrealized loss on financial instrument 177 -- Loss on early extinguishment of debt 1,964 -- -------- -------- EBITDA $ 27,644 $ 19,715 ======== ========
Cash flows provided by (used in): Operating activities $ 21,657 $ 15,826 Investing activities $(16,595) $(13,891) Financing activities $ (5,012) $ (3,042)
FISCAL YEAR ENDED JUNE 30, 2003 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2002
TOTAL REVENUES
Total revenues 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 in revenue from rental of high pressure cylinders and the sale of gases other than CO2.
The following table sets forth, for the periods indicated, the percentage relationship which our service plans bear to total revenues:
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.
PRODUCT SALES - Revenues derived from the product sales portion of our service contracts decreased by $0.4 million, or 0.8%, from $46.2 million in 2002 to $45.8 million in 2003. The decrease in revenues is due to a decrease in the amount of CO2 used by the average customer from 2,311 lbs. to 2,283 lbs., and a $0.7 million decrease in revenues derived from cylinder products, primarily due to the reduction of stand-alone high pressure cylinder customers,
and pricing. These were partially offset by a 4.0% increase in the average number of customers utilizing bulk CO2 products. The decrease in pricing was due in large part to incentive pricing provided to multiple national restaurant organizations utilizing both our equipment lease/product purchase, and product only purchase plans.
EQUIPMENT RENTALS - Revenues derived from the lease portion of our service contracts increased by $2.5 million, or 9.5%, from $26.1 million in 2002 to $28.6 million in 2003, primarily due to a 3.6% increase in the average number of customers leasing equipment from us and price increases to a significant number of our customers. 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, we were able to achieve significant price increases from 4,200 of our renewal customers; however, these improvements were partially offset by incentive pricing provided to multiple national restaurant organizations using our equipment under the equipment lease/product purchase plan.
COST OF PRODUCTS SOLD, EXCLUDING DEPRECIATION AND AMORTIZATION
Costs of products sold, excluding depreciation and amortization, increased from $31.9 million 2002 to $32.0 million in 2003, while increasing as a percentage of product sales from 69.0% to 69.9%. Product costs increased by $0.1 million, from $10.8 million in 2002 to $10.9 million in 2003. The base price with our primary CO2 supplier decreased by 2.0%, while the volume of CO2 sold by us increased by 3.5%.
Operational costs, primarily wages and benefits related to cost of products sold, decreased from $12.8 million in 2002 to $12.4 million in 2003, primarily due to a decrease in operational wages, specifically non-route driver related.
Truck delivery expenses increased from $5.3 million in 2002 to $5.5 million in 2003. Increases in fuel costs and insurance were partially offset by a reduction in net lease costs. We were able to minimize the impact of increased fuel costs and variable lease costs associated with truck usage by reducing overall miles driven by 14% compared to 2002. . Occupancy and shop costs related to cost of products sold increased from $2.9 million in 2002 to $3.2 million in 2003, primarily due to increased occupancy costs attributable to an increase in the number of service depots.
COST OF EQUIPMENT RENTALS, EXCLUDING DEPRECIATION AND AMORTIZATION
Cost of equipment rentals, excluding depreciation and amortization, decreased by $0.1 million from $3.6 million in 2002 to $3.5 million in 2003, while deceasing as a percentage of equipment rental revenue from 13.8% to 12.3%. The reduction in cost of equipment rentals reflected in expense is primarily attributable to a greater percentage of costs being capitalized in connection with our bulk CO2 systems due to increased efficiency of our technical installers and the number of new activations, offset by increased costs related to tank repairs.
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 total revenues from 24.4% in 2002 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 has resulted 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 total revenues, 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 a three to four year period, 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 to 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 total revenues 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 (LOSS)
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 total revenues, 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 total revenues 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 credit facility. The effective interest rate of all debt outstanding during 2003 was 9.6%, as compared to 9.7% in 2002.
NET INCOME (LOSS)
For the reasons described above, net income (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 total revenues 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 Loss on 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
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 on 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 on 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 149 is effective for contracts entered into or modified after June 30, 2003, and designated hedges 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 had no material impact 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 150 as a liability. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is originally effective for the first interim period beginning after June 15, 2003. The adoption of SFAS 150 had no material impact on our financial position, results of operations or cash flows.
On July 1, 2003, we adopted EITF 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. As of June 30, 2004, approximately 57,000 of our customer locations utilized a plan agreement that provides for a fixed monthly payment to cover the use of a bulk CO2 system and a predetermined maximum quantity of CO2 ("budget plan"). Prior to July 1, 2003, as lessor, we recognized revenue from leasing CO2 systems under our budget plan agreements on a straight-line basis over the life of the related leases. We have developed a methodology for the purpose of separating the aggregate revenue stream between the rental of the equipment and the sale of the CO2. Effective July 1, 2003, revenue attributable to the lease of equipment, including equipment leased under the budget plan, is recorded on a straight-line basis over the term of the lease and revenue attributable to the supply of CO2 and other gases, including CO2 provided under the budget plan, is recorded upon delivery to the customer.
We have elected to apply EITF 00-21 retroactively to all budget plan agreements in existence as of July 1, 2003. Based on our analysis, the aggregate amount of CO2 actually delivered under budget plans during the quarter ended June 30, 2003 is not materially different than the corresponding portion of the fixed charges attributable to CO2. Accordingly, we believe the cumulative effect of the adoption of EITF 00-21 as of July 1, 2003 is not significant.
Under the budget plan, each customer has a maximum CO2 allowance that is measured and reset on the contract anniversary date. At that date, it is appropriate to record revenue for contract billings in excess of actual deliveries of CO2. Because of the large number of customers under the budget plan and the fact that the anniversary dates for determining maximum quantities are spread throughout the year, our methodology involves the use of estimates and assumptions to separate the aggregate revenue stream derived from equipment
rentals to budget plan customers, and also to approximate the recognition of revenue from CO2 sales to budget plan customers when earned. We believe that the adoption of EITF 00-21 has the most impact on the recognition of revenue on a quarterly basis as CO2 usage fluctuates during a fiscal year based on factors such as weather, and traditional summer and holiday periods. Over a twelve-month period, we believe that the effect is less significant since seasonal variations are largely eliminated and CO2 allowances under budget plan agreements are measured and reset annually.
In December 2003, the FASB revised FASB Interpretation No. 46, "CONSOLIDATION OF VARIABLE INTEREST ENTITIES." Application of this Interpretation is required in a company's financial statements for interests in variable interest entities for reporting periods ending after March 15, 2004. FASB Interpretation No. 46 did not effect our financial position, results of operations, or cash flows.
In December 2003, the FASB revised SFAS No. 132, "EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS" ("SFAS 132"). SFAS 132 requires additional disclosures regarding the assets, obligations, cash flows, and net periodic benefit cost of defined benefit plans and other defined benefit postretirement plans. SFAS 132 requires that this information be provided separately for pension plans and other postretirement benefit plans. The adoption of the revised SFAS No. 132 during fiscal 2004 had no material impact on our financial position, results of operations, or cash flows.
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, 2004, we anticipated making cash capital expenditures of approximately $20.0 million over the next twelve months, primarily for purchases of bulk CO2 systems for new customers, the replacement with larger bulk CO2 systems of 50 and 100 lb. bulk CO2 systems in service at existing customers and replacement units for our 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 generated 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 ("Amended Credit Facility"). 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, we were not in compliance with certain of the 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, and the maturity of the Amended Credit Facility was extended to November 17, 2003. 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 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, we were in compliance with all of the financial covenants under the Amended Credit Facility.
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.
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 and Revolving Loan Facility mature on August 25, 2007, while the B Term Loan matures on August 25, 2008. 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 ended June 30, 2004, the margin on Eurodollar Loans was 4.0% and the margin for Base Rate Loans was 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 of 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 these 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. We were in compliance with all covenants under the Senior Credit Facility as of September 30, 2003 and all subsequent quarters during fiscal 2004, up to and including June 30, 2004.
In connection with the termination of the Amended Credit Facility, during the first quarter of fiscal 2004, we recognized a loss of $0.9 million from the write-off of unamortized financing costs associated with the Amended Credit Facility and recorded $2.3 million in financing costs associated with the Senior Credit Facility. Such costs are being amortized over the life of the Senior Credit Facility.
As of June 30, 2004, a total of $36.8 million was outstanding pursuant to the Senior Credit Facility with a weighted average interest rate of 6.4%.
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. 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. As of March 31, 2003 and 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. Utilizing 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 $1,573,000. 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 extended to February 2009, resulting in additional value of $1.31 and $0.97 per warrant, respectively, or an aggregate value of $760,090. At the date of issuance, in accordance with APB 14, "ACCOUNTING FOR CONVERTIBLE DEBT AND DEBT ISSUED WITH PURCHASE WARRANTS," we 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, we are required to meet certain affirmative and negative covenants under the New Notes, including but not limited to financial covenants. We were in compliance with all covenants under the New Notes as of September 30, 2003 and all subsequent quarters during fiscal 2004, up to and including June 30, 2004.
In connection with the early repayment of the 1997 Notes and 1999 Notes, during the first quarter of fiscal 2004 we recognized a loss of $1.1 million attributable to the unamortized financing costs and Original Issue Discount associated with the 1997 Notes and 1999 Notes, and recorded $0.5 million of financing costs and Original Issue Discount associated with New Notes. Such fees are being 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%.
In May 2000, we sold 5,000 shares of Series A 8% Cumulative Convertible Preferred Stock, no par value (the "Series A Preferred Stock"), for $1,000 per share. Shares of the Series A Preferred Stock were convertible into shares of common stock at any time subsequent to issuance at a current conversion price of $9.28 per share. Effective August 18, 2004, the holder of the Series A Preferred Stock converted its shares into 754,982 shares of our common stock.
During the fiscal year ended June 30, 2004, our capital resources included cash flows from operations and available borrowing capacity under the Senior Credit Facility. 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 contractual obligations (in thousands):
Less than 1 Contractual obligations Total Year 2-3 Years 4-5 Years Thereafter ----------------------- ---------------------------------------------------------------- Senior Credit Facility Principal $ 36,800 $ 6,000 $ 20,750 $ 10,050 $ -- Interest 6,033 2,135 2,913 985 -- -------- -------- -------- -------- -------- Total Senior Credit Facility 42,833 8,135 23,663 11,035 -- -------- -------- -------- -------- --------
Subordinated debt Principal 30,107 -- -- 30,107 -- Interest** 25,962 3,794 8,092 14,076 -- -------- -------- -------- -------- -------- Total subordinated debt 56,069 3,794 8,092 44,183 -- -------- -------- -------- -------- --------
Other debt, including interest 249 65 130 54 -- Employment agreements 1,207 758 449 -- -- Operating leases 16,617 4,554 7,138 3,923 1,002 -------- -------- -------- -------- -------- Total obligations $116,975 $ 17,306 $ 39,472 $ 59,195 $ 1,002 ======== ======== ======== ======== ========
** INCLUDES PAID-IN-KIND INTEREST PAID UPON LOAN TERMINATION
In addition, in May 1997 we entered into an exclusive bulk CO2 requirements contract with The BOC Group, Inc.
WORKING CAPITAL. At June 30, 2004 and 2003, we had working capital, excluding the current maturities of long-term debt of $1.4 million and $0.6 million, respectively. While working capital increased from 2003 to 2004, we used excess funds generated by operations offset by capital needs to reduce the outstanding debt under our Senior Credit Facility.
CASH FLOWS FROM OPERATING ACTIVITIES. Cash flows provided by operations increased by $5.9 million from $15.8 million in 2003 to $21.7 million in 2004. The improvement is primarily due to our improvement in net income (excluding non-cash charges) of $8.3 million, while cash generated from/(used by) the working capital components of our balance sheet decreased from $1.7 million in 2003 to $(0.8) million in 2004.
During 2003, we enacted a deliberate plan to strengthen cash flows generated by operations by improvements to operating income and the management of working capital assets. For example, improvements were made in the collection of our outstanding accounts receivable, primarily the result of process improvements. While we continue to make improvements in the management of working capital assets, the most dramatic improvement was seen prior to the end of fiscal 2003, as compared to 2002. In contrast, the increase in working capital assets in 2004 was directly attributable to growth in customer sales and amounts placed in escrow by contractual requirements with our business insurance carrier, the majority of which is refundable upon continued favorable claims experience.
CASH FLOWS FROM INVESTING ACTIVITIES. During 2004 and 2003, net cash used in investing activities was $16.6 million and $13.9 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 2004, cash flows used in financing activities were $5.0 million compared to $3.0 million in 2003. In 2004, we refinanced our debt, as previously discussed, receiving proceeds of $73.2 million, paying fees associated with the refinancing of $2.7 million, while simultaneously paying off our previous financing facilities. In addition, we have received $1.7 million from the exercise of options and warrants to purchase shares our common stock.
In 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.
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 exclusive requirements 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 AND SIGNIFICANT ESTIMATES
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 year ended June 30, 2002.
Certain events may occur that would materially affect 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, 2004, depreciation expense was $13.3 million representing 19.4% of operating expenses. If the estimated lives of all assets being depreciated were increased by one year, depreciation expense would have decreased by approximately $1.0 million or 8.0%. Conversely, if the estimated lives of all assets decreased by one year, depreciation expense would have increased by $1.2 million or 9.1%.
Goodwill 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, 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 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 and collections experience, aging of our trade receivables, the creditworthiness 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. Receivables at risk greater than 120 days past due are reserved at approximately 88%, consistent with collections experience. 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. Substantially all of our deferred tax assets represent the benefit of loss carryforwards that arose prior to fiscal year 2004. 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. Among other matters, realization of the entire deferred tax asset is dependent on our ability to generate sufficient taxable income prior to the expiration of the carryforwards. While we attained profitability during fiscal year 2004, based on the available objective evidence and the recent history of losses, management cannot conclude that it is more likely than not that the net deferred tax assets will be fully realizable. Accordingly, we have recorded a valuation allowance equal to the amount of our net deferred tax assets. However, as we continue to generate future taxable income, the valuation allowance will be reviewed, which could result in a material income tax benefit being recorded in our statement of operations.
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, 2004, a total of $36.8 million was outstanding under the Senior Credit Facility with a weighted average interest rate of 6.4%. Based upon the $36.8 million outstanding under the Senior Credit Facility at June 30, 2004, our annual interest cost under the Senior Credit Facility would increase by $0.4 million for each 1% increase in Eurodollar interest rates.
In order to reduce our exposure to increases in Eurodollar interest rates, and consequently to increases in interest payments, on October 2, 2003, we entered into an interest rate swap transaction (the "Swap") in the amount of $20.0 million (the "Notional Amount") with an effective date of March 15, 2004. Pursuant to the Swap, we pay a fixed interest rate of 2.12% per annum and receive a Eurodollar-based floating rate. The effect of the Swap is to neutralize any changes in Eurodollar rates on the Notional Amount. We do not, on a routine basis, enter into speculative derivative transactions or leveraged swap transactions, except as disclosed. As the Swap was not effective until March 15, 2004 and no cash flows were exchanged prior to that date, the Swap did not meet the requirements to be designated as a cash flow hedge. As such, an unrealized loss of $177,000 was recognized in our results of operations for the nine months ended March 31, 2004, reflecting the change in fair value of the Swap from inception to the effective date. As of March 15, 2004, the Swap met the requirements to be designated as a cash flow hedge and is deemed a highly effective transaction.
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.
9B. OTHER INFORMATION.
Not applicable.
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, 2004 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, 2004 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, 2004 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, 2004 pursuant to Regulation 14A.
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The information required by Item 14 is incorporated by reference to our definitive proxy statement to be filed with the SEC no later than October 28, 2004 pursuant to Regulation 14A.
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. (11)
3.7 -- Articles of Amendment to the Articles of Incorporation of the Company, dated December 10, 2003. (12)
3.8 -- Bylaws of the Company. (12)
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. (12)
10.2* -- Directors' Stock Option Plan of the Company. (1)
10.3 -- Credit Agreement among the Company, various lenders and BNP Paribas, as Administrative Agent, dated as of August 25, 2003. (11)
10.4 -- Senior Subordinated Note Purchase Agreement, dated as of August 25, 2003 between the Company and the Investors. (11)
10.5 -- Amendment No. 1 to Senior Subordinated Note Purchase Agreement, dated as of July 9, 2004 between the Company and the Investors. (1)
10.6 -- Warrant Agreement dated as of August 25, 2003 among the Company and the Initial Holders. (11)
10.7 -- Special Warrant Agreement dated as of August 25, 2003 among the Company and the Initial Holders. (11)
10.8 -- Special Warrant Agreement dated as of August 25, 2003 among the Company and the Initial Holder. (11)
10.9 -- Preferred Stock Purchase Agreement, dated as of May 15, 2000, by and between the Company and Chase Capital Investments, L.P. (5)
10.10 -- Preferred Stock Purchase Agreement, dated as of November 1, 2001, by and between the Company and Paribas North America, Inc. (7)
10.11 -- Warrant Agreement ("Warrant Agreement") dated as of October 31, 1997 among the Company and the Initial Holders. (3)
10.12 -- Amendment No. 1 to Warrant Agreement dated as of November 14, 1997. (3)
10.13 -- Amendment No. 2 to Warrant Agreement dated as of May 4, 1999. (4)
10.14 -- Stock Purchase Agreement, dated as of December 7, 2000 by and between The BOC Group, Inc., a Delaware corporation and the Company. (6)
10.15 -- Stock Purchase Agreement, dated as of August 22, 2002, by and between the Company and the purchasers named therein. (9)
10.16 -- Registration Right Agreement, dated as of August 22, 2002, by and between the Company and the selling shareholders named therein. (8)
10.17* -- Amended and Restated Employment Agreement between the Company and Michael DeDomenico, effective as of August 10, 2004. (1)
10.18* -- Employment Agreement between the Company and William Scott Wade, dated as of May 13, 2002. (9)
10.19* -- Employment Agreement between the Company and Robert R. Galvin, dated as of October 21, 2002. (11)
10.20* -- Stock Option Agreement between the Company and Craig L. Burr dated March 21, 2003. (11)
10.21* -- Stock Option Agreement between the Company and Robert L. Frome dated March 21, 2003. (11)
10.22* -- Stock Option Agreement between the Company and Daniel Raynor dated March 21, 2003. (11)
10.23* -- Stock Option Agreement between the Company and Richard D. Waters, Jr. dated March 21, 2003. (11)
10.24* -- Stock Option Agreement between the Company and Craig L. Burr dated March 21, 2003. (11)
10.25* -- Stock Option Agreement between the Company and Robert L. Frome dated March 21, 2003. (11)
10.26* -- Stock Option Agreement between the Company and Daniel Raynor dated March 21, 2003. (11)
10.27* -- Stock Option Agreement between the Company and Richard D. Waters, Jr. dated March 21, 2003. (11)
10.28* -- Stock Option Agreement between the Company and Daniel Raynor dated September 11, 2003. (1)
10.29* -- Stock Option Agreement between the Company and Robert L. Frome dated September 11, 2003. (1)
10.30* -- Stock Option Agreement between the Company and J. Robert Vipond dated April 5, 2004. (1)
14 -- Code of Ethics. (11)
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, 333-89096 and 333-114898) and Form S-3 (No. 333-99201) of the independent registered public accounting firm's 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
None.
---------------------------
(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. (11) Incorporated by reference to the Company's Form 10-K for the year ended June 30, 2003. (12) Incorporated by reference to the Company's Form 10-Q for the quarter ended December 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 13, 2004 /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 13, 2004 -------------------------- Craig L. Burr
/s/ Michael E. DeDomenico Director, September 13, 2004 -------------------------- Chief Executive Officer Michael E. DeDomenico
/s/ Robert L. Frome Director September 13, 2004 ------------------------ Robert L. Frome
/s/ Daniel Raynor Director September 13, 2004 ----------------- Daniel Raynor
/s/ J. Robert Vipond Director September 13, 2004 -------------------- J. Robert Vipond
/s/ Richard D. Waters, Jr. Director September 13, 2004 ------------------------- Richard D. Waters, Jr.
/s/ Robert R. Galvin Chief Financial Officer September 13, 2004 -------------------- Robert R. Galvin
Page No. --------
NUCO2 INC.
Report of Independent Registered Public Accounting Firm................
Financial Statements:
Balance Sheets as of June 30, 2004 and 2003....................
Statements of Operations for the Fiscal Years Ended June 30, 2004, 2003 and 2002........................................
Statements of Shareholders' Equity for the Fiscal Years Ended June 30, 2004, 2003 and 2002...............................
Statements of Cash Flows for the Fiscal Years Ended June 30, 2004, 2003 and 2002........................................
Notes to Financial Statements..........................................
Schedule II - Valuation and Qualifying Accounts for the Fiscal Years Ended June 30, 2004, 2003 and 2002............................
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
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, 2004 and 2003, and the related statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended June 30, 2004. 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 the standards of the Public Company Accounting Oversight Board (United States). 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, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2004 in conformity with United States generally accepted accounting principles. 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 therein.
As discussed in Note 1 to the financial statements, effective July 1, 2003, the Company changed the manner in which it accounts for multiple deliverable revenue arrangements as a result of the adoption of Emerging Issues Task Force Issue No. 00-21, and 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 18, 2004
NUCO2 INC. BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS) ASSETS ------ June 30, -----------------------------
2004 2003 ----------- ------------ Current assets: Cash and cash equivalents $ 505 $ 455 Trade accounts receivable; net of allowance for doubtful accounts of $2,095 and $2,299, respectively 6,141 6,217 Inventories 226 210 Prepaid insurance expense and deposits 2,104 985 Prepaid expenses and other current assets 808 620 ------------ ------------ Total current assets 9,784 8,487 ------------ ------------
Property and equipment, net 92,969 92,448 ------------ ------------
Other assets: Goodwill, net 19,222 19,222 Deferred financing costs, net 2,178 1,593 Customer lists, net 41 25 Non-competition agreements, net 703 985 Deferred lease acquisition costs, net 3,458 2,892 Other assets 181 194 ------------ ------------ 25,783 24,911 ------------ ------------ Total assets $ 128,536 $ 125,846 ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Current liabilities: Current maturities of long-term debt $ 6,048 $ 2,294 Accounts payable 4,579 4,095 Accrued expenses 1,840 1,315 Accrued interest 440 981 Accrued payroll 1,137 1,212 Other current liabilities 343 329 ------------ ------------ Total current liabilities 14,387 10,226
Long-term debt, excluding current maturities 30,962 28,659 Subordinated debt 29,163 39,576 Customer deposits 3,247 3,191 ------------ ------------ Total liabilities 77,759 81,652 ------------ ------------
Commitments and contingencies Redeemable preferred stock 10,021 9,258 ------------ ------------
Shareholders' equity: Preferred stock; no par value; 5,000,000 shares authorized; issued and outstanding 7,500 shares at June 30, 2004 and 2003 -- -- Common stock; par value $.001 per share; 30,000,000 shares authorized; issued and outstanding 10,840,831 shares at June 30, 2004 and 10,633,405 at June 30, 2003 11 11 Additional paid-in capital 96,185 92,938 Accumulated deficit (55,704) (57,884) Accumulated other comprehensive income (loss) 264 (129) ------------ ------------ Total shareholders' equity 40,756 34,936 ------------ ------------ $ 128,536 $ 125,846 ============ ============
See accompanying notes to financial statements.
NUCO2 INC. STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Fiscal Year Ended June 30, -------------------------------------------------- 2004 2003* 2002* ---- ----- -----
Revenues: Product sales $ 49,900 $ 45,833 $ 46,209 Equipment rentals 30,936 28,576 26,103 -------- -------- -------- Total revenues 80,836 74,409 72,312 -------- -------- --------
Costs and expenses: Cost of products sold, excluding depreciation and amortization 33,859 32,047 31,903 Cost of equipment rentals, excluding depreciation and amortization 2,369 3,513 3,595 Selling, general and administrative expenses 15,722 17,484 17,614 Depreciation and amortization 15,234 17,167 16,319 Loss on asset disposal 1,242 1,650 4,654 -------- -------- -------- 68,426 71,861 74,085 -------- -------- --------
Operating income (loss) 12,410 2,548 (1,773)
Loss on early extinguishment of debt 1,964 -- 796 Unrealized loss on financial instrument 177 -- -- Interest expense 7,947 7,487 8,402 -------- -------- --------
Income (loss) before income taxes 2,322 (4,939) (10,971) Provision for income taxes 142 -- -- -------- -------- -------- Net income (loss) $ 2,180 $ (4,939) $(10,971) ======== ======== ========
Weighted average number of common and common equivalent shares outstanding Basic 10,689 10,396 8,742 ======== ======== ======== Diluted 11,822 10,396 8,742 ======== ======== ========
Net income (loss) per basic share $ 0.13 $ (0.54) $ (1.32) ======== ======== ======== Net income (loss) per diluted share $ 0.12 $ (0.54) $ (1.32) ======== ======== ========
See accompanying notes to financial statements. *Restated to conform to current year presentation.
NUCO2 INC. STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
Accumulated Additional Other Total Paid-In Accumulated Comprehensive Shareholders' Common Stock Capital Deficit Income (Loss) Equity ------------ ------- ------- ------------- ------ Shares Amount ------ ------ 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 ----------- -------- -------- -------- ------- ----------- Comprehensive income: Net income -- -- -- 2,180 -- 2,180 Other comprehensive income: Interest rate swap transaction, including reclassification adjustment of $86 -- -- -- -- 393 393 ----------- Total comprehensive income 2,573 Redeemable preferred stock dividend -- -- (763) -- -- (763) Issuance of 425,000 warrants to purchase shares of common stock -- -- 1,573 -- -- 1,573 Extension of 665,403 warrants to purchase shares of common stock -- -- 760 -- -- 760 Issuance of 107,331 shares of common stock -- exercise of warrants 107,331 -- 675 -- -- 675 Issuance of 100,095 shares of common stock --- exercise of options 100,095 -- 1,002 -- -- 1,002 ----------- -------- -------- -------- ------- ----------- Balance, June 30, 2004 10,840,831 $ 11 $ 96,185 $(55,704) $ 264 $ 40,756 =========== ======== ======== ======== ======= ===========
See accompanying notes to financial statements.
NUCO2 INC. STATEMENTS OF CASH FLOWS (IN THOUSANDS)
Years Ended June 30, -------------------- 2004 2003* 2002* -------- -------- -------
Cash flows from operating activities: Net income (loss) $ 2,180 $ (4,939) $(10,971) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization of property and equipment 13,255 13,836 12,604 Amortization of other assets 1,979 3,331 3,715 Amortization of original issue discount 406 210 201 Paid-in-kind interest 1,107 -- -- Loss on asset disposal 1,242 1,650 4,654 Loss on early extinguishment of debt 1,964 -- 796 Unrealized loss on financial instrument 177 -- -- Changes in operating assets and liabilities: Decrease (increase) in: Trade accounts receivable 76 954 575 Inventories (16) 25 (36) Prepaid insurance expense and deposits (1,119) (460) (445) Prepaid expenses and other current assets (188) 821 (302) Increase (decrease) in: Accounts payable 483 743 714 Accrued expenses 530 (968) (627) Accrued payroll (75) 316 17 Accrued interest (413) (198) 51 Other current liabilities 13 (42) (43) Customer deposits 56 547 (45) -------- -------- --------
Net cash provided by operating activities 21,657 15,826 10,858 -------- -------- --------
Cash flows from investing activities: Proceeds from disposal of property and equipment 1 19 91 Purchase of property and equipment (14,962) (12,752) (11,675) Increase in non-competition agreements -- (160) (160) Increase in deferred lease acquisition costs (1,624) (1,125) (928) Decrease (increase) in other assets (10) 127 (145) -------- -------- --------
Net cash used in investing activities $(16,595) $(13,891) $(12,817) -------- -------- --------
See accompanying notes to financial statements. *Restated to conform to current year presentation.
NUCO2 INC. STATEMENTS OF CASH FLOWS (IN THOUSANDS) (CONTINUED)
Years Ended June 30, -------------------- 2004 2003* 2002* -------- -------- ----
Cash flows from financing activities: Net proceeds from issuance of long-term debt and subordinated debt and warrants $ 74,150 $ -- $ 50,000 Repayment of long-term debt and subordinated debt (78,094) (17,340) (49,887) Proceeds from issuance of common stock -- 16,222 -- Issuance costs - common stock -- (1,168) -- Proceeds from issuance of redeemable preferred stock -- -- 2,500 Increase in deferred financing costs (2,745) (762) (2,598) Exercise of options and warrants 1,677 6 2,880 -------- -------- --------
Net cash (used in) provided by financing activities (5,012) (3,042) 2,895 -------- -------- --------
Increase (decrease) in cash and cash equivalents 50 (1,107) 936 Cash and cash equivalents, beginning of year 455 1,562 626 -------- -------- --------
Cash and cash equivalents, end of year $ 505 $ 455 $ 1,562 ======== ======== ========
Supplemental disclosure of cash flow information: Cash paid during the year for:
Interest $ 6,760 $ 7,475 $ 8,066 ======== ======== ========
Income taxes $ 87 $ -- $ -- ======== ======== ========
Supplemental disclosure of non-cash investing and financing activities:
In 2004, 2003 and 2002, the Company increased the carrying amount of the redeemable preferred stock by $763, $706, and $586, respectively, for dividends that have not been paid and accordingly reduced additional paid-in capital by a like amount.
See accompanying notes to financial statements. *Restated to conform to current year presentation.
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 are 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 one hundred and twenty months. Non-competition agreements also include an
NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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) 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 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.
(h) DEFERRED FINANCING COST, NET
Financing costs are being amortized on a straight-line method over the term of the related indebtedness, ranging from forty-eight to sixty-six months. Accumulated amortization of financing costs was $566 and $4,007 at June 30, 2004 and 2003, respectively.
(i) 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 $6,079 and $5,508 at June 30, 2004 and 2003, respectively. Upon early service termination, the unamortized portion of deferred lease acquisition costs are expensed.
(j) 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 over the life of the related leases. The majority of CO2 system agreements 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.
On July 1, 2003, the Company adopted 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. The Company's bulk CO2 budget plan agreements provide for a fixed monthly payment to cover the use of a bulk CO2 system and a predetermined maximum quantity of CO2. As of June 30, 2004, approximately 57,000 of the Company's customer locations utilized this plan. Prior to July 1, 2003, the Company, as lessor, recognized revenue from leasing CO2 systems under its budget plan agreements on a straight-line basis over the life of the related leases. The Company developed a methodology for the purpose of separating the aggregate revenue stream between the rental of the equipment and the sale of the CO2. Effective July 1, 2003, revenue attributable to the lease of equipment, including equipment leased under the budget plan, is recorded on a straight-line basis over the term of the lease and revenue attributable to the supply of CO2 and other gases, including CO2 provided under the budget plan, is recorded upon delivery to the customer.
The Company elected to apply EITF 00-21 retroactively to all budget plan agreements in existence as of July 1, 2003. Based on the Company's analysis, the aggregate amount of CO2 actually delivered under budget plans during the quarter ended June 30, 2003 is not materially different than the corresponding portion of the fixed charges attributable to CO2. Accordingly, the Company believes that the cumulative effect of the adoption of EITF 00-21 as of July 1, 2003 is not significant.
NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Under the budget plan, each customer has a maximum CO2 allowance that is measured and reset on the contract anniversary date. At that date, it is appropriate to record revenue for contract billings in excess of actual deliveries of CO2. Because of the large number of customers under the budget plan and the fact that the anniversary dates for determining maximum quantities are spread throughout the year, the Company's methodology necessarily involves the use of estimates and assumptions to separate the aggregate revenue stream derived from equipment rentals to budget plan customers, and also to approximate the recognition of revenue from CO2 sales to budget plan customers when earned. The Company believes that the adoption of EITF 00-21 has the most impact on the recognition of revenue on a quarterly basis as CO2 usage fluctuates during a fiscal year based on factors such as weather, and traditional summer and holiday periods. Solely for comparative purposes, the Company has separated equipment rentals and CO2 sales in the statements of operations for the years ended June 30, 2003 and 2002; however, the aggregate revenue derived from budget plan agreements for those periods is recognized on a straight-line basis. The Company believes that if the guidance of EITF 00-21 had been applied retroactively, the effect on total revenues and net loss for those periods would be immaterial as the impact of applying EITF 00-21 over a twelve month period is insignificant as seasonal variations are largely eliminated and CO2 allowances under budget plan agreements are measured and reset annually.
(k) 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.
(l) NET INCOME (LOSS) PER COMMON SHARE
Net income (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.
(m) 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.
(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, 2004, 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
NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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.
Fiscal Years Ended June 30, --------------------------- 2004 2003 2002 -------- -------- ------- Net income (loss), as reported $ 2,180 $ (4,939) $(10,971) Less: Stock-based compensation - fair value measurement (1,272) (1,085) (985) -------- -------- -------- Net income (loss), proforma 908 (6,024) (11,956) Preferred stock dividends (763) (706) (586) -------- -------- -------- Net income (loss) available to common shareholders proforma $ 145 $ (6,730) $(12,542) ======== ======== ========
Basic earnings (loss) per share - reported $ 0.13 $ (0.54) $ (1.32) ======== ======== ======== Basic earnings (loss) per share - proforma $ 0.01 $ (0.64) $ (1.43) ======== ======== ========
Diluted earnings (loss) per share - reported $ 0.12 $ (0.54) $ (1.32) ======== ======== ======== Diluted earnings (loss) per share - proforma $ 0.01 $ (0.64) $ (1.43) ======== ======== ========
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.
(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 $548 and $393 during the fiscal years ended June 30, 2004 and 2003, respectively.
(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 collectible. Such reserve is evaluated and adjusted on a monthly basis by examining the Company's historical losses, aging of its trade receivables, the creditworthiness 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.
NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(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.
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 149 is effective for contracts entered into or modified after June 30, 2003, and designated hedges 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 had no material impact 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 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 150 as a liability. SFAS 150 was effective for financial instruments entered into or modified after May 31, 2003, and otherwise is originally effective for the first interim period beginning after June 15, 2003. The adoption of SFAS 150 had no material impact on the Company's financial position, results of operations or cash flows.
NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
In December 2003, the FASB revised FASB Interpretation No. 46, "CONSOLIDATION OF VARIABLE INTEREST ENTITIES." Application of this Interpretation is required in a company's financial statements for interests in variable interest entities for reporting periods ending after March 15, 2004. FASB Interpretation No. 46 did not effect the Company's financial position, results of operations, or cash flows.
In December 2003, the FASB revised SFAS No. 132, "EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS" ("SFAS 132"). SFAS 132 requires additional disclosures regarding the assets, obligations, cash flows, and net periodic benefit cost of defined benefit plans and other defined benefit postretirement plans. SFAS 132 requires that this information be provided separately for pension plans and other postretirement benefit plans. The adoption of the revised SFAS No. 132 during fiscal 2004 had no material impact on the Company's financial position, results of operations, or cash flows.
NOTE 2 - PROPERTY AND EQUIPMENT, NET
Property and equipment, net consists of the following:
As of June 30, --------------------- 2004 2003 -------- -------- Leased equipment $137,124 $127,463 Equipment and cylinders 17,707 16,405 Tanks held for installation 4,557 4,808 Vehicles 285 300 Computer equipment and software 4,401 4,356 Office furniture and fixtures 1,658 1,643 Leasehold improvements 1,963 1,846 -------- -------- 167,695 156,821 Less accumulated depreciation and amortization 74,726 64,373 -------- --------
$ 92,969 $ 92,448 ======== ========
Capitalized component parts and direct costs associated with installation of equipment leased to others included in leased equipment was $41,485 and $36,683 at June 30, 2004 and 2003, respectively. Accumulated depreciation and amortization of these costs was $25,450 and $22,450 at June 30, 2004 and 2003, 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 $13,255, $13,836 and $12,604 for the years ended June 30, 2004, 2003, and 2002, 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 their estimated fair value during fiscal 2001 and 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, 2004 and 2003, the net book value of the 50 and 100 pound tanks still in service was $370 and $1,313, 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, 2004, 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.
Information regarding the Company's goodwill and other intangible assets is as follows:
NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Accumulated Net Book As of June 30, 2004: Cost Amortization Value ---- ------------ ---------- Goodwill $24,228 $ 5,006 $19,222 Non-competition agreements 2,315 1,612 703 Customer lists 62 21 41 ------- ------- ------- $26,605 $ 6,639 $19,966 ======= ======= =======
As of June 30, 2003: 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 ======= ======= =======
Amortization expense for other intangible assets was $291, $552 and $1,155 for the years ended June 30, 2004, 2003 and 2002, 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 $293, $238, $166, $43, and $4 for fiscal years ending June 30, 2005, 2006, 2007, 2008, and 2009, respectively.
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 2010. At June 30, 2004, future minimum payments due from customers include, where applicable, amounts for a continuous supply of CO2 under the budget plan, which provides bundled pricing for tank rental and CO2. The revenue stream has been segregated in conformity with EITF 00-21 between the estimated rental of equipment and the sale of CO2. The following table presents the separate revenue streams attributable to the lease of the equipment and the sale of the CO2:
Year Ending June 30, Equipment CO2 -------------------- --------- ---
2005 $ 27,106 $ 19,197 2006 22,065 15,897 2007 15,857 12,234 2008 11,360 9,018 2009 7,604 6,017 Thereafter 2,641 2,055 -------- -------- $ 86,633 $ 64,418 ======== ========
NOTE 5 - LONG-TERM DEBT
Long-term debt consists of the following:
As of June 30, -------------- 2004 2003 ---------- --------- Note payable to bank under credit facility. Drawings at June 30, 2004 and 2003 are at a weighted average interest rate of 6.4% and 4.7%, respectively. $ 36,800 $ 30,700 Other note payable 210 253 ---------- --------- 37,010 30,953 Less current maturities of long-term debt 6,048 2,294 ---------- --------- Long-term debt, excluding current maturities $ 30,962 $ 28,659 ========== =========
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 contained interest rates and an unused commitment fee based on a pricing grid calculated quarterly on total debt to annualized EBITDA (as defined). The
NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Company was 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 ranged from 2.50% to 4.75%, the applicable unused commitment fee pursuant to the pricing grid ranged from 0.375% to 0.50% and the applicable Base Rate margin pursuant to the pricing grid ranged from 1.50% to 3.75%. Interest only was payable periodically until the termination of the Amended Credit Facility. The Amended Credit Facility was collateralized by substantially all of the Company's assets. Additionally, the Company was precluded from declaring or paying any cash dividends, except the Company was permitted to accrue and accumulate, but not pay, cash dividends on the redeemable preferred stock. The Company was also required to meet certain affirmative and negative covenants including, but not limited to, financial covenants.
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, 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 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.
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 and Revolving Loan Facility mature on August 25, 2007, while the B Term Loan matures on August 25, 2008. 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 the Company's 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 on 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. As of June 30, 2004, no amounts were outstanding under the Revolving Loan Facility.
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 its compliance with these 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 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 the Company's 16.3% Senior Subordinated Notes due February 27, 2009. The Company was in compliance with all covenants under the Senior Credit Facility as of September 30, 2003 and all subsequent quarters during fiscal 2004, up to and including June 30, 2004.
NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
In connection with the termination of the Amended Credit Facility, during the first quarter of fiscal 2004, the Company recognized a loss from the write-off of $860 in unamortized financing costs associated with the Amended Credit Facility and recorded $2,164 in financing costs associated with the Senior Credit Facility. Such costs will be amortized over the life of the Senior Credit Facility.
Effective July 1, 2000, the Company adopted SFAS No. 133 "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES," as amended, which, among other things, 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. Prior to August 25, 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 termination date of September 28, 2003. Under the Prior Swap, the Company paid a fixed interest rate of 5.23% per annum and received a LIBOR-based floating rate. In conjunction with the termination of the Prior Swap prior to maturity, the Company paid $86, which represented the fair value of the swap liability. The $86 was reclassified from other comprehensive income and recognized as a component of the loss on early extinguishment of debt.
The Prior Swap, which was designated as a cash flow hedge, was deemed to be a highly effective transaction, and accordingly the loss on the derivative instrument was reported as a component of other comprehensive income (loss). For the fiscal years ended June 30, 2004, 2003 and 2002, the Company recorded $43 net of the reclassification adjustment of $86, $300, and $(86), respectively, representing the change in fair value of the Prior Swap, as other comprehensive income.
In order to reduce the Company's exposure to increases in Eurodollar rates, and consequently to increases in interest payments, the Company entered into an interest rate swap transaction (the "Swap") on October 2, 2003, in the amount of $20.0 million ("Notional Amount") with an effective date of March 15, 2004 and a maturity date of September 15, 2005. Pursuant to the Swap, the Company pays a fixed interest rate of 2.12% per annum and receives a Eurodollar-based floating rate. The effect of the Swap is to neutralize any changes in Eurodollar rates on the Notional Amount. As the Swap was not effective until March 15, 2004 and no cash flows were exchanged prior to that date, the Swap did not meet the requirements to be designated as a cash flow hedge. As such, an unrealized loss of $177 was recognized in the Company's results of operations for the fiscal year ended June 30, 2004, reflecting the change in fair value of the Swap from inception to the effective date. As of March 15, 2004, the Swap met the requirements to be designated as a cash flow hedge and is deemed a highly effective transaction. Accordingly, the Company recorded $264, representing the change in fair value of the Swap from March 15, 2004 through June 30, 2004, as other comprehensive income.
The aggregate maturities of long-term debt for each of the five years subsequent to June 30, 2004 are as follows:
Year Ending June 30, -------------------- 2005 $ 6,048 2006 9,302 2007 11,557 2008 103 2009 10,000 ------------ $ 37,010 ============
NOTE 6 - SUBORDINATED DEBT
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. Prior to August 25, 2003, the Original Issue Discount was being amortized as interest expense over the
NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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 was 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 were 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.
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 $774, and the warrants issued with the 1999 Notes at $1.47 per warrant, or an aggregate value of $549. Both amounts were recorded 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. After giving effect to the amortization of the Original Issue Discount, the effective interest rate on the 1999 Notes was 13.57% per annum.
During the fiscal year ended June 30, 2002, 65,574 of the warrants issued in connection with the 1997 Notes were exercised and converted into shares of the Company's common stock. On August 22, 2002, in conjunction with the private placement of 1,663,846 shares of the Company's common stock (see Note 4), the remaining warrants issued in conjunction with the 1997 Notes and the warrants issued in connection with the 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. In addition, in fiscal 2004, warrants to purchase 30,831 shares of the Company's common stock issued in connection with the 1997 Notes and 1999 Notes were exercised pursuant to the cashless exercise provision contained in the warrants. In connection with the cashless exercise, warrants to purchase 50,647 shares of the Company's common stock were canceled.
As of December 31, 2002, 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. As of March 31, 2003 and June 30, 2003, the Company was 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, 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. Utilizing 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 extended 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. In addition, in fiscal 2004, warrants to purchase 75,000 shares of the Company's common stock issued in connection with the New Notes were exercised for proceeds of $659, recorded as additional paid-in-capital on the Company's balance sheet as of June 30, 2004. As of June 30, 2004, warrants to purchase 1,283,484 shares of common stock issued in connection with the 1997 Notes, 1999 Notes and New Notes were outstanding.
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. The Company was in compliance with all covenants under the New Notes as of September 30, 2003 and all subsequent quarters during fiscal 2004, up to and including June 30, 2004.
In connection with the early repayment of the 1997 Notes and 1999 Notes, during the first quarter of fiscal 2004, the Company recognized a loss of $1,018 attributable to the unamortized financing costs and Original Issue Discount associated with the 1997 Notes and 1999 Notes, and recorded $581 of
NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
financing costs associated with the New Notes. Such fees are being amortized over the life of the New Notes. The weighted average effective interest rate of the New Notes, including the amortization of Original Issue Discount, is 18.0%.
NOTE 7 - REDEEMABLE 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. Effective August 18, 2004, the holder of the Series A Preferred Stock converted its shares into 754,982 shares of common stock.
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, 2004, 2003 and 2002, the carrying amount (and Liquidation Preferences) of the Series A Preferred Stock and Series B Preferred Stock ("Preferred Stock") was increased by $763, $706 and $586, 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.
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 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 $7.82. In March 2003, the Company granted to each non-employee director options for 6,000 shares of common stock, or an aggregate of 36,000 options at an exercise price of $4.85. In September 2003, the Company granted to two of its non-employee directors options for 22,000 shares of common stock, or an aggregate of 44,000 options at an exercise price of $8.91. In addition, in March 2004, the Company granted a non-employee director options for 6,000 shares of common stock at an exercise price of $16.25. The exercise price for all grants is equal to the average closing price of the common stock on the Nasdaq National Market for the 20 trading days prior to the grant date. All options vest in three to five equal annual installments commencing upon issuance, and have a ten-year term, and as of June 30, 2004 and 2003, options for 58,533 and 37,200 shares, respectively, were exercisable.
NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(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 2,400,000 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, 2004, 2003 and 2002 was $4.11, $2.41 and $4.78, 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, 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 (199,780) 11.36 Exercised (500) 11.25 ---------- Outstanding at June 30, 2003 1,288,520 9.13 640,373 Granted 379,300 15.61 Expired or canceled (73,288) 12.18 Exercised (90,009) 10.17 ---------- Outstanding at June 30, 2004 1,504,523 $ 10.55 865,653 ==========
The following table sets forth certain information as of June 30, 2004:
Options Outstanding Options Exercisable --------------------------------------------------- ---------------------------------
Range of Exercise Options Weighted Average Weighted Average Options Weighted Average Prices Outstanding Remaining Life Exercise Price Exercisable Exercise Price ----------------- ----------- -------------- -------------- ----------- -------------- $ 0.00 - $ 5.00 149,613 7.76 $ 4.83 95,261 $ 4.84 $ 5.01 - $10.00 601,535 6.81 7.56 389,129 7.25 $ 10.01 - $15.00 569,275 7.33 12.40 335,238 11.98 $ 15.01 - $20.00 184,100 9.99 19.29 46,025 19.29 ---------- ----- ------ ------- ------ 1,504,523 7.49 $ 10.55 865,653 $ 9.46 ========== ===== ======== ======= ======
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, 2004, 2003 and 2002 was $3.90, $1.82 and $3.55, respectively.
NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The following summarizes the transactions pursuant to the Directors' Plan:
Weighted Average Options Exercise Price Per Outstanding Option Options Exercisable ----------- ------------------ ------------------- 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 Granted 24,000 13.71 Exercised (10,086) 8.63 ------- Outstanding at June 30, 2004 79,914 $10.55 53,994 =======
The following table sets forth certain information as of June 30, 2004:
Options Outstanding Options Exercisable --------------------------------------------------- ---------------------------------
Range of Exercise Options Weighted Average Weighted Average Options Weighted Average Prices Outstanding Remaining Life Exercise Price Exercisable Exercise Price ----------------- ----------- -------------- -------------- ----------- -------------- $ 5.01 - $10.00 36,000 5.15 $ 7.52 31,998 $ 7.38 $ 10.01 - $15.00 31,914 7.16 12.02 18,000 12.27 $ 15.01 - $20.00 12,000 9.69 15.74 3,996 15.74 ---------- ----- ------ ------- ------ 79,914 6.63 $ 10.55 53,994 $ 9.63 ========== ===== ======== ======= ======
NOTE 9 - EARNINGS PER SHARE
The Company calculates earnings per share in accordance with the requirements of SFAS No. 128, "EARNINGS PER SHARE." The following table presents the Company's net income (loss) available to common shareholders and income (loss) per share, basic and diluted (in thousands, except per share amounts):
Fiscal Year Ended June 30, ------------------------------------ 2004 2003 2002 -------- -------- --------
Net income (loss) $ 2,180 $ (4,939) $(10,971) Redeemable preferred stock dividends (763) (706) (586) -------- -------- -------- Net income (loss) - available to common shareholders $ 1,417 $ (5,645) $(11,557) ======== ======== ========
Weighted average outstanding shares of common stock:
Basic 10,689 10,396 8,742 Diluted 11,822 10,396 8,742
Basic income (loss) per share $ 0.13 $ (0.54) $ (1.32) ======== ======== ======== Diluted income (loss) per share $ 0.12 $ (0.54) $ (1.32) ======== ======== ========
The weighted average shares outstanding used to calculate basic and diluted earnings (loss) per share were calculated as follows:
NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Fiscal Year Ended June 30, -------------------------- 2004 2003 2002 ---------- ---------- ---------
Weighted average shares outstanding - basic 10,688,802 10,396,352 8,741,550
Outanding options and warrants to purchase shares of common stock - remaining shares after assuming repurchase with proceeds from exercise 1,133,033 - - ---------- ---------- ---------
Weighted average shares outstanding - diluted 11,821,835 10,396,352 8,741,550 ========== ========== =========
Excluded from calculation of loss per common share: Outanding options and warrants to purchase shares of common stock - remaining shares after assuming repurchase with proceeds from exercise - 287,915 671,155 ========== ========== =========
During the years ended June 30, 2003 and 2002, the Company excluded the equivalent shares listed as these options and warrants to purchase common stock were anti-dilutive for these periods. In addition, the Company excluded the effects of the conversion of its outstanding redeemable preferred stock using the "if converted" method, as the effect would be anti-dilutive (Note 7). The Company's redeemable preferred stock was convertible into 973,104, 910,983 and 841,609 shares of common stock as of June 30, 2004, 2003 and 2002, respectively. Effective August 18, 2004, the holder of the Series A Preferred Stock converted its shares into 754,982 shares of common stock.
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:
As of June 30, ------------------------------------ Range of Exercise Prices 2004 2003 2002 ------------------------ ------- --------- ------- $ 5.01 - $10.00 - 160,370 0 $ 10.01 - $15.00 112,200 646,087 428,600 $ 15.01 - $20.00 646,779 444,679 443,715 -------- --------- ------- 758,979 1,251,136 872,315 ======== ========= ======= 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, ----------------------- 2004 2003 --------- -------- Deferred tax assets: Allowance for doubtful accounts $ 733 $ 805 Intangible assets 1,254 1,372 Other 4 4 Net operating loss carryforwards 33,523 34,537 -------- -------- Total gross deferred tax assets 35,514 36,718 Less valuation allowance (16,044) (16,975) -------- -------- Net deferred tax assets 19,470 19,743 -------- -------- Deferred tax liabilities: Goodwill (2,042) (1,510) Fixed assets (17,428) (18,233) -------- -------- Total gross deferred tax liabilities (19,470) (19,743) -------- -------- Net deferred 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. Substantially all of the Company's deferred tax assets represent the benefit of loss carryforwards that arose prior to fiscal year 2004. In assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Such items considered are the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Among other matters, realization of the entire deferred tax asset is dependent on the Company's ability to generate sufficient taxable income prior to the expiration of the carryforwards. While the Company attained profitability during fiscal year 2004, based on the available objective evidence and the recent history of losses, management cannot conclude that it is more likely than not that the net deferred tax assets will be fully realizable. Accordingly, the Company has recorded a valuation allowance equal to the amount of its net deferred tax assets. However, as the Company continues to generate future taxable income, the valuation allowance will be reviewed, which could result in a material income tax benefit being recorded in the statement of operations.
NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The reconciliation of the U.S. federal statutory tax rate to the Company's effective tax rate for the year ended June 30, 2004 is as follows:
U.S. federal statutory rate 34.0% Change in valuation allowance (40.0) State income taxes, net 3.7 Nondeductible expenses 5.0 Other 3.4 ------- Effective income tax rate 6.1% =======
For the year ended June 30, 2004 the Company's current provision for income taxes was reduced by $1,014 as the result of the utilization of net operating loss carryforwards.
At June 30, 2004, the Company had net operating loss carryforwards for Federal income tax purposes of approximately $95.8 million, which expire in varying amounts between 2007 through 2024 as follows:
Years of Expiration ---------- 2007 - 2011 $ 4,946 2012 - 2016 18,733 2017 - 2021 58,928 Thereafter 13,174 ------------ $ 95,781 ============
During the year ended June 30, 2004, the Company's valuation allowance was reduced by $931.
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, -------------------- 2005 $ 4,553 2006 3,910 2007 3,228 2008 2,383 2009 1,540 Thereafter 1,003 --------- $ 16,617 =========
Total rental costs under non-cancelable operating leases were approximately $5,336, $5,344 and $5,130 in 2004, 2003 and 2002, 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, 2004, 2003 and 2002 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, 2004, nor were there any customers that accounted for greater than 5% of total accounts receivable at June 30, 2004 or 2003.
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.
NOTE 13 - COMMITMENTS AND CONTINGENCIES
In May 1997, the Company entered into an exclusive 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
NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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 TRANSACTIONS
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 2004, 2003 and 2002, were $117, $184, and $140, respectively.
In connection with the Refinancing described in Note 6, 55,000 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 Craig L. Burr, a Director of the Company, and one of the purchasers of the New Notes, an affiliate of Mr. Burr's. Such warrants were exercised in May 2004.
In connection with the Refinancing described in Note 6, 250,000 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). Richard D. Waters, Jr., a Director of the Company, is an affiliate of J.P. Morgan Partners (BHCA), L.P.
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, -------------- 2004 2003 ------- -------- Cash and cash equivalents $ 505 $ 455 Accounts receivable 6,141 6,217 Accounts payable and accrued expenses 7,996 7,603 Long-term debt, including current maturities 37,010 30,953 Subordinated debt 29,163 39,576 Fair value of swap - asset/(liability) 87 (129)
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NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE 16 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter ----------- ----------- ----------- ----------- 2004 2003 2004 2003 2004 2003 2004 2003 ---- ---- ---- ---- ---- ---- ---- ---- Total revenues (a) $ 20,238 $ 18,678 $ 19,454 $ 18,101 $ 20,072 $ 18,340 $ 21,072 $ 19,290 Gross profit (a) 10,784 9,535 10,688 9,390 11,084 9,591 12,052 10,333 Operating income (loss) 2,442 (118) 2,824 (384) 3,229 1,046 3,915 2,004 Net income (loss) (a)(b) (1,419) (2,110) 774 (2,314) 1,072 (777) 1,753 262
Earnings (loss) per share: Basic $ (0.15) $ (0.24) $ 0.05 $ (0.23) $ 0.08 $ (0.09) $ 0.14 $ 0.01 Diluted $ (0.15) $ (0.24) $ 0.05 $ (0.23) $ 0.07 $ (0.09) $ 0.13 $ 0.01
(a) As discussed in Note 1(j), the Company elected to apply EITF 00-21 retroactively to all budget plan agreements in existence as of July 1, 2003. While the adoption of EITF 00-21 would have had no material effect on aggregate revenues and net loss for the years ended June 30, 2003 and 2002, had the EITF been applied retroactively the effect of adopting EITF 00-21 in the manner described in Note 1(j) prior to July 1, 2003, would have resulted in a change in revenues, gross profit, operating income, net loss and loss per share during the quarterly periods presented above. Solely for comparative purposes, the following table presents the Company's quarterly results of operations to reflect the impact of EITF 00-21 during the periods presented:
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter ----------- ----------- ----------- ----------- 2004 2003 2004 2003 2004 2003 2004 2003 ---- ---- ---- ---- ---- ---- ---- ---- Total revenues $ 20,238 $ 19,085 $ 19,454 $ 17,944 $ 20,072 $ 18,035 $ 21,072 $ 19,345 Gross profit 10,784 9,942 10,688 9,233 11,084 9,286 12,052 10,388 Operating income (loss) 2,442 289 2,824 (541) 3,229 741 3,915 2,059 Net income (loss) (1,419) (1,703) 774 (2,471) 1,072 (1,082) 1,753 317
Earnings (loss) per share: Basic $ (0.15) $ (0.19) $ 0.05 $ (0.25) $ 0.08 $ (0.12) $ 0.14 $ 0.02 Diluted $ (0.15) $ (0.19) $ 0.05 $ (0.25) $ 0.07 $ (0.12) $ 0.13 $ 0.02
(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 to beginning of costs and Charged to Balance at period expenses other accounts Deductions end of period ------ -------- -------------- ---------- -------------- 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 Year ended June 30, 2004 Allowance for doubtful accounts $2,299 $ 316 $ -- $ 520 $2,095