ITEM 1. BUSINESS
General
On December 31, 2006, the Company changed its name from Edgen Corporation to Edgen Murray Corporation and merged its U.S. subsidiaries, Edgen Carbon Products Group, L.L.C and Edgen Alloy Products Group, L.L.C. into Edgen Murray Corporation. The Company’s Canadian subsidiary, Edgen Canada Inc., changed its name to Edgen Murray Canada Inc. Unless otherwise provided in this report, references to “we,” “us,” and “our Company” refer to Edgen Murray Corporation and its consolidated subsidiaries.
We are a distributor and marketer of high performance steel products for use primarily in specialized applications in the energy infrastructure market primarily in North and South America. The products we sell are generally highly engineered prime carbon or alloy steel pipe, pipe components and high grade structural sections and plates, which are designed to withstand the effects of corrosive or abrasive materials and possess performance characteristics required in extreme operating conditions, including high pressure and high/low temperature environments.
We distribute products and provide comprehensive procurement and project management solutions to our customers, primarily in North and South America, on projects spanning the complete lifecycle of the energy infrastructure market, including exploration and production, new rig construction, gathering and transmission, refining and processing, power generation, petrochemical and maintenance, repair and operations (MRO). We believe our sales and distribution network enables us to efficiently procure and deliver these high performance products to customers who may not have the relationships, resources or logistical support or who may not be willing or able to purchase in sufficient volume or on a cost-effective basis to complete procurement independently for their projects. Our customers are principally end-users that operate in or service the energy infrastructure market and providers of MRO products.
We provide our customers with complete logistical support for their projects, including inventory management and just-in-time product delivery on a worldwide basis. We maintain a broad product offering, and we manage a large inventory of components, pipes, plates, and sections. As a result, we are able to supply products that are not generally otherwise available to our customers on a quick-response basis or that cannot be purchased in the smaller quantities needed by customers for specific projects. We also provide additional support for our vendors including sales, marketing and credit functions with respect to the products we distribute.
We employ experienced local market specialists and sales personnel throughout our geography, many of whom have technical backgrounds, training or relevant industry experience. Our sales personnel provide value-added customer support, including, technical consultation on product selection and integration in large, complex projects. In addition to the comprehensive knowledge of our products and the industries we supply, our local market personnel understand the characteristics of the different geographies they serve.
We are headquartered in Baton Rouge, Louisiana and we currently operate in 17 locations, including 15 in the United States and two in Canada. Fourteen of our locations currently stock inventory for distribution. During 2006, we had two operating segments-our alloy products group and our carbon products group. For the year ended December 31, 2006, our total sales were $397.7 million, and our sales for our alloy products group and our carbon products group were $114.6 million and $283.1 million, respectively. For the combined twelve months ended December 31, 2005, our total sales were $281.7 million, and our sales for our alloy products group and our carbon products group were $76.6 million and $205.1 million, respectively. For an explanation of combined results, see “Item 7. Management Discussion and Analysis of Financial Condition and Results of Operations-Predecessor and Successor.” For additional financial information concerning the Company’s operating segments and within geographical areas, see Note 12 to our audited consolidated financial statements included elsewhere in this report.
We are a Nevada corporation. We were founded in 1983 as Thomas Pipe and Steel, Inc. and have grown through various acquisitions since 1996. Our principal offices are located at 18444 Highland Road, Baton Rouge, Louisiana 70809. Our telephone number is (225) 756-9868. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports are available free of charge at the Securities and Exchange Commission’s (“SEC”) website at www.sec.gov.
Key Products, Services and Markets
We principally distribute two categories of products: alloy products and carbon products.
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Alloy steel is composed of iron, carbon and one or more other elements (such as chromium, cobalt, nickel and molybdenum) that undergo a special heat treatment to achieve specific physical properties. Our alloy-based products are primarily specialty pipes, fittings and flanges principally used in high-pressure, extreme temperature and high-corrosion applications, such as in heating, desulphurization, refrigeration and liquefied natural gas units in the processing and refining industries, and in heat recovery steam generation units in the power generation industry. Substantially all of our alloy products are purchased from manufacturers located in Germany, Italy, South Korea or Japan.
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Our carbon-based products are primarily specialty pipe, plates, sections, fittings and flanges and other steel products principally used in high-yield, high-tensile, abrasive applications such as the gathering and transmission of oil, natural gas and phosphates, conductor casing and structural supports for the offshore drilling and production segment of the oil and gas industry. Our carbon products are purchased from manufacturers located worldwide, including the United States.
We also offer a wide range of cutting and finishing services for our products, primarily through third-party service providers.
The following table summarizes our primary product offerings:
Summary of Primary Distributed Products
Product
Characteristics
Material
Qualities
Primary Applications
Alloy Products
Stainless
Seamless
12-16% chromium,
8- 12% nickel
Corrosion resistance
Refining, petrochemical and power
Duplex
Seamless
20% chromium
Higher corrosion resistance
Refining, petrochemical and power
ChromeMoly
Seamless
Chromium and molybdenum
High temperature and pressure tolerance
Refining, petrochemical and power
Nickel Alloys
Seamless
High nickel
High temperature and highest corrosion resistance
Refining, petrochemical and power
Carbon Products
Carbon
Welded and seamless
< 1% carbon
High and low pressure tolerance
Mechanical construction, certain processing
Large Diameter Carbon
Welded, thicker walled
< 1% carbon
High structural strength
Offshore jacket and topside and onshore structural, marine riser and conductor, booster line and annulus pipe
High Yield Carbon
Welded or seamless, thinner walled
Carbon and alloys
Lighter weight, high bursting strength
Gathering and transmission pipelines
Section
Seamless and welded
Carbon
High yield and various thickness, lengths and widths
Offshore topside and onshore structural
Plate
Seamless and welded
Carbon
High yield and various thickness, lengths and widths
Offshore jacket and topside and onshore structural
Tubulars
Seamless and welded
Carbon
High yield and various thickness, lengths and widths
Offshore jacket and topside and onshore structural, marine riser and conductor, booster line and annulus pipe
In addition to our product offerings, we provide technical consultation in areas such as design efficiency and logistics which are valued by our customers.
Customers
We market our products to a diverse base of customers, whose operations are in geographic locations around the world, principally North and South America, and who participate in all sectors of the energy industry. Our customers are generally large, well-capitalized companies that are recognized as leaders in their respective industries. Our customers include engineering and construction firms, equipment fabricators, multi-national major integrated oil and gas companies, independent oil and gas companies, natural gas transmission and distribution companies, petrochemical companies, mining companies, oil sands developers, power generation companies and utilities, alternative energy providers, and certain integrated MRO distribution companies. Our top ten customers accounted for approximately 28% of our total sales for the year ended December 31, 2006.
We supply specialized steel products to fabricators and contractors engaged in the development of new energy infrastructure projects and the maintenance of existing facilities. We also supply products for ongoing MRO projects to other distributors and the ultimate owners and operators of these facilities, including major oil and independent exploration and production companies, gas transmission companies, independent refiners, petrochemical manufacturers and ethanol producers. The alloy-based specialty pipes, fittings and flanges that we distribute and market are principally used in high-pressure, extreme temperature and high-corrosion applications in the process and power generation industries. The carbon-based products that we distribute and market, including prime carbon specialty pipes, fittings and flanges, high grade structural steel products, steel tubes, plates and sections, are principally used in high-yield, high-tensile applications in the oil and gas exploration and production, gathering and transmission, crude oil refining and the energy processing and power generation industries.
Vendors
We have mutually beneficial, longstanding relationships with an established network of vendors. This extensive network of vendor relationships enables us to stock and distribute a considerable breadth of products. Although we concentrate our purchasing power on a select group of highly valued vendors, we have multiple sources for the products we distribute and are not dependent on any single manufacturer. For the year ended December 31, 2006, approximately 55% of our purchases were from our top ten vendors. Consolidating our purchasing power has resulted in favored status with certain of our vendors in regard to lead times, discounts and payment terms. As we continue to strengthen our vendor relationships, we are able to devote increased resources to providing our customers with products that are of greater importance to their businesses and have fewer substitutes.
Our two product groups each have employees who are responsible for making the inventory purchases for their respective groups. These employees are specialists in their product lines and are in continuous contact with our regional managers, sales personnel and customers in our various markets in order to anticipate demand. This enables them to place vendor orders, which often require six to nine months lead time to fill, in a timely manner. Our purchasing staff develops and evaluates our working relationships with vendors to ensure availability, quality and timely delivery of products. We use general economic indicators, inquiries, orders and continuous interaction with our customers to help us determine customer usage patterns, expected delivery dates and the nature of active projects in the market. Our company-wide management information system assists in evaluating historical usage, the inventory at each of our locations, and other purchasing data.
Sales and Marketing
Our sales force operates under a regional branch model. The regional managers employ a mix of district managers and inside and outside sales representatives in their respective territories. The sales representatives are located at various branch locations and are responsible for order solicitation, account and relationship management and market development. The regional managers have responsibility for pricing, order placement and fulfillment, customer service, business development and marketing strategies. In select markets, we contract with agents to market and sell our products. Where agents are used, negotiation and agreement on sales terms is managed by the respective regional manager. Regional managers report to the Americas President who has final authority on all sales and marketing issues. The regional branch model allows the President to have direct control over the management and implementation of our sales and marketing strategy.
The sales force is assisted by a product management team that is responsible for procurement, pricing, product forecasting and vendor development. These teams are organized in a fashion that supports the regional managers in their sales efforts.
Intellectual Property
We have common law trademark rights to a number of names and marks important to our business, including Edgen™, Bartow Steel™, Resource Pipe Co.™, SISCO™, Thomas Pipe™, Pro Metals™, and Radnor Alloys™, although we have not obtained federal registrations for them. We have entered into licensing arrangements with the owners of intellectual property rights used by our business that are not owned by us.
Employees
As of December 31, 2006, our workforce consisted of 260 full time employees, of which 82 were warehouse personnel, 92 were sales personnel and 86 were administrative and support personnel. We have a non-unionized workforce, and none of our full-time employees are covered by a collective bargaining agreement. In general, we consider our employee relations to be good.
Competition
Our products are sold in highly competitive markets. Companies in the steel pipe, pipe components, and high grade structural steel industry compete primarily on price and ability to deliver products in a timely manner. Purchase decisions are also influenced by previous experience with a particular distributor and by a distributor’s ability to supply the full range of pipes, pipe components, plates and sections.
Our primary competitors are numerous smaller, privately-owned regional distributors and subsidiaries of large publicly-held companies. We believe that none of our competitors offer the depth and breadth of products in stock that we offer in any particular market. Although we have competitors with respect to many of the specific products we offer in specific markets and who may be larger and have greater resources than we do, we believe that no competitor or small group of competitors is dominant in any of our markets. While we must be price competitive in all of our markets, we believe that our customers select our products based on local leadership, the product knowledge of the staff, and our broad product offering of specialty products.
Environmental Matters
Our operations are subject to various state and federal laws and regulations relating to environmental concerns. As with other companies engaged in like businesses, the nature of our operations expose us to the risk of liabilities or claims with respect to environmental matters, including those relating to the disposal and release of hazardous substances. In addition, our operations are also governed by laws and regulations relating to workplace safety and worker health which, among other things, regulate employee exposure to hazardous chemicals in the workplace. Management believes that our operations are in substantial compliance with such laws and regulations applicable to us.
We have not made any material expenditures during the last three fiscal years in order to comply with environmental laws or regulations. Based on our experience to date, we believe that the future cost of compliance with existing environmental laws and regulations (and liability for known environmental conditions) will not have a material adverse effect on our business, consolidated financial condition, results of operations or liquidity. However, we cannot predict what environmental or health and safety legislation or regulations will be enacted in the future or how existing or future laws or regulations will be enforced, administered or interpreted, nor can we predict the amount of future expenditures that may be required in order to comply with such environmental or health and safety laws or regulations or to respond to such environmental claims.
Seasonality
Some of our customers may be in seasonal businesses, especially those customers who purchase our products for use in new capital expenditure projects at refineries, oil and gas infrastructures and processing and power generation plants. As a consequence, our results of operations and working capital, including our accounts receivable, inventory and accounts payable, fluctuate during the year. However, because of our geographic, product and customer diversity, our operations have not shown any material seasonal trends. We believe that our significant operations in the milder southern climates moderate our seasonality. In addition, our sales to MRO distributors, who tend not to be seasonal purchasers, mitigate the overall effects of seasonality on our business. Sales in the months of November and December traditionally have been lower than in other months because of a reduced number of working days for shipments of our products and holiday closures for some of our customers. We cannot assure you that period-to-period fluctuations will not occur in the future. Results of any one or more quarters are, therefore, not necessarily indicative of annual results.
Working Capital Practices
Volatility in the specialty pipe, pipe components, and high grade structural steel industry, from time to time, can result in significant fluctuations in cash flow supporting our working capital levels. Inventory and accounts receivable comprise a large percentage of our total assets and can vary significantly from quarter to quarter. At December 31, 2006 and 2005, inventory and accounts receivable represented 66.2% and 59.6%, respectively, of total assets excluding cash. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.”
ITEM 1A.
ITEM 1A. RISK FACTORS
Our results of operations and financial condition can be adversely affected by numerous risks. You should carefully consider the risk factors detailed below in conjunction with the other information contained in this report. If any of the following risks actually occur, our business, financial condition, operating results, cash flows and/or future prospects could be materially adversely affected.
Volatility in the global energy infrastructure market, and in particular oil and gas prices and refining margins and the possibility of decline in oil and gas prices from recent historical highs, could reduce demand for our products, which could cause our sales to decrease.
Proceeds from the sale of specialty steel pipe, pipe components and high grade structural steel sections and plates to the global energy infrastructure market constitute a significant portion of our sales. As a result, we depend upon the global energy infrastructure market, and in particular the oil and gas and refining industries, and the ability and willingness of industry participants to make capital expenditures to explore for, develop and produce, transport, process and refine oil and gas. If these expenditures decline, our business will suffer. The industry’s willingness to explore, develop, produce, transport, process and refine depends largely upon the availability of attractive drilling prospects and the prevailing view of future oil and gas prices and refinery margins and general economic conditions. Recent high prices of oil and gas have increased capital expenditures for new projects and upgrading existing facilities in the industries we service. Oil and gas prices have been at historic highs, but have recently declined and may decline further. Lower oil and gas prices may diminish expenditures for energy infrastructures and the demand on our steel products. Many factors affect the supply and demand for oil and gas and refined products and, therefore, influence our product prices, including:
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the level of domestic and worldwide oil and natural gas production;
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the level of domestic and worldwide supplies of, and demand for, oil and natural gas and refined products;
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the expected cost of delivery of new reserves;
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the availability of attractive oil and gas fields for production, which may be affected by governmental action or environmental policy and which may restrict drilling prospects;
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domestic and worldwide refinery overcapacity or undercapacity and utilization rates;
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changes in the cost or availability of transportation infrastructure;
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levels of drilling activity;
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national, governmental and other political requirements, including the ability of the Organization of the Petroleum Exporting Countries (“OPEC”) to set and maintain production levels and pricing;
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the impact of political instability or armed hostilities involving one or more oil and gas producing nations;
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pricing and other actions taken by competitors that impact the market;
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failure to implement successfully planned capital projects or to realize the benefits expected for those projects;
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changes in fuel specifications required by environmental and other laws, particularly with respect to oxygenates and sulfur content;
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aggregate refinery capacity to convert heavy sour crude oil into refined products;
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the cost of developing alternate energy sources;
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domestic and foreign governmental regulations, especially environmental regulations, trade laws and tax policies; and
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the overall global economic environment.
Oil and gas prices and processing and refining margins have been and are expected to remain volatile. This volatility causes our customers to change their strategies and expenditure levels. We have experienced in the past, and we may experience in the future, significant fluctuations in operating results based on these changes. In particular, such volatility in the oil and gas and refined products margins and markets more generally could adversely affect our business, consolidated financial condition, results of operations and liquidity.
In addition, certain growth opportunities in our industry are influenced by large projects, such as the Rockies Express Pipeline project and the Alaska Pipeline project. We are currently a supplier to the Rockies Express Pipeline project. The Alaska Pipeline project has not been approved, and bids have not been requested. There are no assurances that any of the Alaska Pipeline project or other large infrastructure projects will materialize or that we will be selected as a supplier.
Supply of steel and the price we pay for steel pipe and components and high grade structural steel products may fluctuate due to a number of factors beyond our control, which could adversely affect our operating results.
We purchase large quantities of steel that we sell to a variety of end-users, who are primarily involved in servicing the energy infrastructure market and providers of MRO products. The prices we pay for these products and the prices we charge for our products may change depending on many factors outside of our control, including general economic conditions, competition, production levels, import duties and other trade restrictions, currency fluctuations and surcharges imposed by our vendors. We seek to maintain our profit margins by attempting to increase the price of our products in response to increases in the prices we pay for our inventories. If, however, we are unable to pass on higher costs to our customers in a timely manner, or not at all, or if our supply of products is delayed or curtailed, this could have a material adverse effect on our business, financial condition, results of operations and liquidity. Alternatively, significant steel price decreases could have a material adverse effect on our business, financial condition, results of operation and liquidity if decreases in steel prices necessitate us to reduce product pricing, especially to the extent inventory has been purchased by us prior to the steel price decreases.
Our business is sensitive to economic downturns, which could cause our revenues to decrease.
The demand for our products is dependent on the general economy, the oil and gas, processing and power generation industries and other factors. Downturns in the general economy or in the oil and gas, processing or power generation industries can cause demand for our products to materially decrease. In 2003, the specialty pipe, sections, plates and pipe components industry experienced softness principally due to weak economic conditions in general and reduced spending on expansion and development projects by end-users. During 2003, we experienced a significant decline in sales and profitability, primarily as a result of a severely depressed power generation market and reduced spending in the processing and oil and gas industries, and an internal decision to liquidate inventory of certain low-margin products. In addition, if we are not adequately able to predict demand or if our inventories (or the inventories of manufacturers, other distributors or our customers) become excessive, there could be a material adverse effect on price levels for our products, the quantity of products sold by us and our revenues.
Significant competition from a number of companies could reduce our market share and have an adverse effect on our selling prices and sales volumes.
We operate in a highly competitive industry and compete against a number of companies, some of which have significantly greater financial, technological and marketing resources than we do. We believe that our ability to compete depends on high product performance, short lead-time and timely delivery, competitive pricing and superior customer service and support. We might be unable to compete successfully with respect to these or other factors. If we are unsuccessful, we could lose market share to our competitors. Moreover, actions by our competitors could have an adverse effect on our selling prices and sales volume.
The development of alternatives to specialty pipe and components and high grade structural steel product distributors in the supply chain could cause a decrease in our sales and operating results and limit our ability to grow our business.
If our customers were to decide to purchase products directly from manufacturers, it could negatively affect our sales and earnings. Customers would purchase from our vendors directly in situations where large orders are being placed and where inventory and logistics support planning are not necessary to the delivery. Our vendors also could expand their own local sales force and inventory stocking capabilities and sell more products directly to our customers. These or other actions that remove us from, or limit our role in, the distribution chain, may harm our competitive position in the marketplace and reduce our sales and earnings.
Increases in customer, manufacturer and distributor inventory levels could reduce our sales and profit.
Customer, manufacturer and distributor inventory levels of specialty pipe, plate, sections and pipe component products can change significantly from period to period. Increases in our customers’ inventory levels can have a direct adverse effect on the demand for these products when customers draw from inventory rather than purchase new products. Reduced demand, in turn, would likely result in reduced sales volume and overall profitability.
Increased inventory levels by manufacturers or other distributors can cause an oversupply of specialty products in our markets and reduce the prices that we are able to charge for our products. Reduced prices, in turn, would likely reduce our margins and overall profitability.
We rely on our information technology systems to manage numerous aspects of our business and customer and supplier relationships, and a disruption of these systems could adversely affect our business.
Our information technology (IT) system is an integral part of our business and growth strategies, and a serious disruption to our IT system could significantly limit our ability to manage and operate our business efficiently, which in turn could cause our business and competitive position to suffer and cause our results of operations to be reduced. We depend on our IT system to process orders, track credit risk and manage inventory and accounts receivable collections. Our IT system also allows us to efficiently purchase products from our suppliers and ship products to our customers on a timely basis, maintain cost-effective operations and provide superior service to our customers. While we have contingency plans in place in case of an emergency, we cannot assure you that the plans will allow us to continue to operate at our current level of efficiency.
Loss of third-party transportation providers upon whom we depend or conditions negatively affecting the transportation industry could increase our costs or cause a disruption in our operations.
We depend upon third-party transportation providers for delivery of products to our customers. Strikes, slowdowns, transportation disruptions or other conditions in the transportation industry, including, but not limited to, shortages of truck drivers, disruptions in rail service, increases in fuel prices and weather conditions, could increase our costs and disrupt our operations and our ability to service our customers on a timely basis. We cannot predict whether or to what extent recent increases or anticipated increases in fuel prices may impact our costs or cause a disruption in our operations going forward.
Loss of key suppliers or reduced product availability could decrease our sales and earnings.
For the year ended December 31, 2006, our ten largest suppliers accounted for approximately 55% of our purchases, and our single largest supplier accounted for approximately 8% of our purchases. The loss of any of these suppliers-or a reduction in purchases by us from these suppliers that results in the loss of volume discounts-could result in a decrease in our sales, operating results and earnings by decreasing the availability, or increasing the prices, of products we distribute, which could limit our ability to satisfy our customers’ product needs. Such reduced product availability could put us at a competitive disadvantage.
In addition, particular products or product lines may not be available to us, or available in quantities sufficient to meet our customer demand. A substantial decrease in the availability of these products or product lines could result in a decrease in our sales, operating results and earnings as we might not be able to satisfy our customer’s product needs. Such reduced product availability could put us at a competitive disadvantage.
Our ten largest customers account for a substantial portion of our sales and profits, and the loss of these customers could result in materially decreased sales and profits.
Our top ten customers accounted for approximately 28% of our overall sales for the year ended December 31, 2006, and one customer represented approximately 5% of total sales. While we generally have contracts with our major customers, these contracts generally may be discontinued with 30 days’ notice by either party, are not exclusive and do not require minimum levels of purchases. We may lose a customer for any number of reasons, including as a result of a merger or acquisition, contract expiration, the selection of another provider of our products, business failure or bankruptcy, or our performance. We may not retain long-term relationships or secure renewals of short-term relationships with our major customers in the future. If we were to lose major customers, our revenues and profits would materially decrease.
Our substantial indebtedness could adversely affect our financial condition and prevent us from fulfilling our obligations under our senior secured notes.
Our indebtedness is substantial. As of December 31, 2006, we had approximately $135.0 million of total indebtedness outstanding and had no borrowings under our revolving credit facility. We have the ability to borrow up to $20.0 million under our revolving credit facility. As a result, we are a highly leveraged company. This level of leverage could have important consequences including the following:
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it may be more difficult for us to satisfy our obligations under the senior secured notes and our other indebtedness (for example, we may not be able to pay interest or repurchase the senior secured notes when and if we are required to do so);
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a substantial portion of our cash flow from operations will be dedicated to the repayment of our indebtedness, which would reduce the funds available for operations, future business opportunities or other purposes;
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our ability to obtain additional debt or equity financing in the future to fund working capital, capital expenditures, acquisitions, general corporate or other purposes will be limited;
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our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate will be limited;
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we may be placed at a competitive disadvantage compared to those of our competitors who operate on a less leveraged basis; and
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we will be more vulnerable to adverse changes in economic and industry conditions.
In addition, the indenture governing the senior secured notes and our revolving credit facility contain restrictive covenants that may limit our ability to engage in activities that may be in our long-term best interests. Our failure to comply with those covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all of our indebtedness.
Despite existing debt levels, we may still be able to incur substantially more debt, which would increase the risks associated with our leverage.
We and our subsidiaries may be able to incur substantial amounts of additional debt in the future, including debt resulting from the issuance of additional senior secured notes and borrowings under our revolving credit facility. The terms of the indenture governing the senior secured notes limit our ability to incur additional debt but do not prohibit us from incurring substantial amounts of additional debt for specific purposes or under certain circumstances. As of December 31, 2006, we had the ability to borrow $20.0 million under our revolving credit facility, subject to the restrictions contained therein.
In addition, if we are able to designate some of our restricted subsidiaries under the indenture governing the senior secured notes as unrestricted subsidiaries, those unrestricted subsidiaries would be permitted to borrow beyond the limitations specified in the indenture and engage in other activities in which restricted subsidiaries may not engage. Adding new debt to current debt levels could intensify the leverage-related risks that we and our subsidiaries now face.
The indenture governing the senior secured notes and the instruments governing our other indebtedness, including our revolving credit facility, impose significant operating and financial restrictions on us that may prevent us from pursuing certain business opportunities and restrict our ability to operate our business.
The indenture governing the senior secured notes and our revolving credit facility contain covenants that restrict our ability and the ability of our subsidiaries to take various actions, such as the ability to:
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incur or guarantee additional indebtedness or issue certain preferred stock;
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make capital expenditures, investments or acquisitions;
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pay dividends, redeem subordinated indebtedness or make other specified restricted payments;
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issue capital stock of our restricted subsidiaries;
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create or incur liens;
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transfer or sell assets, including capital stock of our restricted subsidiaries;
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enter into certain transactions with our affiliates;
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incur dividend or other payment restrictions affecting our restricted subsidiaries; and
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consummate a merger, consolidate or sell all or substantially all of our assets.
Our ability to comply with these covenants can be affected by events beyond our control, including prevailing economic, financial and industry conditions, and we cannot assure you that we will satisfy those requirements. A breach of any of these covenants, or failure to meet or maintain ratios or tests could result in a default under the revolving credit facility and /or the indenture governing the senior secured notes. We cannot assure you that our assets would be sufficient to repay such amounts (including amounts due under the senior secured notes) in full. We may also be prevented from taking advantage of business opportunities that arise if we fail to meet certain financial ratios or because of the limitations imposed on us by the restrictive covenants under these instruments. In addition, upon the occurrence of an event of default under the revolving credit facility or the indenture governing the senior secured notes, the lenders could elect to declare all amounts outstanding under the revolving credit facility, together with accrued interest, to be immediately due and payable. If we were unable to repay those amounts, the lenders could proceed against the security granted to them to secure that indebtedness. If the lenders accelerate the payment of the indebtedness, our assets may not be sufficient to repay in full the indebtedness under our revolving credit facility and the senior secured notes.
The credit ratings assigned to our senior secured notes may be downgraded, which may negatively impact the value of or ability to transfer the notes.
The credit ratings assigned by Standard & Poor’s Ratings Group and/or Moody’s Investor Service, Inc. (the “Rating Agencies”) to our senior secured notes represent the opinion and assessment of the Rating Agencies of the credit quality of the senior secured notes and are not a guaranty of quality or a recommendation to buy, sell or hold the senior secured notes. Any ratings assigned by each Rating Agency to the senior secured notes reflect such Rating Agency’s assessment of the likelihood that holders of the senior secured notes will receive timely payments of interest and principal to which they are entitled. Such ratings do not constitute an assessment of the likelihood that principal prepayments (including those caused by defaults) on the senior secured notes will be made, the degree to which the rate of such prepayments might differ from that originally anticipated or the likelihood of early optional termination of the senior secured notes. Such ratings do not address the possibility that prepayment at higher or lower rates than anticipated by a holder of the senior secured notes may cause such holder to experience a lower than anticipated yield or that such holder might fail to recoup its initial investment under certain prepayment scenarios. Such ratings may be downgraded, qualified and/or withdrawn by the Rating Agencies from time to time if, in their judgment, circumstances in the future warrant such action. Any such downgrade, or any qualification or withdrawal, by one or both Rating Agencies may adversely affect the value of the senior secured notes and/or the ability of the holders of the senior secured notes to transfer the senior secured notes to certain investors.
In December 2005, we were notified by Standard & Poor’s of a change in their methodology used to assess the credit rating of bonds, and as a result, the credit rating assigned to our senior secured notes was downgraded by Standard and Poor’s from B-1 to CCC+ in December 2005. There was no change in Moody’s bond credit rating of B3 in 2005. Holders of the senior secured notes are advised to consult with their advisors regarding the effect that a downgrade, qualification or withdrawal of the credit ratings on the senior secured notes may have on the holder’s ability to continue to hold or invest in such senior secured notes.
We may need additional capital in the future, and it may not be available on acceptable terms.
We may require more capital in the future to:
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fund our operations;
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finance investments in equipment and infrastructure needed to maintain and expand our distribution capabilities;
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enhance and expand the range of products we offer; and
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respond to competitive pressures and potential strategic opportunities, such as investments, acquisitions and international expansion.
We cannot assure you that additional financing will be available on terms favorable to us, or at all. The terms of available financing may place limits on our financial and operating flexibility. If adequate funds are not available on acceptable terms, we may be forced to reduce our operations or delay, limit or abandon expansion opportunities. Moreover, even if we are able to continue our operations, the failure to obtain additional financing could reduce our competitiveness as our competitors may provide better maintained networks or offer an expanded range of services.
Risks generally associated with acquisitions, including identifying and integrating future acquisitions, could adversely affect our business.
An important element of our growth strategy has been and is expected to continue to be the pursuit of acquisitions of other businesses that either expand or complement our existing product lines. We cannot assure you, however, that we will be able to identify additional acquisitions or that we would realize any anticipated benefits from such acquisitions. Integrating businesses involves a number of special risks, including the possibility that management may be distracted from regular business concerns by the need to integrate operations, unforeseen difficulties in integrating operations and systems, problems concerning assimilating and retaining the employees of the acquired business, accounting issues that arise in connection with the acquisition, challenges in retaining customers and potential adverse short-term effects on operating results. Acquired businesses may require a greater amount of capital, infrastructure or other spending than we anticipate. In addition, we may incur debt or issue securities to finance future acquisitions, which could adversely affect our ability to fulfill our obligations under our senior secured notes. We cannot assure you that we will be successful in consummating future acquisitions on favorable terms or at all. If we are unable to successfully complete and integrate strategic acquisitions in a timely manner, our growth strategy could be adversely impacted.
Disruptions in the political and economic conditions of the foreign countries in which we purchase and/or distribute our products could adversely affect our business.
We distribute our products internationally, including to Canada, Mexico, and South America. In addition, substantially all of our alloy products are imported from international markets such as Germany, Italy, Japan and South Korea, and we also purchase a portion of our carbon products from abroad. International distribution increases our exposure to risks of war, terrorist attacks, local economic conditions, political disruption, civil disturbance and governmental policies that may:
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disrupt our purchasing and/or distribution capabilities;
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restrict the movement of funds or limit repatriation of profits;
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lead to U.S. government or international sanctions; and
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limit access to markets for periods of time.
Hurricanes or other adverse weather events could negatively affect our local economies or disrupt our operations, which could have an adverse effect on our business or results of operations.
Our market areas in the southeastern United States are susceptible to hurricanes. Such weather events can disrupt our operations, result in damage to our properties and negatively affect the local economies in which we operate. Additionally, we may experience communication disruptions with our customers, suppliers and employees. In late August 2005 and September 2005, Hurricanes Katrina and Rita struck the gulf coast of Louisiana, Mississippi, Alabama and Texas and caused extensive and catastrophic physical damage to those market areas. As a result of Hurricanes Katrina and Rita, our Louisiana and Texas locations sustained minor physical damage and were closed for a minimal number of days to secure our employees. Additionally, our sales order backlog and shipments experienced a temporary decline immediately following the hurricanes.
We cannot predict whether or to what extent damage caused by future hurricanes will affect our operations or the economies in those market areas. Such weather events could result in disruption of our purchasing and/or distribution capabilities, interruption of our business that exceeds our insurance coverage, our inability to collect
from customers and increased operating costs. Our business or results of operations may be adversely affected by these and other negative effects of hurricanes or other adverse weather events.
If we are unable to retain our key management personnel, our growth and future success may be impaired and our financial condition could suffer as a result.
Our success depends to a significant degree upon the continued contributions of senior management, certain of whom would be difficult to replace. The departure of our executive officers could have a material adverse effect on our business, financial condition or results of operations. We maintain key-man life insurance on the President of the Company. We cannot assure you that the services of such personnel will continue to be available to us. See “Item 10. Directors and Executive Officers of the Registrant.”
We might be unable to employ and retain a sufficient number of sales and customer service personnel.
Many of our customers require products that are complex, highly engineered and often must be able to perform in harsh conditions. We believe that our success depends upon our ability to employ and retain qualified sales and service personnel with the ability to understand our products and provide tailored product solutions to our customer base. A significant increase in the wages paid by competing employers could result in a reduction of our skilled labor force, increases in the wage rates that we must pay or both. If either of these events were to occur, our cost structure could increase and our growth potential could be impaired.
We are subject to environmental laws and regulations relating to hazardous materials, substances and waste used in or resulting from our operations. Liabilities or claims with respect to environmental matters could have a significant negative impact on our business.
Our operations are also governed by laws and regulations relating to workplace safety and worker health which, among other things, regulate employee exposure to hazardous chemicals in the workplace. As with other companies engaged in like businesses, the nature of our operations expose us to the risk of liabilities or claims with respect to environmental matters, including those relating to the disposal and release of hazardous substances. Such liabilities or claims, if incurred, could be material.
Based on our company’s experience to date, we believe that the future cost of compliance with existing environmental laws and regulations (and liability for known environmental conditions) will not have a material adverse effect on our business, financial condition or results of operations. We cannot predict, however, what environmental or health and safety legislation or regulations will be enacted in the future or how existing or future laws or regulations will be enforced, administered or interpreted. Nor can we predict the amount of future expenditures that may be required in order to comply with such environmental or health and safety laws or regulations or to respond to such environmental claims.
We may not have adequate insurance for potential liabilities.
Our products are sold primarily for use in the oil and gas, processing and power generation industries, which are subject to inherent risks that could result in death, personal injury, property damage, pollution or loss of production. In addition, defects in our products could result in death, personal injury, property damage, pollution or damage to equipment and facilities. Actual or claimed defects in the products we distribute may give rise to claims against us for losses and expose us to claims for damages. Our insurance may be inadequate or unavailable to protect us in the event of a claim or our insurance coverage may be canceled or otherwise terminated. We face the following additional risks under our insurance coverage:
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we may not be able to continue to obtain insurance on commercially reasonable terms or at all;
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we may be faced with types of liabilities that will not be covered by our insurance, such as damages from environmental contamination or terrorist attacks;
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the dollar amount of any liabilities may exceed our policy limits; and
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we may incur losses from interruption of our business that exceed our insurance coverage.
Even a partially uninsured claim, if successful and of significant size, could have a material adverse effect on our business, consolidated financial condition, results of operations or liquidity.
We are subject to litigation risks that may not be covered by insurance.
In the ordinary course of business, we become the subject of various claims, lawsuits and administrative proceedings seeking damages or other remedies concerning our commercial operations, products, employees and other matters, including occasional claims by individuals alleging exposure to hazardous materials as a result of our products or operations. Some of these claims relate to the activities of businesses that we have sold, and some relate to the activities of businesses that we have acquired, even though these activities may have occurred prior to our acquisition of such businesses. We maintain insurance to cover many of our potential losses, and we are subject to various self-retentions and deductibles under our insurance. It is possible, however, that a judgment could be rendered against us in cases in which we could be uninsured and beyond the amounts that we currently have reserved or anticipate incurring for such matters.
The ownership and control of our Company and MIM UK by a single holding company may result in conflicts of interest between our Company and MIM UK.
We are a wholly owned subsidiary of Edgen/Murray, L.P., which also owns Murray International Metals, Ltd. (“MIM UK”). The ownership of our Company and MIM UK by a single holding company may result in conflicts of interest between MIM UK and our Company. For example, Edgen/Murray, L.P. may cause MIM UK to pursue opportunities that would be attractive to us. If such potential opportunities were diverted from our Company to MIM UK, our business, financial condition and results of operations could be adversely affected. Additionally, our CEO and CFO are officers of Edgen/Murray, L.P. As officers of Edgen/Murray, L.P., our CEO and CFO have substantial responsibilities in connection with the management of the business and operations of Edgen/Murray, L.P., which may lead to the diversion of their time and resources from the day-to-day business and operations of our Company. If our CEO or CFO is unable to devote sufficient time and resources to our Company, our business, financial condition or results of operations could be adversely affected.
We are controlled by parties whose interests may not be aligned with yours.
Funds managed by JCP currently control Edgen/Murray, L.P., our parent holding company. Accordingly, JCP has and will continue to have, by virtue of the ownership interests of these funds and the terms of the limited partnership agreement of Edgen/Murray, L.P., significant influence over our management, and the ability to elect our board of directors and to determine the outcome of any other matter submitted for shareholder approval, including the power to determine the outcome of all corporate transactions, such as mergers, consolidations and the sale of all or substantially all of our assets. The interests of JCP may differ from the interests of our noteholders, and as such JCP may take actions that may not be in their interest. For example, if we encounter financial difficulties or are unable to pay our debts as they mature, the interests of JCP might conflict with the interests of our noteholders. In addition, JCP may have an interest in pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, could enhance its equity investment, even though such transactions might involve risks to the holders of our senior secured notes.
Compliance with regulation of corporate governance and public disclosure will result in additional expenses.
Keeping abreast of, and in compliance with, laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002 and new SEC regulations will require a significant amount of management attention and external resources. We intend to invest all reasonably necessary resources to comply with evolving standards, and this investment will result in increased general and administrative expenses and a diversion of management time and attention from revenue generating activities to compliance activities.
Our internal controls over financial reporting may not be effective and our independent registered public accounting firm may not be able to certify as to their effectiveness, which could have a significant and adverse effect on our business and reputation.
We are evaluating our internal controls over financial reporting in order to allow management to report on, and our independent registered public accounting firm to attest to, our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002, as amended, and rules and regulations of the SEC thereunder, which we refer to as “Section 404.” We are in the process of documenting and testing our internal control procedures to satisfy the requirements of Section 404, which requires annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent registered public
accountants addressing these assessments. During the course of our testing, we may identify deficiencies which we may not be able to remediate in time to meet the deadline imposed by the Sarbanes-Oxley Act for compliance with the requirements of Section 404. We expect that we will be required to comply with the requirements of Section 404 at December 31, 2007. In addition, if we fail to achieve and maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404. We cannot be certain as to the timing of completion of our evaluation, testing and any remediation actions or the impact of the same on our operations. If we are not able to implement the requirements of Section 404 in a timely manner or with adequate compliance, our independent registered public accounting firm may not be able to certify as to the effectiveness of our internal control over financial reporting and we may be subject to sanctions or investigation by regulatory authorities, such as the SEC. As a result, there could be a negative reaction in the financial markets due to a loss of confidence in the reliability of our financial statements. In addition, we may be required to incur costs in improving our internal control system and the hiring of additional personnel. Any such action could negatively affect our results of operations.
ITEM IB. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
As of March 29, 2007, we currently operate in 17 locations: 15 in the United States and two in Canada. These locations consist of inventory stocking facilities, sales offices, and administrative offices. We own facilities in Port Allen, Louisiana and Mulberry, Florida, and the rest of our locations are leased. Our corporate headquarters is located in an approximately 14,500 square-foot facility in Baton Rouge, Louisiana. The following table provides a summary of our facilities.
Summary of leased and owned facilities
(1) Our owned real property is pledged to secure indebtedness outstanding under our senior credit facility and our senior secured notes.
(2) Lease terminates in April 2007.
All of our facilities have been continually maintained, and we consider them to be in good repair. We currently do not expect to have any significant capital expenditures or upgrades in the near future. Our maintenance capital expenditures have averaged approximately $1.4 million over the past three years, and management expects annual capital expenditures to be consistent with historical capital expenditures in 2007 and 2008. None of our inventory stocking facilities is currently operating at or near capacity.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are from time to time a party to various claims and legal proceedings related to our business. There are no current material claims or legal proceedings pending against us that, in the opinion of our management, individually or in the aggregate, if determined adversely to us, would have a material adverse effect on our business, financial condition, results of operations or liquidity. Additionally, management is not aware of any legal issues that may have an adverse effect on us in the foreseeable future.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of fiscal 2006, no matters were submitted to a vote of stockholders through solicitation of proxies or otherwise.
Part II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
We are wholly-owned by Edgen/Murray, L.P., a limited partnership. There is currently no established public trading market for our common equity interests or for those of Edgen/Murray, L.P.
Holders
As of March 29, 2007, Edgen/Murray, L.P. was the sole record holder of our Common Stock, and there were 25 record holders of the common equity interests of Edgen/Murray, L.P.
Dividends
During 2006 and 2005, we did not pay any dividends on our common stock. Our ability to pay dividends is restricted by certain covenants contained in our senior credit facility, as well as certain restrictions contained in the indenture relating to the senior secured notes.
Securities Authorized For Issuance under Equity Compensation Plans
For information on securities authorized for issuance under equity compensation plans, see “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
In connection and simultaneously with the purchase of all of our capital stock by Edgen Acquisition Corporation and related financing transactions, on February 1, 2005, Edgen Corporation merged with Edgen Acquisition Corporation, with Edgen Corporation surviving the merger. In the table below, “Successor” refers to Edgen Corporation following the merger, and “Predecessor” refers to Edgen Corporation prior to the merger. The Successor conducted no operations from the date of formation of Edgen Acquisition Corporation until the merger on February 1, 2005.
Our selected statement of operations and balance sheet data for the fiscal years ended December 31, 2006 and 2005 (Successor) and December 31, 2004, 2003, and 2002 (Predecessor) have been derived from our audited consolidated financial statements.
Historical results presented below are not necessarily indicative of results of future operations, and the results for any interim period are not necessarily indicative of the results that may be expected for a full year. The selected financial data presented below should be read in conjunction with, and is qualified in its entirety by reference to, “Item 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward looking statements as a result of certain factors, including those set forth under the heading “Forward-Looking Statements” above and “Item 1A. Risk Factors.”
Prior to December 31, 2006, the Company was referred to as Edgen or Edgen Corporation. On December 31, 2006, the Company changed its name to Edgen Murray Corporation and merged its U.S. subsidiaries into Edgen Murray Corporation. The Company’s Canadian subsidiary, Edgen Canada Inc. changed its name to Edgen Murray Canada Inc. Unless otherwise provided below, references to “we,” “us,” and “our Company” refer to Edgen Murray Corporation and its consolidated subsidiaries. The following discussion should be read in conjunction with our consolidated financial statements and related notes thereto included elsewhere in this report.
General
Background
We are a distributor and marketer of high performance steel products for use primarily in specialized applications in the energy infrastructure market primarily in North and South America. The products we sell are generally highly engineered prime carbon or alloy steel pipe, pipe components and high grade structural sections and plates, which are designed to withstand the effects of corrosive or abrasive materials and possess performance characteristics required in extreme operating conditions, including high pressure and high/low temperature environments.
Operating segments
During 2006, we had two operating segments-our alloy products group and our carbon products group. Our alloy products group primarily distributes alloy based specialty pipes, fittings and flanges that are principally used in high-pressure, extreme temperature and high-corrosion applications in the process and power generation industries. Our carbon products group primarily distributes prime carbon specialty pipes, fittings and flanges and high grade structural steel products that are principally used in high-yield, high-tensile applications in the oil and gas, offshore construction and mining industries.
On December 31, 2006, the Company changed its name to Edgen Murray Corporation and merged its U.S. subsidiaries into Edgen Murray Corporation. The Company’s Canadian subsidiary, Edgen Canada Inc., changed its name to Edgen Murray Canada Inc. In connection with the merger, the Company’s parent company, Edgen/Murray, L.P., began managing the Company as its Americas segment with a single operating segment president. Edgen/Murray, L.P.’s other operating segments include the United Kingdom (Europe/West Africa), Singapore (Asia/Pacific) and the United Arab Emirates (Middle East). As a result, the Company intends to present financial information under one operating segment in 2007, the first period for which the Company will manage the Americas operating segment of Edgen/Murray, L.P.
Predecessor and successor
On December 31, 2004, Edgen Acquisition Corporation, a corporation newly formed by Jefferies Capital Partners (“JCP”), entered into a stock purchase agreement with Edgen Corporation and the stockholders of Edgen Corporation to purchase all of the outstanding capital stock of Edgen Corporation from its then existing stockholders for an aggregate purchase price of approximately $124.0 million, which included the assumption or repayment of indebtedness of Edgen Corporation but excluded payment of fees and expenses. The acquisition closed on February 1, 2005 and was funded with proceeds to Edgen Acquisition Corporation from the issuance and sale of $105.0 million 97/8% Senior Secured Notes 2011, which we refer to as the senior secured notes, as well as an equity investment from funds managed by JCP and certain members of management of Edgen Corporation. We refer to
these transactions collectively as the “Buy-out Transaction.” A discussion of our senior secured notes is included below under “-Liquidity and Capital Resources.”
Concurrent with the acquisition and the issuance of the senior secured notes, Edgen Corporation also entered into a new $20.0 million senior secured revolving credit facility, which we refer to as the revolving credit facility, and borrowed $2.7 million thereunder.
Simultaneous with the acquisition and the related financing transactions, Edgen Acquisition Corporation was merged with and into Edgen Corporation, which survived the merger and became liable for all obligations under the senior secured notes and borrowings under the revolving credit facility. Edgen Corporation following the merger is referred to as the “Successor.” Edgen Corporation prior to the merger is referred to as the “Predecessor.” Edgen Corporation subsequently changed its name to Edgen Murray Corporation on December 31, 2006.
In accordance with accounting principles generally accepted in the United States of America (“GAAP”), we have separated our historical financial results for the Predecessor and the Successor. The separate presentation is required under GAAP in situations when there is a change in accounting basis, which occurred when purchase accounting was applied to the acquisition of the Predecessor. Purchase accounting requires that the historical carrying value of assets acquired and liabilities assumed be adjusted to fair value, which may yield results that are not comparable on a period-to-period basis due to the different, and sometimes higher, cost basis associated with the allocation of the purchase price. Fair value purchase price adjustments consisted of a $2.0 million increase in inventory related to our alloy segment, a $1.9 million increase in land and buildings, a $24.2 million increase in customer relationships, a $2.4 million increase in tradenames, and a $22.0 million increase in goodwill. In addition, at the time of the acquisition of the Predecessor, we experienced changes in our business as a result of the Buy-out Transaction, which was consummated simultaneously with the acquisition of the Predecessor. There have been no material changes to the operations or customer relationships of our business as a result of the acquisition of the Predecessor.
In evaluating our results of operations and financial performance, our management has used combined results for the twelve months ended December 31, 2005 as a single measurement period. Due to the Buy-out Transaction, we believe that comparisons between the fiscal year ended December 31, 2004 and either the Predecessor’s results for the period from January 1, 2005 to January 31, 2005 or the Successor’s results for the period from February 1, 2005 to December 31, 2005 may impede the ability of users of our financial information to understand our operating and cash flow performance.
Consequently, to enhance an analysis of our operating results and cash flows, we have presented our operating results and cash flows on a combined basis for the twelve month period ended December 31, 2005. This combined presentation for the twelve month period ended December 31, 2005 simply represents the mathematical addition of the pre-merger results of operations of the Predecessor for the period from January 1, 2005 to January 31, 2005 and the results of operations of the Successor for the period from February 1, 2005 to December 31, 2005. The Successor conducted no operations from the date of formation of Edgen Acquisition Corporation until the merger on February 1, 2005. We believe the combined presentation provides relevant information for investors. These combined results, however, are not intended to represent what our operating results would have been had the Buy-out Transaction occurred at the beginning of the period. A reconciliation showing the mathematical combination of our operating results for such periods is included below under “-Results of Operations.”
Principal factors that affect our business
Our business is substantially dependent upon conditions in the energy industry and, in particular, capital expenditures by customers in the oil and gas exploration and production, gathering and transmission, crude oil refining and the energy processing and power generation industries. The level of energy-related capital expenditures generally depends on prevailing views of future oil, natural gas, refined products, electric power and petrochemical prices, which are influenced by numerous factors, including but not limited to:
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changes in U.S. and international economic conditions;
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demand for oil, natural gas, refined products, petrochemicals and electric power, particularly in the developed OECD markets and rapidly developing markets such as China and India;
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worldwide political conditions, particularly in significant oil-producing regions such as the Middle East, West Africa and Latin America;
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actions taken by OPEC;
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the availability and discovery rate of new oil and natural gas reserves in offshore areas;
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the cost of offshore exploration for, and production and transportation of, oil and natural gas;
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the ability of oil and natural gas companies to generate funds or otherwise obtain external capital for exploration, development and production operations;
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technological advances affecting energy exploration, production, transportation, storage and refining;
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the availability of offshore drilling rigs for exploration, appraisal and developmental drilling;
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the availability of infrastructure to efficiently transport natural gas from remote regions to points of consumption;
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the existence of capacity to process or upgrade heavy and sour grades of crude oil and bitumen;
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increases in power generation capacity in the U.S. and international markets;
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weather conditions;
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environmental or other government regulations; and
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tax policies.
Fluctuations in the costs of the products we supply are largely driven by changes in the condition of the general economy, changes in product inventories held by our customers, our vendors and other distributors and prevailing steel prices around the world. We have historically managed to successfully defend our profit margins by adjusting the prices we charge our customers to reflect variances in the cost of our products.
Revenue sources
We generate substantially all of our revenues from the sale of our products to third parties. Sales are reduced by returns and sales discounts and incentives provided to our customers. We recognize revenue on product sales when the customer takes title and assumes the risk of loss.
Principal costs and expenses
Our principal costs and expenses consist of the following: cost of sales (exclusive of depreciation and amortization), selling, general and administrative expenses, depreciation and amortization, and interest expense.
Our most significant cost is cost of sales (exclusive of depreciation and amortization), which includes the cost to purchase the products we distribute, freight in and freight out and services provided by third parties to prepare the product for sale. Our product costs are reduced by vendor discounts and purchase incentives. We buy and pay for most of our products on standard commercial terms (e.g., payment typically due within 30 to 60 days).
Selling, general and administrative expenses include sales and administrative employee compensation and benefit costs, as well as travel expenses for sales representatives, information technology infrastructure and communication costs, office rent and supplies, professional services, and other general corporate expenses. Selling, general and administrative expenses also include costs for warehouse personnel and benefits, supplies, equipment maintenance and rental and contract storage and distribution expenses.
Depreciation and amortization consists of amortization of acquired other intangible assets, including customer relationships and backlog, and the depreciation of property, plant and equipment including leasehold improvements, capitalized leases, and picking and lifting equipment.
Interest expense includes interest incurred on our indebtedness and amortization of deferred financing costs associated with such indebtedness.
Principal Cash Flows
We generate cash primarily from our operating activities, and historically we have used cash flows from operating activities, if positive, and our revolving credit facility as the primary sources of funds to purchase our inventory, fund working capital and capital expenditures, and make acquisitions.
Critical Accounting Policies
The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses in our consolidated financial statements. We base our estimates on historical experience and other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates under different circumstances or conditions. If actual amounts are ultimately different from these estimates, the revisions are included in our results of operations for the period in which the actual amounts become known.
We believe the following critical accounting policies and estimates affect our more significant judgments and estimates used in preparing our consolidated financial statements. (See Note 1 of the notes to our audited consolidated financial statements included elsewhere in this report for a summary of our significant accounting policies.)
Revenue recognition
Revenue is recognized on products’ sales when the customer takes title and assumes risk of loss. Revenue is recorded, net of discounts, sales incentives, value added tax and similar taxes as applicable in foreign jurisdictions. Rebates and discounts to customers are determined based on the achievement of certain agreed upon terms and conditions by the customer during each period.
Accounts receivable
We maintain an allowance for doubtful accounts to reflect our estimate of the uncollectibility of accounts receivable. Concentration of credit risk with respect to accounts receivable is within several industries and is limited because of our broad customer base. We perform ongoing credit evaluations of customers and set credit limits based upon reviews of customers’ current credit information and payment histories. We monitor customer payments and maintain a provision for estimated uncollectible accounts based on historical experience and specific customer collection issues that we have identified. Estimation of such losses requires adjusting historical loss experience for current economic conditions and judgments about the probable effects of economic conditions on certain customers. The rate of future credit losses may not be similar to past experience.
We record the effect of any necessary adjustments prior to the publication of our consolidated financial statements. We consider all available information when assessing the adequacy of the provision for allowances, claims and doubtful accounts. Adjustments made with respect to the allowance for doubtful accounts often relate to improved information not previously available. Uncertainties with respect to the allowance for doubtful accounts are inherent in the preparation of financial statements. For example, during 2006, our financial statements were impacted by a $0.7 million increase in our accounts receivable allowance related to the bankruptcy of a customer.
Inventories
We state our inventories at the lower of cost or market (net realizable value). We account for our inventories using the weighted average cost method of accounting. Cost includes all costs incurred in bringing the product to its present location and condition, based on purchase cost on a weighted average cost basis. We write down inventory for damaged, slow-moving and unmarketable inventory to reflect the difference between the cost of the inventory and the estimated market value. We regularly review our inventory on hand and reduce inventory as considered necessary based on historical and current sales trends. Changes in product demand and our customer base may affect the value of inventory on hand and may require higher inventory allowances. Uncertainties with respect to the inventory valuation are inherent in the preparation of financial statements. For example, during 2000, 2001 and 2002, there was considerable construction activity for merchant power plants to which we supplied specialized pipe and fittings. In 2003, because of the uncertainties in the energy industries, power generation projects were cancelled, stopped or delayed, and costs for steel products fell with the diminished demand. This collapse was associated with the sudden decrease of energy infrastructure following the Enron collapse and the bankruptcy of
Enron in 2002. As a result, in 2003, our financial results included a $2.4 million write-down of inventory associated with the collapse of the power generation construction market and the lack of an active market for certain related products.
Goodwill and other intangible assets
Goodwill represents the excess of the amount we paid to acquire a company over the estimated fair value of tangible assets and identifiable assets acquired, less liabilities assumed. As of December 31, 2006, the goodwill and other intangible assets with indefinite lives, tradenames and trademarks, balance was $36.8 million, representing 14.8% of total assets.
We account for goodwill under the provisions of the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards No. (“SFAS No.”) 142, Goodwill and Other Intangible Assets. Under these rules we test goodwill and other intangibles with indefinite lives for impairment annually or at any other time when impairment indicators exist. As of January 1, 2007, we performed our annual goodwill impairment test, which requires comparison of our estimated fair value to our book value including goodwill. As a result of the test, we believe the goodwill on our balance sheet is not impaired. In assessing the recoverability of our goodwill and other intangibles, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. We estimate future cash flows at the reporting unit level. A key assumption that we make is that our business will grow at approximately 10% per year for the next three years and approximately 5% to 4% thereafter, adjusted for the current economic outlook. If these estimates or their related assumptions change in the future, we may be required to record impairment charges not previously recorded for these assets.
Long-lived assets
We assess the impairment of long-lived assets, including customer relationships, when events or changes in circumstances indicate that the carrying value of the assets or the asset group may not be recoverable. The asset impairment review assesses the fair value of the assets based on the future cash flows the assets are expected to generate. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset plus net proceeds expected from the disposition of the asset (if any) are less than the related asset’s carrying amount. Impairment losses are measured as the amount by which the carrying amounts of the assets exceed their fair values. Estimates of future cash flows are judgments based on our experience and knowledge of our operations and the industries in which we operate. We also estimate the useful lives of other intangible assets based on estimates of the economic benefit expected to be received from the acquired assets which could differ from actual results. These estimates can be significantly affected by future changes in market conditions, the economic environment, and capital spending decisions of our customers and inflation.
As of December 31, 2006 and December 31, 2005, our long-lived assets, including property, plant and equipment and customer relationships, were $32.1 million and $32.3 million, representing 12.9% and 14.5% of total assets, respectively. If the useful lives of our customer relationship intangible assets, our largest long-lived asset which is amortized over approximately 7 years, were reduced by one year, operating income and net income would have been reduced by $0.7 million and $0.4 million, respectively, for the year ended December 31, 2006.
Share-based payments
Prior to January 1, 2006, we issued stock-based compensation in the form of restricted common partnership units to certain members of management and a director. We accounted for these restricted common units by applying the Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, which required us to recognize compensation expense related to this employee stock-based compensation. After January 1, 2006, we account for these stock based compensation grants using the fair value recognition provision of SFAS No. 123(R), Share-Based Payment (“SFAS No. 123(R)”). Stock-based compensation expense is measured as the difference between the fair value of the award at grant date and the exercise price to be paid by the holder. No amounts are paid by management or directors to obtain the restricted common units.
The fair value of restricted common units granted was estimated by management and/or our controlling shareholder, JCP, using an internal valuation methodology. We believe that our management team and JCP had the appropriate expertise and experience to perform such analyses; and we utilized a market approach to estimate our enterprise value using estimates of earnings before interest, taxes, depreciation and amortization “EBITDA” multiplied by relevant market multiples, adjusted to take into account particular characteristics of our businesses. We used market multiples of companies that we believed to be most comparable to our business.
Income tax expense estimates and policies
As part of the income tax provision process of preparing our consolidated financial statements, we are required to estimate our income taxes. This process involves estimating our current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income, and to the extent we believe the recovery is not likely, we must establish a valuation allowance. Further, to the extent that we establish a valuation allowance or increase this allowance in a financial accounting period, we must include a tax provision, or reduce our tax benefit in our consolidated statement of operations. We use our judgment to determine our provision or benefit for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets.
We recorded a valuation allowance in 2002 against a portion of deferred tax assets because management believed that the deferred tax assets related to goodwill impairment (see Note 10 to our audited consolidated financial statements included elsewhere in this report) would not more than likely be realized in full through future operating results and the reversal of taxable timing differences. Based on operating results for the year ended December 31, 2004 and projected operating results for the years ended December 31, 2005 and 2006, management believed this was no longer the case, and the valuation allowance was reversed as of December 31, 2004. This resulted in an increase in the deferred tax asset and a related decrease in income tax expense of $7.1 million.
There are various factors that may cause our tax assumptions to change in the near term, and we may have to record a valuation allowance against our deferred tax assets. We cannot predict whether future US federal and state income tax laws and regulations might be passed that could have a material effect on our results of operations. We assess the impact of significant changes to the US federal and state income tax laws and regulations on a regular basis and update the assumptions and estimates used to prepare our financial statements when new legislation and regulations are enacted.
Results of Operations
2006 Financial Overview
Our financial results for the year ended December 31, 2006 were positively impacted by various factors including:
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sustained high oil and gas prices, which have driven increased capital expenditures by the customers we serve, predominantly in the oil and gas production and the natural gas gathering and transmission sector;
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increases in the price of and demand for other natural resources, particularly phosphate;
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increased demand for alternative fuels in North America particularly ethanol; and
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increases in sales prices, particularly for our alloy products, because of limited availability of certain products and demand for specialty materials used in the energy infrastructure industry.
We grew sales 41.2% to $397.7 million in 2006 from $281.7 million in 2005. This increase was primarily the result of strong demand driven by the energy markets, changes in sales product mix, $44.6 million in sales from acquisitions, and increased sales prices for alloy products.
Operating income in 2006 increased $24.4 million to $34.1 million from $9.7 million in 2005. Operating income in 2006 includes $5.3 million of amortization related to other intangible assets. Operating income in 2005 included $12.0 million in Buy-out Transaction-related expenses, $3.2 million in amortization of other intangible assets, and a $1.7 million purchase price adjustment to cost of sales. The increase in operating income was primarily the result of increased volumes and higher margins for carbon products, a change in sales mix with higher margin products, the introduction of a new alloy product line, and increased operating income from the acquisitions of Western Flow Products, Inc. (“Western Flow”) and Murray International Metals, Inc. (“MIM US”).
Cash on hand at December 31, 2005 and cash from operations in 2006, provided sufficient cash to make the scheduled $13.4 million interest payment on our senior secured notes and to meet working capital needs.
The following table provides our statements of operations, our sales to international customers and our sales, operating profits and cost of sales as a percentage of sales for our operating segments. The table shows the segments as they are reported to management, and they are consistent with the segment reporting in Note 12 to our audited consolidated financial statements included elsewhere in this report. The period-to-period comparisons of financial results are not necessarily indicative of future results, or in the case of the interim periods, results for a full year.
Year Ended December 31, 2006 Compared to Combined Twelve Months Ended December 31, 2005
Sales
Overall. For the year ended December 31, 2006, our sales increased $116.0 million, or 41.2%, to $397.7 million compared to the combined twelve months ended December 31, 2005. The increase in sales was primarily the result of sustained high oil and gas prices, which drive capital expenditures and maintenance projects for the products that we supply, predominantly in the oil and gas production and the natural gas gathering and transmission sectors; of increased demand for alternative energy, particularly the production of ethanol; price increases for natural resources, particularly phosphate; and increases in sales prices, particularly for our alloy products because of limited product availability driven by demand for specialty materials used in the energy infrastructure industry. The increase in sales also reflects the operating results of the acquisition of Western Flow and MIM US, which contributed a combined $44.6 million in sales.
Sales order backlog increased from $88.6 million at December 31, 2005 to $126.8 million at December 31, 2006. The increase was primarily due to increased new project and expansion spending by gas transmission and ethanol production markets and as a result of the acquisition of MIM US in late 2005. Our backlog has also
expanded to include sales orders for projects that typically have a longer term from the date of sales order to shipment, as opposed to maintenance and repair orders which tend to ship quickly. As a result, project orders may have a significant impact on our backlog, and ultimately our sales, from period to period. Project orders are driven by scheduled shipment dates and planned major capital expenditures, as opposed to quick-ship inventory orders used primarily for daily customer repair and maintenance activity.
Alloy Products. For the year ended December 31, 2006, alloy product sales increased $38.0 million, or 49.6%, to $114.6 million compared to the combined twelve months ended December 31, 2005. This increase was the result of the Western Flow acquisition that contributed $14.1 million in sales driven by energy infrastructure projects in Canada, increased demand for products for construction of alternative fuel refining capacity, increased demand in the petrochemical sector, and sales price increases, particularly stainless steel pipe.
Carbon Products. For the year ended December 31, 2006, carbon product sales increased $78.0 million, or 38.0%, to $283.1 million compared to the combined twelve months ended December 31, 2005. This increase was driven by $30.5 million in sales contributed by the MIM US acquisition, an increase in sales volume of high yield pipe and fittings to the gas transmission market, increased activity in the alternative energy sector, an increase in demand for our products supplied to the phosphate mining industry, and to a lesser extent, sales price increases.
Operating Income (Loss)
Overall. Our operating income for the year ended December 31, 2006 increased $24.3 million to operating income of $34.1 million compared to the combined twelve months ended December 31, 2005. The increase in consolidated operating income was primarily the result of increased volumes and higher margins for carbon products; a change in sales product mix with higher margin products; the introduction of a new alloy product line; increased operating income from the acquisitions of Western Flow and MIM US; and approximately $12.0 million in Buy-out Transaction related expenses incurred in the combined twelve months ended December 31, 2005, which expenses did not occur in the same period in 2006. Operating income was partially offset by increased amortization expense of other intangible assets of $2.1 million related to the Buy-out Transaction and the MIM US acquisition, and an increase in general corporate expenses related to employee and facility costs and to business development efforts.
Alloy Products. Our alloy products operating income for the year ended December 31, 2006 was $15.6 million, a $4.9 million increase from the combined twelve months ended December 31, 2005. The increase was primarily the result of increased sales volumes with corresponding margin increases, the introduction of a new alloy product line and margin increases related to sales driven by the Western Flow acquisition, partially offset by a $1.1 million increase in amortization related to other intangible assets and by an increase in selling, general and administrative expenses related to the acquisition of Western Flow. Operating income was also negatively impacted by a $0.7 million increase in our allowance for uncollectible accounts as the result of the bankruptcy of a significant customer.
Carbon Products. Our carbon products operating income for the year ended December 31, 2006 was $28.0 million, an increase of $8.6 million from the combined year ended December 31, 2005. The increase in operating income was driven by increases in margins from increased sales to the gas gathering and transmission industry, improved overall margins as a result of extended mill delivery times, a change in sales product mix with higher margins, and by the acquisition of MIM US. This increase in operating income was partially offset by a $4.2 million
increase in amortization related to other intangible assets and an increase in selling, general and administrative expenses related to the acquisition of MIM US.
General Corporate. General corporate operating loss decreased from $20.4 million for the combined year ended December 31, 2005 to $9.5 million for the year ended December 31, 2006 as a result of the $12.0 million Buy-out Transaction related expenses incurred in the combined year ended December 31, 2005, which did not occur in the same period in 2006, offset by an increase in employee and facility expenses related to the Western Flow and MIM US acquisitions, an increase in travel expenses related to business development efforts, and an increase in our employee bonus plan accrual, which increase has been supported by the current year growth and performance of the Company.
Other income (expense)
Other income (expense) for the year ended December 31, 2006 of $0.5 million is comprised of recognized gains on foreign currency exchange forward contracts.
Interest Expense, net
Interest expense, net, for the year ended December 31, 2006 increased $4.0 million, or 34.4%, to $15.7 million from $11.7 million for the combined year ended December 31, 2005. The increase in interest expense was the result of the issuance of an additional $31 million of senior secured notes in December 2005 and borrowings under our revolving line of credit during the second and third quarters in 2006, partially offset by the retirement of $47.7 million of revolving line of credit and term loan debt on February 1, 2005. Additionally, interest expense for the year ended December 31, 2006 includes $1.7 million of deferred financing costs amortization compared to $1.1 million of deferred financing costs amortization for the combined year ended December 31, 2005.
Income Tax Expense
Income tax expense was $7.0 million for the year ended December 31, 2006 compared to income tax expense of $0.9 million for the combined year ended December 31, 2005. The effective tax rate was approximately 36.6% for the year ended December 31, 2006, and was approximately 36.2% for the period February 1, 2005 to December 31, 2005 and (18.9%) for the period January 1, 2005 to January 31, 2005. The increase for the year ended December 31, 2006 is primarily the result of an increase in state income taxes. The effective tax rate for the period January 1, 2005 to January 31, 2005 was impacted by Buy-out Transaction related expenses, for which a portion were non-deductible for income tax purposes.
Preferred Stock Dividends and Related Charges
On September 30, 2006, all outstanding redeemable preferred stock was contributed to Paid-in Capital by the Company’s shareholder, Edgen/Murray, L.P. As a result, preferred stock dividends decreased to $1.4 million for the year ended December 31, 2006 compared to $1.9 million for the combined year ended December 31, 2005.
Combined Twelve Months December 31, 2005 Compared to Fiscal 2004
Sales
Overall. For the combined twelve months ended December 31, 2005, our consolidated sales increased $73.9 million, or 35.5%, to $281.7 million compared to the year ended December 31, 2004. Sales volumes were positively impacted by the worldwide demand for oil and gas, and refined products, particularly in energy markets.
Sales prices were positively impacted by a favorable change in the mix of products sold and by continued demand for iron ore, nickel, chrome and copper which are the raw materials of our specialty products. Of the $73.9 million increase, $5.7 million related to revenue from the acquisitions of Western Flow and MIM US. Our sales order backlog significantly increased from $36.7 million at December 31, 2004 to $88.6 million at December 31, 2005 primarily due to large project orders for three customers totaling $43.8 million or 49% of the sales backlog at December 31, 2005 and from the acquisition of MIM US which had backlog of $17.6 million as of December 31, 2005. We anticipate substantially all of our backlog will be shipped in 2006.
Alloy Products. For the combined twelve months ended December 31, 2005, our alloy products sales increased $24.3 million, or 46.6%, to $76.6 million compared to the year ended December 31, 2004. The increase in sales was the result of increased alloy pipe sales volumes, increased foreign sales and improved pricing, partially offset by a decrease in stainless and low temperature pipe sales volume. For the combined twelve months ended December 31, 2005, our alloy products sales order backlog increased from $18.5 million at December 31, 2004 to $21.8 million at December 31, 2005. The increase in alloy products sales order backlog reflects a large customer project order for $11.7 million.
Carbon Products. For the combined twelve months ended December 31, 2005, our carbon products sales increased $49.5 million, or 31.8%, to $205.1 million as compared to the year ended December 31, 2004. The increase was driven by a change in product mix as a result of demand for high priced seamless products primarily from the oil and gas industry. General economic demand for both welded and seamless pipe and for high yield carbon fittings and components provided the basis for continued sales price increases. Carbon products sales order backlog increased from $18.2 million at December 31, 2004 to $66.8 million at December 31, 2005. The increase in carbon products sales order backlog is due primarily to several new large project orders totaling $32.1 million and approximately $17.6 million from the acquisition of MIM US.
Operating Income (Loss)
Overall. Our consolidated operating income of $9.7 million for the combined twelve months ended December 31, 2005 decreased $8.4 million from operating income of $18.1 million for the year ended December 31, 2004. The consolidated operating income for the combined twelve months ended December 31, 2005 includes Buy-out Transaction-related expenses of approximately $12.0 million, an increase in depreciation and amortization expense of $3.3 million related to acquired customer relationships, and as discussed above, a purchase price allocation adjustment in cost of sales of $1.7 million. Consolidated operating income as a percentage of consolidated sales for the combined twelve months ended December 31, 2005 and the year ended December 31, 2004 was 3.5%, and 8.7%, respectively. The decrease as a percentage of consolidated sales reflects the $12.0 million in Buy-out Transaction-related expenses, the increase in depreciation and amortization expense of $3.3 million, and the $1.7 million purchase price allocation adjustment, offset by a reduction of selling, general and administrative expenses which included a reduction in the employee bonus pool accrual and related payroll taxes.
Alloy Products. Our alloy products operating income for the combined twelve months ended December 31, 2005 was $10.7 million, an increase of $5.4 million compared to the year ended December 31, 2004. The majority of the increase was the result of sales increases as previously discussed partially offset by the $1.7 million purchase price allocation adjustment, an increase in salaries and related benefits and payroll taxes, and an increase in travel and selling expenses associated with increased business development efforts. The acquisition of Western Flow had a modest positive impact on operating income for the combined twelve months ended December 31, 2005.
Carbon Products. Our carbon products operating income for the combined twelve months ended December 31, 2005 was $19.4 million, a decrease of $2.4 million compared to the year ended December 31, 2004. The decrease in operating income was driven by an increase in cost of sales as previously discussed which was partially offset by a reduction in the employee bonus pool accrual and related payroll taxes within selling, general and administrative expenses. The acquisition of MIM US had a modest positive impact on operating income for the combined twelve months ended December 31, 2005.
Interest Expense
Interest expense, net, for the combined twelve months ended December 31, 2005 increased $6.5 million, or 125%, to $11.7 million. Interest expense, net for the year ended December 31, 2004 was $5.2 million. The increase in interest expense was the result of the issuance of the senior secured notes on February 1, 2005 and borrowings under the Company’s new revolving line of credit, partially offset by the retirement of $47.7 million of revolving line of credit and term loan debt as of February 1, 2005. Interest expense for the combined twelve months ended December 31, 2005 included $1.1 million of deferred financing costs amortization compared to $1.5 million for the year ended December 31, 2004.
Income Tax Expense
Income tax expense was $2.8 million for the period February 1, 2005 to December 31, 2005 compared to an income tax benefit of $(1.9 million) for the period January 1, 2005 to January 31, 2005 and income tax benefit of $(3.2 million) for the year ended December 31, 2004. The effective tax rate was approximately 41% for the combined twelve months ended December 31, 2005 and approximately 25% for the year ended December 31, 2004. The income tax benefit and effective tax rate for the combined twelve months ended December 31, 2005 reflects the impact of Buy-out Transaction-related expenses, which may not be fully deductible for income tax purposes. For the year ended December 31, 2004, reflects the reversal of the valuation allowance recorded against the deferred tax asset related to goodwill impairment in 2002. Additionally, deferred tax liabilities recorded in connection with the Buy-out Transaction include temporary differences consisting of customer relationships being amortized for book purposes but non-deductible for tax purposes, non-deductible tradename intangibles with indefinite lives, and a fair value adjustment to inventory which is reduced in the period the inventory is sold.
Preferred Stock Dividends and Related Charges
Preferred stock dividends and related charges were $1.9 million for the combined twelve months ended December 31, 2005 as compared to $2.2 million for the year ended December 31, 2004. The decrease resulted from our repurchase of all outstanding shares of our mandatorily redeemable preferred stock, partially offset by the issuance of our Series A cumulative compounding preferred stock in connection with the Buy-out Transaction.
Liquidity and Capital Resources
Future Capital Needs
We finance our operations principally through cash flows generated from operations and borrowings under our revolving credit facility. Our principal liquidity requirements are to meet debt service requirements, finance our capital expenditures and provide working capital. In addition, we may need capital to fund strategic business acquisitions. Our primary source of acquisition funds has historically been the issuance of preferred and common equity and debt securities and cash flow from operations.
Our ability to make payments on and to refinance our indebtedness, and to fund planned capital expenditures will depend on our ability to generate cash in the future, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Our total indebtedness, excluding any related discount, was $136.2 million and $136.4 million at December 31, 2006 and December 31, 2005, respectively. Under our revolving credit facility, we had approximately $20.0 million available for borrowings and other commitments as of December 31, 2006.
Based on our current level of operations, we believe our cash flow from operations, available cash and available borrowings under our revolving credit facility will be adequate to meet our liquidity needs for at least the next twelve months and the foreseeable future. We continue to evaluate appropriate growth strategies for the Company including possible acquisition opportunities. These growth strategies may require us to use cash on hand, make additional borrowings under our revolving credit facility, or enter into other financing arrangements in order to
support these growth strategies. We cannot assure you, however, that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under our revolving credit facility in an amount sufficient to enable us to service our indebtedness or to fund our other liquidity needs.
Year Ended December 31, 2006 Compared to Combined Twelve Months Ended December 31, 2005
Operating Activities. Net cash outflows from operating activities were $12.7 million for the year ended December 31, 2006, compared with net cash inflows of $13.8 million for the combined year ended December 31, 2005. The increase in net cash outflows from operating activities is primarily the result of increased working capital requirements, including the purchase of inventory as a result of sales increases to customers and higher inventory costs.
Investing Activities. Net cash outflows from investing activities were $1.7 million for the year ended December 31, 2006, compared with net cash outflows from investing activities of $135.9 million for the combined year ended December 31, 2005. The reduction in cash outflows is the result of no acquisitions made during the year ended December 31, 2006 compared to the Buy-out Transaction, and the acquisitions of Western Flow and MIM US for a combined cash purchase price of approximately $135.4 million during 2005. Capital expenditures increased to $1.6 million for the year ended December 31, 2006 compared to $1.3 million for the same period in 2005 in support of increased facilities and equipment related to our Canadian operations, and corporate expenditures related to information technology infrastructure.
Financing Activities. Net cash outflows from financing activities were $1.0 million for the year ended December 31, 2006, compared with net cash inflows of $143.0 million from financing activities during the combined twelve months ended December 31, 2005. The decrease in cash inflows from financing activities is due primarily to the issuance of the senior secured notes in connection with the Buy-out Transaction, and the MIM US acquisition, and the issuance of common and preferred stock for the combined twelve months ended December 31, 2005, which did not occur during the year ended December 31, 2006.
Preferred stock dividends
Preferred stock dividends were $1.4 million for the year ended December 31, 2006 as compared to $1.9 million for the combined twelve months ended December 31, 2005. As of December 17, 2005, all of the redeemable preferred stock was held by Edgen/Murray, L.P., and on September 29, 2006, the redeemable preferred stock and accumulated accrued dividends with a combined value of approximately $24.7 million was contributed to Edgen. This transaction resulted in a decrease in redeemable preferred stock and a corresponding increase in additional paid in capital included within shareholder’s equity.
Indebtedness
Senior Secured Notes. We have outstanding $136.0 million aggregate principal amount of 9 7/8% Secured Senior Notes due 2011. Total cash interest payments required under the senior secured notes are in excess of $13.4 million on an annual basis. The indenture governing the senior secured notes contains various covenants that limit our discretion in the operation of our business. It, among other things: (i) limits our ability and the ability of our subsidiaries to incur additional indebtedness, issue shares of preferred stock, incur liens and enter into certain
transactions with affiliates; (ii) places restrictions on our ability to pay dividends or make certain other restricted payments; and (iii) places restrictions on our ability and the ability of our subsidiaries to merge or consolidate with any other person or sell, assign, transfer, convey or otherwise dispose of all or substantially all of our assets. The indenture provides for a restricted payment pool out of which we are permitted to make certain restricted payments, including cash dividends, provided that no event of default has occurred and we would be able to incur additional indebtedness under the applicable restrictive covenant. The restricted payment pool is generally an amount calculated based on 50% of our consolidated net income, as defined in the indenture, and earned during the period beginning February 1, 2005 and ending on the last day of the most recent fiscal quarter prior to the restricted payment, as adjusted and subject to certain exceptions as provided in the indenture. Any future domestic subsidiaries of ours will be required to fully and unconditionally guarantee the senior secured notes on a joint and several basis. The senior secured notes and the related guarantees are secured by liens on substantially all of our assets and the assets of any future domestic restricted subsidiaries of ours (other than certain excluded assets such as our leasehold interests and the capital stock of any of our future subsidiaries). These liens, in the case of assets consisting of inventory, accounts receivable and certain related assets, are contractually subordinated to liens thereon that secure our revolving credit facility. Neither Edgen/Murray, L.P. nor MIM UK guarantees the senior secured notes.
Senior Credit Facility. On February 1, 2005, we entered into a five-year $20.0 million senior secured revolving credit facility, with a $5.0 million sublimit for letters of credit. Interest accrues on borrowings (at our option) at either (i) the prime rate of interest announced by the administrative agent (8.25% at December 31, 2006), or (ii) a Eurodollar rate based on LIBOR plus 2.00% per annum (7.32% at December 31, 2006). We must also pay a monthly facility fee of 0.50% per annum on the unused portion of the maximum revolving amount. There were no borrowings under the Credit Agreement as of December 31, 2006. The revolving credit facility contains various affirmative and negative covenants, including limitation on additional indebtedness and liens, the making of distributions, loans and advances, transactions with affiliates, dispositions or mergers, and the sale of assets. We borrowed approximately $2.7 million under the revolving credit facility in connection with the consummation of the Buy-out Transaction. As of December 31, 2006 and 2005, we had no borrowings outstanding under the revolving credit facility. The revolving credit facility is secured by a first priority security interest in all of our and any of our future domestic subsidiaries’ working capital assets, which security interest is contractually senior to the liens on such assets securing the senior secured notes, and by a second priority security interest in substantially all of our and any of our future domestic subsidiaries’ other assets (other than certain excluded assets such as our leasehold interests and the capital stock of our existing and future subsidiaries), which security interest is contractually subordinated to the liens on such assets securing the senior secured notes.
As of December 31, 2006, we were in compliance with the covenants contained in the Senior Secured Notes and the Senior Credit Facility.
Commitments and Contractual Obligations
Our contractual obligations and commitments principally include obligations associated with our outstanding indebtedness and future minimum operating lease obligations as set forth in the following table as of December 31, 2006:
(1) Includes interest obligations on the senior secured notes at an interest rate of 9.875% per annum and assumes no borrowings under our revolving credit facility.
(2) Includes purchase commitments for inventory. As of December 31, 2006, our sales order backlog was approximately $126.8 million. Both our purchase commitments and sales order backlog have been impacted by several outstanding large customer orders as of December 31, 2006.
Recent accounting pronouncements
From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) which are adopted by us as of the specified effective date. Unless otherwise discussed, management believes the impact of recently issued standards which are not yet effective will not have a material impact on our consolidated financial statements upon adoption.
In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109 (“FIN 48”), which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. FIN No. 48 requires a new evaluation process for all tax positions taken. If the probability for sustaining said tax position is greater than 50%, then the tax position is warranted and recognition should be at the highest amount which would be expected to be realized upon ultimate settlement. FIN No. 48 requires expanded disclosure at each annual reporting period unless a significant change occurs in an interim period. Differences between the amounts recognized in the statements of financial position prior to the adoption of FIN No. 48 and the amounts reported after adoption are to be accounted for as an adjustment to the beginning balance of retained earnings. FIN No. 48 is effective as of the beginning of fiscal years that begin after December 15, 2006. We will adopt FIN No. 48 in the first quarter of fiscal 2007. We are currently evaluating the impact that the adoption of FIN No. 48 will have on our consolidated results of operations, financial position, and cash flows.
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140 (“SFAS No. 155”). SFAS No. 155 amends FASB Statements No. 133, Accounting for Derivative Instruments and Hedging Activities, and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities SFAS No. 155 resolves issues addressed in FASB Statement No. 133 Implementation Issue No. D1, Application of Statement 133 to Beneficial Interests in Securitized Financial Assets SFAS No. 155 is effective for fiscal years beginning after September 15, 2006. The adoption of SFAS No. 155 is not expected to have any impact on our consolidated results of operations, financial position, and cash flows.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”), which establishes a single authoritative definition of fair value, sets out a frame-work for measuring fair value, and requires additional disclosures about fair-value measurements. SFAS No. 157 applies to fair value measurements that are already required or permitted by existing standards except for measurements of share-based payments and measurements that are similar to, but not intended to be, fair value. SFAS No. 157 does not impose any additional fair value measurements in financial statements and is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The adoption of SFAS No. 157 is not expected to have a material impact on our consolidated results of operations, financial position, and cash flows.
In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB No. 108”). SAB No. 108 establishes a single quantification framework wherein the significance measurement is based on the effects of the misstatements on each of the financial statements as well as the related financial statement disclosures. SAB No. 108 is effective for the first annual period ending after November 15, 2006. The adoption of SAB No. 108 is not expected to have a material impact on our consolidated results of operations, financial position, and cash flows.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”), which allows measurement of specified financial instruments, warranty and insurance contracts at fair value on an instrument by instrument or contract by contract basis, with changes in fair value recognized in earnings in each period. SFAS No. 159 is effective at the beginning of the fiscal year that begins after November 15, 2007. We have not yet determined the impact that the implementation of SFAS No. 159 will have on our consolidated results of operations, financial position, and cash flows.
Related Party Transactions
See “Item 13. Certain Relationships and Related Transactions, and Director Independence.”
Financial Instruments
In our business, we may enter into purchase and sales commitments that are denominated in a foreign currency (primarily the Euro). Our practices include entering into foreign currency forward exchange contracts to minimize foreign currency exposure related to forecasted purchases and sales of certain inventories. As of December 31, 2006, we had one contract related to a purchase of inventory that matures in May 2007 to purchase a notional amount of $6.3 million of foreign currency. During the third quarter of 2006, we also had five contracts related to the purchases of inventory and five contracts related to the sale of inventory, which contracts matured in varying increments.
As of December 31, 2006, the fair value of these foreign currency forward exchange contracts of $0.1 million was recorded as an asset on the consolidated balance sheet. For the year ended December 31, 2006, we recognized a gain of $0.5 million in gains (losses) on foreign currency forward exchange contracts reflected in other income (expense) on the statement of operations.
Off-Balance Sheet Arrangements
We did not have any off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K as of December 31, 2006.
Inflation
Inflation has not had a material impact on our results of operations or financial condition during the preceding three years. In the past, we have generally been successful in adjusting prices to our customers to reflect changes in metal prices. For example, in 2004 we were able to increase the prices of our products in response to higher inventory costs resulting from higher steel prices. We can provide no assurance that our operating results will not be affected by inflation in the future.
Seasonality
Some of our customers may be in seasonal businesses, especially those customers who purchase our products for use in new capital expenditure projects at refineries, oil and gas infrastructure, and processing and power generation plants. As a consequence, our results of operations and working capital, including our accounts receivable, inventory and accounts payable, fluctuate during the year. However, because of our geographic, product and customer diversity, our operations have not shown any material seasonal trends. We believe that our significant operations in the milder southern climates moderate our seasonality. In addition, our sales to MRO distributors, who tend not to be seasonal purchasers, mitigate the overall effects of seasonality on our business. Sales in the months of November and December traditionally have been lower than in other months because of a reduced number of working days for shipments of our products and holiday closures for some of our customers. We cannot assure you that period-to-period fluctuations will not occur in the future. Results of any one or more quarters are, therefore, not necessarily indicative of annual results.
Capital Expenditures
We currently do not expect to have any significant capital expenditures or upgrades in the near future. Our maintenance capital expenditures have averaged approximately $1.4 million over the past three years, and management expects annual capital expenditures to remain consistent with prior year amounts in 2007 and 2008.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
In the normal course of operations, we are exposed to market risks arising from adverse changes in interest rates and foreign exchange rates. Market risk is defined for these purposes as the potential change in the fair value of financial assets or liabilities resulting from an adverse movement in interest rates or foreign exchange rates.
Interest Rate Risk. As of December 31, 2006, we have no borrowings under our revolving credit facility, which bears interest at several alternative variable rates as stipulated in the revolving credit facility.
Foreign Currency Risk. Substantially all of our net sales and expenses are denominated in U.S. dollars. From time to time, we seek to mitigate our exposure to exchange rate movements on transactions denominated in foreign currencies by entering into foreign currency forward exchange contracts. As of December 31, 2006, we had one contract related to a purchase of inventory that matures in May 2007 to purchase a notional amount of $6.3 million of foreign currency. We do not monitor our foreign currency forward exchange contracts for hedge effectiveness. As of December 31, 2006, the fair value of these foreign currency forward exchange contracts of $0.1 million was recorded as an asset on the consolidated balance sheet. For the year ended December 31, 2006, we recognized a gain of $0.5 million in gains (losses) on foreign currency forward exchange contracts reflected in other income (expense) on the statement of operations.
Credit risk. Our credit risk on liquid resources and derivative financial instruments is limited because the counterparties are banks with high credit ratings assigned by international credit-rating agencies. We have no significant concentration of credit risk with a specific counterparty because exposure is spread over a number of counterparties.
Item 8.
Item 8.
Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Edgen Murray Corporation-Audited Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2006 and 2005
Consolidated Statements of Operations for the year ended December 31, 2006, the period February 1, 2005 to December 31, 2005, the period January 1, 2005 to January 31, 2005, and the year ended December 31, 2004
Consolidated Statements of Shareholder’s Equity (Deficit) for the year ended December 31, 2006, the period February 1, 2005 to December 31, 2005, the period January 1, 2005 to January 31, 2005, and the year ended December 31, 2004
Consolidated Statements of Cash Flows for the year ended December 31, 2006, the period February 1, 2005 to December 31, 2005, the period January 1, 2005 to January 31, 2005, and the year ended December 31, 2004
Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholder of
Edgen Murray Corporation
Baton Rouge, Louisiana
We have audited the accompanying consolidated balance sheets of Edgen Murray Corporation and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, shareholder’s equity (deficit), and cash flows for the year ended December 31, 2006, the period February 1, 2005 to December 31, 2005, the period January 1, 2005 to January 31, 2005, and the year ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements 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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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, such consolidated financial statements present fairly, in all material respects, the financial position of Edgen Murray Corporation and subsidiaries at December 31, 2006 and 2005, and the results of its operations and its cash flows for the year ended December 31, 2006, the period February 1, 2005 to December 31, 2005, the period January 1, 2005 to January 31, 2005, and the year ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America.
Deloitte & Touche LLP
New Orleans, Louisiana
March 30, 2007
EDGEN MURRAY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2006 and 2005
EDGEN MURRAY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31, 2006, Period February 1, 2005 to December 31, 2005, Period January 1, 2005 to
January 31, 2005, and Year Ended December 31, 2004
See accompanying notes to consolidated financial statements.
EDGEN MURRAY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDER’S EQUITY (DEFICIT)
Year Ended December 31, 2006, Period February 1, 2005 to December 31, 2005, Period January 1, 2005 to
January 31, 2005, and Year Ended December 31, 2004
See accompanying notes to consolidated financial statements
EDGEN MURRAY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, 2006, Period February 1, 2005 to December 31, 2005, Period January 1, 2005 to
January 31, 2005, and Year Ended December 31, 2004
See accompanying notes to consolidated financial statements.
EDGEN MURRAY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2006, 2005 and 2004
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business-Edgen Corporation (“Edgen”) a Nevada corporation, was formed on November 30, 2000. On December 31, 2006, Edgen changed its name to Edgen Murray Corporation (“Edgen Murray Corporation” or the “Company”) and merged its U.S. subsidiaries, Edgen Carbon Products Group, L.L.C. (“Edgen Carbon”) and Edgen Alloy Products Group, L.L.C. (“Edgen Alloy”), into Edgen Murray Corporation. The Company’s Canadian subsidiary, Edgen Canada Inc., changed its name to Edgen Murray Canada Inc. (“Edgen Murray Canada”).
On February 1, 2005, Edgen Acquisition Corporation, a corporation newly formed by Jefferies Capital Partners (“JCP”) and certain members of Edgen management, purchased all of the outstanding capital stock of Edgen from its existing stockholders for an aggregate purchase price of approximately $124.0 million, which included the assumption or repayment of indebtedness of Edgen but excluded the payment of fees and expenses. The acquisition was funded with proceeds to Edgen Acquisition Corporation from the issuance and sale of $105.0 million aggregate principal amount of 97/8% Senior Secured Notes (“Notes”) due 2011 and from an equity investment from funds managed by JCP and certain members of Edgen management. Concurrent with the purchase, Edgen entered into a new $20.0 million senior secured revolving credit facility.
Simultaneous with the acquisition and the related financing transactions, Edgen Acquisition Corporation was merged with and into Edgen Corporation, which survived the merger and became liable for all obligations under the Notes and borrowings under the new revolving credit facility. We refer to the acquisition of Edgen Corporation, the offering and issuance of the old notes, the equity investment, the related financing transactions and the merger collectively as the “Buy-out Transaction.” Edgen Corporation following the merger is referred to as the “Successor.” Edgen Corporation prior to the merger is referred to as the “Predecessor.”
On December 16, 2005, our stockholders organized a new holding company, Edgen/Murray L.P., to hold all of the outstanding equity interests of Edgen and a newly created company, Pipe Acquisition Limited (“PAL”), which acquired Murray International Metals Ltd. (“MIM UK”) on December 16, 2005. In a separate but related transaction, Edgen acquired Murray International Metals, Inc. (“MIM US”), the U.S. subsidiary of MIM UK. Edgen/Murray L.P. is a Delaware limited partnership and is controlled by funds managed by JCP. Additionally, certain members of Edgen’s management are officers of Edgen/Murray, L.P. In a common control transaction, the Edgen shareholders exchanged their direct ownership of Edgen for ownership interests in Edgen/Murray, L.P., which resulted in Edgen becoming a wholly owned subsidiary of Edgen/Murray, L.P. Prior to the formation of Edgen/Murray, L.P., Edgen was held directly by the Edgen shareholders. Edgen/Murray, L.P. is controlled by investment funds managed by JCP, the general partner. In connection with the MIM UK acquisition, Edgen/Murray, L.P. also issued additional partnership interests to the funds managed by JCP, to certain members of management of our company and MIM UK and the sellers of MIM UK.
The Company distributes and sells prime carbon steel pipe, alloy grade pipe, fittings and flanges, high grade structural tubes, sections and plates, and provides services for the applications of such pipe and steel products.
Basis of Presentation-The consolidated financial statements and notes are presented in accordance with accounting principles generally accepted in the United States of America (“generally accepted accounting principles” or “GAAP”). The consolidated financial statements include the accounts of Edgen and its wholly owned subsidiaries. All intercompany transactions are eliminated in consolidation.
Our foreign subsidiary, Edgen Canada, maintains its accounting records in its local currency, the Canadian dollar (“CAD”). All of the assets and liabilities of this subsidiary (including long-term assets, such as goodwill) are converted to U.S. dollars with the effect of the foreign currency translation reflected in accumulated other comprehensive income, a component of shareholder’s equity (deficit), in accordance with the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 52, “Foreign Currency Translation,” and SFAS No. 130, “Reporting Comprehensive Income.” Foreign transaction gains or losses are charged to income in the period the transactions are settled.
In accordance with GAAP, we have separated our historical financial results for the Predecessor and the Successor. The separate presentation is required under GAAP in situations when there is a change in accounting
basis, which occurred when purchase accounting was applied to the acquisition of the Predecessor. Purchase accounting requires that the historical carrying value of assets acquired and liabilities assumed be adjusted to fair value, which may yield results that are not comparable on a period-to-period basis due to the different, and sometimes higher, cost basis associated with the allocation of the purchase price. In addition, at the time of the acquisition of the Predecessor, we experienced changes in our business as a result of the other transactions that were consummated in connection with the acquisition of the Predecessor. There were no material changes to the operations or customer relationships of the business as a result of the acquisition of the Predecessor.
Use of Estimates-The preparation of the Company’s consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates and assumptions are primarily made in relation to the valuation of accounts receivable and inventory, the recoverability of goodwill and other intangible assets, and deferred tax assets in establishing a valuation allowance, if any.
Cash equivalents-The Company considers all highly-liquid investments with an original maturity of three months or less at the time of purchase to be cash equivalents.
Accounts receivable-Accounts receivable from customers is shown net of allowance for doubtful accounts which reflects the Company’s estimate of the uncollectible accounts receivable based on the aging of specific customer receivable accounts.
Inventory-Inventory consists primarily of prime carbon steel pipe and plate, alloy grade pipe, fittings and flanges and structural sections and plates. Inventory is stated at the lower of cost or market (net realizable value). Cost is determined by the average cost method. Cost includes all costs incurred in bringing the product to its present location and condition, based on purchase cost on a weighted average cost basis. Net realizable value is based on estimated normal selling price less further costs expected to be incurred to completion and disposal. Inventory is written off for obsolete, slow-moving or defective items where appropriate.
Property, plant and equipment-Property, plant and equipment are recorded at cost. Depreciation of property, plant and equipment is provided for financial reporting purposes on the straight-line method over the estimated useful lives of the individual assets, which range from less than one year to 7 years for leasehold improvements, 2 to 10 years for equipment and computers and 10 to 50 years for buildings and land improvements. For income tax purposes, accelerated methods of depreciation are used. Ordinary maintenance and repairs which do not extend the physical or economic lives of the plant or equipment are charged to expense as incurred.
Leases-The Company enters into both capital and operating lease agreements. Fixed assets held under lease agreements, which confer rights and obligations similar to those attached to owned assets, are capitalized as fixed assets and are depreciated over their economic lives. The capital elements of future lease obligations are recorded as liabilities, while the interest element is charged to the statement of operations over the period of the related capital lease obligation. Rentals under operating leases are charged to the statements of operations on a straight-line basis over the lease term, even if the payments are not made on such a basis.
Goodwill and other intangible assets-Goodwill represents the excess of the amount the Company paid to acquire a company over the estimated fair value of tangible assets and identifiable assets acquired, less liabilities assumed. Other identifiable intangible assets include customer relationships, tradenames, backlog, non-competition agreements and trademarks. Other identifiable intangible assets with finite useful lives are amortized to expense over the estimated useful life of the asset. Customer relationships, non-competition agreements, and backlog are amortized on a straight-line basis over their estimated useful lives: 7 years for customer relationships, 1 to 5 years for non-competition agreements, and within one year for backlog. Identifiable intangible assets with an indefinite useful life; including goodwill, tradenames and trademarks; are evaluated annually in the first quarter or more frequently if circumstances dictate, for impairment by comparison of their carrying amounts with the fair value of the individual assets. No goodwill, tradename or trademark impairment was identified in 2006, 2005, and 2004.
Impairment of long-lived assets-The Company assesses the impairment of long-lived assets, including property, plant and equipment and customer relationships, when events or changes in circumstances indicate that the carrying value of the assets or the asset group may not be recoverable. The asset impairment review assesses the fair value of the assets based on the future cash flows the assets are expected to generate. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset plus net proceeds expected
from the disposition of the asset (if any) are less than the related asset’s carrying amount. Impairment losses are measured as the amount by which the carrying amounts of the assets exceed their fair values.
Deferred financing costs-Deferred financing costs are charged to operations as additional interest expense over the life of the underlying indebtedness using the interest method. Deferred financing costs charged to the statements of operations as interest during the year ended December 31, 2006, the period February 1, 2005 to December 31, 2005, the period January 1, 2005 to January 31, 2005 and the year ended December 31, 2004 were $1,680,211, $1,131,491, $35,272, and $1,519,002, respectively.
Income taxes-Income taxes are provided using the liability method in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 109, Accounting for Income Taxes. Under this method, deferred income taxes are recorded based upon differences between the financial reporting and income tax basis of assets and liabilities and are measured using the enacted income tax rates and laws that will be in effect when the differences are expected to reverse.
Revenue recognition-Revenue is recognized on products sales when products are shipped or at the time of delivery, depending on the terms of the sale and when the customer takes title and assumes risk of loss. Revenue is recorded, net of discounts, rebates, value added tax and similar taxes as applicable in foreign jurisdictions. Rebates and discounts to customers are determined based on the achievement of certain agreed-upon terms and conditions by the customer during each period. Shipping and handling costs incurred are included as a component of cost of sales (exclusive of depreciation and amortization) on the statement of operations.
Unit/share-based compensation-Prior to January 1, 2006, the Company accounted for its unit/share-based employee compensation plan which allowed for the granting of stock options and restricted stock/units using the intrinsic value-based method of accounting, as permitted, and disclosed, if material, pro forma information as if accounted for using the fair value-based method as prescribed by accounting principles. Because the exercise price of the Company’s employee stock options equaled the market price of the underlying stock on the date of grant, no compensation expense was recognized on options granted.
Effective, January 1, 2006, the Company began accounting for stock-based compensation in accordance with SFAS No. 123(R), Share-Based Payment (“SFAS No. 123(R)”), which eliminates the ability to account for share-based compensation transactions using the intrinsic value-based method of accounting, and generally requires such transactions be accounted for using a fair-value based method. SFAS No. 123(R) permits use of option pricing models other than the Black-Scholes option pricing model. There was no impact on the Company’s consolidated financial statements as a result of the adoption of SFAS No. 123(R) on January 1, 2006; however, for the year ended December 31, 2006, the Company recorded $569,299 in stock-based compensation (see Note 8).
Foreign currency-The Company’s foreign subsidiary maintains its accounting records in its functional currency. Monetary assets and liabilities in foreign currencies are translated into the relevant measurement currency for each entity/division at the rate of exchange at the balance sheet date. Transactions in foreign currencies are translated into the relevant measurement currency at the average rate of exchange during the period. Foreign currency transaction gains of $62,502 are included in the statement of operations for the year ended December 31, 2006, while an immaterial amount was included in the statement of operations for the period ended February 1, 2005 to December 31, 2005. The Company’s foreign currency transactions were not material prior to the acquisition of Western Flow in July 2005.
The results of foreign operations, whose functional currency is not the US dollar, are translated at the average rates of exchange during the period and their assets and liabilities at the rates at the balance sheet date. The cumulative effect of exchange rate movements is included in a separate component of the Statement of Shareholders’ Equity (Deficit) in accordance with the SFAS No. 52, Foreign Currency Translation and SFAS No. 130, Reporting Comprehensive Income. Foreign transaction gains or losses are charged to net income (loss) in the period the transactions are settled.
Derivative financial instruments-The Company enters into foreign currency forward exchange contracts to minimize its foreign exchange risks associated with certain inventory purchase transactions and sales which are denominated in a foreign currency (primarily the Euro). The Company does not enter into any financial instruments for investment or speculative purposes.
Monetary assets and liabilities denominated in foreign currencies at each period end are reported at the rates of exchange prevailing at the balance sheet date and all derivatives are carried at fair value on the balance sheet. The
Company has not designated any of its derivative instruments as qualifying hedge instruments under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. Accordingly, all gains and losses arising from changes in the fair value of derivatives are charged or credited in determining net income (loss) and are accounted for as other income (loss) on the consolidated statement of operations.
Other comprehensive income-Comprehensive income includes all changes in equity during the period presented that result from transactions and other economic events other than transactions with shareholders.
Fair values of financial instruments-The carrying value of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their fair value due to the short maturity of those instruments. The fair value of long-term debt is based on market quotes or recent trades. The fair value of derivatives is based on the estimated amount the Company would receive or pay if the transaction was terminated, taking into consideration prevailing exchange rates.
New accounting standards-From time to time, new accounting pronouncements are issued by the FASB which are adopted by the Company as of the specified effective date. Unless otherwise discussed, management believes the impact of recently issued standards which are not yet effective will not have a material impact on the Company’s consolidated financial statements upon adoption.
In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109 (“FIN No. 48”), which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. FIN No. 48 requires a new evaluation process for all tax positions taken. If the probability for sustaining said tax position is greater than 50%, then the tax position is warranted and recognition should be at the highest amount which would be expected to be realized upon ultimate settlement. FIN No. 48 requires expanded disclosure at each annual reporting period unless a significant change occurs in an interim period. Differences between the amounts recognized in the statements of financial position prior to the adoption of FIN No. 48 and the amounts reported after adoption are to be accounted for as an adjustment to the beginning balance of retained earnings. FIN No. 48 is effective as of the beginning of fiscal years that begin after December 15, 2006. We will adopt FIN No. 48 in the first quarter of fiscal 2007. We are currently evaluating the impact that the adoption of FIN No. 48 will have on our consolidated results of operations, financial position, and cash flows.
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140 (“SFAS No. 155”). SFAS No. 155 amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS No. 155 resolves issues addressed in SFAS No. 133 Implementation Issue No. D1, Application of Statement 133 to Beneficial Interests in Securitized Financial Assets. SFAS No. 155 is effective for fiscal years beginning after September 15, 2006. The adoption of SFAS No. 155 is not expected to have any impact on the Company’s consolidated results of operations, financial position, and cash flows.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”) which establishes a single authoritative definition of fair value, sets out a frame-work for measuring fair value, and requires additional disclosures about fair-value measurements. SFAS No. 157 applies to fair value measurements that are already required or permitted by existing standards except for measurements of share-based payments and measurements that are similar to, but not intended to be, fair value. SFAS No. 157 does not impose any additional fair value measurements in financial statements and is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The adoption of SFAS No. 157 is not expected to have a material impact on the Company’s consolidated results of operations, financial position, and cash flows.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB No. 108”). SAB No. 108 establishes a single quantification framework wherein the significance measurement is based on the effects of the misstatements on each of the financial statements as well as the related financial statement disclosures. SAB No. 108 is effective for the first annual period ending after November 15, 2006. The adoption of SAB No. 108 is not expected to have a material effect on our consolidated results of operations, financial position, and cash flows.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”), which allows measurement of specified financial instruments, warranty and insurance contracts at fair value on an instrument by instrument or contract by contract basis, with changes in fair value recognized in earnings in each period. SFAS No. 159 is effective at the beginning of the fiscal year that begins after
November 15, 2007. We have not yet determined the impact that the implementation of SFAS No. 159 will have on our consolidated results of operations, financial position, and cash flows.
2. ACQUISITIONS
Edgen Corporation
As described in Note 1, on February 1, 2005, Edgen Acquisition Corp. purchased all of the outstanding capital stock of Edgen from its existing shareholders for an aggregate purchase price of approximately $124,000,000, which included the assumption or repayment of indebtedness of Edgen but excluded the payment of certain fees and expenses. The acquisition was funded with (i) proceeds to Edgen Acquisition Corp. from the issuance and sale of $105,000,000, aggregate principal amount of 9 7/8% Senior Secured Notes due 2011, (ii) from a $21,610,000, equity investment from funds managed by JCP, (iii) $2,390,000, equity investment from funds received from Edgen management, and (iv) a payable to the sellers of approximately $2,975,000, based upon receipt of certain income tax refunds for the remainder of the purchase price. The goodwill and other intangible assets recorded in the Buy-out Transaction are not deductible for income tax purposes except for $6.2 million of goodwill (see Note 9).
As discussed in Note 1, Edgen Acquisition Corp. was merged with and into Edgen, which survived the merger and became liable for all obligations under the senior secured notes and any other borrowings. The acquisition of Edgen, the offering and issuance of the senior secured notes, the equity investment, the related financing transactions and the merger are referred to collectively as the “Buy-out Transaction.”
The estimated fair value of the assets acquired and liabilities assumed relating to the acquisition is summarized below:
The weighted average amortization period for customer relationships is 7 years. The weighted average amortization period for non-competition agreements is less than one year. The weighted average amortization period for total intangible assets subject to amortization is approximately 7 years.
Western Flow Products, Inc.
On July 15, 2005, our subsidiary, Edgen Canada Inc., acquired the common stock of Western Flow Products, Inc. (“Western Flow”) for a purchase price of approximately $1,971,000 (2,400,000 CAD) consisting of a cash payment of approximately $1,725,000 (2,100,000 CAD) and the issuance of a note payable to the sellers for approximately $246,000 (300,000 CAD). An additional $451,469 (527,000 CAD) of purchase price that was
contingent upon the achievement of a specified earnings threshold subsequent to the acquisition was paid upon achievement of that threshold. Western Flow is located in Edmonton, Alberta and is a specialty alloy pipe and components distributor primarily to the oil and gas, processing and power generation industries. The operations of this acquisition have been merged into the Company’s subsidiary, Edgen Canada Inc., and are included in our operating results from the date of the acquisition. The goodwill recorded in this acquisition is not deductible for income tax purposes.
The final purchase price allocation is summarized below:
Murray International Metals, Inc.
On November 29, 2005, our subsidiary, Edgen Carbon Products Group, L.L.C., entered into a purchase agreement with MIM UK to acquire all of the equity interests of MIM UK’s U.S. subsidiary, MIM US, for an aggregate purchase price, including assumption of debt, of approximately $20,600,000. The assumption of debt included a 2,900,000 GBP (approximately 5,000,000 USD) note payable to MIM UK which was funded and paid by Edgen upon closing.
MIM US, a leading supplier of high yield and special grade structural steel to oil and gas projects being engineered and managed by leading operators, engineering houses and offshore fabricators in the oil and gas industry primarily in North and South America (the “Americas”), offering a complete range of high yield steel plate, sections, and tubulars, merged into Edgen Carbon Products Group, L.L.C. during the third quarter 2006.
During the third quarter 2006, the Company finalized its purchase price allocation related to the MIM US acquisition. As of September 30, 2006, the purchase price allocation included the identification of other intangible assets, including customer relationships, tradenames, and backlog for which amortization related to these other intangibles was recorded during the nine months ended September 30, 2006. The final purchase price follows:
The goodwill generated from the MIM US acquisition represents the potential to attract new customers to the combined organization, the potential for sales to customers in a concentrated market, the oil and gas industry, which is currently experiencing record growth that may be sustained in the near term, and the ability to offer new product to existing customers (cross-selling of alloy products and other specialty carbon products).
The weighted average amortization period for customer relationships is 7 years. The weighted average amortization period for backlog is less than one year. The weighted average amortization period for total intangible assets subject to amortization is approximately 6 years.
In connection with the Buy-out Transaction and the MIM US acquisition, the fair value of customer relationships and backlog have been derived using an income/excess earnings valuation method which is based on the assumption that earnings are generated by all of the tangible and intangible assets held by the Company. The income/excess earnings method estimates the fair value of an intangible asset by discounting its future cash flows and applying charges for contributory assets. Certain estimates and assumptions were used to derive the customer relationship intangible including future earnings projections, discount rates and customer attrition rates. In determining the fair value of backlog, the projected earnings from open sales orders as of the acquisition date was discounted back to the acquisition date. The useful lives for customer relationships has been estimated based on historical customer attrition rates while the useful life for backlog has been based on the scheduled delivery dates of the applicable open sales orders.
The fair value of tradenames was derived using a relief from royalty valuation method which assumes that the owner of intellectual property is “relieved” from paying a royalty for the use of that asset. The royalty rate attributable to the intellectual property represents the cost saving that are available through ownership of the asset by the avoidance of paying royalties to license the use of the intellectual property from another owner. Accordingly, earnings forecasts of income reflect an estimate of a fair royalty that a licensee would pay, on a percentage of revenue basis, to obtain a license to utilize the intellectual property. Estimates and assumptions used in deriving the fair value of tradenames include future earnings projections, discount rates, and market royalty rates identified in similar recent transactions.
The following table reflects the pro forma revenue and net income (loss) for the periods presented as if the Buy-out transaction and the acquisitions of Western Flow and MIM US had taken place on January 1, 2005:
3. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment at December 31, 2006 and 2005 consisted of the following:
Substantially all of the Company’s property, plant and equipment serves as collateral for the Company’s credit arrangements and long-term debt (see Note 6). Depreciation expense for the year ended December 31, 2006, the period February 1, 2005 to December 31, 2005, the period January 1, 2005 to January 31, 2005, and the year ended December 31, 2004 was $2,297,990, $2,265,398, $189,812, and $2,281,652, respectively.
4. INTANGIBLE ASSETS
Intangible assets at December 31, 2006 and 2005 consisted of the following:
In connection with the Buy-out Transaction on February 1, 2005 and the MIM US acquisition on December 16, 2005, customer relationships and tradename intangible assets were identified and recorded in the purchase price allocation (see Note 2).
Amortization expense was $5,341,687, $3,200,725, $10,832, and $117,917, for the year ended December 31, 2006, the period February 1, 2005 to December 31, 2005, the period January 1, 2005 to January 31, 2005, and the year ended December 31, 2004, respectively. Accumulated amortization of intangible assets at December 31, 2006 and 2005 was $8,758,247 and $3,416,560, respectively.
The following table presents scheduled amortization expense for the next five years:
5. GOODWILL
Under SFAS No. 142, an impairment test is required to be performed upon adoption and at least annually thereafter. The impairment test is the result of adopting a fair value approach to testing goodwill as compared to the previous method utilized in which evaluations of goodwill impairment were made using the estimated future undiscounted cash flows compared to the carrying amount. Material amounts of recorded goodwill attributable to each of the Company’s reporting units were tested on January 1, 2007, 2006, and 2005 for impairment by comparing the fair value of each reporting unit with its carrying value. Fair value was determined using discounted cash flows, and guideline company multiples. Significant estimates used in the methodologies include estimates of future cash flows, future short-term and long-term growth rates, weighted average cost of capital and guideline company multiples for each of the reportable units. On an annual basis (absent any impairment indicators), the Company expects to perform its impairment tests during the first quarter.
Based on the impairment test, the Company recognized no impairment charge in 2006, 2005 and 2004.
The following table reflects changes to goodwill by reportable segment and changes to goodwill during the year ended December 31, 2006, the period February 1, 2005 to December 31, 2005, the period January 1, 2005 to January 31, 2005, and the year ended December 31, 2004:
The following table reflects goodwill and changes to goodwill by reportable segment as follows:
As a result of finalizing the purchase price allocation related to the MIM US acquisition during the third quarter 2006, goodwill was reduced by $4.8 million, and customer relationships, tradenames, and backlog were increased by $7.7 million, and deferred tax liability was increased by $3.0 million. Additionally, amortization of these intangible assets in the amount of $1.9 million was recorded for the year ended December 31, 2006 and included the full amortization of backlog during the period.
6. LONG-TERM DEBT AND CREDIT ARRANGEMENTS
Long-term debt consisted of the following at December 31, 2006 and 2005:
Senior Secured Notes
On February 1, 2005, the Company issued $105.0 million aggregate principal amount of 97/8% Senior Secured Notes due 2011. The proceeds from the issuance of the senior secured notes were used to retire substantially all of the Company’s long-term debt under its existing revolving credit facility and certain other notes and loans on February 1, 2005. Then on December 16, 2005, the Company issued an additional $31.0 million aggregate principal amount of senior secured notes with the proceeds funding the acquisition of MIM US (see Note 2).
Interest accrues on the senior secured notes at the stated rate semi-annually and is payable in arrears on each February 1 and August 1, beginning on August 1, 2005.
The Company may redeem some or all of the senior secured notes at any time prior to February 1, 2008 at a make-whole redemption price set forth in the terms of the senior secured notes. On or after February 1, 2008, the Company may at its option, redeem some or all of the senior secured notes at the following redemption prices, plus accrued and unpaid interest to the date of redemption:
In addition, at any time prior to February 1, 2007, the Company may redeem up to 35% of the aggregate principal amounts of the senior secured notes issued under the indenture at a price equal to 109.875% of their principal amount, plus accrued and unpaid interest, to the date of redemption with the net cash proceeds of certain equity offerings. The terms of the senior secured notes also contain certain change in control and sale of asset provisions where the holders of the senior secured notes have the right to require the Company to repurchase all or any part of the senior secured notes at an offer price in cash equal to 101% and 100%, respectively, of their principal amount, plus accrued and unpaid interest, to the date of the repurchase.
The indenture governing the senior secured notes contains various covenants that limit our discretion in the operation of our business. It, among other things: (i) limits our ability and the ability of our subsidiaries to incur additional indebtedness, issue shares of preferred stock, incur liens and enter into certain transactions with affiliates; (ii) places restrictions on our ability to pay dividends or make certain other restricted payments; and (iii) places
restrictions on our ability and the ability of our subsidiaries to merge or consolidate with any other person or sell, assign, transfer, convey or otherwise dispose of all or substantially all of our assets. The indenture provides for a restricted payment pool out of which we are permitted to make certain restricted payments, including cash dividends, provided that no event of default has occurred and we would be able to incur additional indebtedness under the applicable restrictive covenant. The restricted payment pool is generally an amount calculated based on 50% of our consolidated net income, as defined in the indenture, and earned during the period beginning on February 1, 2005 and ending on the last day of the most recent fiscal quarter prior to the restricted payment, as adjusted and subject to certain exceptions as provided in the indenture.
Any future domestic subsidiaries of the Company will be required to fully and unconditionally guarantee the senior secured notes on a joint and several basis. Neither Edgen/Murray, L.P. nor MIM UK guarantees the senior secured notes. The senior secured notes and the related guarantees are secured by a lien on substantially all of the Company’s assets and the assets of any future domestic restricted subsidiaries of the Company (other than certain excluded assets such as leasehold interests and the capital stock of any future subsidiaries), subject to certain permitted liens and other limitations. Under an intercreditor agreement, the security interest in those assets consisting of inventory, accounts receivable, lockboxes, deposit accounts, securities accounts and financial assets credited thereto, and certain related assets that secure the senior secured notes and the related guarantees, are subordinated to a lien thereon that secures our revolving credit facility. As a result of such lien subordination, the senior secured notes are effectively subordinated to our revolving credit facility to the extent of the value of such assets.
Revolving Credit Facility
In connection with the Buy-out Transaction, Edgen entered into a new $20 million senior secured revolving credit facility (the “Credit Agreement”) with GMAC Commercial Finance LLC (“GMAC CF”), replacing its $55.5 million revolving credit agreement. The Credit Agreement is subject to certain borrowing limitations and matures on February 1, 2010. Under the Credit Agreement, interest accrues on borrowings (at the option of the Company) at either (i) the prime rate of interest announced by GMAC CF (8.25% at December 31, 2006), or (ii) a Eurodollar rate based on LIBOR plus 2.00% per annum (7.32% at December 31, 2006). The Company must also pay a monthly facility fee of 0.50% per annum on the unused portion of the maximum revolving amount. There were no borrowings under the Credit Agreement as of December 31, 2006.
The Credit Agreement is guaranteed by all of our domestic subsidiaries and is secured by a first priority security interest in all of the Company’s and its domestic subsidiaries’ working capital assets and a second priority security interest in all of the Company’s and its domestic subsidiaries’ other assets (other than certain excluded assets such as the Company’s leasehold interests and the capital stock of its subsidiaries). Pursuant to the terms of the intercreditor agreement described above, the security interest on the collateral consisting of working capital assets that secures the Notes and related guarantees is contractually subordinated to the liens thereon securing the Credit Agreement, and the security interest, if any, on substantially all of the Company’s and its domestic subsidiaries’ other assets (other than certain excluded assets such as the Company’s leasehold interests and the capital stock of its subsidiaries) that secure the Credit Agreement are contractually subordinated to the liens thereon securing the Notes and related guarantees.
In addition, the Credit Agreement contains various affirmative and negative covenants, including limitations on additional indebtedness, the making of distributions, loans and advances, transactions with affiliates, dispositions or mergers, and the sale of assets.
As of December 31, 2006, we were in compliance with the covenants contained in the Senior Secured Notes and Senior Credit Facility.
Scheduled annual maturities for all outstanding credit arrangements and long-term debt for the years after December 31, 2006 are as follows:
7. REDEEMABLE AND MANDATORILY REDEEMABLE PREFERRED STOCK
Redeemable Preferred Stock - On February 1, 2005, the Company issued Series A 8 1/2% Cumulative Compounding Preferred Stock, $0.01 par value (“Series A Preferred Stock”), in connection with the Buy-out Transaction. The holders of Series A Preferred Stock were entitled to receive annual dividends when, as and if, declared. The dividends were cumulative, whether or not earned or declared, and accrued at a rate of 8.5%, compounding annually, and were payable in cash or shares of Series A Preferred Stock, at the discretion of the board of directors. Upon the occurrence of certain events, including a public offering, the sale of substantially all the assets of the Company or a change in control, and the approval of the board of directors, which is controlled by JCP, the Series A Preferred Stock could have been redeemed by the Company at a price of $1,000 per share, plus accrued and unpaid dividends. For the year ended December 31, 2006 and the period February 1, 2005 to December 31, 2005, the Company accrued dividends of $1,392,300 and $1,703,400, respectively, on the shares of outstanding Series A Preferred Stock. As of December 31, 2005, all of the outstanding shares of the Series A Preferred Stock were held by Edgen/Murray, L.P., which is controlled by JCP.
The Notes indenture restricts the payment of dividends to preferred stock holders as well as the redemption of the Series A Preferred Stock, subject to an incurrence test based on a consolidated net income threshold, and subject to the availability of certain baskets under the indenture.
On September 29, 2006, Edgen/Murray, L.P., contributed all of the outstanding shares of Series A Preferred Stock to Paid-in capital, included in the statement of shareholders’ equity (deficit). As a result, the redeemable preferred stock line item was reduced to zero, and a corresponding increase in Paid-in capital was made within shareholder’s equity.
Mandatorily Redeemable Preferred Stock - In connection with the Buy-out Transaction on February 1, 2005, all mandatorily redeemable preferred stock of Edgen was redeemed. Prior to February 1, 2005, the holders of the Series A Cumulative Redeemable Preferred Stock, $.01 par value (“Series A Redeemable Preferred Stock”), were entitled to receive cash dividends at the rate of $6.00 per annum per share. Outstanding shares of Series A Redeemable Preferred Stock were mandatorily redeemable by the Company upon the occurrence of certain events including a public offering, the sale of substantially all the assets of the Company or a change in control, at a price of $100.00 per share, plus accrued and unpaid dividends. The Preferred Stock was also subject to optional redemption at the discretion of the board of directors at a price of $100.00 per share, plus accrued and unpaid dividends.
Holders of the Series B Redeemable Preferred Stock, $.01 par value (“Series B Redeemable Preferred Stock”), with respect to rights of liquidation, winding up and dissolution, ranked junior to the Series A Redeemable Preferred Stock, but senior to all other Edgen equity securities. The holders of the Series B Redeemable Preferred Stock were not entitled to receive cash dividends. The outstanding shares of Series B Redeemable Preferred Stock were mandatorily redeemable similarly to the Series A Redeemable Preferred Stock except that the redemption price was $400 per share plus a “return” amount up to an additional $400 per share.
For the period January 1, 2005 to January 31, 2005, and the year ended December 31, 2004, the Company accrued dividends of $189,949 and $2,205,864, respectively, on the shares of outstanding Series A Preferred Stock.
8. SHAREHOLDER’S EQUITY
Common Stock-The holders of Class A Common Stock $.01 per share (“Class A Common Stock”), and Class B Common Stock, $.01 per share (“Class B Common Stock”), are entitled to vote. In connection with the Buy-out Transaction, the Class B Common Stock, which was exchangeable at the option of the holder in Class A Common Stock on a one-to-one basis, was cancelled.
During 2004, the Company repurchased shares of Class A common stock under an employee repurchase agreement for the Company’s former Chief Executive Officer and agreements with other employees resulting in the repurchase of Class A common stock of $1,313,561. The repurchased share price was based on a stated per share amount (original cost), which reimbursed the shareholders for their original investment. In connection with the repurchased shares, any outstanding shareholder notes that were issued in connection with the issuance of the Class A common shares were repaid to the Company in full. The repurchased shares were accounted for as a reduction in total equity with no compensation expense being recognized in the statement of operations.
Stock Options-In December 1998, the stockholders of the Company approved a stock option plan to provide stock options as incentives and rewards for employees of the Company. Under the stock option plan, a maximum of 550,000 shares of the Company’s Class A Common Stock could be granted. In connection with the Buy-out
Transaction on February 1, 2005, the Company’s stock option plan and all outstanding stock options were cancelled and restricted stock was granted under a new incentive compensation plan.
Prior to cancellation, the terms of the stock options included an exercise price at the fair market value of the shares at the date of grant and the options vested ratably over a five year period. At December 31, 2004, 113,283 options were outstanding and unexercised.
The Company had granted these stock options to employees with an exercise price equal to the fair value of the shares at the date of grant and were accounted for in accordance with APB Opinion No. 25 (the intrinsic value method). Under APB Opinion No. 25, because the exercise price of the Company’s employee stock options equaled the market price of the underlying stock on the date of grant, no compensation expense was recognized.
For purpose of pro forma disclosures, as required by SFAS No. 123, the estimated fair value of the options (net of expected tax benefits) would have been amortized to expense over the options’ five year vesting period. The pro forma impact for the period January 1, 2005 to January 31, 2005 and for the year ended December 31, 2004 did not have a significant impact on the Company’s results of operations or financial position.
A summary of changes in options is as follows:
The following table presents information relating to Edgen’s stock options outstanding at December 31, 2004 (share data in thousands):
Non-Vested Common Units/Shares - On February 1, 2005, 281,565 shares of restricted stock were granted to certain employees of the Company, including the Chief Executive Officer, the Chief Financial Officer and the two Operating Segment Presidents under a new incentive compensation plan. Vesting of the restricted stock was based on either time or a combination of performance and time. The time-based vesting schedule was generally 20% per year over a five-year period subject to the holder’s continued employment with the Company. Restricted stock grants that used a vesting schedule that combined performance and time generally vested 10% per year over five years subject to continued employment with the Company plus an additional 10% or more per year for each year that the Company achieved certain performance goals as determined by the board of directors. Performance-based restricted stock was cumulative so if the performance goals were achieved in any year of the five-year period, all restricted stock subject to the performance criteria for that year and prior years would vest. If the performance goals were not achieved within five years of the grant date, the restricted stock subject to the performance goals would be forfeited. Upon a change in control, all restricted stock subject to time-based vesting would fully and immediately vest.
Effective December 15, 2005, the Company’s equity incentive plan was cancelled; however, the Company’s new parent company, Edgen/Murray, L.P., exchanged all outstanding awards for awards issued under its equity
incentive plan with substantially equivalent terms. The Edgen/Murray, L.P. incentive plan authorizes the granting of awards to Edgen employees of up to 550,000 common units of Edgen/Murray, L.P. that are subject to restrictions on transfer until such time as they are vested. Vesting is based on either time or a combination of performance and time. For the period February 1, 2005 to December 31, 2005, the statement of operations includes $281,565 of stock-based compensation expense related to the outstanding restricted stock shares which were exchanged on December 15, 2005.
During 2006 and 2005, Edgen/Murray, L.P. granted approximately 56,155 and 10,000 shares of non-vested common units, respectively, with vesting terms ranging from one to five years, of which all were outstanding at December 31, 2006. There were no forfeitures as of December 31, 2006. The estimated weighted average grant date fair value of the non-vested common units as of December 31, 2006 was $6.04. The fair value price of the awards is a calculated value based on the grant date of each of the respective grants using a combination of a share-based pricing model and financial metrics from recent transactions of companies with similar characteristics of Edgen/Murray, L.P. As of December 31, 2006, there was $1,249,367 of total unrecognized compensation cost at Edgen/Murray, L.P. related to these non-vested common units to be recognized through August 2010.
Stock-based compensation expense related to the granting of the Edgen/Murray, L.P. non-vested common units to the Company’s employees is allocated to Edgen and expensed within its condensed consolidated statement of operations. For the year ended December 31, 2006 and the period February 1, 2005 to December 31, 2005, the condensed consolidated statement of operations reflects $569,299 and $291,173, respectively, of stock-based compensation expense related to non-vested common units/shares.
9. INCOME TAXES
Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts for income tax purposes. Significant components of the Company’s deferred tax assets and liabilities at December 31, 2006 and 2005 are as follows:
As of December 31, 2006 and 2005, deferred tax liabilities include the difference in book and tax basis related to other identifiable intangibles, customer relationships and tradenames, identified in the Buy-out Transaction (see Note 2).
As presented in the consolidated statement of cash flows, the change in deferred income taxes for the year ended December 31, 2006 includes, among other items, the change in deferred income taxes related to the deferred income tax provision, the change between the deferred income taxes estimated for 2005 and actual deferred income taxes for 2005, and $2,948,330 in acquired deferred tax liabilities related to the MIM US acquisition purchase price allocation adjustment in 2006 (see Note 5). For the period February 1, 2005 to December 31, 2005, the change in deferred income taxes includes, among other items, the change in deferred income taxes related to the deferred income tax provision and the change between the deferred income taxes estimated for 2004, $146,290 in acquired deferred tax assets and $14,401,791 in acquired deferred tax liabilities in connection with the Buy-out Transaction and the acquisition of MIM US.
Income (loss) from operations for each jurisdiction follows for the respective period:
Components of income tax expense (benefit) are as follows:
For the year ended December 31, 2006, the period February 1, 2005 to December 31, 2005 and the year ended December 31, 2004, we made payments related to income taxes totaling $11,451,549, $211,929 and
$1,327,110, respectively. No tax payments were made for the period January 1, 2005 to January 31, 2005. In 2005, the Company deferred its third and fourth quarter 2005 estimated federal tax payments as allowed by the Katrina Emergency Tax Relief Act of 2005. These estimated 2005 tax payments were paid on February 28, 2006.
The total provision for income taxes varied from the US federal statutory rate due to the following:
As of December 31, 2006, United States taxes were not provided on earnings of our foreign subsidiaries, as we have invested or expect to invest the undistributed earnings indefinitely. If in the future these earnings are repatriated to the United States, or if we determine that the earnings will be remitted in the foreseeable future, additional tax provisions may be required.
As of December 31, 2002, a valuation allowance was recorded against the deferred tax asset because management believed that the deferred tax assets related to the goodwill impairment would not more than likely be realized in full through future operating results and the reversal of taxable timing differences. Based on operating results for fiscal 2004 and projected operating results for fiscal 2005 and 2006, management believed that a valuation allowance was no longer required, and the valuation allowance was reversed as of December 31, 2004. This resulted in an increase in the deferred tax asset as of December 31, 2004 and a corresponding decrease in income tax expense for the year then ended of $7.1 million.
For state income tax purposes, the Company has net operating loss carryforwards (“NOLs”) of approximately $1,200,000 available to reduce future state taxable income at December 31, 2006. These NOLs expire in varying amounts beginning in 2014 through 2018.
10. COMMITMENTS AND CONTINGENCIES
Operating Leases - Through its subsidiaries, Edgen leases various properties, warehouses, equipment and office space under operating leases with remaining terms ranging from two to twelve years with various renewal options. Substantially all leases require payment of taxes, insurance and maintenance costs in addition to rental payments. Total rental expense for all operating leases was $1,785,797, $1,384,595, $100,252, and $1,251,180 for the year ended December 31, 2006, the period February 1, 2005 to December 31, 2005, the period January 1, 2005 to January 31, 2005, and the year ended December 31, 2004, respectively.
Future minimum payments under noncancelable leases with initial or remaining terms in excess of one year for fiscal years beginning after December 31, 2006 are:
Employment Agreements - In the ordinary course of business, the Company has entered into employment contracts with certain executives and former owners; these contracts provide for minimum salary levels and incentive bonuses.
Legal Proceedings - The Company is involved in various claims, lawsuits and proceedings arising in the ordinary course of business. While there are uncertainties inherent in the ultimate outcome of such matters and it is impossible to presently determine the ultimate costs that may be incurred, management believes the resolution of such uncertainties and the incurrence of such costs will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.
11. CONCENTRATION OF CREDIT RISK
For the year ended December 31, 2006, the Company’s ten largest customers represented approximately 28% of the Company’s sales, and no one customer accounted for more than 10%.
During the period February 1, 2005 to December 31, 2005, the period January 1, 2005 to January 31, 2005, and the year ended December 31, 2004, the Company’s ten largest customers represented approximately 26%, 22%, and 22%, respectively, of the Company’s sales, and no one customer accounted for more than 10%.
Financial instruments that would potentially subject the Company to a significant concentration of credit risk consist primarily of accounts receivable. However, concentration of credit risk with respect to the accounts receivable is limited due to a large number of entities comprising the customer base.
The Company relies on a limited number of third parties to supply its inventory. For the year ended December 31, 2006, during the period February 1, 2005 to December 31, 2005 and the period January 1, 2005 to January 31, 2005, and the year ended December 31, 2004, the Company’s ten largest vendors accounted for approximately 55%, 58%, 54%, and 55% respectively, of the Company’s purchases and the Company’s single largest vendor accounted for approximately 8%, 15%, 11% and 12%, respectively, of the Company’s purchases in these periods.
12. SEGMENT AND GEOGRAPHIC AREA INFORMATION
Edgen markets and distributes specialty steel pipe, pipe components, and structural plates and sections made of highly engineered prime carbon and alloy steel. Edgen distributes its products primarily to companies operating within the energy infrastructure markets primarily in the oil and gas production and transmission, the process/petrochemical and the power generation industries. During 2006, Edgen aggregated its operations into two reportable segments: alloy products and carbon products.
The alloy products segment distributes specialty steel pipe and components for use in environments that are highly corrosive, extremely high or low temperature and/or involve high pressures. These products are sold primarily to the process/petrochemical and power generation industries.
The carbon products segment distributes specialty carbon steel pipe, pipe components and high grade structural sections and plates primarily for use in high pressure and/or abrasive environments. The primary industries served are the oil and gas production and transmission, the process and the power generation industries.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. Edgen evaluates performance based on profit or losses from operations before income taxes not including nonrecurring gains or losses and discontinued operations.
The following table presents the financial information for each reportable segment and selected geographic areas:
The Company’s sales to external customers and total assets are attributed to the following countries based upon the Company’s selling location:
On December 31, 2006, the Company changed its name to Edgen Murray Corporation and merged its U.S. subsidiaries into Edgen Murray Corporation. The Company’s Canadian subsidiary, Edgen Canada Inc., changed its
name to Edgen Murray Canada Inc. In connection with the merger, the Company’s parent company, Edgen/Murray, L.P. began managing the Company as its Americas segment with one operating segment president. Edgen/Murray, L.P.’s other operating segments include the United Kingdom (Europe/West Africa), Singapore (Asia/Pacific) and United Arab Emirates (Middle East). As a result, the Company intends to present financial information under one operating segment in 2007, the first period for which the Company will be managed as the Americas operating segment of Edgen Murray, L.P.
13. DERIVATIVES AND OTHER FINANCIAL INSTRUMENTS
Currency Exchange Rate Risk - In our business, we may enter into purchase and sales commitments that are denominated in a foreign currency (primarily the Euro). Our practices include entering into foreign currency forward exchange contracts to minimize foreign currency exposure related to forecasted purchases and sales of certain inventories. As of December 31, 2006, we had one contract related to a purchase of inventory that matures in May 2007 to purchase a notional amount of $6.3 million of foreign currency.
As of December 31, 2006, the fair value of these foreign currency forward exchange contracts of $0.1 million was recorded as an asset on the consolidated balance sheet. For the year ended December 31, 2006, we recognized a gain of $0.5 million in gains (losses) on foreign currency forward exchange contracts reflected in other income (expense) on the statement of operations.
As of December 31, 2005, we had 13 contracts related to purchases of inventory, that matured in varying increments through August 2006, to purchase an aggregate notional amount of $20.8 million of foreign currency. We also had three contracts related to the sale of inventory that matured in varying increments through August 2006, to receive an aggregate notional amount of $2.1 million of foreign currency. As of December 31, 2005, the fair value of these foreign currency forward exchange contracts of $0.4 million was recorded as a liability on the consolidated balance sheet. For the combined twelve months ended December 31, 2005, we recognized ($0.4 million) in losses on foreign currency forward exchange contracts reflected in other income (expense) on the statement of operations.
Credit risk - The Company’s credit risk on liquid resources and derivative financial instruments is limited because the counterparties are banks with high credit ratings assigned by international credit-rating agencies. The Company has no significant concentration of credit risk with a specific counterparty because exposure is spread over a number of counterparties.
Fair values - Shown below is a comparison by category of the book values and the estimated fair value of the Company’s financial assets and financial liabilities, and the associated derivative financial instruments described above. The fair value amounts shown are not necessarily indicative of the amounts that the Company would realize upon disposition, nor do they indicate the Company’s intent or ability to dispose of the financial instruments.
The comparison of carrying value and fair value of the Company’s financial instruments at December 31, 2006 and 2005 is presented below (in thousands):
The fair value of the Edgen Senior Secured Notes, excluding unamortized discount, has been estimated based upon market quotes approximating the fair value at the balance sheet.
The fair value of cash at bank and in hand, accounts receivable and accounts payable approximates its carrying value due to the short-term maturity of these instruments.
The fair value of derivative instruments is based on the estimated amount the Company would receive or pay if the transaction was terminated, taking into consideration prevailing exchange rates. The foreign currency forward
contracts fair value includes the value of contracts used as hedges of future sales or purchases. The Company believes that the carrying amount of other financial assets and liabilities approximates their fair values.
14. EMPLOYEE BENEFIT PLAN
The Company maintains a 401(k) plan for all employees who have met the eligibility requirements to participate. Under the plan, employees may contribute up to 15% of compensation, subject to an annual maximum as determined under the Internal Revenue Code. The Company matches 50% of up to 6% of the employees’ contributions. The plan provides that employees’ contributions will be 100% vested at all times and that the Company’s contributions vest over a five year period. Effective December 16, 2005, the Company began sponsoring a 401(k) profit-sharing plan for its subsidiary, MIM US, which covers eligible employees at least 21 years of age who have completed at least three months of service. The plan allows for employee contributions through salary deductions up to 19% of total compensation, subject to the statutory limits. Employer matching contributions can be made at the discretion of the Company. The Company contributed $349,261, $251,629, $16,694, and $250,937 to these plans for the year ended December 31, 2006, the period February 1, 2005 to December 31, 2005, the period January 1, 2005 to January 31, 2005, and the year ended December 31, 2004, respectively.
15. RELATED PARTY TRANSACTIONS
In connection with the Buy-out Transaction and pursuant to a transaction fee agreement with the Company’s board of directors and certain members of management including Edward J. DiPaolo, John B. Elstrott, Edgar Hotard, Daniel J. O’Leary, and David L. Laxton, the Company paid a transaction fee in an amount equal to 2% of the aggregate purchase price of approximately $124.0 million, or $2,480,000, which was allocated among Messrs. DiPaolo, Elstrott, Hotard, O’Leary and Laxton. At the same time, pursuant to value bonus compensation awards approved by our board of directors, certain members of management became eligible for value bonuses in an aggregate amount of $3,000,000, which bonuses were distributed to our named executive officers and other members of management. Furthermore, our board of directors approved an additional senior management bonus equal to 20% of the net proceeds from the sale of Edgen Corporation in excess of $64.0 million. The amount of this bonus was approximately $1.5 million in the aggregate, and was distributed among the senior management by the mutual agreement of Mr. Kleinman, a Harvest Partners’ board member, and Mr. O’Leary.
Prior to the consummation of the Buy-out Transaction, Harvest Partners and its affiliates owned approximately 63% of our outstanding preferred stock and approximately 70% of our outstanding Class A common stock. In addition, Harvest Partners and its affiliates held $5.0 million principal amount of our then existing subordinated notes. Pursuant to an amended and restated management agreement between Harvest Partners and us, the Company paid Harvest Partners a quarterly management fee and reimbursed Harvest Partners for reasonable expenses. Management fees paid for the period January 1, 2005 to January 31, 2005 and the year ended December 31, 2004 were $123,900, and $495,600, respectively. Upon the consummation of the Buy-out Transaction, we paid Harvest Partners a transaction fee in an amount equal to 0.826 times 2% of the aggregate purchase price of $124.0 million, or $2,048,480, at which time the management agreement was terminated. This transaction fee was expensed in selling, general and administrative expenses within the statement of operations for the period January 1, 2005 to January 31, 2005. Effective February 1, 2005, Harvest Partners no longer holds any of the Company’s equity or debt securities.
Prior to the consummation of the Buy-out Transaction, Stonehenge Capital owned approximately 17% of our outstanding preferred stock and approximately 20% of our Class A common stock. Pursuant to an amended and restated management agreement between Stonehenge Capital and us, the Company paid Stonehenge Capital a quarterly management fee and reimbursed Stonehenge Capital for reasonable expenses. Management fees paid to Stonehenge for the period January 1, 2005 to January 31, 2005 and the year ended December 31, 2004, were $26,100 and $104,000, respectively. Upon the consummation of the Buy-out Transaction, the Company paid Stonehenge Capital a transaction fee in an amount equal to 0.174 times 2% of the aggregate purchase price of approximately $124.0 million, or $431,520, at which time the management agreement was terminated. This transaction fee was expensed in selling, general and administrative expenses within the statement of operations for the period January 1, 2005 to January 31, 2005. Effective February 1, 2005, Stonehenge Capital no longer holds any of the Company’s equity or debt securities.
On October 25, 2000, we issued four convertible term notes, in an aggregate principal amount of $15.0 million, to certain stockholders of our Company. Three convertible term notes were issued to affiliates of Harvest Partners: two notes to Harvest Partners III, L.P. in the initial principal amounts of approximately $8.7 million and approximately $2.5 million and one note to Harvest Partners III, Beteiligungsgesellschaft buergerlichen Rechts mit Haftungsbeschraenkung in the initial principal amount of approximately $1.5 million. The fourth convertible term note was issued to Bank One Equity Investors Inc. in the initial principal amount of approximately $2.2 million. In
connection with the consummation of the Buy-out Transaction, the Company repaid the remaining principal and interest obligations of approximately $2.8 million in the aggregate as of December 31, 2004, and these convertible term notes were terminated.
With the acquisition of MIM US by the Company and the acquisition of MIM UK by Pipe Acquisition Limited, an affiliate of the Company, on December 16, 2005, certain related party transactions commenced. During the year ended December 31, 2006, the Company allocated $0.9 million of selling, general and administrative expenses to MIM UK related to executive payroll and related benefits including stock-based compensation, travel and other administrative expenses.
Purchases from MIM UK and its subsidiaries were $2,785,632 for the year ended December 31, 2006. Sales to MIM UK and its subsidiaries were $1,037,580 for the year ended December 31, 2006. As of December 31, 2006 and 2005, amounts due to MIM UK were $1,442,205 and $218,094, respectively. As of December 31, 2006 and 2005, amounts due from MIM UK were $468,911 and $19,483, respectively.
16. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The table below sets forth unaudited financial information for each of the quarters in fiscal 2006 and 2005, including the periods February 1, 2005 to March 31, 2005 and January 1, 2005 to January 31, 2005:
The period January 1, 2005 to January 31, 2005 reflects $12.0 million in Buy-out Transaction related expense included in selling, general and administrative expenses related to the acquisition of Edgen by JCP. Operations for the fourth quarter of 2005 reflect the impact of the MIM US acquisition on December 16, 2005 (see Note 2).
17. CONDENSED CONSOLIDATING FINANCIAL INFORMATION
In connection with the issuance of our Notes, our domestic subsidiaries issued joint and several guarantees of the Notes. These subsidiaries are referred to as the Guarantor Subsidiaries in the condensed consolidating financial information which is presented below. Our subsidiaries which have not issued guarantees for the Notes (our Canadian foreign subsidiaries including Edgen Canada and its subsidiary Western Flow) are referred to as the Non-Guarantor Subsidiaries. Prior to the acquisition of Western Flow on July 15, 2005, the Non-Guarantor Subsidiaries were considered to be “minor” as that term is defined in Rule 3-10 of Regulation S-X promulgated by the Securities and Exchange Commission.
The following presents the condensed consolidating financial information with respect to our financial position as of December 31, 2006 and 2005, and our cash flows for the year ended December 31, 2006, the period February 1, 2005 to December 31, 2005, and the period January 1, 2005 to January 31, 2005. The principal eliminating entries eliminate investment in subsidiaries, intercompany balances and intercompany revenues and expenses.
EDGEN MURRAY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEET
(Unaudited)
EDGEN MURRAY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
EDGEN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
EDGEN MURRAY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
EDGEN MURRAY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of the principal executive officer (“CEO”) and principal financial officer (“CFO”), of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act.) Based on this evaluation, the CEO and CFO concluded that, as of the end of the period ended December 31, 2006, our disclosure controls and procedures are effective to provide reasonable assurance 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 Securities and Exchange Commission rules and forms, and to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our CEO and CFO, to allow timely decisions regarding required disclosure. There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
As of January 1, 2006, the Company was not an “accelerated filer” as defined in Rule 12b-2 under the Exchange Act. Accordingly, pursuant to SEC rules and regulations, the Company is not required to provide, and we have not provided, Management’s Annual Report on Internal Control Over Financial Reporting or the associated report of our independent registered public accounting firm in this Annual Report on Form 10-K. Management and our Audit Committee are continuing to review our internal control over financial reporting as part of our preparation for the need to provide Management’s Annual Report on Internal Control Over Financial Reporting and the associated report of our independent registered public accounting firm, and complete phase-in of compliance standards under Section 404 of the Sarbanes-Oxley Act of 2002. Any deficiencies identified by this review will be reported to the Audit Committee, and we will take appropriate action to correct any deficiencies.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
MANAGEMENT
Executive Officers and Directors
Our executive officers and directors are as follows:
Name
Age
Title
Daniel J. O’Leary
Chief Executive Officer and Director
David L. Laxton, III
Executive Vice President, Chief Financial Officer and Director
Robert L. Gilleland
Senior Vice President - Global Supply Chain and Vendor Development
Craig S. Kiefer
President - Americas
Nicholas Daraviras
Director
James L. Luikart
Director
Edward J. DiPaolo
Director
Daniel J. O’Leary, 51, Chief Executive Officer and Director, has been involved in the steel pipe and distribution industries for 28 years. Mr. O’Leary joined us in January 2003 as our Chief Operating Officer and was promoted to Chief Executive Officer in August 2003. Mr. O’Leary served as our President from August 2003 through November 2006. Mr. O’Leary was appointed to our board of directors upon consummation of the Buy-out Transaction in February 2005. Before joining our Company, Mr. O’Leary served as President and Chief Operating Officer of Stupp Corporation, an independent manufacturer of electric-resistance welded custom steel line pipe, from 1995 to 2002. Prior to joining Stupp Corporation, he was Executive Vice-President and Chief Operating Officer of Maverick Tube Corporation from 1989 to 1995. He has also held management and executive positions with Red Man Pipe & Supply Company and Lone Star Steel Company. Mr. O’Leary is a former Vice-Chairman of the Committee on Pipe and Tube Imports and a member of the National Association of Steel Pipe Distributors. Mr. O’Leary is a graduate of the University of Tulsa with a B.S. in Education.
David L. Laxton, III, 57, Executive Vice President, Chief Financial Officer and Director, has more than 20 years experience in industrial distribution. Mr. Laxton joined us in December 1996 as Senior Vice President and Chief Financial Officer. Mr. Laxton became Executive Vice President and Chief Financial Officer in February 2005. Mr. Laxton was appointed as a director on August 25, 2005. Prior to joining Edgen, Mr. Laxton served as Chief Financial Officer of a distributor of tube fittings, controls and filtration products. Mr. Laxton has also held consulting positions with a big four accounting firm and with an investment banking firm. Mr. Laxton is currently Vice Chairman of American Gateway Bank and is the former president of the Baton Rouge Chapter of the National Association of Purchasing Management. Mr. Laxton has recently been named to the Advisory Committee to the School of Accounting at Louisiana State University, where he received a B.A. in History and an M.S. in Accounting.
Robert L. Gilleland, 66, Senior Vice President - Global Supply Chain and Vendor Development, has more than 30 years of experience in the pipe and steel industry. Mr. Gilleland joined Edgen in 1998 as our Senior Vice President and General Manager. He was promoted to President of Alloy Products Group in September 2003 and became Senior Vice President - Global Supply Chain and Vendor Development in November 2006. Prior to joining Edgen, Mr. Gilleland was employed with LaBarge Pipe & Steel Company for 16 years. He was Executive Vice President and part owner in a leveraged buy-out of LaBarge Pipe & Steel Company in 1982. At LaBarge Pipe & Steel Company, Mr. Gilleland was responsible for inventory, purchasing and sales activities. Prior to joining LaBarge Pipe & Steel Company, Mr. Gilleland was employed with Edgcomb Metals Company, a subsidiary of Williams Companies, for 18 years. He holds a B.S. in Business Administration from Western Kentucky University.
Craig S. Kiefer, 52, President - Americas, has more than 30 years of experience in the industrial distribution market. Mr. Kiefer joined our Company in April 2002 as the President of Service Industrial Supply Co. (SISCO). He was promoted to President of Carbon Products Group in March 2003 and became our President - Americas in November 2006. Prior to joining Edgen, Mr. Kiefer was President and Chief Executive Officer of SISCO, which he formed in 1979 and which was acquired by Edgen in 2002.
Nicholas Daraviras, 33, Director. Mr. Daraviras was appointed to our board of directors upon consummation of the Buy-out Transaction in February 2005. Mr. Daraviras is a Managing Director of JCP. He joined JCP in 1996. Mr. Daraviras also serves as a director of The Sheridan Group in which JCP also has an interest. Mr. Daraviras graduated as a Wharton Scholar and received his B.S. and an M.B.A. from The Wharton School of the University of Pennsylvania.
James L. Luikart, 61, Director. Mr. Luikart was appointed to our board of directors upon consummation of the Buy-out Transaction in February 2005. Mr. Luikart is Executive Vice President of JCP. Mr. Luikart joined JCP in 1995 after spending over twenty years with Citicorp, the last seven years of which were as Vice President of Citicorp Venture Capital, Ltd. Mr. Luikart also serves as a director of W&T Offshore, Inc., and Ascent Energy in which JCP also has an interest. Mr. Luikart received a B.A. in History magna cum laude from Yale University and an M.I.A. from Columbia University.
Edward J. DiPaolo, 54, Director. Mr. DiPaolo was appointed to our board of directors on August 25, 2005, and had previously served on our board of directors from 2001 until the consummation of the Buy-out Transaction on February 1, 2005. Mr. DiPaolo has over 26 years in energy services through his employment with Halliburton Energy Services where he held several positions including Group Senior Vice President Global Business Development and Senior Vice President Global Business Development. In 2002, Mr. DiPaolo retired from Halliburton Energy Services. Mr. DiPaolo currently serves as a director of Evolution Petroleum, Boots & Coots International Well Control, Inc., Innicor Subsurface Technologies Inc., and Superior Well Services, Inc. and has served as director for privately held companies. Mr. DiPaolo received a B.S. in Agricultural Engineering from West Virginia University.
Audit Committee
Our Audit Committee consists of Messrs. Daraviras, Luikart and DiPaolo. Neither Mr. Daraviras nor Mr. Luikart is independent as that term is used in Section 10A(m)(3) of the Exchange Act, and none of Messrs. Daraviras, Luikaut or DiPaolo qualifies as an audit committee financial expert as that term is defined by applicable SEC regulations.
However, the board of directors believes that each of the members of the Audit Committee has demonstrated that he is capable of analyzing and evaluating our financial statements and understanding internal controls and procedures for financial reporting. As the board of directors believes that the current members of the Audit Committee are qualified to carry out all of the duties and responsibilities of the Audit Committee, the board of directors does not believe that it is necessary at this time to actively search for an outside person to serve on the board of directors who would qualify as an audit committee financial expert.
Our audit committee is responsible for overseeing our financial reporting processes on behalf of our board of directors. Our independent registered public accounting firm reports directly to our audit committee.
Compensation Committee
Messrs. Daraviras, Luikart and DiPaolo currently perform the functions of a compensation committee in addressing salaries and incentive compensation for our executive officers and none of our officers, or employees or former officers participated in such deliberations during 2006. See “Item 13. Certain Relationships and Related Transactions, and Director Independence.”
Corporate Governance and Nominating Committee
We do not have a corporate governance and nominating committee.
Code of Ethics
We do not have a code of ethics within the meaning of Item 406 of Regulation S-K because we are in the process of adapting our existing code of business ethics and conduct for this purpose.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION DISCUSSION AND ANALYSIS
Overview of Compensation Program
Messrs. Daraviras, Luikart and DiPaolo (for purposes of this section, the “Committee”) oversee the implementation of the Company’s executive compensation program with regard to all named executive officers and are charged with setting total compensation for all named executive officer’s including base salaries, incentive compensation and benefits at levels designed to meet the objectives of our executive compensation program. For purposes of this section, the term “named executive officers” refers to those individual executive officers named in the Summary Compensation Table and other tabular disclosure below.
Compensation Philosophy and Objectives
Our executive compensation program is designed to attract, motivate, and retain, as needed, individuals with the skills necessary for us to achieve our business plan and increase shareholder value, to provide and reward those individuals whose contributions enhance the Company’s results, and to align executive remuneration with the interests of the stockholders. The Committee’s compensation philosophy includes (i) setting base salaries at levels comparable to its peer group to attract and retain named executive officers and (ii) aligning the performance-based compensation at levels designed to promote executive contribution to shareholder value. It is also designed to encourage our executives to focus on both the short-term and long-term performance goals of the Company and its shareholders through an annual performance-based cash bonus that focuses on short-term and long-term performance goals, and equity-based incentive compensation that focuses on long-term performance goals.
During 2006, the Company’s Committee conducted a review of the Company’s named executive officers’ compensation compared to compensation of officers from comparable private and public companies, and based on the data reviewed and on JCP’s experience with similar companies, approved salary increases for the Company’s named executive officers effective January 1, 2007. The compensation review included the review of compensation for named executive officers with similar duties and responsibilities and assisted in establishing appropriate levels of base salary, incentive compensation and other benefits. The named executive officers, who serve as directors of the board, were not involved in the decision process of determining the total compensation to named executive officers in 2007. Prior to 2006, compensation levels for the Chief Executive Officer and the Chief Financial Officer were determined in connection with their original investment. Compensation levels for other named executive officers were determined by the Chief Executive Officer based on experience and current market conditions, and then recommended to the Committee for approval.
Elements of Compensation
Our executive compensation program is comprised of the following elements, each of which is discussed in more depth in the paragraphs that follow:
•
Base Salary,
•
Annual Performance-Based Cash Bonuses,
•
Equity-Based Incentive Compensation, and
•
General Employee Benefits.
Base Salary. Base salaries of our executive officers are reviewed and analyzed on an annual basis. Increases, if any, are determined based on a combination of factors, including the executive’s experience level, job responsibility, salary levels for executives in our peer group, and the individual’s efforts in achieving business results.
2006 Base Salaries. Salaries for our named executives in 2006 were $275,000 for Mr. O’Leary, $225,000 for Mr. Laxton, $225,000 for Mr. Gilleland, and $200,000 for Mr. Kiefer and such amounts are reflected in the summary compensation table.
2007 Base Salaries. Salaries for 2007 have been established for our named executives at $425,000 for Mr. O’Leary, $325,000 for Mr. Laxton, $240,000 for Mr. Kiefer, and $240,000 for Mr. Gilleland. The salaries for Mr. O’Leary, Mr. Laxton and Mr. Gilleland were increased in 2007 to reflect expanded responsibilities and duties of
establishing policies for the Company’s parent company, Edgen/Murray, L.P., and its subsidiaries, as the Chief Executive Officer, Chief Financial Officer, and Senior Vice-President of Global Supply Chain and Vendor Development, respectively. Additionally, Mr. Kiefer’s base salary was increased in 2007 to reflect his increased responsibilities and duties as the President of Edgen Murray Corporation.
Annual Performance-Based Cash Bonus. The Company maintains an Annual Employee Cash Bonus Plan for all employees (the “Cash Bonus Plan”) in order to motivate each eligible employee, including named executive officers, to achieve designated annual Company financial targets. We believe the employee bonus plan is an essential factor in attracting, motivating, and retaining qualified executives because it provides an additional earning opportunity based on the named executives’ contributions to the Company’s financial success through the achievement of minimum earnings (Earnings Before Interest, Taxes, Depreciation and Amortization or “EBITDA”) and working capital thresholds. If actual EBITDA is less than or equal to the minimum EBITDA (50% of target EBITDA), a named executive officer is not entitled to any bonus. If, however, the EBITDA is greater than the minimum EBITDA, then the named executive officer is entitled to receive a bonus in an amount equal to 2% of the officer’s annual target bonus for each 1% of EBITDA in excess of the minimum EBITDA. Named executive officers continue to earn an additional 1% of the target bonus for each 1% that actual EBITDA exceeds the target EBITDA. If the Company’s working capital threshold exceeds annual threshold targets established by the board of directors, then the named executive officer’s bonus may be reduced. The working capital threshold is calculated as the sum of accounts receivable and inventories divided by the sum of trade accounts payable and accrued expenses, expressed as a percent of consolidated sales. The target bonus may not be reduced by more than 20%.
On an annual basis, the Company’s CEO and CFO establish the minimum EBITDA and working capital thresholds based on current market conditions and potential strategic initiatives, and considers how the annual EBITDA target will contribute to the Company’s long-term performance goals. The Company’s CEO and CFO submit the projections, the minimum EBITDA target and working capital threshold for approval by the Committee, which excludes named executive officers. The Committee has discretion to adjust awards or the computation of the EBITDA target and working capital thresholds based on factors outside of the control of individual participants if considered appropriate and approved by the Committee.
In 2006, the Company’s EBITDA target, before employee bonuses, was $44.2 million, and except for Mr. O’Leary and Mr. Laxton, each named executive officer’s bonus opportunity was 100% of base salary. The Company’s 2006 EBITDA before bonuses was $45.7 million, and because the EBITDA target was exceeded, the named executive officer’s other than the Chief Executive Officer and the Chief Financial Officer, earned a bonus at a level of 103.5% of each executive’s target bonus opportunity. As a result of expanded responsibilities in connection with Edgen/Murray, L.P.’s acquisition of MIM Ltd. and its subsidiaries, Mr. O’Leary and Mr. Laxton’s cash bonus plan for 2006 was determined based on targets of $425,000 and $325,000, respectively, rather than on their base salaries for 2006. The amounts paid to each named executive officer under the Company’s cash bonus plan for 2006 is set forth in the Summary Compensation Table, under the column “Non-Equity Incentive Plan Compensation.”
All bonuses under this plan are paid on or before March 15 of the year following the year in which the bonus is earned.
Equity-Based Incentive Compensation. The Company originally established the Edgen Corporation Incentive Plan in order to align the interests of executive officers, including named executive officers, with the interests of the Company’s other shareholders, and to motivate such named executive officers to create long-term shareholder value by granting to executive officers restricted common shares. In connection with the formation of the Company’s parent company, Edgen/Murray, L.P., restricted shares of Edgen issued under the Edgen Corporation Incentive Plan were exchanged, on a value-for-value basis, for restricted common partnership units (“restricted units”) under the Edgen/Murray, L.P. Incentive Plan (for Edgen and its Subsidiaries) as described below.
The Company established the Edgen/Murray, L.P. Incentive Plan to grant restricted equity units that are designed to encourage the holder’s continued service and contribution to the value of the Company. Restricted units received in connection with the formation of Edgen/Murray, L.P., are comprised of both time and performance-based units. The time-based units vest pro rata over a five year period and the performance-based units vest based on the achievement of target Company values which are measured annually as the Edgen Per Share Equity Value. The Edgen Per Share Equity Value is defined in the Edgen/Murray, L.P. Incentive Plan as multiplying the Company’s EBITDA, as defined in the plan, for the respective year by the number 5.76, and subtracting from that amount, the sum of (a) all indebtedness for borrowed money outstanding at year end, as defined by the plan, (b) the aggregate liquidation preferences (including accrued but unpaid dividends) of all shares of any equity security of the Company, including redeemable preferred stock, in the event of liquidation, which entitles the holders of such securities to be paid before the holders of the Company’s common stock and that are outstanding at year end, offset by (c) the amount of cash and cash equivalents on the Company’s balance sheet as of year end. Certain directors, senior management and other key employees of Edgen/Murray, L.P. and its subsidiaries are entitled to receive restricted units under the Edgen/Murray, L.P. Incentive Plan. The Company, in its sole discretion, determines the number of restricted units to award to any of the named executive officers, in its sole discretion. Vesting of restricted units may be accelerated in the case of certain events, such as a
change in control or an approved sale of the Company or Edgen. Such accelerated vesting is described more fully in the section below entitled “Potential Payments Upon Termination or Change in Control.”
In 2006, Edgen made additional grants under the Edgen/Murray, L.P. Incentive Plan in the amount of 11,661.8 restricted units to David L. Laxton, III and 17,492.8 restricted units to Daniel J. O’Leary. Because each executive remained employed by the Company, these restricted units vested in full on December 31, 2006. The FAS No. 123R expense to the Company in 2006 is disclosed in the “Summary Compensation Table” in the “Stock Awards” column and the number of Restricted Units is repeated in the “Grants of Plan Based Awards in 2006” table below under the “Estimated Future Payouts Under Equity Incentive Plan Awards” column.
Also in 2006, certain time-vesting and performance-vesting restricted units were vested for Messrs. O’Leary, Laxton, Gilleland and Kiefer under awards they were granted in 2005. The FAS No. 123R expense to the Company in 2006 is disclosed in the “Summary Compensation Table” in the “Stock Awards” column. The number of units which vested for each executive are as follows:
General Benefits.
Health and Welfare Plans. The Company has established employee benefit plans for all employees, including medical, dental, group life, disability and accidental death and dismemberment insurance, in order to provide a competitive overall benefits package to attract and retain employees at all levels. Named Executive Officers are eligible to participate in all such plans, in each case on the same basis as other employees.
401(k) Plan. The Company has established the Edgen Corporation 401(k) Plan (the “401(k) Plan”) for all eligible employees of the Company, to provide a competitive overall benefits package, and to attract and retain employees at all levels. Executive officers are eligible to participate in the 401(k) Plan on the same basis as other employees. The 401(k) Plan is tax-qualified and eligible employees may accumulate savings for retirement on a pre-tax basis. The Company makes matching contributions on behalf of employees, on a nondiscretionary basis, up to 50% of the employee’s contributions, up to a maximum of 6% of the employee’s eligible compensation. In addition, the Company may, from time to time, make discretionary profit sharing contributions, the amount of which is determined by the Company in its sole discretion. Employer contributions to the 401(k) plan, including profit sharing contributions, and employer matching contributions, vest 25% after the second year of employment, 50% after the third year of employment, 75% after the fourth year of employment and 100% after the fifth year of employment.
Perquisites. Perquisites for our named executives include auto allowances, supplemental payments, country club membership dues, life insurance premiums and tax preparation reimbursement, if applicable. These perquisites help to provide competitive total compensation packages to the named executive officers, and we believe compare favorably with other companies in the Company’s industry who have officers with similar responsibilities.
Executive Time Off. Our executive officers receive a guaranteed amount of Paid Time Off, or PTO, pursuant to employment agreements which generally provide for four weeks. Our executive officers are expected to manage personal time off in a manner that does not impact performance or achievement of goals. Under the Company PTO benefit program, upon termination, neither Company employees or named executive officers are entitled to payment of any unused portion of PTO.
Compensation Committee Report
Messrs. Daraviras, Luikart and DiPaolo perform the functions of a compensation committee for the Company and have reviewed and discussed the Compensation Discussion and Analysis with management. Based on such
review and discussions, Messrs. Daraviras, Luikart and DiPaolo recommended to the board of directors that the Compensation Discussion and Analysis be included in the registrant’s annual report on Form 10-K.
Nicholas Daraviras
James L. Luikart
Edward J. DiPaolo
2006 Summary Compensation Table
The following table sets forth certain information with respect to annual compensation for services in all capacities for fiscal year 2006 paid to the principal executive officer, the principal financial officer, and the next two highly compensated executive officers responsible for establishing policies during the last fiscal year.
Summary Compensation Table
(1) Amounts represent discretionary cash bonuses to assist the executives with personal income taxes related to restricted common unit grants in February 2006 and were not tied directly to achievement of specified performance goals.
(2) Amount represents the FAS No. 123R stock-based compensation expense recorded within the statements of operations for the year ended December 31, 2006 for all outstanding restricted units for each named executive officer.
(3) No option awards were granted in 2006.
(4) Represents the dollar value of any premiums paid by, or on behalf of, during 2006 with respect to term life insurance for the benefit of the named executive officer and their named beneficiaries, auto allowances, supplemental payments under employment agreements, matching contribution to the Company’s 401(k) plan and club membership allowances for all employees as follows:
Daniel O’Leary: $2,665 insurance premiums, $14,400 automobile allowance, $9,500 supplemental payment, $6,005 401(k) matching, and $7,605 club membership allowance.
David L. Laxton, III: $1,460 insurance premiums and income tax gross-up of $837, $14,400 automobile allowance, $7,500 supplemental payment, $6,051 401(k) matching, and $4,400 club membership allowance.
Robert L. Gilleland: $3,050 insurance premiums, $14,400 automobile allowance, $7,500 supplemental payment, $6,600 401(k) matching, and $8,855 club membership allowance.
Craig S. Kiefer: $3,485 insurance premiums, $12,000 automobile allowance, $7,500 supplemental payment, $4,587 401(k) matching, and no club membership allowance.
Grants of Plan Based Awards
The board of directors approved awards under our Employee Incentive Plan to the Chief Executive Officer and Chief Financial Officer in 2006. Set forth below is information regarding awards granted during 2006:
Grants of Plan Based Awards in 2006
(1) If actual EBITDA is less than or equal to the minimum EBITDA (50% of the target EBITDA), then the named executive officer is not entitled to any bonus. If the actual EBITDA is greater than the minimum EBITDA, the named executive officer is entitled to receive a bonus in an amount equal to 2% of the officer’s annual target bonus for each 1% of actual EBITDA in excess of the minimum EBITDA. The threshold amount included above assumes that actual EBITDA is 51% of target EBITDA.
(2) The target is calculated as 100% of the named executive officer’s target amount for 2006, as determined by the Committee at its discretion as described in the “Annual Performance-Based Cash Bonus.”
(3) There is no maximum amount related to the annual cash bonus plan.
(4) Grant date fair value of stock and option awards was calculated as the number of shares of stock or units multiplied by the fair value of $6.04.
Compensation Discussion and Analysis
During 2006, the Company maintained compensation levels consistent with 2005 related to base salary, non-equity incentive compensation and perquisites for all named executive officers. The Company did issue additional awards of restricted equity units to Mr. O’Leary and Mr. Laxton in 2006 as a result of the Company’s parent company, Edgen/Murray, L.P., acquiring MIM Ltd. and its subsidiaries in December 2005. The acquisition of MIM Ltd. expanded the oversight and policy function responsibilities of both Mr. O’Leary and Mr. Laxton, particularly, with the task of integrating the businesses. As a result, the Committee believed additional compensation was supported by these expanded responsibilities. In connection with the issuance of the restricted units, a cash bonus of $60,000 and $40,000 was extended to Mr. O’Leary and Mr. Laxton, respectively, to assist with income tax requirements associated with the issuance of the new equity awards.
The Committee also modified the annual cash bonus plan for Mr. O’Leary and Mr. Laxton in 2006 to provide for fixed target amounts of $425,000 and $325,000, respectively, to be used in calculating the cash bonus, rather than using a percentage of the current year base salary. As a result, the cash bonuses paid to Mr. O’Leary and Mr. Laxton were $439,875 and $336,375, respectively, rather than $284,625 and $232,875, respectively, if their base salaries for 2006 had been used in the 2006 cash bonus plan calculation.
Each named executive officer is party to an employment agreement with the Company that provides for base salary, bonus opportunity and additional compensation. In addition, each named executive officer, who has received a grant under the Company’s incentive plan, is party to an award agreement which describes the material terms of such award. The material terms of these agreements are described below with respect to each named executive officer.
Daniel J. O’Leary
Mr. O’Leary’s employment agreement with the Company, effective January 1, 2005, entitles him to a base salary of $275,000 per year, subject to increase by the Board in its discretion. Effective January 1, 2007, Mr. O’Leary’s base salary was increased to $425,000. In addition to base salary, Mr. O’Leary is entitled to earn an annual bonus under the Cash Bonus Plan, described above, of up to 100% of his base salary based on the Company’s annual performance, but subject to a downward working capital adjustment, if necessary. The annual bonus can exceed 100% of his base salary if actual EBITDA exceeds the target EBITDA threshold. The terms of the Company’s bonus plan are described in more depth above under the caption “Annual Performance-Based Cash Bonus.”
Mr. O’Leary’s employment agreement also provides for a supplemental payment of $9,500 per year for miscellaneous expenses not directly reimbursed by the Company including, but not limited to, annual physicals, and an allowance of up to $1,500 per year for tax and financial preparation and planning. Finally, Mr. O’Leary’s employment agreement provides that the Company will pay the premiums on a term life insurance policy valued at $1,000,000 for the benefit of Mr. O’Leary’s beneficiaries, and an automobile allowance of $1,200 per month.
The FAS No. 123R expense reported in the Summary Compensation Table for Mr. O’Leary reflects the vesting of two restricted unit awards, one granted in 2005 and the other in 2006, as described in the Compensation Discussion and Analysis. In 2006, Mr. O’Leary was granted 17,493 restricted units which were subject to a time-vesting schedule under which all of the restricted units vested in full on December 31, 2006. In 2005, Mr. O’Leary was granted 93,855 restricted units, 50% of which were subject to a time-vesting schedule and 50% of which were subject to a performance vesting schedule, which were exchanged for Edgen/Murray, L.P. restricted units in December 2005. The performance vesting units vest as follows:
If Edgen Per Share
Equity Value is at
least $15.71 on
12/31/2005, then
If Edgen Per Share
Equity Value is at
least $22.20 on
12/31/2006, then
If Edgen Per Share
Equity Value is at
least $29.89 on
12/31/2007, then
If Edgen Per Share
Equity Value is at
least $41.27 on
12/31/2008, then
If Edgen Per Share
Equity Value is at
least $46.46 on
12/31/2009, then
9,385.5 vest on
2/1/2006
9,385.5 vest on
2/1/2007
9,385.5 vest on
2/1/2008
9,385.5 vest on
2/1/2009
9,385.5 vest on
2/1/2010
The time-vesting units vest as follows:
2/1/2006
2/1/2007
2/1/2008
2/1/2009
2/1/2010
9,385.5
9,385.5
9,385.5
9,385.5
9,385.5
David L. Laxton, III
Mr. Laxton’s employment agreement with the Company, effective January 1, 2005, entitles him to a base salary of $225,000 per year, subject to increase by the Board in its discretion. Effective January 1, 2007, Mr. Laxton’s base salary was increased to $325,000 per year. In addition to base salary, Mr. Laxton is entitled to earn an annual bonus under the Cash Bonus Plan of up to 100% of his base salary based on the Company’s annual performance, but subject to a downward working capital adjustment, if necessary. The annual bonus can exceed 100% of his base salary if actual EBITDA exceeds the target EBITDA threshold. The terms of the Company’s bonus plan are described in more depth above under the caption “Annual Performance-Based Cash Bonus.”
Mr. Laxton’s employment agreement also provides for a supplemental payment of $7,500 per year for miscellaneous expenses not directly reimbursed by the Company including, but not limited to, annual physicals, and an allowance of up to $1,500 per year for tax and financial preparation and planning. Finally, Mr. Laxton’s employment agreement provides that the Company will pay the premiums on a term life insurance policy valued at $1,000,000 for the benefit of Mr. Laxton’s beneficiaries, and an automobile allowance of $1,200 per month.
The FAS No. 123R expense reported in the Summary Compensation Table for Mr. Laxton reflects the vesting of two restricted unit awards, one granted in 2005 and the other in 2006, as described in the Compensation Discussion and Analysis. In 2006, Mr. Laxton was granted 11,662 restricted units which were subject to a time-vesting schedule under which all of the restricted units vested in full on December 31, 2006. In 2005, Mr. Laxton was granted 40,223 shares of Edgen, 50% of which were subject to a time-vesting schedule and 50% of which were subject to a performance vesting schedule, which were exchanged for Edgen/Murray, L.P. restricted units in December 2005. The performance vesting units vest as follows:
The time-vesting units vest as follows:
2/1/2006
2/1/2007
2/1/2008
2/1/2009
2/1/2010
4,022.3
4,022.3
4,022.3
4,022.3
4,022.3
Robert L. Gilleland
Mr. Gilleland’s employment agreement with the Company, effective January 1, 2004, entitles him to a base salary of $210,017 per year, subject to increase by the Board in its discretion. Effective October 1, 2005, Mr. Gilleland’s salary was increased to $225,000 per year and effective January 1, 2007, was increased to $240,000. In addition to base salary, Mr. Gilleland is entitled to earn an annual bonus under the Cash Bonus Plan of up to 100% of his base salary based on the Company’s annual performance, but subject to a downward working capital adjustment, if necessary. The annual bonus can exceed 100% of his base salary if actual EBITDA exceeds the target EBITDA threshold. The terms of the Company’s bonus plan are described in more depth above under the caption “Annual Performance-Based Cash Bonus.”
In 2005, Mr. Gilleland’s employment agreement was amended to provide for a supplemental payment of $7,500 per year for miscellaneous expenses not directly reimbursed by the Company including, but not limited to, annual physicals. Finally, Mr. Gilleland’s employment agreement provides that the Company will pay the premiums on a term life insurance policy for the benefit of Mr. Gilleland’s beneficiaries, and an automobile allowance of $1,200 per month.
The FAS No. 123R expense reported in the Summary Compensation Table for Mr. Gilleland reflects the vesting of the restricted unit award, granted in 2005, under which he was granted 26,816 shares of Edgen and later exchanged for Edgen/Murray, L.P. restricted units under the Edgen/Murray, L.P. Incentive Plan. 50% of these units are subject to a performance vesting schedule and 50% are subject to a time-vesting schedule. The performance vesting units vest as follows:
If Edgen Per Share
Equity Value is at
least $15.71 on
12/31/2005, then
If Edgen Per Share
Equity Value is at
least $22.20 on
12/31/2006, then
If Edgen Per Share
Equity Value is at
least $29.89 on
12/31/2007, then
If Edgen Per Share
Equity Value is at
least $41.27 on
12/31/2008, then
If Edgen Per Share
Equity Value is at
least $46.46 on
12/31/2009, then
2,681.6 vest on
2/1/2006
2,681.6 vest on
2/1/2007
2,681.6 vest on
2/1/2008
2,681.6 vest on
2/1/2009
2,681.6 vest on
2/1/2010
The time-vesting units vest as follows:
2/1/2006
2/1/2007
2/1/2008
2/1/2009
2/1/2010
2,681.6
2,681.6
2,681.6
2,681.6
2,681.6
Craig S. Kiefer
Mr. Kiefer’s employment agreement with Edgen Carbon Products Group, L.L.C., a wholly owned subsidiary of the Company, effective April 30, 2004, entitles him to a base salary of $180,000 per year, subject to increase by the Board in its discretion. Effective October 1, 2005, Mr. Kiefer’s salary was increased to $200,000 per year and effective January 1, 2007, was increased to $240,000. In addition to base salary, Mr. Kiefer is entitled to earn an annual bonus under the Cash Bonus Plan of up to 100% of his base salary based on the Company’s annual performance, but subject to a downward working capital adjustment, if necessary. The annual bonus can exceed 100% of his base salary if actual EBITDA exceeds the target EBITDA threshold. The terms of the Company’s bonus plan are described in more depth above under the caption “Annual Performance-Based Cash Bonus.”
In 2005, Mr. Kiefer’s employment agreement was amended to provide for a supplemental payment of $7,500 per year for miscellaneous expenses not directly reimbursed by the Company including, but not limited to, annual physicals. Finally, Mr. Kiefer’s employment agreement provides that the Company will pay the premiums on a term life insurance policy for the benefit of the Company, and an automobile allowance of $1,000 per month.
The FAS No. 123R expense reported in the Summary Compensation Table for Mr. Kiefer reflects the vesting of the restricted unit award, granted in 2005, under which he was granted 26,816 restricted units of Edgen and later exchanged for Edgen/Murray units under the Edgen/Murray, L.P. Incentive Plan. 50% of these units are subject to a performance vesting schedule and 50% are subject to a time-vesting schedule. The performance vesting units vest as follows:
If Edgen Per Share
Equity Value is at
least $15.71 on
12/31/2005, then
If Edgen Per Share
Equity Value is at
least $22.20 on
12/31/2006, then
If Edgen Per Share
Equity Value is at
least $29.89 on
12/31/2007, then
If Edgen Per Share
Equity Value is at
least $41.27 on
12/31/2008, then
If Edgen Per Share
Equity Value is at
least $46.46 on
12/31/2009, then
2,681.6 vest on
2/1/2006
2,681.6 vest on
2/1/2007
2,681.6 vest on
2/1/2008
2,681.6 vest on
2/1/2009
2,681.6 vest on
2/1/2010
The time-vesting units vest as follows:
2/1/2006
2/1/2007
2/1/2008
2/1/2009
2/1/2010
2,681.6
2,681.6
2,681.6
2,681.6
2,681.6
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
(1) The Company’s equity securities do not have a readily determinable fair market value. The market or payout value was calculated as unearned shares, units, or other rights that have not vested multiplied by the Edgen Per Share Equity Value for the year ended December 31, 2006 of $32.41.
OPTION EXERCISES AND STOCK VESTED
(1) The Company’s equity securities do not have a readily determinable fair market value. The value realized upon vesting was calculated as the number of shares or units acquired upon vesting multiplied by the Edgen Per Share Equity Value for the year ended December 31, 2006 of $32.41.
Potential Payments Upon Termination or Change of Control
The following summaries set forth potential payments payable to our named executive officers upon termination of their employment or a change of control of the Company. The potential payments described below are estimated based on the assumption that such termination of employment or change of control occurred on December 31, 2006. Actual payments, if any, may be more or less than the amounts described below. In addition, the Company may enter into new arrangements or modify these arrangements, from time to time.
Daniel J. O’Leary
In addition to the payment of accrued, but unpaid, annual bonus and base salary, if Mr. O’Leary’s employment with the Company is terminated, for certain reasons described below, he may be entitled to severance payments. Mr. O’Leary’s right to any severance payments described below are conditioned upon his continued compliance with the noncompetition and nonsolicitation provisions of his employment agreement, which prevent him from competing with the Company’s and its affiliates’ and subsidiaries’ business and from soliciting customers, suppliers, and employees away from the Company and its affiliates and subsidiaries. Accordingly, if Mr. O’Leary breaches those provisions of his employment agreement during any period in which he is entitled to severance payments, the Company is entitled to terminate further severance payments and seek to enforce the noncompetition and nonsolicitation provisions.
If Mr. O’Leary is terminated due to disability, his employment agreement provides that he will be paid his current annual salary over the twelve months following the termination date and a pro rated bonus for the year of termination. If Mr. O’Leary terminates due to death, Mr. O’Leary’s beneficiaries will be entitled to the proceeds of a life insurance policy on the life of Mr. O’Leary in the amount of $1,000,000. If Mr. O’Leary is terminated by the Company without cause, his employment agreement provides that he is entitled to continued payment of base salary for the greater of twelve months or the remainder of the employment term, a pro rated bonus for the year of termination and continued medical and health benefits for Mr. O’Leary for a one-year period following such termination. Finally, if Mr. O’Leary’s employment terminates in connection with a change in control, he is entitled to receive a lump sum payment equal to twelve months base salary, a pro-rated annual bonus for the year of termination and continued medical and health benefits for Mr. O’Leary for a one-year period following such termination.
If, during Mr. O’Leary’s employment with the Company, there occurs a change in control of the Company or Edgen, as defined in the Edgen/Murray, L.P. Incentive Plan, or an approved sale of the Company, as defined in the Edgen limited partnership agreement, then, subject to the right of the administrator to accelerate the vesting of
all restricted units, that portion of Mr. O’Leary’s award which is subject to the time-vesting schedule and the portion that is subject to the performance vesting targets for the year of the change in control and all future years will vest in full. That portion of Mr. O’Leary’s award which is subject to performance vesting targets for years prior to the change in control that have not been attained at the time of the change in control or approved sale will be forfeited with no further compensation due to Mr. O’Leary. If such change in control occurred on December 31, 2006, then 37,542 time-vesting units would vest immediately and 37,542 performance-vesting units would vest immediately (assuming that all performance targets were attained).
Assuming Mr. O’Leary’s employment was terminated under each of these circumstances on December 31, 2006, such payments and benefits have an estimated value of:
(1) The Company’s equity securities do not have a readily determinable fair market value. The value of accelerated equity and performance awards was calculated as the number of units outstanding as December 31, 2006 multiplied by the Edgen Per Share Equity Value for the year ended December 31, 2006 of $32.41.
David L. Laxton, III
In addition to the payment of accrued, but unpaid, annual bonus and base salary, if Mr. Laxton’s employment with the Company is terminated, for certain reasons described below, he may be entitled to severance payments. Mr. Laxton’s right to any severance payments described below are conditioned upon his continued compliance with the noncompetition and nonsolicitation provisions of his employment agreement, which prevent him from competing with the Company’s and its affiliates’ and subsidiaries’ business and from soliciting customers, suppliers, and employees away from the Company and its affiliates and subsidiaries. Accordingly, if Mr. Laxton breaches those provisions of his employment agreement during any period in which he is entitled to severance payments, the Company is entitled to terminate further severance payments and seek to enforce the noncompetition and nonsolicitation provisions.
If Mr. Laxton is terminated due to disability, his employment agreement provides that he will be paid his current annual salary over the twelve months following the termination date and a pro rated bonus for the year of termination. If Mr. Laxton terminates due to death, Mr. Laxton’s beneficiaries be entitled to the proceeds of a life insurance policy on the life of Mr. Laxton in the amount of $1,000,000. If Mr. Laxton is terminated by the Company without cause, his employment agreement provides that he is entitled to continued payment of base salary for the greater of twelve months or the remainder of the employment term, a pro rated bonus for the year of termination and continued medical and health benefits for Mr. Laxton for a one-year period following such termination. Finally, if Mr. Laxton’s employment terminates in connection with a change in control, he is entitled to receive a lump sum payment equal to twelve months base salary, a pro-rated annual bonus for the year of termination and continued medical and health benefits for Mr. Laxton for a one-year period following such termination.
If, during Mr. Laxton’s employment with the Company, there occurs a change in control of the Company or Edgen, as defined in the Edgen/Murray, L.P. Incentive Plan, or an approved sale of the Company, as defined in the Edgen limited partnership agreement, then, subject to the right of the administrator to accelerate the vesting of all restricted units, that portion of Mr. Laxton’s award which is subject to the time-vesting schedule and the portion that is subject to the performance vesting targets for the year of the change in control and all future years will vest in full. That portion of Mr. Laxton’s award which is subject to performance vesting targets for years prior to the
change in control that have not been attained at the time of the change in control or approved sale will be forfeited with no further compensation due to Mr. Laxton. If such change in control occurred on December 31, 2006, then 16,089.2 time-vesting units would vest immediately and 16,089.2 performance-vesting units would vest immediately (assuming that all performance targets were attained).
Assuming Mr. Laxton’s employment was terminated under each of these circumstances on December 31, 2006, such payments and benefits have an estimated value of:
(1) The Company’s equity securities do not have a readily determinable fair market value. The value of accelerated equity and performance awards was calculated as the number of units outstanding as December 31, 2006 multiplied by the Edgen Per Share Equity Value for the year ended December 31, 2006 of $32.41.
Robert L. Gilleland
In addition to the payment of accrued, but unpaid, annual bonus and base salary, if Mr. Gilleland’s employment with the Company is terminated, for certain reasons described below, he may be entitled to severance payments. Mr. Gilleland’s right to any severance payments described below are conditioned upon his continued compliance with the noncompetition and nonsolicitation provisions of his employment agreement, which prevent him from competing with the Company’s and its affiliates’ and subsidiaries’ business and from soliciting customers, suppliers, and employees away from the Company and its affiliates and subsidiaries. Accordingly, if Mr. Gilleland breaches those provisions of his employment agreement during any period in which he is entitled to severance payments, the Company is entitled to terminate further severance payments and seek to enforce the noncompetition and nonsolicitation provisions.
If Mr. Gilleland is terminated due to disability, his employment agreement provides that he will be paid his current annual salary over the twelve months following the termination date and a pro rated bonus for the year of termination. If Mr. Gilleland terminates due to death, Mr. Gilleland’s beneficiaries will be entitled to continued payment of Mr. Gilleland’s base salary for twelve months following his death and a pro rated bonus for the year in which such termination occurs. If Mr. Gilleland is terminated by the Company without cause, his employment agreement provides that he is entitled to continued payment of base salary for twelve months following termination, annual bonus for the year of termination as though Mr. Gilleland had remained employed for the duration of such year and continued medical and health benefits for Mr. Gilleland for a one-year period following such termination. Finally, if Mr. Gilleland’s employment terminates in connection with a change in control, he is entitled to continued payment of base salary for one year following such termination, a pro-rated annual bonus for the year of termination and continued medical and health benefits for Mr. Gilleland for a one-year period following such termination.
If, during Mr. Gilleland’s employment with the Company, there occurs a change in control of the Company or Edgen, as defined in the Edgen/Murray, L.P. Incentive Plan, or an approved sale of the Company, as defined in the Edgen limited partnership agreement, then, subject to the right of the administrator to accelerate the vesting of all Restricted Units, that portion of Mr. Gilleland’s award which is subject to the time-vesting schedule and the portion that is subject to the performance vesting targets for the year of the change in control and all future years will vest in full. That portion of Mr. Gilleland’s award which is subject to performance vesting targets for years prior to the change in control that have not been attained at the time of the change in control or approved sale will be forfeited with no further compensation due to Mr. Gilleland. If such change in control occurred on December 31,
2006, then 10,726.4 time-vesting units would vest immediately and 10,726.4 performance-vesting units would vest immediately (assuming that all performance targets were attained).
Assuming Mr. Gilliland’s employment was terminated under each of these circumstances on December 31, 2006, such payments and benefits have an estimated value of:
(1) The Company’s equity securities do not have a readily determinable fair market value. The value of accelerated equity and performance awards was calculated as the number of units outstanding as December 31, 2006 multiplied by the Edgen Per Share Equity Value for the year ended December 31, 2006 of $32.41.
Craig S. Kiefer
In addition to the payment of accrued, but unpaid, annual bonus and base salary, if Mr. Kiefer’s employment with the Company is terminated, for certain reasons described below, he may be entitled to severance payments. Mr. Kiefer’s right to any severance payments described below are conditioned upon his continued compliance with the noncompetition and nonsolicitation provisions of his employment agreement, which prevent him from competing with the Company’s and its affiliates’ and subsidiaries’ business and from soliciting customers, suppliers, and employees away from the Company and its affiliates and subsidiaries. Accordingly, if Mr. Kiefer breaches those provisions of his employment agreement during any period in which he is entitled to severance payments, the Company is entitled to terminate further severance payments and seek to enforce the noncompetition and nonsolicitation provisions.
If Mr. Kiefer is terminated due to disability, his employment agreement provides that he will be paid his current annual salary over the twelve months following the termination date and a pro rated bonus for the year of termination. If Mr. Kiefer terminates due to death, Mr. Kiefer’s beneficiaries will be entitled to continued payment of Mr. Kiefer’s base salary for twelve months following his death and a pro rated bonus for the year in which such termination occurs. If Mr. Kiefer is terminated by the Company without cause, his employment agreement provides that he is entitled to continued payment of base salary for twelve months following termination, annual bonus for the year of termination as though Mr. Kiefer had remained employed for the duration of such year and continued medical and health benefits for Mr. Kiefer for a one-year period following such termination. Finally, if Mr. Kiefer’s employment terminates in connection with a change in control, he is entitled to continued payment of base salary for one year following such termination, a pro-rated annual bonus for the year of termination and continued medical and health benefits for Mr. Kiefer for a one-year period following such termination.
If, during Mr. Kiefer’s employment with the Company, there occurs a change in control of the Company or Edgen, as defined in the Edgen/Murray, L.P. Incentive Plan, or an approved sale of the Company, as defined in the Edgen limited partnership agreement, then, subject to the right of the administrator to accelerate the vesting of all Restricted Units, that portion of Mr. Kiefer’s award which is subject to the time-vesting schedule and the portion that is subject to the performance vesting targets for the year of the change in control and all future years will vest in full. That portion of Mr. Kiefer’s award which is subject to performance vesting targets for years prior to the change in control that have not been attained at the time of the change in control or approved sale will be forfeited with no further compensation due to Mr. Kiefer. If such change in control occurred on December 31, 2006, then 10,726.4 time-vesting units would vest immediately and 10,726.4 performance-vesting units would vest immediately (assuming that all performance targets were attained).
Assuming Mr. Kiefer’s employment was terminated under each of these circumstances on December 31, 2006, such payments and benefits have an estimated value of:
(1) The Company’s equity securities do not have a readily determinable fair market value. The value of accelerated equity and performance awards was calculated as the number of units outstanding as December 31, 2006 multiplied by the Edgen Per Share Equity Value for the year ended December 31, 2006 of $32.41.
Compensation Committee Interlock and Insider Participation
None of our executive officers serves as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving on our compensation committee. No interlocking relationships exist between any member of the board of directors or any member of the compensation committee of any other company.
Director compensation
Our policy is not to pay director compensation to directors who are also our employees. We anticipate that each outside director will enter into compensation arrangements to be determined. One of our directors, Mr. DiPaolo, receives director fees as a director of Edgen. Edgen pays Mr. DiPaolo $20,000 in director fees annually. For the year ended December 31, 2006 and the period February 1, 2005 to December 31, 2005, the Company paid Mr. DiPaolo $20,000 and $10,000, respectively, in director fees and on December 16, 2005 Edgen/Murray, L.P. granted Mr. DiPaolo restricted common partnership units with a fair value of approximately $60,400 for services rendered as a board member and audit committee member of Edgen. See “Item 13. Certain Relationships and Related Transactions.”
All of our directors are entitled to receive reimbursement of their out-of-pocket expenses in connection with their travel to and attendance at meetings of the board of directors or committees thereof.
The following table sets forth a summary of the compensation we paid to our non-employee directors in 2006:
Director Compensation Table
(1) Represents the FAS No. 123R stock-based compensation expense recorded within the statements of operations for the year ended December 31, 2006 for all outstanding restricted units for Mr. DiPaolo.
(2) No perquisities were extended to any director for the year ended December 31, 2006.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Our outstanding securities consist of approximately 2,681,564 shares of common stock as of March 29, 2007. As of September 30, 2006, 21,600 shares of Series A preferred stock were contributed to Paid-in Capital by the Company’s shareholder, Edgen/Murray, L.P.
Effective December 15, 2006, our stockholders transferred all of their equity interests in our Company to Edgen/Murray, L.P. in exchange for common and preferred partnership interests of Edgen/Murray, L.P. As a result, 100% of our outstanding common stock and preferred stock is now owned by Edgen/Murray, L.P.
The general partner of Edgen/Murray, L.P. is Edgen/Murray GP, LLC, a company wholly owned by funds managed by JCP. The limited partnership interests of Edgen/Murray, L.P. are divided into common units and preferred units. The following table sets forth certain information regarding the ownership of Edgen/Murray, L.P.’s common and preferred units as of March 30, 2007 by (i) each person or entity known to us to own more than 5% of any class of Edgen/Murray, L.P.’s partnership interests, (ii) each member of our board of directors and each of our named executive officers and (iii) all of the members of the board of directors and executive officers as a group. To our knowledge, each of the security holders listed below has sole voting and investment power as to the partnership interests shown unless otherwise noted and subject to community property laws where applicable.
Beneficial ownership of the securities listed in the table has been determined in accordance with the applicable rules and regulations promulgated under the Exchange Act.
(1) Pursuant to Rule 13d-3 under the Exchange Act, a person has beneficial ownership of any securities as to which such person, directly or indirectly, through any contract, arrangement, undertaking, relationship or otherwise has or shares voting power and/or investment power and as to which such person has the right to acquire such voting and/or investment power within 60 days. Percentage of beneficial ownership as to any person as of a particular date is calculated by dividing the number of shares beneficially owned by such person by the sum of the number of shares outstanding as of such date plus the number of shares as to which such person has the right to acquire voting and/or investment power within 60 days.
(2) Consists of (a) 2,931,463.82 common units held by ING Furman Selz Investors III L.P., 1,037,894.15 common units held by ING Barings U.S. Leveraged Equity Plan LLC and 237,709.85 common units held by ING Barings Global Leveraged Equity Plan Ltd. and (b) 26,744.58 preferred units held by ING Furman Selz Investors III L.P., 9,468.87 preferred units held by ING Barings U.S. Leveraged Equity Plan LLC and 2,168.78 preferred units held by ING Barings Global Leveraged Equity Plan Ltd. ING Furman Selz Investors III L.P., ING Barings U.S. Leveraged Equity Plan LLC and ING Barings Global Leveraged Equity Plan Ltd. are private equity investment funds managed by JCP. Brian P. Friedman and Mr. Luikart are the managing members of the managers of these funds and may be considered the beneficial owners of the shares owned by ING Furman Selz Investors III L.P., ING Barings U.S. Leveraged Equity Plan LLC and ING Barings Global Leveraged Equity Plan Ltd., but each of Messrs. Friedman and Luikart expressly disclaim beneficial ownership of such shares, except to the extent of each of their pecuniary interests therein. The address for each of the funds managed by Jefferies Capital Partners is 520 Madison Avenue, 12th Floor, New York, New York 10022.
(3) The address of Murray Metals Group Limited is 9 Charlotte Square, Edinburg EH2 4DR, United Kingdom.
(4) The address of such person is c/o Edgen Murray Corporation, 18444 Highland Road, Baton Rouge, Louisiana 70809. The number of common units includes 150,172.0 restricted units including 75,088.0 for Mr. O’Leary, 32,178.4 for Mr. Laxton, 21,452.8 for Mr. Gilleland and 21,452.8 for Mr. Kiefer.
(5) The address of each of Mr. Daraviras and Mr. Luikart is c/o Jefferies Capital Partners, 520 Madison Avenue, 12th Floor, New York, New York 10022.
(6) Does not include 2,931,463.82 common units and 36,922 preferred units owned by ING Furman Selz Investors III L.P., ING Barings U.S. Leveraged Equity Plan LLC and ING Barings Global Leveraged Equity Plan Ltd. Mr. Luikart is a managing member of the manager of these funds and may be considered the beneficial owner of such shares, but he expressly disclaims such beneficial ownership of the shares owned by ING Furman Selz Investors III L.P., ING Barings U.S. Leveraged Equity Plan LLC and ING Barings Global Leveraged Equity Plan Ltd., except to the extent of his pecuniary interest therein.
(7) The address of Mr. DiPaolo is 363 N. Sam Houston Parkway East, Suite 550, Houston, Texas 77060. 3,654 of the common units and 31.20 of the preferred units listed for Mr. DiPaolo are owned by Hickory Hills Investments, LTD, a family limited partnership of which Mr. DiPaolo is a limited partner. The number of common units includes 8,000 restricted units.
(8) The number of common units includes 158,172.0 restricted units including 75,088.0 for Mr. O’Leary, 32,178.4 for Mr. Laxton, 21,452.8 for Mr. Gilleland, 21,452.8 for Mr. Kiefer and 8,000 for Mr. DiPaolo.
Edgen/Murray Partnership Interests
In general, under the limited partnership agreement of Edgen/Murray, L.P., the general partner of Edgen/Murray, L.P. has control over its business and affairs and the limited partners do not participate, as limited partners, in the business and affairs of Edgen/Murray, L.P. Distributions of cash or property of Edgen/Murray, L.P. may be made only when and if, and in the amounts, determined by the general partner. Any such distributions must be made first to the holders of preferred units until each holder of preferred units has received cumulative aggregate distributions in an amount equal to, but not in excess of, the specified preferred return attributable to his, her or its preferred units. Then any remaining or subsequent distributions may be made to the holders of the common units.
Equity Compensation Plan Information
Equity Compensation Plan Information
As of December 31, 2006
(1) Includes restricted common units available for grant under the Edgen/Murray, L.P. Incentive Plan.
(2) Not applicable.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Transactions with Affiliated Companies
With the acquisition of MIM US by us, and the acquisition of MIM UK by Pipe Acquisition Limited, an affiliate of the Company, on December 16, 2005, certain related party transactions commenced. During the year ended December 31, 2006, we allocated $0.9 million of selling, general and administrative expenses to MIM UK related to the compensation of Mr. O’Leary, our Chief Executive Officer, and Mr. Laxton, our Chief Financial Officer, including payroll and related benefits including stock-based compensation, travel and other administrative expenses.
In addition, purchases from MIM UK and its subsidiaries were $2.8 million for the year ended December 31, 2006. Sales to MIM UK and its subsidiaries were $1.0 million for the year ended December 31, 2006. As of December 31, 2006 and 2005, amounts due to MIM UK were $1.4 million and $0.2 million, respectively. As of December 31, 2006 and 2005, amounts due from MIM UK were $0.5 million and less than $0.1 million, respectively.
Management Agreement
In connection with the Buy-out Transaction, we entered into a management agreement with JCP. Pursuant to this management agreement, JCP may provide management, business and organizational strategy and merchant and investment banking services to us, which services include, but are not limited to, advice on corporate and financial planning, oversight of operations, including the marketing, sales and distribution of our products, development of business plans, the structure of our debt and equity capitalization and the identification and development of business opportunities. In exchange for these services, we may pay JCP an annual management fee in an amount agreed to between JCP and us from time to time, plus reasonable out-of-pocket expenses. It is not currently contemplated that we will pay a management fee to JCP. In addition, JCP may negotiate with us to provide additional management, financial or other corporate advisory services in connection with any transaction, including any acquisition, divestiture or financing, in which we may be, or may consider becoming, involved. The management agreement provides that JCP will be paid a transaction fee for such services rendered by JCP in an amount mutually agreed upon by JCP and us, plus reasonable out-of-pocket expenses. The management agreement has an initial term of ten years. The agreement will automatically renew for additional one year terms unless either we or JCP give written notice of termination within 90 days prior to the expiration of the initial term or any extension. There are no minimum levels of service required to be provided pursuant to the management agreement. The management agreement includes customary indemnification provisions in favor of JCP.
Director Independence
Although our securities are not listed on the New York Stock Exchange, for purposes of this Item we have adopted the definition of “independence” applicable under the listing standards of the New York Stock Exchange. Using such definition, the board of directors has determined that Mr. DiPaolo is independent. If we were listed on the New York Stock Exchange, we would be exempt from certain independence requirements with respect to our board of directors and board committees under the “controlled company” exemption.
Policy for Approval of Related Person Transactions
We do not have a formal policy for the treatment of transactions required to be disclosed under Item 404(a) of Regulation S-K.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
Independent Auditors
Our Audit Committee appointed Deloitte & Touche LLP (“Deloitte & Touche”) as our Company’s independent auditors to conduct the audit of our Company’s books and records for the fiscal year ending December 31, 2006. Deloitte & Touche has served as our independent auditors since 1996.
Principal Accounting Fees and Services
The following table sets forth the aggregate fees incurred by the Company for services performed by Deloitte & Touche:
Audit Fees represent the aggregate fees billed or estimated to be billed to us for professional services rendered for the audit of our annual financial statements, review of financial statements included in our Form 10-Qs and services normally provided by our accountants in connection with statutory and regulatory filings or engagements.
Audit-Related Fees represent the aggregate fees billed to us or estimated to be billed to us for assurance and related services that were reasonably related to the performance of the audit or review of our financial statements and are not reported under “Audit Fees” above. In 2005, the nature of the services consisted principally of fees for the examination of offering circulars and a registration statement on Form S-4 in connection with the offering of our senior secured notes, and for the preparation of comfort letters issued to the initial purchaser of our senior secured notes. In 2005, these services also included a closing balance sheet audit in connection with the acquisition of Western Flow and an annual audit of MIM US included in an offering circular. In 2006, the nature of the services consisted of fees for the examination of a registration statement on Form S-4 in connection with the offering of our senior secured notes and the acquisition of MIM US. During 2006, the Company’s parent company, Edgen/Murray, L.P. also incurred $624,297 in audit-related fees associated with filing its Form S-1 with the Securities and Exchange Commission on November 13, 2006. These fees have not been included in the table above.
Tax Fees represent the aggregate fees billed to us or estimated to be billed to us for professional services rendered for tax compliance, tax advice and tax planning. In fiscal year 2005, the services included tax advice and planning related to our operations in Canada.
All Other Fees represent the aggregate fees billed to us or estimated to be billed to us for products or services provided to us by Deloitte & Touche, other than the services reported in the above categories.
Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of the Independent Auditor
Our Audit Committee is responsible for appointing, setting compensation for and overseeing the work of the independent auditor. The Audit Committee has established a policy requiring its pre-approval of all audit and permissible non-audit services provided by the independent auditor. The Audit Committee considers whether such services are consistent with the rules of the SEC on auditor independence as well as whether the independent auditor is best positioned to provide the most effective and efficient service, for reasons such as familiarity with our Company’s business, people, culture, accounting systems, risk profile and other factors and input from our management. The Audit Committee may delegate to one or more of its members the pre-approval of audit and permissible non-audit services provided that those members report any pre-approvals to the full committee. Pursuant to this authority, the Audit Committee has delegated to its Chair the authority to address any requests for pre-approval of services between Audit Committee meetings provided that the amount of fees for any particular services requested does not exceed $10,000, and the Chair must report any pre-approval decisions to the Audit Committee at its next scheduled meeting. The policy prohibits the Audit Committee from delegating to management the Audit Committee’s responsibility to pre-approve permitted services of the independent auditor. All services performed by Deloitte & Touche have been or will be approved by the Audit Committee prior to performance in accordance with legal requirements.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this report:
(1) All Financial Statements.
The financial statements listed in the Index to Consolidated Financial Statements under “Item 8. Financial Statements and Supplementary Data” are filed as part of this report.
(2) Financial Statement Schedules.
The financial statement schedules are not required under the related instructions or are inapplicable and therefore have been omitted.
(3) Exhibits.
The following is a list of exhibits filed as part of this report. Where so indicated, exhibits which were previously filed are incorporated by reference.
* Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 15(b) of this report.
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.
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.
INDEX TO EXHIBITS