UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended October 2, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to _______________
Commission File Number 1-313
THE LAMSON & SESSIONS CO.
---------------------------
(Exact name of Registrant as specified in its charter)
Ohio 34-0349210
------------------------------- ---------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
25701 Science Park Drive
Cleveland, Ohio 44122-7313
------------------------------- ---------------------------------
(Address of principal executive (Zip Code)
offices)
216/464-3400
------------------------------------------------------
(Registrant's telephone number, including area code)
-------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
APPLICABLE ONLY TO ISSUERS INVOLVED
IN BANKRUPTCY PROCEEDINGS DURING
THE PRECEDING FIVE YEARS:
Indicate by check mark whether the Registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of October 2, 2004 the Registrant had outstanding 13,837,024 common shares.
PART I
ITEM 1 - FINANCIAL STATEMENTS
CONSOLIDATED INCOME STATEMENTS (UNAUDITED)
THE LAMSON & SESSIONS CO. AND SUBSIDIARIES
(Dollars in thousands, except per share data)
THIRD QUARTER ENDED NINE MONTHS ENDED
--------------------------------- ---------------------------------=
2004 2003 2004 2003
----------------- --------------- ----------------- ----------------
NET SALES $ 106,403 100.0% $ 95,251 100.0% $ 294,153 100.0% $ 261,768 100.0%
Cost of products sold 87,993 82.7% 79,968 84.0% 241,752 82.2% 217,158 83.0%
--------- -------- --------- ---------
GROSS PROFIT 18,410 17.3% 15,283 16.0% 52,401 17.8% 44,610 17.0%
Operating expenses 12,903 12.1% 10,713 11.2% 36,879 12.5% 32,433 12.3%
Litigation settlement 1,728 1.6% - 0.0% 1,728 0.6% - 0.0%
Other expense (income) 395 0.4% - 0.0% (231) -0.1% - 0.0%
--------- -------- --------- ---------
OPERATING INCOME 3,384 3.2% 4,570 4.8% 14,025 4.8% 12,177 4.7%
Interest expense, net 1,992 1.9% 2,094 2.2% 5,897 2.0% 6,432 2.5%
--------- -------- --------- ---------
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES 1,392 1.3% 2,476 2.6% 8,128 2.8% 5,745 2.2%
Income tax provision 559 0.5% 958 1.0% 3,251 1.1% 2,298 0.9%
--------- -------- --------- ---------
INCOME FROM CONTINUING OPERATIONS 833 0.8% 1,518 1.6% 4,877 1.7% 3,447 1.3%
Income from discontinued operations, net of
income tax of $256 - 0.0% - 0.0% 401 0.1% - 0.0%
--------- -------- --------- ---------
NET INCOME $ 833 0.8% $ 1,518 1.6% $ 5,278 1.8% $ 3,447 1.3%
========= ======== ========= =========
BASIC EARNINGS PER COMMON SHARE:
Earnings from continuing operations $ 0.06 $ 0.11 $ 0.35 $ 0.25
Earnings from discontinued operations, net of tax - - 0.03 -
--------- -------- --------- ---------
NET EARNINGS $ 0.06 $ 0.11 $ 0.38 $ 0.25
========= ======== ========= =========
DILUTED EARNINGS PER COMMON SHARE:
Earnings from continuing operations $ 0.06 $ 0.11 $ 0.35 $ 0.25
Earnings from discontinued operations, net of tax - - 0.03 -
--------- -------- --------- ---------
NET EARNINGS $ 0.06 $ 0.11 $ 0.37 $ 0.25
========= ======== ========= =========
See notes to Consolidated Financial Statements (Unaudited).
2
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
THE LAMSON & SESSIONS CO. AND SUBSIDIARIES
(Dollars in thousands)
THIRD QUARTER THIRD QUARTER
ENDED YEAR ENDED ENDED
------------------------------------------
2004 2003 2003
------------- ---------- -------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 533 $ 468 $ 553
Accounts receivable, net of allowances of
$1,634, $1,532 and $2,152, respectively 59,561 38,196 52,467
Inventories, net
Raw materials 3,922 2,560 3,105
Work-in-process 4,827 3,266 4,228
Finished goods 31,381 24,317 27,186
--------- --------- ---------
40,130 30,143 34,519
Deferred tax assets 8,961 7,996 9,979
Prepaid expenses and other 5,293 4,574 4,477
--------- --------- ---------
TOTAL CURRENT ASSETS 114,478 81,377 101,995
PROPERTY, PLANT AND EQUIPMENT
Land 3,320 3,537 3,537
Buildings 24,897 25,776 25,221
Machinery and equipment 118,161 121,887 120,658
--------- --------- ---------
146,378 151,200 149,416
Less allowances for depreciation and amortization 98,536 99,874 98,560
--------- --------- ---------
TOTAL NET PROPERTY, PLANT AND EQUIPMENT 47,842 51,326 50,856
GOODWILL 21,519 21,519 21,558
PENSION ASSETS 30,388 30,016 30,232
DEFERRED TAX ASSETS 13,455 17,612 14,477
OTHER ASSETS 5,350 6,463 6,442
--------- --------- ---------
TOTAL ASSETS $ 233,032 $ 208,313 $ 225,560
========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 32,388 $ 16,928 $ 26,654
Accrued compensation and benefits 11,787 10,633 8,721
Customer volume & promotional accrued expenses 6,208 6,024 4,216
Other accrued expenses 9,940 8,273 11,843
Taxes 3,738 3,408 3,890
Secured credit agreement - current 83,100 11,000 11,000
Current maturities of long-term debt 860 760 755
--------- --------- ---------
TOTAL CURRENT LIABILITIES 148,021 57,026 67,079
LONG-TERM DEBT 11,756 82,990 89,619
POST-RETIREMENT BENEFITS AND OTHER
LONG-TERM LIABILITIES 28,749 29,782 28,627
SHAREHOLDERS' EQUITY
Common shares 1,384 1,379 1,379
Other capital 75,787 75,534 75,527
Retained earnings (deficit) (28,551) (33,829) (31,384)
Accumulated other comprehensive income (loss) (4,114) (4,569) (5,287)
--------- --------- ---------
TOTAL SHAREHOLDERS' EQUITY 44,506 38,515 40,235
--------- --------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 233,032 $ 208,313 $ 225,560
========= ========= =========
See notes to Consolidated Financial Statements (Unaudited).
3
CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
THE LAMSON & SESSIONS CO. AND SUBSIDIARIES
(Dollars in thousands)
NINE MONTHS ENDED
--------------------
2004 2003
-------- --------
OPERATING ACTIVITIES
Net income $ 5,278 $ 3,447
Adjustments to reconcile net income to cash provided by
operating activities:
Depreciation 6,901 6,890
Amortization 1,199 1,199
Gain on sale of property, plant and equipment (933) -
Deferred income taxes 2,862 2,102
Net change in working capital accounts:
Accounts receivable (21,365) (15,781)
Inventories (9,987) (2,335)
Prepaid expenses and other (316) (104)
Accounts payable 15,460 5,445
Accrued expenses and other current liabilities 2,349 (1,741)
Pension plan contributions (1,792) (1,067)
Other long-term items 1,893 2,285
-------- --------
CASH PROVIDED BY OPERATING ACTIVITIES 1,549 340
INVESTING ACTIVITIES
Net additions to property, plant and equipment (4,592) (5,787)
Refund of deposits on equipment operating leases 580 -
Proceeds from sale of property, plant and equipment 1,595 -
Acquisitions and related items (187) (750)
-------- --------
CASH USED IN INVESTING ACTIVITIES (2,604) (6,537)
FINANCING ACTIVITIES
Net borrowings under secured credit agreement 1,700 6,000
Payments on other long-term borrowings (734) (748)
Purchase and retirement of treasury stock (205) -
Exercise of stock options 359 2
-------- --------
CASH PROVIDED BY FINANCING ACTIVITIES 1,120 5,254
-------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 65 (943)
Cash and cash equivalents at beginning of year 468 1,496
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 533 $ 553
======== ========
See notes to Consolidated Financial Statements (Unaudited).
4
THE LAMSON & SESSIONS CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements do not include all
of the information and notes required by accounting principles generally
accepted in the United States for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring accruals and
changes in accounting estimates) considered necessary for a fair presentation
have been included. Certain 2003 amounts have been reclassified to conform with
2004 classifications.
NOTE B - INCOME TAXES
The year-to-date 2004 income tax provision was calculated based on management's
estimate of the annual effective tax rate of 40% for the year. The provisions
for 2004 and 2003 are primarily non-cash charges.
NOTE C - BUSINESS SEGMENTS
The Company's reportable segments are as follows:
Carlon - Industrial, Residential, Commercial, Telecommunications and Utility
Construction: The major customers served are electrical contractors and
distributors, original equipment manufacturers, electric power utilities, cable
television (CATV), telephone and telecommunications companies. The principal
products sold by this segment include electrical and telecommunications raceway
systems and a broad line of enclosures, electrical outlet boxes and fittings.
Examples of the applications for the products included in this segment are
multi-cell duct systems and High Density Polyethylene ("HDPE") conduit designed
to protect underground fiber optic cables, allowing future cabling expansion and
flexible conduit used inside buildings to protect communications cable.
Lamson Home Products - Consumer: The major customers served are home centers and
mass merchandisers for the "do-it-yourself" (DIY) home improvement market. The
products included in this segment are electrical outlet boxes, liquidtight
conduit, electrical fittings, door chimes and lighting controls.
PVC Pipe: This business segment primarily supplies electrical, power and
communications conduit to the electrical distribution, telecommunications,
consumer, power utility and sewer markets. The electrical and telecommunications
conduit is made from polyvinyl chloride ("PVC") resin and is used to protect
wire or fiber optic cables supporting the infrastructure of power or
telecommunications systems.
5
THE LAMSON & SESSIONS CO. AND SUBSIDIARIES
NOTE C - BUSINESS SEGMENTS - CONTINUED
(Dollars in thousands)
THIRD QUARTER ENDED NINE MONTHS ENDED
---------------------- ----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
NET SALES
Carlon $ 51,857 $ 43,755 $ 139,487 $ 116,879
Lamson Home Products 24,019 22,259 67,053 59,834
PVC Pipe 30,527 29,237 87,613 85,055
--------- --------- --------- ---------
$ 106,403 $ 95,251 $ 294,153 $ 261,768
========= ========= ========= =========
OPERATING INCOME (LOSS)
Carlon $ 4,565 $ 4,204 $ 12,812 $ 9,885
Lamson Home Products 1,431 3,696 6,283 9,544
PVC Pipe (597) (2,115) (765) (2,824)
Corporate Office (1,620) (1,215) (4,536) (4,428)
Other (Expense) Income (see Note I) (395) - 231 -
--------- --------- --------- ---------
$ 3,384 $ 4,570 $ 14,025 $ 12,177
========= ========= ========= =========
DEPRECIATION AND AMORTIZATION
Carlon $ 1,313 $ 1,688 $ 4,078 $ 5,136
Lamson Home Products 458 433 1,393 1,286
PVC Pipe 891 615 2,629 1,667
--------- --------- --------- ---------
$ 2,662 $ 2,736 $ 8,100 $ 8,089
========= ========= ========= =========
In September 2004 the Company settled its patent infringement litigation as the
result of a mediation process. The effect of this litigation settlement has
reduced operating income by $864,000 in both the Carlon and Lamson Home Products
business segments in the third quarter of 2004. Total assets by business segment
at October 2, 2004, January 3, 2004 and October 4, 2003 are as follows:
(Dollars in thousands)
OCTOBER 2, JANUARY 3, OCTOBER 4,
2004 2004 2003
---------- ---------- ----------
IDENTIFIABLE ASSETS
Carlon $ 87,075 $ 79,900 $ 89,470
Lamson Home Products 33,484 30,065 31,674
PVC Pipe 50,307 34,232 41,667
Corporate Office (includes deferred tax and
pension assets) 62,166 64,116 62,749
-------- -------- --------
$233,032 $208,313 $225,560
======== ======== ========
6
THE LAMSON & SESSIONS CO. AND SUBSIDIARIES
NOTE D - COMPREHENSIVE INCOME
The components of comprehensive income for the third quarter and first nine
months of 2004 and 2003 are as follows:
(Dollars in thousands)
THIRD QUARTER ENDED NINE MONTHS ENDED
---------------------- ----------------------
OCTOBER 2, OCTOBER 4, OCTOBER 2, OCTOBER 4,
2004 2003 2004 2003
---------- ---------- ---------- ----------
Net income $ 833 $1,518 $ 5,278 $3,447
Foreign currency translation adjustments (56) 57 (78) 114
Interest rate swaps, net of tax 124 252 533 469
----- ------ ------- ------
Comprehensive income $ 901 $1,827 $ 5,733 $4,030
===== ====== ======= ======
The components of accumulated other comprehensive loss, at
October 2, 2004, January 3, 2004 and October 4, 2003 are as follows:
(Dollars in thousands)
OCTOBER 2, JANUARY 3, OCTOBER 4,
2004 2004 2003
---------- ---------- ----------
Foreign currency translation adjustments $ (519) $ (441) $ (500)
Minimum pension liability adjustments,
net of tax (3,289) (3,289) (3,706)
Interest rate swaps, net of tax (306) (839) (1,081)
------- ------- -------
Accumulated other comprehensive loss $(4,114) $(4,569) $(5,287)
======= ======= =======
7
THE LAMSON & SESSIONS CO. AND SUBSIDIARIES
NOTE E - EARNINGS PER SHARE CALCULATION
The following table sets forth the computation of basic and diluted earnings per
share:
(Dollars and shares in thousands, except per share amounts)
THIRD QUARTER ENDED NINE MONTHS ENDED
------------------- -----------------
2004 2003 2004 2003
-------- ------- ------- -------
BASIC EARNINGS-PER-SHARE COMPUTATION
Net Income $ 833 $ 1,518 $ 5,278 $ 3,447
======= ======= ======= =======
Average Common Shares Outstanding 13,809 13,786 13,793 13,785
======= ======= ======= =======
Basic Earnings Per Share $ 0.06 $ 0.11 $ 0.38 $ 0.25
======= ======= ======= =======
DILUTED EARNINGS-PER-SHARE COMPUTATION
Net Income $ 833 $ 1,518 $ 5,278 $ 3,447
======= ======= ======= =======
Basic Shares Outstanding 13,809 13,786 13,793 13,785
Stock Options Calculated Under
the Treasury Stock Method 373 140 287 76
------- ------- ------- -------
Total Shares 14,182 13,926 14,080 13,861
======= ======= ======= =======
Diluted Earnings Per Share $ 0.06 $ 0.11 $ 0.37 $ 0.25
======= ======= ======= =======
NOTE F - DERIVATIVES AND HEDGING
The Company recognizes all derivative financial instruments as either assets or
liabilities at fair value. Derivative instruments that are not hedges are
adjusted to fair value through net income. Changes in the fair value of
derivative instruments that are classified as fair value hedges are offset
against changes in the fair value of the hedged assets, liabilities, or firm
commitments, through net income. Changes in the fair value of derivative
instruments that are classified as cash flow hedges are recognized in other
comprehensive income until such time as the hedged items are recognized in net
income.
During the first quarter of 2001, the Company entered into two interest rate
swap agreements for a total notional amount of $58.5 million, of which $22.0
million was outstanding at October 2, 2004. The agreements are coterminous with
the Company's secured credit facility and expire in August 2005. The swap
agreements effectively fix the interest rate on its variable rate debt at 5.41%
and 5.48% plus the Company's risk premium of 1.5% to 4.0%, respectively. These
transactions are considered cash flow hedges and, therefore, the fair market
value at the end of the third quarter of 2004 of a $306,000 (net of $195,000 in
tax) loss, has been recognized in other comprehensive income (loss). There is no
ineffectiveness on the cash flow hedges, therefore, all changes in the fair
value of these derivatives are recorded in equity and not included in the
current period's income statement. The entire $501,000 of loss on the fair value
of the hedges is classified in current accrued liabilities.
The Company has no derivative instruments that are classified as fair value
hedges.
8
THE LAMSON & SESSIONS CO. AND SUBSIDIARIES
NOTE G - DISCONTINUED OPERATIONS
As of the end of the first quarter of 2004 the Company was informed that YSD
Industries Inc. ("YSD"), a business which the Company sold in 1988, was selling
the assets of the business and would be unable to fund certain post-retirement
medical and life insurance benefits, for which the Company was contingently
liable. The Company had recorded a net charge ($2.7 million) at the 2003
year-end reflecting the actuarial calculation of this estimated liability for
payments to eligible participants through February 2011 when the Company's
obligation will end. As a result of YSD's asset sale, the Company was able to
realize payment of $668,000 for notes receivable that had been previously
written off as uncollectible in 2003. The net impact of this recovery, $401,000
(net of tax), has been recorded as income from discontinued operations in the
first quarter of 2004.
NOTE H - STOCK COMPENSATION PLANS
The Company currently has three stock compensation plans. The Company accounts
for those plans under the recognition and measurement principles of APB Opinion
No. 25, "Accounting for Stock Issued to Employees," and related interpretations.
No stock-based employee compensation cost is reflected in net income, as all
options granted under those plans had an exercise price equal to the market
value of the underlying common stock on the date of grant. In accordance with
SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure," the following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions of FASB Statement No. 123, "Accounting for Stock-Based Compensation,"
to stock-based employee compensation.
(Dollars in thousands, except per share data)
THIRD QUARTER ENDED NINE MONTHS ENDED
--------------------- ----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Net income As reported $ 833 $ 1,518 $ 5,278 $ 3,447
Total stock-based employee
compensation, net of tax (135) (156) (374) (491)
--------- --------- --------- ---------
Net income Pro forma $ 698 $ 1,362 $ 4,904 $ 2,956
========= ========= ========= =========
Basic earnings per share As reported $ 0.06 $ 0.11 $ 0.38 $ 0.25
Pro forma 0.05 0.10 0.36 0.21
Diluted earnings per share As reported $ 0.06 $ 0.11 $ 0.37 $ 0.25
Pro forma 0.05 0.10 0.35 0.21
NOTE I - SALE OF ASSETS
In the first quarter of 2004, the Company sold a manufacturing facility located
in Pasadena, Texas for net proceeds of $1.5 million. The remaining production
equipment is being relocated to other Lamson & Sessions facilities over the next
quarter. The Company anticipates incurring total severance, training and other
moving costs of $800,000 to $1,000,000 in 2004. These costs are charged against
other income as required under Financial Accounting Standard (FAS) No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities." During the
third quarter the Company incurred a charge of $0.4 million, primarily the
accrual of severance costs and expenditures on training and moving costs. For
the nine months ended October 2, 2004, a gain on the sale of the facility ($0.9
million), net of severance and other costs associated with the closure of the
facility ($0.7 million), was incurred totaling $0.2 million.
9
THE LAMSON & SESSIONS CO. AND SUBSIDIARIES
NOTE J - PENSION AND OTHER POST-RETIREMENT BENEFIT PLANS
The Company sponsors several qualified and non-qualified pension plans and other
post-retirement benefit plans for its current and former employees. As of
January 1, 2003 the Company eliminated the salary defined benefit pension plan
for future employees. This action makes all defined benefit pension and other
post-retirement benefit plans closed to new entrants and will reduce future
service costs.
The components of net periodic benefit cost (income) are as follows:
(Dollars in thousands)
THIRD QUARTER ENDED NINE MONTHS ENDED
------------------------------------- ---------------------------------------
PENSION BENEFITS OTHER BENEFITS PENSION BENEFITS OTHER BENEFITS
------------------ --------------- ------------------ -----------------
2004 2003 2004 2003 2004 2003 2004 2003
------- ------- ----- ------ ------- ------- ------- ------
Service cost $ 298 $ 267 $ 1 $ 2 $ 894 $ 801 $ 4 $ 6
Interest cost 1,219 1,261 168 292 3,657 3,783 460 876
Expected return on assets (1,486) (1,350) - - (4,458) (4,050) - -
Net amortization
and deferral 388 603 (53) 47 1,164 1,809 (7) 140
Defined contribution plans 250 161 - - 815 684 - -
------- ------- ----- ------ ------- ------- ------- ------
$ 669 $ 942 $ 116 $ 341 $ 2,072 $ 3,027 $ 457 $1,022
======= ======= ===== ====== ======= ======= ======= ======
Contributions of $983,000 were made in the third quarter of 2004, bringing total
contributions by the Company to its defined benefit pension plans to $1,792,000
in 2004. The Company expects to make $855,000 in contributions over the next 12
months, a reduction from previous estimates.
The above information includes the effect of YSD's other post-retirement benefit
costs which were assumed in April 2004.
On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the Act) was signed into law. The Act introduces a
prescription drug benefit under Medicare (Medicare Part D) as well as a federal
subsidy to sponsors of retiree health care benefit plans that provide a benefit
that is at least actuarially equivalent to Medicare Part D. In accordance with
FSP No. 106-2, "Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003," the effects of
the subsidy resulted in a $0.6 million reduction of the accumulated
post-retirement benefit obligation, which will be recognized prospectively.
NOTE K - DEBT CLASSIFICATION
The Company's secured credit agreement matures in August 2005. As a result, the
debt was reclassified as current at the end of the third quarter of 2004. The
Company intends to refinance this obligation in the first half of 2005.
10
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis provides information which management
believes is relevant to an assessment and understanding of the Company's
consolidated results of operations and financial condition. The discussion
should be read in conjunction with the Consolidated Financial Statements.
EXECUTIVE OVERVIEW
The Company continues to experience strong sales growth, recording the highest
quarterly net sales levels in its history. A surge in demand for
telecommunications duct to support Fiber-to-the-Premise (i.e. FTTP) projects and
the strong housing start results helped to raise sales activity. Generally,
order levels slowed in July and August but picked up in September recording the
highest monthly net sales in over five years.
Escalating resin costs remain the Company's foremost challenge. With oil prices
at record levels PVC and HDPE feedstocks have been increasing in price, driving
resin producers to pass the higher costs through with higher prices. Typically,
resin costs begin to decline in the third quarter and reach their low point at
year-end. This is not happening in 2004. Although some of the Carlon and PVC
Pipe segment business contains price escalators, much of it is dependent upon
end market demand in order to receive higher prices. Margins are most
significantly impacted by the fact that Lamson Home Products has been unable,
thus far, to obtain any price increases from its major retail customers. In
addition, the higher oil prices are causing increased fuel costs resulting in
rising freight costs.
In order to reduce costs and improve efficiencies, the Company continues to
implement its closure plan for its Pasadena, Texas facility. A portion of the
production capacity has been moved and installed at its Clinton, Iowa facility.
The project is on schedule to be completed in the fourth quarter of 2004.
Finally, in September 2004 the Company settled its patent infringement
litigation as a result of a mediation process. In connection with the
settlement, the Company recorded a net charge of $1.7 million in the third
quarter.
11
2004 COMPARED WITH 2003
RESULTS OF CONTINUING OPERATIONS
The following table sets forth, for the periods indicated, items from the
Consolidated Income Statements as a percentage of net sales for the third
quarter and nine months ended:
THIRD QUARTER ENDED NINE MONTHS ENDED
------------------- -----------------
2004 2003 2004 2003
-------- -------- ------- -------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of products sold 82.7 84.0 82.2 83.0
----- ----- ----- -----
Gross profit 17.3 16.0 17.8 17.0
Operating expenses 12.1 11.2 12.5 12.3
Litigation settlement 1.6 - 0.6 -
Other expense (income) 0.4 - (0.1) -
----- ----- ----- -----
Operating income 3.2 4.8 4.8 4.7
Interest expense 1.9 2.2 2.0 2.5
----- ----- ----- -----
Income from continuing operations
before income taxes 1.3 2.6 2.8 2.2
Income tax provision 0.5 1.0 1.1 0.9
----- ----- ----- -----
Income from continuing operations 0.8% 1.6% 1.7% 1.3%
===== ===== ===== =====
Net sales for the third quarter of 2004 increased to $106.4 million, an $11.1
million or 11.6% increase, over the third quarter of 2003. All three business
segments reflected higher net sales levels as telecom construction continued on
a similar pace as the second quarter, home improvement DIY sales were
supported by healthy home sales and improved spending on sewer infrastructure
projects began to be realized. Year-to-date net sales total $294.2 million, a
$32.4 million, or 12.4% increase, over the $261.8 million in net sales for the
first nine months of 2003.
Gross profit, although hindered by higher raw material costs, improved to $18.4
million, 17.3% of net sales, for the third quarter of 2004, compared with $15.3
million, 16.0% of net sales, for the third quarter of 2003. For the nine months
ended October 2, 2004 the gross profit was up by $7.8 million, totaling $52.4
million, 17.8% of net sales compared with $44.6 million, 17.0% of net sales for
the nine months ended October 4, 2003, a 17.5% improvement. As indicated
earlier, the cost of PVC continued to rise through the third quarter of 2004.
Procurement costs were up 21.0% this quarter compared with the third quarter of
2003, and up an average of 16.0% for the first nine months of 2004 compared with
the same period in 2003. These increased costs have been only partially offset
by price increases and productivity improvements.
Operating expenses increased to $12.9 million, or 12.1% of net sales, and $36.9
million, or 12.5% of net sales for the third quarter and first nine months,
respectively. In the third quarter, operating expenses were $2.2 million higher
than the $10.7 million in the third quarter of 2003. Much of the increase is
caused by higher variable selling expenses as sales were up by almost 12.0%. In
addition, the Company had higher incentive compensation expense ($1.4 million),
which was offset by reduced pension ($350,000) and retiree medical expenses
($225,000) in the current quarter compared with the prior year third quarter. In
the first nine months of 2004, operating expenses were $4.4 million, or 12.4%
higher than the $32.4 million of expenses in 2003. A majority of the increase is
a result of the 12.4% higher sales level in 2004 year-to-date compared with the
first nine months of 2003, causing more variable selling expenses. As noted in
the third quarter, comparative incentive compensation costs are higher ($2.6
million) than last year. In addition, for the first nine months of 2004 higher
medical
12
expenses for active employees ($980,000) and professional fees ($300,000),
addressing Sarbanes-Oxley compliance items, were incurred while there was a
reduction in costs from lower pension and retiree medical expenses along with
recovery of a bankruptcy claim. Operating income was $14.0 million for the first
nine months of 2004. Included in these results are the net effects of a
litigation settlement of $1.7 million, completed in September 2004, and the sale
and closure of the Company's Pasadena, Texas facility (see Note G).
Net interest declined to $5.9 million for the first nine months of 2004 compared
with $6.4 million in the same period in the prior year. Average borrowings over
the first nine months of 2004 are lower by $3.4 million from the first nine
months of 2003 while interest rates are 5.63% for 2004 year-to-date down from
the 6.21% average for the prior year-to-date period.
The Company's earnings before interest, taxes, depreciation and amortization
(EBITDA) was $6.0 million for the third quarter of 2004 and $22.1 million for
the first nine months of 2004 compared with $7.3 million and $20.3 million for
the respective periods in 2003.
The components of this calculation are as follows:
(Dollars in thousands)
THIRD QUARTER ENDED NINE MONTHS ENDED
------------------- ------------------
2004 2003 2004 2003
------ ------ ------- -------
Operating income $3,384 $4,570 $14,025 $12,177
Depreciation 2,263 2,337 6,901 6,890
Amortization 399 399 1,199 1,199
------ ------ ------- -------
EBITDA $6,046 $7,306 $22,125 $20,266
====== ====== ======= =======
EBITDA Margin (EBITDA/Net Sales) 5.7% 7.7% 7.5% 7.7%
EBITDA is a calculation used by management to measure liquidity. EBITDA is not a
recognized term under accounting principles generally accepted in the United
States and does not purport to be an alternative to operating income or cash
flows from operating activities as a measure of liquidity.
The following is a reconciliation of EBITDA to cash provided (used) by operating
activities:
(Dollars in thousands)
THIRD QUARTER ENDED NINE MONTHS ENDED
------------------- -------------------
2004 2003 2004 2003
------- -------- -------- --------
EBITDA $ 6,046 $ 7,306 $ 22,125 $ 20,266
Gain on sale of property, plant and
equipment (investing activities) - - (933) -
Interest expense (1,992) (2,094) (5,897) (6,432)
Increase in net operating (assets) (4,259) (1,723) (13,746) (13,494)
------- ------- -------- --------
Cash (used) provided by
operating activities $ (205) $ 3,489 $ 1,549 $ 340
======= ======= ======== ========
BUSINESS SEGMENTS
CARLON
The Carlon business segment had net sales of $51.9 million in the third quarter
2004, an 18.5% increase over the $43.8 million in net sales reported in the
prior year third quarter. All three quarters of 2004 have experienced double
digit percentage net sales growth from their comparable quarter in 2003. This
expansion is led again by
13
an approximate 25.0% increase in telecom wireline product sales, primarily from
higher demand for HDPE conduit, to support the initial rollout of
fiber-to-the-premise projects. Electrical product sales are also up by about
6.0% in the third quarter 2004 and 10.5% year-to-date compared with their
respective periods in 2003. Carlon has realized market expansion as well as some
price increases to offset some of the raw material cost increases. Year-to-date,
Carlon's net sales have increased by $22.6 million, or 19.3%, to $139.5 million
from $116.9 million in the first nine months of 2003.
Gross margin was favorably impacted by the higher telecom sales volume, enabling
the HDPE extrusion facilities to run at close to 60.0% capacity for the last two
quarters. By achieving some price increases Carlon has been able to mitigate a
portion of the steep raw material cost increases. The increased volume has also
allowed the Company to better leverage its fixed costs.
Operating income for Carlon was $4.6 million (8.8% of net sales) and $12.8
million (9.2% of net sales) in the third quarter 2004 and the first nine months
of 2004, respectively. This compares with operating income of $4.2 million (9.6%
of net sales) and $9.9 million (8.5% of net sales) in the third quarter 2003 and
the first nine months of 2003, respectively. Included in the business segment's
operating expenses for the third quarter of 2004 is approximately $0.85 million
related to a litigation settlement. Operating expenses year-to-date 2004 are
approximately $2.5 million higher than the comparable period of 2003. In
addition to the litigation charge and related legal fees, Carlon has incurred
higher variable selling expenses and product development expenses. These
expenses were somewhat offset by the partial recovery ($300,000) of an accounts
receivable that was written off in 2002 relating to the Adelphia bankruptcy.
LAMSON HOME PRODUCTS
Lamson Home Products continued its steady growth, recording $24.0 million in net
sales in the third quarter 2004, a 7.9%, or $1.8 million increase, over the
$22.3 million in net sales in the third quarter of 2003. In addition to the
business segment's electrical box and fitting product lines, it has seen more
recent growth in the innovative chimes and lighting control products that it
offers. This business segment continues to gain shelf space at many of its
retail, DIY customers.
The business segment has been hit the hardest by the dramatic increases in PVC
resin costs over the past year. Unfortunately, despite these well documented
rising costs, they have not been recovered in price increases from the "big box"
retailers. This has caused a reduction in gross margin, compared with the prior
year, of approximately 300 basis points. The Company continues to invest in
new equipment and other productivity-improvement initiatives in an attempt to
mitigate these margin reductions.
Operating income was $1.4 million, or 6.0% of net sales, in the third quarter
2004 compared with $3.7 million, or 16.6% of net sales, in the third quarter
2003. Included in this quarter's operating expenses is $0.85 million related to
a litigation settlement. Year-to-date 2004 operating income totaled $6.3
million, or 9.4% of net sales, compared with $9.5 million, or 16.0% of net
sales, for the first nine months of 2003. In addition to the lower gross margins
in 2004 and litigation and related legal expenses, the business segment is
incurring higher variable selling expenses and new product development costs to
support, in particular, the chimes and lighting control product line expansions.
PVC PIPE
Net sales for the third quarter 2004 in the PVC Pipe business segment rose to
$30.5 million, a $1.3 million, or 4.4% improvement over the third quarter of
2003. Healthy residential construction activity continues to support this
business segment along with a resurgence of sewer infrastructure spending. Rigid
pipe volume was relatively slow in July and August before beginning to rebound
in September. It ended this quarter about 17.5% behind the third quarter of
2003. The volume decline in the third quarter 2004 was offset by increased
pricing of almost 18.0% compared with the third quarter 2003. For the first nine
months of 2004 net sales were $87.6 million, $2.6 million, or 3.0% higher than
the $85.1 million in net sales reported in the comparable period of 2003. Volume
of pipe pounds sold was down by 6.0% year-to-date 2004, while price was higher
by almost
14
9.0% over the same period last year. The Vylon large diameter sewer pipe product
line continued to see increased shipment and order rates during the third
quarter.
Gross margin was impacted by higher PVC resin costs, but the majority of these
increases were reflected in higher selling prices, improving margins over 2003.
Lower conduit sales volume has driven PVC extrusion utilization this quarter
under 70.0% in order to control the related pipe inventory. On a positive note,
the favorable product mix from Vylon sewer pipe sales has helped to offset this
lower utilization as these engineered products command a much higher margin than
standard electrical conduit.
The PVC Pipe business segment had a $0.6 million operating loss for the third
quarter of 2004 resulting in a business segment operating loss-to-date of $0.8
million. This reflects an improvement over the prior year third quarter and
year-to-date reported operating losses of $2.1 million and $2.8 million,
respectively. The improvements this year come primarily at the gross margin line
as operating expenses for the most part are similar to 2003. Operating expenses
have increased slightly this year from expanded Vylon product research and
development costs in order to gain new business.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of liquidity and capital resources is cash from
operating activities and availability under its secured credit facility.
Cash provided by operating activities was $1.5 million in the first nine months
of 2004 compared with $0.3 million in the first nine months of 2003. Although
the Company grew its investment in working capital year-to-date to support
increased business activity, it was able to maintain positive cash flow through
improved operating results. Accounts receivable alone has grown $21.4 million
since the 2003 year-end, a 55.9% increase, and reflects a $7.1 million, or a
13.5%, increase over the third quarter of 2003. This is directly attributable to
the higher sales levels especially late in the third quarter of 2004 as days
sales outstanding, calculated using a 3-month rolling average, was 50.1 days at
the end of the third quarter of 2004 compared with 47.3 days at the end of the
third quarter of 2003.
Inventory began to decline slightly in the third quarter 2004 in anticipation of
the seasonal slowdown experienced in the winter months. Inventory levels of
$40.1 million remain $10.0 million higher than year-end and $5.6 million more
than the end of the third quarter 2003. Despite this increase, inventory turns
rose to 7.7 times at the end of the third quarter 2004, compared with 7.3 times
at the prior third quarter-end. Much of the increased inventory levels are to
support new business obtained by the Lamson Home Products segment and higher
demand seen for telecommunication products, especially HDPE conduit. PVC resin
pounds in inventory at October 2, 2004 were 14.6% higher than year-end 2003 and
10.7% more than at October 4, 2003. The cost per pound of PVC resin in inventory
has increased by approximately 25.0% since year-end 2003 and the end of the
third quarter of 2003.
Accounts payable at October 2, 2004 was $32.4 million, an increase of $15.5
million from year-end 2003 and $5.7 million higher than October 4, 2003. The
increase in payables primarily reflects the comparatively higher cost of
inventory and increased business activity and the timing of the 2003 year-end
payments which lowered the payables balance at year-end. Total accruals were
$27.9 million at October 2, 2004, $3.1 million higher than the $24.8 million at
October 4, 2003. The current accrual balances reflect a higher anticipated
incentive compensation estimate, the remainder of the litigation settlement,
higher retiree medical payable (primarily for the addition of YSD retirees) and
selling and marketing programs partially offset by lower freight accruals due to
timing of payments compared with the prior year third quarter.
Capital expenditures increased during the third quarter bringing the amount
invested year-to-date to $4.6 million compared with $5.8 million invested at
this time last year. Investments during the third quarter of 2004 include the
fixed asset additions to support the move of capacity from Pasadena, Texas to
other facilities, productivity investments in both the Company's molding and PVC
extrusion facilities and tooling to support new product offerings.
15
As of the end of the third quarter of 2004 the Company's secured credit facility
was classified as a current debt as its maturity date is in August 2005. The
Company is not in violation with any of its covenants, has adequate credit
capacity and expects to pay down its bank debt during the fourth quarter as the
need for working capital slows. It is also anticipated that the Company will
refinance this obligation in the first half of 2005 pending the evaluation of
various strategic alternatives being investigated by management and the
Company's investment bankers.
CRITICAL ACCOUNTING ESTIMATES
We have no material changes to the disclosure on this matter since the end of
our most recent fiscal year, January 3, 2004 except as follows.
DEFERRED TAX ASSETS
As of October 2, 2004 the Company had approximately $22.4 million of net
deferred tax assets including loss carryforwards that expire through 2022 and
other temporary differences. The valuation of these deferred tax assets would be
negatively impacted if corporate statutory income tax rates decline. In October
2004, a Corporate tax reduction bill was enacted. The Company is evaluating the
impact on the value of its net operating loss carryforward and other timing
differences, which is not expected to be material. The realization of these net
assets is based primarily upon estimates of future taxable income. Current
expectations of operating results are sufficient to sustain realization of these
net assets. However, should taxable income estimates for the carryforward period
be significantly reduced, the full realization of net deferred tax assets may
not occur.
OUTLOOK FOR 2004
The third quarter has seen a continuation of the upswing in telecom product
sales in the Carlon business segment. In October, the Federal Communications
Commission (FCC) relieved the telecom industry of unbundling requirements for
FTTP loops. We believe this will stimulate more outside plant capital spending
to build-out the last mile of the fiber network.
Residential construction remains strong with housing starts approximately 2.0
million units for the last year. We expect this pace to decline slightly to the
1.7 to 1.8 million unit range through next year as mortgage interest rates and
construction costs rise. Non-residential and industrial construction should,
however, offset this decline as vacancy rates have stabilized. Improved
corporate profits and capital spending should result in modest growth in
commercial construction through 2005.
Resin costs, both HDPE and PVC, are expected to stay at the current high levels
even through the winter months when they traditionally have declined. It is
currently expected with the high oil and natural gas prices, supported by the
strong global demand for these resins, that these costs may average 10.0% higher
in 2005 than 2004. The Company intends to pass on these material related cost
increases with further price increases in 2005 wherever possible.
The Company continues its management of working capital as evidenced by
inventory turns reaching 7.7 turns compared with 7.3 turns a year ago. Despite
very high net sales levels this quarter the days sales outstanding remains at 50
days. Payments for pension contributions and a litigation settlement lowered
cash flow generated this quarter; however, we still expect substantial positive
operating cash flow in the fourth quarter 2004 reducing outstanding debt at
year-end to the lowest level since 2000.
As announced in early October, the Company has hired an investment banker to
review various strategic alternatives in order to improve shareholder value
including the potential sale of all or a portion of the Company. As a result,
management has deemed it prudent to delay the refinancing of its secured credit
facility which expires in August 2005. Management believes the refinancing will
take place in the first half of 2005 pending the conclusion of the strategic
review.
16
Based on the results through the third quarter and expectations for our markets,
we anticipate net sales growth will be 10.0% to 12.0% for 2004 and an additional
8.0% to 10.0% for 2005.
Despite the litigation charge of $1.7 million incurred in the third quarter of
2004, we continue to believe projected earnings for 2004 will be between 43 to
48 cents per diluted share.
Certain sections of this Quarterly Report on Form 10-Q, including this Outlook
Section, contain forward-looking comments. The comments are subject to, and the
actual future results may be impacted by, the cautionary limitations and factors
outlined in the following narrative comments.
This Management's Discussion and Analysis of Financial Condition and Results of
Operations contain expectations that are forward-looking statements that involve
risks and uncertainties within the meaning of the Private Securities Litigation
Reform Act of 1995. Actual results may differ materially from those expected as
a result of a variety of factors, such as: (i) the volatility of resin pricing,
(ii) the ability of the Company to pass through raw material cost increases to
its customers, (iii) maintaining a stable level of housing starts,
telecommunications infrastructure spending, consumer confidence and general
construction trends, (iv) the continued availability and reasonable terms of
bank financing (v) the outcome and effects of the Company's exploration of
strategic alternatives and (vi) any adverse change in the recovery trend of the
country's general economic condition affecting the markets for the Company's
products. Because forward-looking statements are based on a number of beliefs,
estimates and assumptions by management that could ultimately prove to be
inaccurate, there is no assurance that any forward-looking statement will prove
to be accurate.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have no material changes to the disclosure on this matter since the end of
our most recent fiscal year, January 3, 2004.
ITEM 4 - CONTROLS AND PROCEDURES
As of October 2, 2004, an evaluation was performed under the supervision and
with the participation of the Company's management, including the Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures. Based
on that evaluation, the Company's management, including the Chief Executive
Officer and Chief Financial Officer, concluded that the Company's disclosure
controls and procedures were effective. There have been no significant changes
in the Company's internal controls or in other factors that could significantly
affect internal controls subsequent to their evaluation.
17
PART II
ITEM 1 - LEGAL PROCEEDINGS
On September 23, 1999, the Company announced that a United States District Court
jury in the Northern District of Illinois found that the Company willfully
infringed on a patent held by Intermatic Incorporated ("Intermatic") of Spring
Grove, Illinois, relating to the design of an in-use weatherproof electrical
outlet cover, and awarded Intermatic $12.5 million in damages plus pre-judgment
interest of approximately $1.5 million. The Company pursued a vigorous appeal
and on December 17, 2001 the United States Court of Appeals ruled that, as a
matter of law, Lamson & Sessions' products did not infringe Intermatic's patent
and that the Company has no liability to Intermatic. The trial jury's earlier
verdict in favor of Intermatic in the amount of $12.5 million, plus pre-judgment
and post-judgment interest estimated to be in excess of $3.0 million, was
reversed. Intermatic filed for a rehearing of the ruling to the Court of Appeals
en banc, which was denied. Intermatic then filed a petition for certiorari with
the United States Supreme Court. The United States Supreme Court reversed the
decision of the Court of Appeals and remanded the case back to it. In March
2003, the Court of Appeals remanded this litigation back to the United States
District Court for reconsideration. On September 17, 2004, the Company announced
the settlement of this litigation arrived at through a mediation process. The
net effect of that settlement has been reflected in the third quarter 2004
operating results.
The Company is also a party to various other claims and matters of litigation
incidental to the normal course of its business. Management believes that the
final resolution of these matters will not have a material adverse effect on the
Company's financial position, cash flows or results of operations.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
31.1 Certification of John B. Schulze, Chief Executive Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of James J. Abel, Chief Financial Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of John B. Schulze, Chief Executive Officer,
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of James J. Abel, Chief Financial Officer,
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
1. The Company's current report on Form 8-K, dated July 28, 2004,
relating to the Company's earnings for the second quarter of
2004.
2. The Company's current report on Form 8-K, dated September 17,
2004, relating to the Company's settlement of its patent
infringement litigation with Intermatic Incorporated of Spring
Grove, Illinois.
3. The Company's current report on Form 8-K, dated October 5,
2004, relating to the Company's exploration of strategic
alternatives.
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
THE LAMSON & SESSIONS CO.
-------------------------
(Registrant)
October 28, 2004 By: /s/ James J. Abel
------------------------------------------
James J. Abel
Executive Vice President, Secretary,
Treasurer and Chief Financial Officer
19