10-Q 1 0001.txt SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 June 30, 2000 0-22906 --------------------------- ------------------------ For the Quarterly Period Ended Commission File Number ABC-NACO INC. (Exact name of registrant as specified in its charter) Delaware 36-3498749 ---------------------------.............................----------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 2001 Butterfield Road, Suite 502, Downers Grove, IL 60515 ---------------------------------------------------------- (Address of principal executive offices, including zip code) Registrant's telephone number, including area code (630) 852-1300 --------------- 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at August 10, 2000 ----------------------------- ----------------------------- COMMON STOCK, $.01 PAR VALUE 19,872,242 SHARES ABC-NACO INC. INDEX Page ---- Part I Financial Statements Item 1 Unaudited Consolidated Financial Statements Unaudited Consolidated Balance Sheets 3 Unaudited Consolidated Statements of Operations 4 Unaudited Consolidated Statements of Changes in Stockholders' Equity 5 Unaudited Consolidated Statements of Cash Flows 6 Notes to Unaudited Consolidated Financial Statements 7 - 16 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 17 - 25 Item 3 Quantitative and Qualitative Disclosures About Market Risk 25 Part II Other Information Item 6 Exhibits and Reports on Form 8-K 26
ABC-NACO INC. CONSOLIDATED BALANCE SHEETS As of June 30, 2000 and December 31, 1999 (Unaudited) (In thousands, except share data) June 30, December 31, 2000 1999 -------- ----------- ASSETS ------ CURRENT ASSETS: Cash and cash equivalents $ 35 $ 351 Accounts receivable, less allowances of $2,212 and $1,804, respectively. 99,855 79,617 Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111,151 94,132 Prepaid expenses and other current assets. . . . . . . . . . . . . . . . 13,708 12,401 Prepaid income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . 8,657 8,680 ---------- ---------- Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . 233,406 195,181 ---------- ---------- PROPERTY, PLANT AND EQUIPMENT: Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,692 7,644 Buildings and improvements . . . . . . . . . . . . . . . . . . . . . . . 47,270 42,268 Machinery and equipment. . . . . . . . . . . . . . . . . . . . . . . . . 281,589 267,189 Patterns, tools, gauges and dies . . . . . . . . . . . . . . . . . . . . 13,912 14,610 Construction in progress . . . . . . . . . . . . . . . . . . . . . . . . 21,442 28,302 ---------- ---------- 371,905 360,013 Less - Accumulated depreciation. . . . . . . . . . . . . . . . . . . . . (129,854) (115,003) ---------- ---------- Net property, plant and equipment. . . . . . . . . . . . . . . . . . 242,051 245,010 ---------- ---------- INVESTMENT IN UNCONSOLIDATED JOINT VENTURES . . . . . . . . . . . . . . . . 14,535 13,886 ---------- ---------- OTHER NONCURRRENT ASSETS - net . . . . . . . . . . . . . . . . . . . . . . . 43,035 38,394 ---------- ---------- Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 533,027 $ 492,471 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY ---------------------------------------------------------------------------- CURRENT LIABILITIES: Current maturities of long-term debt . . . . . . . . . . . . . . . . . . $ 7,916 $ 6,207 Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83,460 89,678 Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39,959 42,983 ---------- ---------- Total current liabilities. . . . . . . . . . . . . . . . . . . . . . 131,335 138,868 ---------- ---------- LONG-TERM DEBT, less current maturities. . . . . . . . . . . . . . . . . . . 263,353 246,247 ---------- ---------- DEFERRED INCOME TAXES. . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,667 6,699 ---------- ---------- OTHER NONCURRENT LIABILITIES. . . . . . . . . . . . . . . . . . . . . . . . 14,385 13,978 COMMITMENTS AND CONTINGENCIES . . . . . . . . . . . . . . . . . . . . . . . STOCKHOLDERS' EQUITY: Preferred stock, $1.00 par value; 1,000,000 shares authorized; 300,000 shares issued and outstanding. . . . . . . . . . . . . . . . 28,425 - Common stock, $.01 par value; 25,000,000 shares authorized; 19,872,242 and 19,372,242 issued and outstanding at 6/30/00 and 12/31/99, respectively. . . . . . . . . . . . . . . . . 199 194 Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . 94,965 79,240 Retained earnings (deficit). . . . . . . . . . . . . . . . . . . . . . . (5,026) 7,954 Cumulative translation adjustment. . . . . . . . . . . . . . . . . . . . (1,276) (709) ---------- ---------- Total stockholders' equity . . . . . . . . . . . . . . . . . . . . . 117,287 86,679 ---------- ---------- Total liabilities and stockholders' equity . . . . . . . . . . . . . $ 533,027 $ 492,471 ========== ========== The accompanying notes to the unaudited consolidated financial statements are an integral part of these consolidated balance sheets.
ABC-NACO INC. CONSOLIDATED STATEMENTS OF OPERATIONS For the Three and Six Months Ended June 30, 2000 and 1999 (Unaudited) (In thousands, except per share data) Three Months Ended Six Months Ended June 30, June 30, -------- -------- 2000 1999 2000 1999 --------- --------- --------- --------- NET SALES $155,054 $163,229 $312,032 $329,944 COST OF SALES. . . . . . . . . . . . . . . . . . . . . . . . . . . 134,604 141,551 270,739 288,639 --------- --------- --------- --------- Gross profit . . . . . . . . . . . . . . . . . . . . . . . 20,450 21,678 41,293 41,305 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES . . . . . . . . . . . 14,596 15,238 28,347 30,904 MERGER AND OTHER RESTRUCTURING CHARGES . . . . . . . . . . . . . . - 5,829 1,589 21,925 --------- --------- --------- --------- Operating income (loss). . . . . . . . . . . . . . . . . . 5,854 611 11,357 (11,524) EQUITY INCOME (LOSS) OF UNCONSOLIDATED JOINT VENTURES. . . . . . . 854 (310) 1,307 87 INTEREST EXPENSE . . . . . . . . . . . . . . . . . . . . . . . . . 6,056 4,317 12,228 8,570 AMORTIZATION OF DEFERRED FINANCING COSTS . . . . . . . . . . . . . 299 249 544 436 --------- --------- --------- --------- Income (loss) before income taxes and extraordinary item. 353 (4,265) (108) (20,443) PROVISION (BENEFIT) FOR INCOME TAXES . . . . . . . . . . . . . . . 199 1,410 242 (2,403) --------- --------- --------- --------- Income (loss) before extraordinary item . . . . . . . . . 154 (5,675) (350) (18,040) EXTRAORDINARY ITEM, net of income tax of $2,062. . . . . . . . . . - - - (3,158) --------- --------- --------- --------- Net income (loss). . . . . . . . . . . . . . . . . . . . . $ 154 $ (5,675) $ (350) $(21,198) ========= ========= ========= ========= EARNINGS PER SHARE DATA: Income (loss) before extraordinary item . . . . . . . . . . $ 154 $ (5,675) $ (350) $(18,040) Adjustment related to preferred stock . . . . . . . . . . . - - (11,877) - Preferred stock dividends. . . . . . . . . . . . . . .. . . (600) - (753) - --------- --------- --------- --------- Adjusted loss before extraordinary item . . . . . . . . . . (446) (5,675) (12,980) (18,040) Extraordinary item. . . . . . . . . . . . . . . . . . . . . - - - (3,158) --------- --------- --------- --------- Net loss available to common stockholders . . . . . . . $ (446) $ (5,675) $(12,980) $(21,198) ========= ========= ========= ========= BASIC AND DILUTED EARNINGS PER SHARE: Adjusted loss before extraordinary item. . . . . . . . . . $ (0.02) $ (0.31) $ (0.67) $ (0.99) Extraordinary item . . . . . . . . . . . . . . . . . . . . - - - (0.17) --------- --------- --------- --------- Net loss available to common stockholders . . . . . . $ (0.02) $ (0.31) $ (0.67) $ (1.16) ========= ========= ========= ========= WEIGHTED AVERAGE SHARES OUTSTANDING. . . . . . . . . . . . . . . . 19,375 18,356 19,374 18,289 ========= ========= ========= =========
The accompanying notes to the unaudited consolidated financial statements are an integral part of these consolidated statements.
ABC-NACO INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the Six Months Ended June 30, 2000 and 1999 (Unaudited) (In thousands) Additional Retained Cumulative Preferred Common Paid-in Earnings Translation Stock Stock Capital (Deficit) Adjustment Total ----------- --------- ----------- ---------- ------------- --------- BALANCE December 31, 1998. . . . . . . $ - $ 184 $ 67,981 $ 28,888 $ (676) $ 96,377 Comprehensive income (loss) . . . . . . - - - (21,198) 425 (20,773) ----------- --------- ----------- ---------- ------------- --------- BALANCE June 30, 1999. . . . . . . . . $ - $ 184 $ 67,981 $ 7,690 $ (251) $ 75,604 =========== ========= =========== ========== ============= ========= BALANCE December 31, 1999. . . . . . . $ - $ 194 $ 79,240 $ 7,954 $ (709) $ 86,679 Comprehensive loss . . . . . . . . . . - - - (350) (567) (917) Preferred stock issued . . . . . . . . 28,425 - 11,877 (11,877) - 28,425 Preferred stock dividends earned . . . - - 753 (753) - - Shares issued in business acquisition. - 5 3,095 - - 3,100 ----------- --------- ----------- ---------- ------------- --------- BALANCE June 30, 2000. . . . . . . . . $ 28,425 $ 199 $ 94,965 $ (5,026) $ (1,276) $117,287 =========== ========= =========== ========== ============= =========
The accompanying notes to the unaudited consolidated financial statements are an integral part of these consolidated statements.
ABC-NACO INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For the Three and Six Months Ended June 30, 2000 and 1999 (Unaudited) (In thousands) Three Months Ended Six Months Ended June 30, June 30, -------------------- ------------------- 2000 1999 2000 1999 --------- --------- --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $154 $(5,675) $(350) $(21,198) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Extraordinary item. . . . . . . . . . . . . . . . . . . . . . . - - - 3,158 Merger and other restructuring charges. . . . . . . . . . . . . - 5,829 1,589 21,925 Equity (income) loss of unconsolidated joint ventures . . . . . (854) 310 (1,307) (87) Depreciation and amortization. . . . . . . . . . . . . . . . . 8,683 7,718 17,057 15,345 Deferred income taxes . . . . . . . . . . . . . . . . . . . . . (28) 405 (9) 1,048 Changes in certain assets and liabilities Accounts receivable - net. . . . . . . . . . . . . . . . 2,705 (2,974) (19,938) (10,794) Inventories. . . . . . . . . . . . . . . . . . . . . . . (12,479) 7,057 (17,019) 10,149 Prepaid expenses and other current assets. . . . . . . . (847) (3,270) (1,307) (18,510) Other noncurrent assets. . . . . . . . . . . . . . . . . (237) 40 (1,320) (109) Accounts payable and accrued expenses. . . . . . . . . . (3,936) 6,923 (9,496) (424) Other noncurrent liabilities . . . . . . . . . . . . . . 80 2,146 (160) 3,305 --------- --------- --------- --------- Net cash provided by (used in) operating activities . (6,759) 18,509 (32,260) 3,808 --------- --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures . . . . . . . . . . . . . . . . . . . . . . (4,284) (10,891) (10,760) (21,168) Dividends from unconsolidated joint venture. . . . . . . . . . . 658 - 658 - Cost of business acquisition. . . . . . . . . . . .. . . . . . . (2,000) - (2,000) - --------- --------- --------- --------- Net cash used in investing activities . . . . . . . . (5,626) (10,891) (12,102) (21,168) --------- --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings under revolving lines of credit . . . . . . . . . 14,517 400 17,274 45,927 Change in cash overdrafts. . . . . . . . . . . . . . . . . . . . (2,138) (5,125) - (4,289) Payment of term debt . . . . . . . . . . . . . . . . . . . . . . - (1,264) (959) (25,247) Borrowings of term debt. . . . . . . . . . . . . . . . . . . . . 44 507 - 3,507 Payment of deferred financing costs. . . . . . . . . . . . . . . (3) (1,176) (694) (1,182) Issuance of convertible preferred stock. . . . . . . . . . . . . - - 28,425 - --------- --------- --------- --------- Net cash provided by (used in) financing activities. 12,420 (6,658) 44,046 18,716 --------- --------- --------- --------- Net change in cash . . . . . . . . . . . . . . . . . 35 960 (316) 1,356 CASH AND CASH EQUIVALENTS, beginning of period . . . . . . . . . . . . . - 560 351 164 --------- --------- --------- --------- CASH AND CASH EQUIVALENTS, end of period . . . . . . . . . . . . . . . . $ 35 $ 1,520 $ 35 $ 1,520 ========= ========= ========= =========
The accompanying notes to the unaudited consolidated financial statements are an integral part of these consolidated statements. ABC-NACO INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION ABC-NACO Inc. (the "Company") is a supplier of technologically advanced products and services to the freight railroad and flow control industries. The Company operates in three business segments: Rail Products, Rail Services and Systems, and Flow and Specialty Products, and has four technology centers around the world supporting its three business segments. The Company holds pre-eminent market positions in the design, engineering, and manufacture of high performance freight railcar, locomotive and passenger rail suspension and coupler systems, wheels and mounted wheel sets, and specialty track products. The Company also supplies freight railroad and transit signaling systems and services, as well as highly engineered valve bodies and components for industrial flow control systems worldwide. The accompanying unaudited consolidated financial statements include, in the opinion of management, all adjustments (consisting of only normal recurring adjustments) necessary for a fair presentation of the results of operations and financial condition of the Company for and as of the interim dates. Results for the interim period are not necessarily indicative of results for the entire year. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). The Company believes that the disclosures contained herein are adequate to make the information presented not misleading. These unaudited consolidated financial statements should be read in conjunction with the information and the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended July 31, 1999 and the Company's Transition Report on Form 10-K for the five months ended December 31, 1999. The Company is a result of a merger (the "Merger") on February 19, 1999, between ABC Rail Products Corporation ("ABC") and NACO, Inc. ("NACO"). As a result of the Merger, each outstanding share of NACO common stock was converted into 8.7 shares of the Company's common stock, resulting in the issuance of approximately 9.4 million shares. The Merger was treated as a tax-free reorganization for federal income tax purposes and has been accounted for as a pooling-of-interests transaction. The accompanying consolidated financial statements reflect the combined results of ABC and NACO as if the Merger occurred on the first day of the earliest period presented. Unaudited results of operations for ABC and NACO prior to the Merger from January 1, 1999, to February 19, 1999 were (in thousands): ABC NACO -------- --------- Revenue $ 52,659 $ 60,552 Net loss (669) (51) On September 23, 1999, the Company's Board of Directors adopted a resolution changing the Company's fiscal year-end to December 31 from July 31. The principal reason for the change was to align the Company's fiscal year-end with the fiscal year-end of its major customers. The Company filed a Form 10-K transition report for the five-month transition period from August 1, 1999 to December 31, 1999 (the "Transition Period"). 2. INVENTORIES Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method for substantially all inventories. Inventory costs include material, labor and manufacturing overhead. Inventories at June 30, 2000, and December 31, 1999, consisted of the following (in thousands):
June 30, December 31, 2000 1999 --------- ------------- Raw materials. . . . . . . . . . . $ 52,570 $ 44,148 Supplies and spare parts . . . . . 4,312 5,258 Work in process and finished goods 54,269 44,726 --------- ------------- $ 111,151 $ 94,132 ========= ==========
3. DEBT Immediately after the consummation of the Merger, the Company entered into a new revolving credit facility (the "Credit Facility") with a syndicate of financial institutions, in which Bank of America National Trust & Savings Association acted as the Agent and Letter of Credit Issuing Lender and Bank of America Canada acted as the Canadian Revolving Lender. The Credit Facility provides the Company with a revolving line of credit of up to $200.0 million. The Credit Facility's covenants include ratio restrictions on total leverage, senior leverage, interest coverage, minimum net worth restriction and restrictions on capital expenditures. The initial net proceeds of the Credit Facility were used to (i) refinance existing bank debt and certain other indebtedness of the Company, (ii) refinance substantially all of NACO's outstanding debt, (iii) provide initial financing for the Company's on-going working capital needs, and (iv) pay fees and expenses relating to the Merger and the Credit Facility. The early retirement of the refinanced debt resulted in a $5.2 million extraordinary charge ($3.2 million after-tax) representing the non-cash write-off of related unamortized deferred financing costs and prepayment penalties of $4.5 million. The Credit Facility employs an IBOR-based variable interest rate index and assesses a spread over the IBOR base which is determined by a Consolidated Leverage pricing grid. The weighted average interest rate at June 30, 2000 was 9.7%. Availability at June 30, 2000 was $16.6 million. On October 12, 1999, the Company entered into an Amendment, Waiver and Release Agreement to the Credit Agreement to release certain collateral related to its Mexican subsidiary and to reflect the change in the Company's fiscal year and reporting periods for covenant measurement purposes. The Company then entered into two subsequent modifications to the Credit Agreement that were effective as of October 29, 1999 to modify certain of the financial leverage covenants in the Credit Agreement which the Company otherwise would not have been in compliance with as of October 31, 1999. On March 8, 2000, the Company entered into a second Amendment and Restatement of the Credit Agreement that was effective as of December 30, 1999 to modify certain of the financial covenants in the Credit Agreement, which the Company otherwise would have not been in compliance with as of December 31, 1999. The amended covenants included the Maximum Consolidated Leverage Ratio, Maximum Senior Leverage Ratio and the Minimum Interest Coverage Ratio. In addition, a minimum pro-forma EDITDA covenant was added to the Credit Agreement. The Company and its Lenders also modified other terms and conditions within the Credit Agreement including the pricing grid, which is based upon the Company's Consolidated Leverage Ratio. The currently applied margin of 300 basis points over IBOR is the maximum IBOR margin provided for by the Amendment. The revolving line of credit now has scheduled commitment reductions as follows: January 1, 2001-$10 million, June 30, 2001-$5.0 million, January 1, 2002-$10.0 million, June 30, 2002-$5.0 million and January 1, 2003-$15.0 million. The total commitment reductions aggregate to $45.0 million and will reduce the revolving credit commitment to a total of $155.0 million as of January 1, 2003. With the second Amendment and Restatement of the Credit Agreement, the Company was in compliance with the Credit Agreement as of December 31, 1999 and June 30, 2000. On February 1, 1997, the Company completed an offering (the ''Offering'') of $50 million of 9 1/8% Senior Subordinated Notes (the ''9 1/8% Notes''). The Company used the $47.9 million of net proceeds of the Offering to repay certain outstanding indebtedness under its primary and other credit facilities. The 9 1/8% Notes are general unsecured obligations of the Company and are subordinated in right of payment to all existing and future senior indebtedness of the Company and other liabilities of the Company's subsidiaries. The 9 1/8% Notes will mature in 2004, unless repurchased earlier at the option of the Company at 100% of face value. The 9 1/8% Notes are subject to mandatory repurchase or redemption prior to maturity upon a Change of Control (as defined). The indenture under which the 9 1/8% Notes were issued limits the Company's ability to (i) incur additional indebtedness, (ii) complete certain mergers, consolidations and sales of assets, and (iii) pay dividends or other distributions. On December 23, 1997, the Company completed a second offering of $25.0 million of 8 3/4% Senior Subordinated Notes, Series B (the ''8 3/4% Notes'') due in 2004 with similar provisions as the 9 1/8% Notes. The Company is required to meet a number of financial covenants on its 9 1/8% Notes and 8 3/4% Notes including minimum Operating Coverage Ratio, Minimum Consolidated Net Worth and Maximum Funded Debt to Capitalization. The Operating Coverage Ratio at June 30, 2000 was 2.43 with the minimum requirement under the Note indenture of 2.40. The funded Debt to Capitalization ratio at June 30, 2000 was 70.3% with the maximum allowable under the Note indenture being 75.0%. These same leverage covenant tests are to be met at each quarter-end through the maturity dates for these Notes. Failure to meet these covenant tests would give the noteholders the unilateral right to accelerate the maturity of the related debt after a requisite cure period. In addition, cross-default provisions under the Credit Agreement would be triggered upon a default under the Notes. If the Company does not have adequate cash or is unable to remain compliant with such financial covenants, it may be required to further refinance its existing indebtedness, seek additional financing, or issue common stock or other securities to raise cash to assist in financing its operations. The Company has no current commitments or arrangements for such financing alternatives, and there can be no assurances that such financing alternatives will be available on acceptable terms, or at all. The Company is expecting continuing softness in the demand for loose wheels and lower than normal sales activity with select other core products due to reduced new freight car production and the railroads ongoing cut-back of spending on discretionary maintenance and repair items. In addition, the Company anticipates a third quarter pre-tax special charge of $8.0 million to $12.0 million for permanent facility and operational consolidations associated with improved manufacturing process changes. As a result of these factors, the related impact on earnings in the third and fourth quarters of 2000 and based on its current operating budget, the Company may not be in compliance with the Operating Coverage Ratio covenant applicable to the Notes, at the fiscal quarters ended September 30, 2000 and December 31, 2000, unless the covenant is amended. An event of default under the Indenture would constitute a default under the Credit Facility as well. In addition, the Company may not be in compliance with the Leverage Ratio, Senior Leverage Ratio and Interest Coverage Ratio covenants of the Credit Agreement at the fiscal quarter ended 9/30/00, and the Leverage Ratio and the Senior Leverage ratio covenants at the fiscal quarter ended 12/31/00, unless the covenants are amended for those respective periods. To address these issues, the Company has commenced on August 3, 2000, a consent solicitation seeking the consent of the holders of it Notes to an amendment to change the Operating Coverage Ratio to 1.8:1.0 from the current ratio of 2.4:1.0. As part of the consent solicitation, the annual interest rate for the Notes would increase from 9 1/8% (per annum) to 10 1/2% for the current 9 1/8% Notes and from 8 3/4% to 10 1/2% for the 8 3/4% Notes. Other than the annual interest rate, none of the maturity dates, payment provisions, redemption provisions, or any other similar terms of the Notes will be amended as a result of the proposed amendments. The expiration date for the consent solicitation is August 30, 2000, and if the amendments are approved, the increased annual interest rates will become effective October 1, 2000 and the Operating Coverage Ratio will become effective for the quarter ended September 30, 2000. In addition, the Company has begun discussions with its agent bank to modify appropriate covenants in the Credit Facility. The Company's inability to make any payments when due or to satisfy its financial covenants under its existing borrowing facilities could have a material adverse effect on the Company. A universal shelf registration was declared effective by the Securities and Exchange Commission on October 29, 1999, for issuances up to $300 million of debt or equity securities. As of June 30, 2000, no securities were issued under the new universal shelf registration. 4. CONVERTIBLE PREFERRED STOCK On March 8, 2000, the Company issued 300,000 shares of Series B cumulative convertible preferred stock ($1 par value) to private equity funds managed by ING Furman Selz Investments for $30 million. The preferred stock has voting rights under certain circumstances and will pay dividends at the rate of 8% per annum accrued semi-annually and paid in the form of common stock or cash, at the discretion of the Company. The preferred stock is convertible into common stock at the average closing price of the Company's common stock for the thirty trading days ending February 17, 2000, which was $9.00 per share. The preferred stock can be converted into common shares at the Company's option under certain conditions at any time three years after issuance. The net proceeds received from the sale of preferred stock ($28.4 million after offering costs) were applied to reduce the outstanding indebtedness under the Company's Credit Facility. While the conversion price may change under specific conditions, the $9.00 per share price on the date that the Company and the preferred stock holders were committed to completing the transaction represented a discount from the market value of the underlying common stock on that date by an aggregate of $11.9 million. This discount represents the value of the beneficial conversion feature of the preferred stock. Accordingly, the Company initially recorded the value of the preferred stock as $18.1 million offset by $1.6 million of transaction costs, with the $11.9 million credited to additional paid-in capital. Since the preferred stock is convertible at any time at the holders' option, this discount also represents an immediate deemed dividend to those holders at the date of issuance. Accordingly, upon issuance, the Company also recorded a $11.9 million dividend to these holders. Additionally, the preferred stock earned actual dividends of $0.8 million during the six months ended June 30, 2000. Both the actual and deemed dividends are deducted from the net loss for the three and six months ended June 30, 2000 to arrive at loss available to common stockholders in the earnings per share calculations for those periods. In such calculations, other common stock equivalents, which would have increased diluted shares by 3,333,000 for the three months and six months ended June 30, 2000, but were not included in the computation of diluted earnings per share because the assumed exercise of such equivalents would be antidilutive. 5. MERGER AND OTHER RESTRUCTURING COSTS During the six months ended June 30, 2000, the Company recorded $1.6 million of Merger and other restructuring charges. This charge included cash employee severance costs for 35 salaried employees and 30 hourly plant employees and was part of the Company's year-long effort to eliminate duplicate functions and to improve operating efficiencies as a result of the Merger. As of June 30, 2000, all of these employees have been terminated and $1.1 million of related costs were paid. During the third and fourth quarters of the fiscal year ended July 31, 1999, the Company recorded $16.1 million and $5.8 million, respectively, of Merger and other restructuring charges. During the Transition Period, the Company recorded additional charges of $1.2 million, including adjustments of previously-recorded charges based on actual expenses incurred on the related initiatives. The primary components of the aggregate $23.1 million of calendar 1999 charges include: (a) $9.5 million of costs incurred as a direct result of the Merger for advisory and other professional fees, (b) the consolidation of the corporate activities of the merged companies into one facility, and (c) the consolidation of several manufacturing and assembly operations into fewer facilities to eliminate duplicative functions and to improve operating efficiencies. The charges were computed based on actual cash payouts, management's estimate of realizable value of the affected tangible and intangible assets and estimated exit costs including severance and other employee benefits based on existing severance policies. The Company expects that these restructuring efforts will result in reduced operating costs, including lower salary and hourly payroll costs and depreciation/amortization. Employee severance costs included in the aggregate charge, totaling $7.9 million, were for 33 corporate employees, 109 salaried plant employees and 581 hourly plant employees. As of December 31, 1999, all of these employees had been terminated. Certain of the restructuring initiatives within the Rail Services and Systems segment were prompted by the excess capacity resulting from the operation of the Company's new state-of-the-art rail mill facility in Chicago Heights, Illinois. With this new capacity on line, the Company closed its Cincinnati, Ohio facility and discontinued manufacturing at its Newton, Kansas facility (which also has a distribution operation) by July 31, 1999. The Company also closed its foundry operation in Anderson, Indiana by October 31, 1999. The Manganese castings used in specialty track products that were produced at Andersen are now produced at the Company's manufacturing facility in Richmond, Texas. The duplicative leased corporate facility and another administrative facility was closed in September 1999. In addition to these closures, the Company has decided to close an assembly facility in Verona, Wisconsin. This Rail Services and Systems facility is expected to be closed by the end of 2000 with all operations being transferred to another Company location. Costs associated with these facility closures, excluding severance, are $2.2 million of non-cash provisions for the write down of obsolete assets and leasehold improvements and $1.4 million in cash provisions for idle facility and property disposal costs. In addition to these costs, the Company incurred $2.1 million of cash costs related to the transfer of Manganese castings and other operations into the Richmond facility and the relocation of previous Richmond operations into another Company facility. These costs primarily represent the relocation of equipment and employees and the installation of the new operations at Richmond. The following table is a summary roll forward of the Merger and other restructuring reserves recorded in 1999 and in the first quarter of 2000, through June 30, 2000 (in thousands):
Aggregate Charge Deductions Balance ----------------- ------------ -------- Cash provisions: Merger advisory and other fees. . . . . . $ 9.5 $ (9.5) $ - Employee severance. . . . . . . . . . . . 7.9 (6.7) 1.2 Idle facility and property disposal costs 1.4 (1.3) 0.1 Relocation of operations. . . . . . . . . 2.1 (2.1) - ----------------- ------------ -------- Total cash costs . . . . . . . . . . . 20.9 $ (19.6) $ 1.3 ============ ======== Non-cash asset writedowns. . . . . . . . . . 2.2 ----------------- Total. . . . . . . . . . . . . . . . . $ 23.1 =================
The remaining cash costs are expected to be expended during the next six to nine months. 6. BUSINESS SEGMENT INFORMATION The Company manages its operations through three reporting segments: Rail Products, Rail Services and Systems, and Flow and Specialty Products. These distinct business units generally serve separate markets. They are managed separately since each business requires different technology, servicing and marketing strategies. The following describes the types of products and services from which each segment derives its revenues: Rail Products Freight car and locomotive castings Rail Services and Systems Specialty trackwork, wheel assembly and signal systems Flow and Specialty Products Valve housing and related castings The Company realigned its segments during the Transition Period to better reflect the organizational and marketing changes that were enacted within the Company. The Company's trackwork product line which previously had been reported as part of the Rail Products segment is now included as part of the Rail Services and Systems segment. In addition, the Company for strategic reasons, placed its metal brake shoe foundry into the Flow and Specialty Products segment. The current and historical segment financial information has been restated to reflect these changes. Management continually evaluates its internal structure and aligns its reporting structure to maximize its operating results. Changes to segment reporting are made to reflect the way management evaluates its businesses. To evaluate the performance of these segments, the Chief Executive Officer examines operating income or loss before interest and income taxes, as well as operating cash flow. Operating cash flow is defined as operating income or loss plus depreciation and amortization. The accounting policies for the operating segments are the same as those for the consolidated company. Intersegment sales and transfers are accounted for on a cost plus stipulated mark-up which the Company believes approximates arm's length prices. Corporate headquarters and ABC-NACO Technologies primarily provide support services to the operating segments. The costs associated with these services include interest expense, income tax expense (benefit), Merger and other restructuring charges, research and development expense, and goodwill amortization, among other costs. These costs are not allocated to the segments and are included within ''other'' below. The following tables present a summary of operating results by segment and a reconciliation to the Company's consolidated totals (in thousands):
Three months ended Six months ended June 30, June 30, REVENUES 2000 1999 2000 1999 ------------------------------------------ --------- --------- --------- --------- Rail Products . . . . . . . . . . . . . . $ 71,312 $ 98,082 $150,467 $197,363 Rail Services and Systems . . . . . . . . 74,049 60,442 139,269 122,300 Flow and Specialty Products . . . . . . . 20,733 16,922 43,889 33,900 --------- --------- --------- --------- Total Reportable Segments . . . . . . 166,094 175,446 333,625 353,563 Elimination and Other . . . . . . . . . . (11,040) (12,217) (21,593) (23,619) --------- --------- --------- --------- Total . . . . . . . . . . . . . . $155,054 $163,229 $312,032 $329,944 ========= ========= ========= ========= OPERATING INCOME. . . . . . . . . . . . . 2000 1999 2000 1999 ------------------------------------------ --------- --------- --------- --------- Rail Products . . . . . . . . . . . . . . $ 5,125 $ 11,212 $ 10,741 $ 19,270 Rail Services and Systems . . . . . . . . 5,387 2,320 10,042 4,484 Flow and Specialty Products . . . . . . . 2,580 875 5,853 2,249 --------- --------- --------- --------- Total Reportable Segments . . . . . . 13,092 14,407 26,636 26 003 Elimination and Other . . . . . . . . . . (7,238) (13,796) (15,279) (37,527) --------- --------- --------- --------- Total . . . . . . . . . . . . . . $ 5,854 $ 611 $ 11,357 $(11,524) ========= ========= ========= =========
7. BUSINESS ACQUISITIONS On October 29, 1999, the Company acquired all outstanding common stock of COMETNA - Companhia Metalurgica Nacional, S.A. (Cometna) located in Lisbon, Portugal for $8.3 million, or 674,796 shares, of the Company's common stock. Cometna manufactures and machines products for the freight and passenger rail industries in Europe and is part of the Company's Rail Products segment. On June 23, 2000, the Company acquired certain assets of Donovan Demolition, Inc. ("Donovan") located in Danvers, Illinois. In addition, the Company acquired a patent from a shareholder of Donovan. The total purchase price of $7.6 million for these assets included $2.0 million in cash, a $2.5 million note and 500,000 shares of the Company's common stock valued at $3.1 million. The Donovan bargain purchase amount of $2.6 million has been deducted from the appraised value of property, plant and equipment. These acquisitions were accounted for under the purchase method of accounting. Accordingly, certain recorded assets and liabilities of the acquired businesses were revalued to estimated fair values as of the acquisition dates. Management used its best judgement and available information in estimating the fair value of those assets and liabilities. Any changes to those estimates are not expected to be material. The operating results of the acquired businesses are included in the Company's consolidated statements of operations from their acquisition dates. 8. UNCONSOLIDATED JOINT VENTURES The Company owns 50% of Anchor Brake Shoe, L.L.C. (''Anchor''). Anchor designs, manufactures, markets and sells railcar composite brake shoes. The Company's investment in Anchor was $7.1 million as of June 30, 2000. Each partner's share of the joint venture can be purchased by the other partner, at market value, if the other partner is involved in a future change in control situation. Additionally, the other partner has an option which it can exercise as of April 1, 2001, to purchase the Company's interest in Anchor. Summarized financial information for Anchor for the three and six months ended June 30, 2000, and 1999 is as follows (in thousands):
Three Months Six Months Ended Ended June 30, June 30, ------------- ----------- 2000 1999 2000 1999 ------- ----------- ------ ------ Net sales. . $4,649 $4,863 $9,739 $9,996 Gross profit 1,385 1,451 2,809 3,124 Net income . 737 707 1,509 1,778
In addition, the Company has other joint venture arrangements which are not significant to the Company's results of operations. 9. SUPPLEMENTAL CASH FLOW A summary of supplemental cash flow information follows (in thousands):
Three months ended Six months ended June 30, June 30, 2000 1999 2000 1999 --------- ------- ------- ------- Interest paid in cash. . . . . . . . $ 5,033 $4,086 $11,580 $7,747 Income taxes paid (received) in cash 89 18 (1,409) 625 Acquisition of businesses (Note 7): Working capital, except cash . . . 300 - 300 - Property, plant and equipment and acquisition- related costs . . . . 2,800 - 2,800 - Other noncurrent assets. . . . . . 4,500 - 4,500 - Acquisition debt . . . . . . . . . (2,500) - (2,500) - Stock issuance . . . . . . . . . . (3,100) - (3,100) - ---------- ----- --------- ------ Net cash used . . . . . . . . . $ 2,000 $ 0 $ 2,000 $ 0 ========= ====== ======= =======
ITEM 2 ABC-NACO INC. Management's Discussion and Analysis of Financial Condition and Results of Operations The following is management's discussion and analysis of certain significant factors which have affected the Company's financial condition and results of operations during the interim periods included in the accompanying unaudited Consolidated Financial Statements. ABC-NACO Inc. (''the Company'') is a supplier of technologically advanced products and services to the freight railroad and flow control industries through its three business segments or groups: Rail Products, Rail Services and Systems, and Flow and Specialty Products. With four technology centers around the world supporting its three business segments, the Company holds pre-eminent market positions in the design, engineering, and manufacture of high performance freight railcar, locomotive and passenger rail suspension and coupler systems, wheels and mounted wheel sets, and specialty track products. The Company also supplies freight, railroad and transit signaling systems and services, as well as highly engineered valve bodies and components for industrial flow control systems worldwide. In the aggregate, the Company operates 20 U.S manufacturing plants in 12 states; plants in Sahagun, Mexico, Mexico City, Mexico, Lisbon, Portugal, Leven, Scotland and Dominion, Canada; has unconsolidated joint ventures with plants in Illinois, China and Mexico; and has other facilities (administrative, engineering, etc.) in 4 U.S. states. The current composition of the Company was achieved by the consummation of a merger (the ''Merger'') on February 19, 1999, between a wholly owned subsidiary of the Company (formerly ABC Rail Products Corporation (''ABC'')) and NACO, Inc. (''NACO''). As a result of the Merger, each outstanding share of NACO common stock was converted into 8.7 shares of ABC common stock, resulting in the issuance of approximately 9.4 million shares. The Merger was treated as a tax-free reorganization for federal income tax purposes and is accounted for as a pooling-of-interests transaction. The accompanying consolidated financial statements reflect the combined results of ABC and NACO as if the Merger occurred on the first day of the earliest period presented. The Company manages its operations through three reporting segments or groups: Rail Products, Rail Services and Systems, and Flow and Specialty Products. These distinct business units generally serve separate markets. They are managed separately since each business requires different technology, servicing and marketing strategies. The following describes the types of products and services from which each segment derives its revenues: Rail Products-Freight car and locomotive castings Rail Services and Systems-Specialty trackwork, wheel assembly and signal systems Flow and Specialty Products-Valve housing and related castings ------ RESULTS OF OPERATIONS ----------------------- Three Months Ended June 30, 2000 Compared To Three Months June 30, 1999 Net Sales. Consolidated net sales decreased $8.2 million or 5.0% to $155.1 million in 2000. The decline in the new freight car build rate, the impact of higher fuel prices and the related reduced spending for maintenance and other discretionary programs by railroads, have negatively impacted consolidated sales for the Company beyond previous expectations. Sales within the Rail Products Segment decreased $26.8 million or 27.3% from $98.1 million in 1999 to $71.3 million in 2000. High fuel prices, which in turn resulted in reduced spending on maintenance items such as loose wheels by the railroads, contributed to significantly reduced sales within this segment. Sales within the Rail Services and Systems Segment increased 22.5% to $74.0 million in 2000 from $60.4 million in 1999. The increase versus the same quarter of 1999 is primarily due to the Company's long-term supply agreement with the Union Pacific Railroad to supply and service wheel sets for its North American operations. This agreement took effect in November 1999. Sales within the Flow and Specialty Products Segment also increased 22.5% from $16.9 million in 1999 to $20.7 million in 2000. The surge in oil prices has generated additional demand for exploration, which in turn has increased demand for valve bodies sold by this segment. Gross Profit. Consolidated gross profit decreased 5.7% to $20.5 million in 2000 from $21.7 million in 1999. Gross profit for the three months ended June 30, 2000 includes $1.2 million for vendor rebates, compared to none recorded in the comparable period for 1999. Despite low sales activity during the period, gross margin of 13.2% of net sales in 2000 is only slightly below 1999 margin of 13.3%, largely due to operating efficiencies resulting from the Merger. Gross profit within the Rail Products Segment decreased 40.3% to $8.8 million in 2000. Profit shortfalls in this segment reflected lower sales volume. Within the Rail Services and Systems segment, gross profit of $8.0 million increased 55.4% versus 1999. Strong sales growth, reflecting the Company's long-term supply agreement with the Union Pacific Railroad, resulted in improved margins. Gross profit within the Flow and Specialty Products Segment more than doubled in 2000 to $3.7 million versus $1.8 million in 1999. Solid operational performance maximized profits on the higher sales activity within this group, which resulted in margins increasing to 17.8% of sales in 2000 versus 10.8% last year. Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased $0.6 million or 4.2%. The decrease in expenses between periods primarily reflects expected operating efficiencies stemming from the Merger. Merger and Other Restructuring Costs. The Company incurred an after-tax charge of $5.8 million in the prior year quarter relative to the direct costs associated with the Merger. The Merger related charge included advisory fees, employee severance obligations and other general expenses. Refer to Footnote (5) for a more detailed description of these costs. Equity Income of Unconsolidated Joint Ventures. The Company's income from its equity investments in joint ventures improved to $0.9 million in 2000 versus a loss of $0.3 million in 1999. Improving volumes in the China wheel business, along with continued earnings growth from the brake shoe joint venture contributed to this gain. Interest Expense. Interest expense, excluding the effect of capitalizing $0.1 million of interest in 2000 and $0.4 million in 1999, increased $1.7 million to $6.1 million in 2000. This increase was attributable to higher borrowing levels and increased borrowing rates. Net Income (Loss). Net income of $0.2 million for the current period compares favorably to a loss in the prior year's quarter of $ 5.7 million. 1999 second quarter results were impacted by an after-tax special charge of $5.8 million related to the merger. Including the effect of preferred stock dividends in 2000, and Merger related charges in 1999, earnings per share in the current quarter was a loss of $0.02 versus a loss of $0.31 in the corresponding quarter of 1999. Six Months Ended June 30, 2000 Compared To Six Months June 30, 1999 Net Sales. Year-to-date consolidated net sales of $312.0 million in 2000 is 5.4% lower than 1999 net sales of $329.9 million for the corresponding six-month period. Significant market softness in the Rail Products Segment is only partially offset by good sales growth year-to-year in the Company's other two primary segments. Sales within the Rail Products Segment through six months decreased 23.7% or $46.9 million to $150.5 million in 2000. The impact of high fuel prices, resulting in reduced spending on maintenance items such as loose wheels by the railroads, have negatively impacted sales within this segment year-to-date. Sales of $139.3 million within the Rail Services and Systems Segment in 2000 are 13.9% higher than 1999 sales of $122.3 million, in part due to the Company's November 1999 long-term supply agreement with the Union Pacific Railroad to supply and service wheel sets for its North American operations. Increased demand for valve bodies due to additional demand for fuel exploration has resulted in a 29.5% sales increase within the Flow and Specialty Products Segment year-to-year. Sales increased from $33.9 million in 1999 to $43.9 million in 2000. Gross Profit. Six-month consolidated gross profit of $41.3 million in 2000 is equal to 1999 gross profit despite lower overall sales activity. Gross margin of 13.2% of net sales in 2000 compares favorably to 12.5% of net sales one year ago despite lower sales, due largely to efficiencies resulting from the Merger. Gross profit for the six months ended June 30, 200 includes $1.2 million for vendor rebates, compared to none recorded in the comparable period of 1999. Rail Products gross profit declined $8.6 million or 32.1% to $18.2 million in 2000 from $26.9 million in 1999. Profit shortfalls in this segment reflect low sales volume due to rail supply industry market conditions previously described. Within the Rail Services and Systems segment, gross profit increased 37.8% or $4.0 million to $14.7 million in 2000 versus $10.6 million in 1999. Increased sales contribute to improved margins. Gross profit within the Flow and Specialty Products Segment increased to $8.1 million in 2000 versus $4.2 million in 1999. Margins in this group improved to 18.5% of net sales in 2000 versus 12.3% in 1999. Selling, General and Administrative Expenses. Selling, general and administrative expenses are down $2.6 million or 8.3% year-to-year due primarily to expected operating efficiencies stemming from the Merger. Merger and Other Restructuring Costs. During the six months ended June 30, 2000, the Company recorded $1.6 million of Merger and other restructuring charges. This charge included cash employee severance costs for 35 salaried employees and 30 hourly plant employees and was part of the Company's long-term effort to eliminate duplicate functions and improve operating efficiencies as a result of the Merger. As of June 30, 2000, all of these employees have been terminated and $1.1 million of related costs were paid. The Company incurred a pre-tax charge of $21.9 million in the six months ended June 30, 1999 relative to the direct costs associated with the February 19, 1999 Merger between ABC Rail Products and NACO as well as costs associated with the restructuring of the Track Products Group. The Merger related charge totaled $18.4 million on a pre-tax basis and included advisory fees, employee severance obligations and other general expenses. The Track Products Group's restructuring charge totaled $3.5 million on a pre-tax basis and included costs for shutting down facilities, employee severance obligations and other general expenses. Equity Income of Unconsolidated Joint Ventures. The Company's income from its equity investments in joint ventures improved to $1.3 million in 2000 versus $0.1 million in 1999. Improving volumes in the China wheel business, along with continued earnings from the brake shoe joint venture contributed to this gain, which was mostly realized in the second quarter of 2000. Interest Expense. Interest expense, excluding the effect of capitalizing $0.1 million of interest in 2000 and $0.7 million in 1999, increased $3.7 million to $12.2 million in 2000. This increase was attributable to higher borrowing levels and increased borrowing rates. Extraordinary Item. On February 19, 1999, the Company, in conjunction with the Merger, entered into a new credit facility with a syndicate of financial institutions. This triggered the write-off of unamortized deferred financing balances, make whole payments and early termination fees that resulted form the extinguishment of the old debt. The after-tax charge recorded to account for these items was $3.2 million. Net Loss. Net loss of $0.4 million for the current six-month period compares favorably to a prior year loss of $21.2 million. 1999 first half results were impacted by a pre-tax charge of $21.9 million for Merger and other restructuring costs and an after-tax extraordinary loss of $3.2 million described above. 2000 results include a pre-tax charge of $1.6 million of Merger and other Restructuring Charges. Including the effect of preferred stock dividends in 2000, and Merger related charges and extraordinary losses in 1999 and in 2000, earnings per share in the current six-month period was a loss of $0.67 versus a loss of $1.16 in the corresponding six-months of 1999. LIQUIDITY AND CAPITAL RESOURCES ---------------------------------- For the six months ended June 30, 2000, net cash used in operating activities totaled $32.3 million compared to net cash provided by operating activities of $3.8 million in 1999. The decrease in operating cash flow is due primarily to increases in the Company's inventory and receivable levels. The increase in inventory relates to the initial stock levels required to implement the service agreement with Union Pacific Railroad Company, and a slow-down in overall orders at the end of the quarter. The Company expects inventory levels to reduce to more normal levels as it moves beyond the initial implementation stage of the service agreement with Union Pacific Railroad. Receivable levels at December 31, 1999 were abnormally low compared to historical amounts. On October 29, 1999, the Company acquired all outstanding common stock of COMETNA - Companhia Metalurgica Nacional, S.A. (Cometna) located in Lisbon, Portugal for $8.3 million or 674,796 shares of the Company's common stock. Cometna manufactures and machines products for the freight and passenger rail industries in Europe and is part of the Company's Rail Products segment. On June 23, 2000, the Company acquired certain assets of Donovan Demolition, Inc. ("Donovan") located in Danvers, Illinois. In addition, the Company acquired a patent from a shareholder of Donovan. The total purchase price of $7.6 million for these assets included $2.0 million in cash, a $2.5 million note and 500,000 shares of the Company's common stock valued at $3.1 million. The Donovan bargain purchase amount of $2.6 million has been deducted from the appraised value of property, plant and equipment. Capital expenditures during the six months ended June 30, 2000 and 1999 were $10.8 million and $21.2 million, respectively. Capital spending during the second half of 2000 will be reduced to less than the first half-year spending level as most of the major initiatives started in 1999 to improve operating processes are nearing their final stages of completion. In total, capital spending will be approximately $4.0 million less than the Company's full-year original projection of $25.0 million. For six months ended June 30, 2000 and 1999, net cash provided by financing activities totaled $44.0 million and $18.7 million, respectively. The net increase in 2000 was primarily funded through the Company's issuance of its Series B cumulative convertible preferred stock along with increased borrowing on the Company's existing Credit Facility, each as described below. Immediately after the consummation of the Merger, the Company entered into a new revolving credit facility (the "Credit Facility") with a syndicate of financial institutions, in which Bank of America National Trust & Savings Association acted as the Agent and Letter of Credit Issuing Lender and Bank of America Canada acted as the Canadian Revolving Lender. The Credit Facility provides the Company with a revolving line of credit of up to $200.0 million. The Credit Facility's covenants include ratio restrictions on total leverage, senior leverage, interest coverage, minimum net worth restriction and restrictions on capital expenditures. The initial net proceeds of the Credit Facility were used to (i) refinance existing bank debt and certain other indebtedness of the Company, (ii) refinance substantially all of NACO's outstanding debt, (iii) provide initial financing for the Company's on-going working capital needs, and (iv) pay fees and expenses relating to the Merger and the Credit Facility. The early retirement of the refinanced debt resulted in a $5.2 million extraordinary charge ($3.2 million after-tax) representing the non-cash write-off of related unamortized deferred financing costs and prepayment penalties of $4.5 million. The Credit Facility employs an IBOR-based variable interest rate index and assesses a spread over the IBOR base which is determined by a Consolidated Leverage pricing grid. The weighted average interest rate at June 30, 2000 was 9.7%. Availability at June 30, 2000 was $16.6 million. On October 12, 1999, the Company entered into an Amendment, Waiver and Release Agreement to the Credit Agreement to release certain collateral related to its Mexican subsidiary and to reflect the change in the Company's fiscal year and reporting periods for covenant measurement purposes. The Company then entered into two subsequent modifications to the Credit Agreement that were effective as of October 29, 1999 to modify certain of the financial leverage covenants in the Credit Agreement which the Company otherwise would not have been in compliance with as of October 31, 1999. On March 8, 2000, the Company entered into a second Amendment and Restatement of the Credit Agreement that was effective as of December 30, 1999 to modify certain of the financial covenants in the Credit Agreement, which the Company otherwise would have not been in compliance with as of December 31, 1999. The amended covenants included the Maximum Consolidated Leverage Ratio, Maximum Senior Leverage Ratio and the Minimum Interest Coverage Ratio. In addition, a minimum pro-forma EDITDA covenant was added to the Credit Agreement. The Company and its Lenders also modified other terms and conditions within the Credit Agreement including the pricing grid, which is based upon the Company's Consolidated Leverage Ratio. The currently applied margin of 300 basis points over IBOR is the maximum IBOR margin provided for by the Amendment. The revolving line of credit now has scheduled commitment reductions as follows: January 1, 2001-$10 million, June 30, 2001-$5.0 million, January 1, 2002-$10.0 million, June 30, 2002-$5.0 million and January 1, 2003-$15.0 million. The total commitment reductions aggregate to $45.0 million and will reduce the revolving credit commitment to a total of $155.0 million as of January 1, 2003. With the second Amendment, the Company was in compliance with the Credit Agreement as of December 31, 1999 and June 30, 2000. On February 1, 1997, the Company completed an offering (the ''Offering'') of $50 million of 9 1/8% Senior Subordinated Notes (the ''9 1/8% Notes''). The Company used the $47.9 million of net proceeds of the Offering to repay certain outstanding indebtedness under its primary and other credit facilities. The 9 1/8% Notes are general unsecured obligations of the Company and are subordinated in right of payment to all existing and future senior indebtedness of the Company and other liabilities of the Company's subsidiaries. The 9 1/8% Notes will mature in 2004, unless repurchased earlier at the option of the Company at 100% of face value. The 9 1/8% Notes are subject to mandatory repurchase or redemption prior to maturity upon a Change of Control (as defined). The indenture under which the 9 1/8% Notes were issued limits the Company's ability to (i) incur additional indebtedness, (ii) complete certain mergers, consolidations and sales of assets, and (iii) pay dividends or other distributions. On December 23, 1997, the Company completed a second offering of $25.0 million of 8 3/4% Senior Subordinated Notes, Series B (the ''8 3/4% Notes'') due in 2004 with similar provisions as the 9 1/8% Notes. The Company is required to meet a number of financial covenants on its 9 1/8% Notes and 8 3/4% Notes including minimum Operating Coverage Ratio, Minimum Consolidated Net Worth and Maximum Funded Debt to Capitalization. The Operating Coverage Ratio at June 30, 2000 was 2.43 with the minimum requirement under the Note indenture of 2.40. The funded Debt to Capitalization ratio at June 30, 2000 was 70.3% with the maximum allowable under the Note indenture being 75.0%. These same leverage covenant tests are to be met at each quarter-end through the maturity dates for these Notes. Failure to meet these covenant tests would give the noteholders the unilateral right to accelerate the maturity of the related debt after a requisite cure period. In addition, cross-default provisions under the Credit Agreement would be triggered upon a default under the Notes. If the Company does not have adequate cash or is unable to remain compliant with such financial covenants, it may be required to further refinance its existing indebtedness, seek additional financing, or issue common stock or other securities to raise cash to assist in financing its operations. The Company has no current commitments or arrangements for such financing alternatives, and there can be no assurances that such financing alternatives will be available on acceptable terms, or at all. The Company is expecting continuing softness in the demand for loose wheels and lower than normal sales activity with select other core products due to reduced new freight car production and the railroads ongoing cut-back of spending on discretionary maintenance and repair items. In addition, the Company anticipates a third quarter pre-tax special charge of $8.0 million to $12.0 million for permanent facility and operational consolidations associated with improved manufacturing process changes. As a result of these factors, the related impact on earnings in the third and fourth quarters of 2000 and based on its current operating budget, the Company may not be in compliance with the Operating Coverage Ratio covenant applicable to the Notes, at the fiscal quarters ended September 30, 2000 and December 31, 2000, unless the covenant is amended. An event of default under the Indenture would constitute a default under the Credit Facility as well. In addition, the Company may not be in compliance with the Leverage Ratio, Senior Leverage Ratio and Interest Coverage Ratio covenants of the Credit Agreement at the fiscal quarter ended 9/30/00, and the Leverage Ratio and the Senior Leverage ratio covenants at the fiscal quarter ended 12/31/00, unless the covenants are amended for those respective periods. To address these issues, the Company has commenced on August 3, 2000, a consent solicitation seeking the consent of the holders of it Notes to an amendment to change the Operating Coverage Ratio to 1.8:1.0 from the current ratio of 2.4:1.0. As part of the consent solicitation, the annual interest rate for the Notes would increase from 9 1/8% (per annum) to 10 1/2% for the current 9 1/8% Notes and from 8 3/4% to 10 1/2% for the 8 3/4% Notes. Other than the annual interest rate, none of the maturity dates, payment provisions, redemption provisions, or any other similar terms of the Notes will be amended as a result of the proposed amendments. The expiration date for the consent solicitation is August 30, 2000, and if the amendments are approved, the increased annual interest rates will become effective October 1, 2000 and the Operating Coverage Ratio will become effective for the quarter ended September 30, 2000. In addition, the Company has begun discussions with its agent bank to modify appropriate covenants in the Credit Facility. The Company's inability to make any payments when due or to satisfy its financial covenants under its existing borrowing facilities could have a material adverse effect on the Company. A universal shelf registration was declared effective by the Securities and Exchange Commission on October 29, 1999, for issuances up to $300 million of debt or equity securities. As of June 30, 2000, no securities were issued under the new universal shelf registration. On March 8, 2000, the Company issued 300,000 shares of Series B cumulative convertible preferred stock ($1 par value) to private equity funds managed by ING Furman Selz Investments for $30 million. The preferred stock has certain voting rights and will pay dividends at the rate of 8% per annum accrued semi-annually and paid in the form of common stock or cash, at the discretion of the Company. The preferred stock is convertible into common stock at the average closing price of the Company's common stock for the thirty trading days ending February 17, 2000, which was $9.00 per share. The preferred stock can be converted into common shares at the Company's option under certain conditions at any time three years after issuance. The net proceeds received from the sale of preferred stock ($28.4 million after offering costs) were applied to reduce the outstanding indebtedness under the Company's Credit Facility. While the conversion price may change under specific conditions, the $9.00 per share price on the date that the Company and the preferred stock holders were committed to completing the transaction represented a discount from the market value of the underlying common stock on that date by an aggregate of $11.9 million. This discount represents the value of the beneficial conversion feature of the preferred stock. Accordingly, the Company initially recorded the value of the preferred stock as $18.1 million offset by $1.6 million of transaction costs, with the $11.9 million credited to additional paid-in capital. Since the preferred stock is convertible at any time at the holders' option, this discount also represents an immediate deemed dividend to those holders at the date of issuance. Accordingly, upon issuance, the Company also recorded a $11.9 million dividend to these holders. Additionally, the preferred stock earned actual dividends of $0.8 million during the six months ended June 30, 2000. Both the actual and deemed dividends are deducted from the net loss for the three and six months ended June 30, 2000 to arrive at loss available to common stockholders in the earnings per share calculations for those periods. In such calculations, other common stock equivalents, which would have increased diluted shares by 3,333,000 for the three months and six months ended June 30, 2000, but were not included in the computation of diluted earnings per share because the assumed exercise of such equivalents would be antidilutive. During the quarter ending January 31, 1999, the Company suspended its previous plan to construct a plant in central Illinois to process used rail into reusable heat-treated and head-hardened rail. The project is being re-evaluated by the Company. The machinery and equipment built is being stored pending completion of a revised business plan. The total investment to date for this project is $11.6million. RISK MANAGEMENT ---------------- Foreign Currency As a Company with multi-national operations, many of the Company's transactions are denominated in foreign currencies. The Company uses financial instruments to hedge or reduce its overall exposure to the effects of currency fluctuations on its cash flows. The Company's policy is not to speculate in such financial instruments for profit or gain. Instruments used as hedges must be effective at reducing the risk associated with the exposure being hedged and must be designated as a hedge at the inception of the contract. Currently, the Company hedges forecasted transactions relating to its manufacturing operations for its ABC-NACO de Mexico subsidiary located in Sahagun, Mexico and its Cometna subsidiary located in Lisbon, Portugal. At June 30, 2000, the Company had approximately $38.5 million of foreign currency option collar contracts outstanding with expiration dates through March, 2001, hedging manufacturing cost exposures within its ABC-NACO de Mexico subsidiary. Also at June 30, 2000, the Company had $4.0 million of foreign currency forward contracts outstanding relating to forecasted U.S. dollar transactions within its Cometna subsidiary with expiration dates through March, 2001. Interest Rate From time to time, the Company enters into various interest rate hedging transactions for purposes of managing exposures to fluctuations in interest rates. Currently, the Company hedges a portion of its exposure to fluctuations in LIBOR interest rates through the use of an interest rate reversion swap. This swap effectively converts a portion of the Company's outstanding credit facility borrowings from a floating LIBOR rate to a fixed rate of interest, up to a maximum trigger point, at which time these borrowings revert back to the floating LIBOR rate of interest. At June 30, 2000, the Company had $25.0 million of interest rate reversion swap contracts outstanding. REGARDING FORWARD-LOOKING STATEMENTS -------------------------------------- This report contains forward-looking statements that are based on current expectations and are subject to a number of risks and uncertainties. Actual results could differ materially from current expectations due to a number of factors, including general economic conditions; competitive factors and pricing pressures; shifts in market demand; the performance and needs of industries served by the Company's businesses; actual future costs of operating expenses such as rail and scrap steel, self-insurance claims and employee wages and benefits; actual costs of continuing investments in technology; the availability of capital to finance possible acquisitions and to refinance debt; the ability of management to implement the Company's long-term business strategy of acquisitions; and the risks described from time to time in the Company's SEC reports. Some of the uncertainties that may affect future results are discussed in more detail in the Company's Annual Report on Form 10-K for the Transition Period ending December 31, 1999. All forward-looking statements included in this document are based upon information presently available, and the Company assumes no obligation to update any forward looking statements. ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS The Company has experienced no material changes in its market risk exposure since the filing of its Form 10-K report for the Transition Period ended December 31, 1999. For further description regarding foreign currency and interest rate hedging risks, refer to the Risk Management section of Management's Discussion and Analysis of Financial Condition and Results of Operation. Part II OTHER INFORMATION Item 6 - Exhibits and Reports on Form 8-K (a) Exhibits 27.1 Financial Data Schedule for period ended June 30, 2000. (b) Reports on Form 8-K None 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. ABC-NACO Inc. (Registrant) By: ----------------------- J. P. Singsank Senior Vice President and Chief Financial Officer By: ---------------------- Larry A. Boik Vice President and Corporate Controller (Chief Accounting Officer) Date: August 14, 2000 ----------------------- EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION OF DOCUMENT ------ ------------------------- 27.1 Financial Data Schedule for quarter ended June 30, 2000.