-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CqEFBC9IkuyO+sU+23jRsDFm9LYnUGkLcZJlVumf7NpYI0FQeFuSsozEXOkf81Mi 02ErZFEiMBmihL74r96fyA== 0000950129-03-005680.txt : 20031114 0000950129-03-005680.hdr.sgml : 20031114 20031114142307 ACCESSION NUMBER: 0000950129-03-005680 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20030930 FILED AS OF DATE: 20031114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NATCO GROUP INC CENTRAL INDEX KEY: 0001057693 STANDARD INDUSTRIAL CLASSIFICATION: FABRICATED PLATE WORK (BOILER SHOPS) [3443] IRS NUMBER: 222906892 STATE OF INCORPORATION: DE FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-15603 FILM NUMBER: 031003167 BUSINESS ADDRESS: STREET 1: BROOKHOLLOW CENTRAL III STREET 2: 2950 NORTH LOOP WEST STE 750 CITY: HOUSTON STATE: TX ZIP: 77092 BUSINESS PHONE: 7136839292 MAIL ADDRESS: STREET 1: BROOKHOLLOW CENTERL III STREET 2: 2950 NORTH LOOP WEST STE 750 CITY: HOUSTON STATE: TX ZIP: 77092 10-Q 1 h10469e10vq.txt NATCO GROUP INC.- SEPTEMBER 30, 2003 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003, 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 1-15603 NATCO GROUP INC. (Exact name of registrant as specified in its charter) DELAWARE 22-2906892 (State or other jurisdiction of incorporation (I.R.S. Employer or organization) Identification No.) 2950 NORTH LOOP WEST 7TH FLOOR HOUSTON, TEXAS 77092 (Address of principal executive offices) (Zip Code) 713-683-9292 (Registrant's telephone number, including area code) 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 12 b-2 of the Exchange Act). 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: As of November 1, 2003, $0.01 par value per share, 15,854,067 shares ================================================================================ NATCO GROUP INC. FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2003 TABLE OF CONTENTS
PAGE NO. --- PART I -- FINANCIAL INFORMATION Item 1. Financial Statements................................ 3 Condensed Consolidated Balance Sheets -- September 30, 2003 (unaudited) and December 31, 2002.......... 3 Unaudited Condensed Consolidated Statements of Operations -- Three and Nine Months Ended September 30, 2003 and 2002.................................. 4 Unaudited Condensed Consolidated Statements of Cash Flows -- Nine Months Ended September 30, 2003 and 2002................................................ 5 Notes to Unaudited Condensed Consolidated Financial Statements.......................................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................. 19 Item 3. Quantitative and Qualitative Disclosures About Market Risk......................................... 31 Item 4. Controls and Procedures.............................. 32 PART II -- OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K..................... 33 Signatures ..................................................... 34
2 PART I ITEM 1. FINANCIAL STATEMENTS NATCO GROUP INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30, DECEMBER 31, 2003 2002 ------------ ----------- (UNAUDITED) ASSETS Current assets: Cash and cash equivalents.................................. $ 1,134 $ 1,689 Trade accounts receivable, net............................. 69,444 74,677 Inventories................................................ 37,976 32,400 Prepaid expenses and other current assets.................. 7,588 7,611 ---------- --------- Total current assets................................. 116,142 116,377 Property, plant and equipment, net........................... 35,201 31,485 Goodwill, net................................................ 79,831 78,977 Deferred income tax assets, net.............................. 2,581 2,984 Other assets, net............................................ 1,436 1,772 ---------- --------- Total assets......................................... $ 235,191 $ 231,595 ========== ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current installments of long-term debt..................... $ 16,992 $ 7,097 Accounts payable........................................... 36,379 36,074 Accrued expenses and other................................. 31,679 37,243 Customer advances.......................................... 3,517 1,354 ---------- --------- Total current liabilities............................ 88,567 81,768 Long-term debt, excluding current installments............... 26,716 45,257 Postretirement benefit and other long-term liabilities....... 12,080 12,718 ---------- --------- Total liabilities.................................... 127,363 139,743 ---------- --------- Series B redeemable convertible preferred stock (aggregate redemption value of $15,000), $.01 par value. 15,000 shares authorized, issued and outstanding (net of issuance costs) 14,101 -- Stockholders' equity: Preferred stock $.01 par value. Authorized 5,000,000 shares (of which 500,000 are designated as Series A and 15,000 are designated as Series B); no shares issued and outstanding -- -- (except Series B shares above)............................. Series A preferred stock, $.01 par value. Authorized 500,000 shares; no shares issued and outstanding......... -- -- Common stock, $.01 par value. Authorized 50,000,000 shares; issued and outstanding 15,854,067 and 15,803,797 shares as of September 30, 2003 and December 31, 2002, respectively.......................... 159 158 Additional paid-in capital................................. 97,343 97,223 Accumulated earnings....................................... 8,511 8,734 Treasury stock, 795,692 shares at cost as of September 30, 2003 and December 31, 2002........................... (7,182) (7,182) Accumulated other comprehensive loss....................... (1,301) (3,395) Notes receivable from officers............................. (3,803) (3,686) ----------- --------- Total stockholders' equity........................... 93,727 91,852 ---------- --------- Commitments and contingencies Total liabilities and stockholders' equity........... $ 235,191 $ 231,595 ========== =========
See accompanying notes to unaudited condensed consolidated financial statements. 3 NATCO GROUP INC. AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------- ----------------------- 2003 2002 2003 2002 ---------- ---------- ---------- --------- Revenues .......................................... $ 65,801 $ 66,563 $ 204,427 $ 214,537 Cost of goods sold ................................ 49,777 51,655 156,045 163,704 --------- --------- --------- --------- Gross profit ............................ 16,024 14,908 48,382 50,833 Selling, general and administrative expense ....... 12,647 13,299 38,291 39,863 Depreciation and amortization expense ............. 1,167 1,288 3,651 3,640 Closure and other ................................. 722 -- 947 -- Interest expense .................................. 950 1,280 3,089 3,423 Interest cost on postretirement benefit liability . 209 122 628 367 Interest income ................................... (42) (47) (141) (174) Other, net ........................................ (74) (271) 830 (236) --------- --------- --------- --------- Income (loss) before income taxes and cumulative effect of change in accounting principle .... 445 (763) 1,087 3,950 Income tax provision (benefit) .................... 255 (427) 499 1,379 --------- --------- --------- --------- Net income (loss) before cumulative effect of change in accounting principle .............. 190 (336) 588 2,571 Cumulative effect of change in accounting principle (net of tax benefit of $18)............. -- -- 34 -- --------- --------- --------- --------- Net income (loss) ....................... $ 190 $ (336) $ 554 $ 2,571 Preferred stock dividends.......................... 378 -- 777 -- --------- --------- --------- --------- Net income (loss) available to common stockholders.................... $ (188) $ (336) $ (223) $ 2,571 ========= ========= ========= ========= Earnings (loss) per share--basic: Net income (loss) before cumulative effect of change in accounting principle ................. $ (0.01) $ (0.02) $ (0.01) $ 0.16 Cumulative effect of change in accounting principle -- -- -- -- --------- --------- --------- --------- Net income (loss) ....................... $ (0.01) $ (0.02 $ (0.01) $ 0.16 ========= ========= ========= ========= Earnings (loss) per share--diluted: Net income (loss) before cumulative effect of change in accounting principle ................. $ (0.01) $ (0.02) $ (0.01) $ 0.16 Cumulative effect of change in accounting principle -- -- -- -- --------- --------- --------- --------- Net income (loss) ....................... $ (0.01) $ (0.02) $ (0.01) $ 0.16 ========= ========= ========= ========= Basic weighted average number of shares of common stock outstanding ........................ 15,854 15,804 15,836 15,804 Diluted weighted average number of shares of common stock outstanding ..................... 15,854 15,804 15,836 15,937
See accompanying notes to unaudited condensed consolidated financial statements. 4 NATCO GROUP INC. AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30, ----------------- 2003 2002 ---- ---- Cash flows from operating activities: Net income ............................................... $ 552 $ 2,571 Adjustments to reconcile net income to net cash provided by operating activities: Cumulative effect of change in accounting principle ........................................... 34 -- Deferred income tax expense ........................... 1,433 1,894 Depreciation and amortization expense ................. 3,651 3,640 Non-cash interest income .............................. (116) (159) Revaluation of warrants ............................... (15) -- Interest cost on postretirement benefit liability ..... 628 367 Gain on the sale of property, plant and equipment ..... (265) (14) Change in assets and liabilities: (Increase) decrease in trade accounts receivable .... 6,389 (4,747) (Increase) decrease in inventories .................. (3,755) 2,572 Increase in prepaid expense and other current assets ............................................ (683) (450) Increase in long-term assets ........................ (299) (422) Increase in accounts payable ........................ 3,039 1,114 Decrease in accrued expenses and other .............. (6,731) (3,522) Increase (decrease) in customer advances ............ 2,133 (1,800) -------- -------- Net cash provided by operating activities ........ 5,995 1,044 -------- -------- Cash flows from investing activities: Capital expenditures for property, plant and equipment .............................................. (8,347) (3,882) Proceeds from the sale of property, plant and equipment .............................................. 670 44 Issuance of related party note receivable ................ -- (216) Acquisitions, net ........................................ -- (240) -------- -------- Net cash used in investing activities ............ (7,677) (4,294) -------- -------- Cash flows from financing activities: Change in bank overdrafts ................................ (3,450) 155 Net borrowings (repayments) under long-term revolving credit facilities ...................................... (3,877) 6,594 Repayments of long-term debt ............................. (5,324) (5,299) Borrowings of long-term debt ............................. -- 1,460 Proceeds from the issuance of preferred stock, net ....... 14,101 -- Issuance of common stock ................................. 111 -- Payments on postretirement benefit liability ............. (1,338) (1,434) Dividends paid ........................................... (399) -- Other, net ............................................... 558 541 -------- -------- Net cash provided by financing activities ........ 382 2,017 -------- -------- Effect of exchange rate changes on cash and cash equivalents ............................................. 745 506 -------- -------- Change in cash and cash equivalents ........................ (555) (727) Cash and cash equivalents at beginning of period ........... 1,689 3,093 -------- -------- Cash and cash equivalents at end of period ................. $ 1,134 $ 2,366 ======== ======== Cash payments for: Interest ................................................. $ 2,260 $ 2,277 Income taxes ............................................. $ 782 $ 2,350
See accompanying notes to unaudited condensed consolidated financial statements. 5 NATCO GROUP INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (1) BASIS OF PRESENTATION The accompanying condensed consolidated interim financial statements and related disclosures are unaudited and have been prepared by NATCO Group Inc. pursuant to generally accepted accounting principles for interim financial statements and the rules and regulations of the Securities and Exchange Commission. As permitted by these regulations, certain information and footnote disclosures that would typically be required in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. However, the Company's management believes that these statements reflect all the normal recurring adjustments necessary for a fair presentation, in all material respects, of the results of operations for the periods presented, so that these interim financial statements are not misleading. These condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K filing for the year ended December 31, 2002. To prepare financial statements in accordance with generally accepted accounting principles, the Company's management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenues and expenses incurred during the reporting period. Actual results could differ from those estimates. Furthermore, certain reclassifications have been made to fiscal year 2002 amounts in order to present these results on a comparable basis with amounts for fiscal year 2003. These reclassifications had no impact on net income. References to "NATCO" and "the Company" are used throughout this document and relate collectively to NATCO Group Inc. and its consolidated subsidiaries. (2) EMPLOYEE STOCK OPTIONS The Company accounts for its employee stock option plans by applying the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," as permitted by Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123 allows entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. If entities continued to apply the provision of APB Opinion No. 25, pro forma net income and earnings per share disclosures would be required for all employee stock option grants made in 1995 and subsequent years, as if the fair value-based method defined in SFAS No. 123 had been applied. SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure, an amendment to FASB Statement No. 123," issued in December 2002, provided alternative methods to transition to the fair value method of accounting for stock-based compensation, on a volunteer basis, and required additional disclosures at annual and interim reporting dates. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and to provide the pro forma disclosures required by SFAS No. 123. The Company determines pro forma net income and earnings per share by applying the Black-Scholes Single Option--Reduced Term valuation method. This valuation model requires management to make highly subjective assumptions about the volatility of NATCO's common stock, the expected term of outstanding stock options, the Company's risk-free interest rate and expected dividend payments during the contractual life of the options. The following table summarizes these pro forma net earnings and earnings per share amounts for the three-month and nine-month periods ended September 30, 2003 and 2002. 6
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------ ----------------- 2003 2002 2003 2002 ---- ---- ---- ---- (UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Net income (loss) before cumulative effect of change in accounting principle--as reported ............................................ $ 190 $ (336) $ 588 $ 2,571 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects.......................................... 118 236 439 721 ------- ------- ------- --------- Pro forma net income (loss) ........................... $ 72 $ (572) $ 149 $ 1,850 ======= ======= ======= ========= Earnings (loss) per share: Basic -- as reported ............................... $ (0.01) $ (0.02) $ (0.01) $ 0.16 Basic -- pro forma ................................. $ (0.02) $ (0.04) $ (0.04) $ 0.12 Diluted -- as reported ............................. $ (0.01) $ (0.02) $ (0.01) $ 0.16 Diluted -- pro forma ............................... $ (0.02) $ (0.04) $ (0.04) $ 0.12
Pursuant to the NATCO Group Inc. Directors Compensation Plan, as amended, and the NATCO Group Inc. 2001 Stock Incentive Plan, the Company granted 2,500 restricted shares to each of its five non-employee directors during June 2003. These restricted shares vest 100% on June 3, 2006, but are forfeitable if service discontinues prior to this date (other than for death, disability or retirement). The Company will recognize expense of $85,000 related to these grants ratably over the vesting period. In addition, the Company granted each of these non-employee directors options to purchase 2,500 shares of the Company's common stock at the fair market value on the date of grant. These options vest 100% following one year of service, on the anniversary date of their issuance. (3) CAPITAL STOCK AND REDEEMABLE CONVERTIBLE PREFERRED STOCK On March 13, 2003, the Company issued 15,000 shares of Series B Convertible Preferred Stock ("Series B Preferred Shares") and warrants to purchase 248,800 shares of NATCO's common stock, to Lime Rock Partners II, L.P., a private investment fund, for an aggregate price of $15.0 million. Approximately $99,000 of the aggregate purchase price was allocated to the warrants. Proceeds from the issuance of these securities, net of related estimated issuance costs of approximately $800,000, were used to reduce the Company's outstanding revolving debt balances and for other general corporate purposes. Each of the Series B Preferred Shares has a face value of $1,000 and pays a cumulative dividend of 10% per annum of face value, which is payable semi-annually on June 15 and December 15 of each year, except the initial dividend payment which was payable on July 1, 2003. Each of the Series B Preferred Shares is convertible, at the option of the holder, into (i) a number of shares of common stock equal to the face value of such Series B Preferred Share divided by the conversion price, which was $7.805 (or an aggregate of 1,921,845 shares) at September 30, 2003, and (ii) a cash payment equal to the amount of dividends on such shares that have accrued since the prior semi-annual dividend payment date. As of September 30, 2003, the Company had accrued dividends payable of $378,000 related to the Series B Preferred Shares. The Company paid dividends of $399,000 on July 1, 2003, to the holders of the Series B Preferred Shares. In the event of a change in control, as defined in the certificate of designations for the preferred shares, each holder of the Series B Preferred Shares has the right to convert the Series B Preferred Shares into common stock or to cause the Company to redeem for cash some or all of the Series B Preferred Shares at an aggregate redemption price equal to the sum of (i) $1,000 (adjusted for stock splits, stock dividends, etc.) multiplied by the number of shares to be redeemed, plus (ii) an amount (not less than zero) equal to the product of $500 (adjusted for stock splits, stock dividends, etc.) multiplied by the aggregate number of the Series B Preferred Shares to be redeemed less the sum of the aggregate amount of dividends paid in cash since the issuance date, plus any gain on the related stock warrants. If the holder of the Series B Preferred Shares converts upon a change in control occurring on or before March 25, 2006, the holder would also be entitled to receive cash in an amount equal to the dividends that would have accrued through March 25, 2006 less the sum of the aggregate amount of dividends paid in cash through the date of conversion, and the aggregate amount of dividends accrued in prior periods but not yet paid. 7 The Company has the right to redeem the Series B Preferred Shares for cash on or after March 25, 2008, at a redemption price per share equal to the face value of the Series B Preferred Shares plus the amount of dividends that have been accrued but not paid since the most recent semi-annual dividend payment date. The Company adopted SFAS No. 150, "Accounting for Certain Instruments with Characteristics of both Liabilities and Equity," on July 1, 2003. Under SFAS No. 150, the Series B Preferred Shares would be classified as permanent equity. However, due to the cash redemption features upon a change in control as described above, the Series B Preferred Shares do not qualify for permanent equity treatment in accordance with the Emerging Issues Task Force Topic D-98: "Classification and Measurement of Redeemable Securities," which specifically requires that permanent equity treatment be precluded for any security with redemption features that are not solely within the control of the issuer. Therefore, the Company has accounted for the Series B Preferred Shares as temporary equity in the accompanying balance sheet, and has not assigned any value to its right to redeem the Series B Preferred Shares on or after March 25, 2008. If the Series B Preferred Shares are converted under contingent redemption features, any redemption amount greater than carrying value would be recorded as a reduction of income available to common shareholders when the event becomes probable. If the Company fails to pay dividends for two consecutive periods or any redemption price due with respect to the Series B Preferred Shares for a period of 60 days following the payment date, the Company will be in default under the terms of such shares. During a default period, (1) the dividend rate on the Series B Preferred Shares would increase to 10.25%, (2) the holders of the Series B Preferred Shares would have the right to elect or appoint a second director to the Board of Directors and (3) the Company would be restricted from paying dividends on, or redeeming or acquiring its common or other outstanding stock, with limited exceptions. If the Company fails to set aside or make payments in cash of any redemption price due with respect to the Series B Preferred Shares, and the holders elect, the Company's right to redeem the shares may be terminated. The warrants issued to Lime Rock Partners II, L.P. have an exercise price of $10.00 per share of common stock and expire on March 25, 2006. The Company can force the exercise of the warrants if NATCO's common stock trades above $13.50 per share for 30 consecutive days. The warrants contain a provision whereby the holder could require the Company to make a net-cash settlement for the warrants in the case of a change in control. The warrants were deemed to be derivative instruments and, therefore, the warrants were recorded at fair value as of the issuance date. Fair value, as agreed with the counter-party to the agreement, was calculated by applying a pricing model that included subjective assumptions for stock volatility, expected term that the warrants would be outstanding, a dividend rate of zero and an overall liquidity factor. The Company recorded the resulting liability of $99,000 as of the issuance date. At September 30, 2003, this liability was $84,000, reflecting a decline in fair market value of the warrants since the date of acquisition of $15,000. Changes in fair value in future periods will be recorded as charges or credits to net income during the period of the change, as applicable. On January 1, 2002, all outstanding shares of the Company's Class B Common Stock, 334,719 shares, were converted automatically to Class A Common Stock, on a share for share basis, in accordance with the terms under which the Class B Common Stock was originally issued, resulting in a single class that was re-designated "Common Stock." 8 (4) EARNINGS PER SHARE The Company computed basic earnings per share by dividing net income available to common shareholders by the weighted average number of shares outstanding for the period. Net income available to common shareholders at September 30, 2003, represented net income before cumulative effect of change in accounting principle less preferred stock dividends accrued and paid. The Company determined diluted earnings per common and potential common share at September 30, 2003, as net income before the cumulative effect of change in accounting principle divided by the weighted average number of shares outstanding for the period, after applying the if-converted method to determine any incremental shares associated with convertible preferred stock, warrants and restricted stock outstanding. Since the effect of such incremental shares was anti-dilutive at September 30, 2003, these shares were not considered common and potential common shares for purposes of calculating earnings per share at September 30, 2003, in accordance with SFAS No. 128, "Earnings per Share." Outstanding employee stock options were considered potential common shares for purposes of this calculation. However, potential common shares related to employee stock options were anti-dilutive for the three-month periods ended September 30, 2003 and 2002, and for the nine months ended September 30, 2003, as the Company recorded a net loss available to common shareholders during these periods. Diluted shares for the nine months ended September 30, 2002 included potential common shares related to employee stock options of 133,677 shares. Anti-dilutive stock options were excluded from the calculation of potential common shares. If anti-dilutive shares were included in the calculation for the three and nine months ended September 30, 2003, the impact would have been a reduction of 407,211 shares and 495,320 shares, respectively. If anti-dilutive shares were included for the three and nine months ended September 30, 2002, the impact would have been a reduction of 409,192 shares and 250,119 shares, respectively. The following table presents the computation of basic and diluted earnings per common and potential common share for the three and nine months ended September 30, 2003 and 2002, respectively:
THREE MONTHS ENDED SEPTEMBER 30, 2003 THREE MONTHS ENDED SEPTEMBER 30, 2002 ------------------------------------- ------------------------------------- INCOME SHARES PER-SHARE INCOME SHARES PER-SHARE (NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT ----------- ------------- ------ ----------- ------------- ------ (UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Income (loss) before cumulative effect of change in accounting principle ..................... $ 190 $ (336) Less: Preferred stock dividends accrued and paid .................. (378) -- -------- ----- Basic EPS: Loss available to common stockholders before cumulative effect of change in accounting principle ..................... $ (188) 15,854 $ (0.01) $ (336) 15,804 $ (0.02) ======== ======== Effect of dilutive securities: Stock options ................................. -- -- -- -- -------- ------ ------ ------ Diluted EPS: Loss available to common stockholders before cumulative effect of change in accounting principle + assumed conversions ......................... $ (188) 15,854 $ (0.01) $ (336) 15,804 $ (0.02) ======== ====== ======== ====== ====== ========
9
NINE MONTHS ENDED SEPTEMBER 30, 2003 NINE MONTHS ENDED SEPTEMBER 30, 2002 ------------------------------------ ------------------------------------ INCOME SHARES PER-SHARE INCOME SHARES PER-SHARE (NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT ----------- ------------- --------- ----------- ------------- --------- (UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Income before cumulative effect of change in accounting principle ................................ $ 588 $ 2,571 Less: Preferred stock dividends accrued and paid .......................... (777) -- ------- ------- Basic EPS: Income (loss) available to common stockholders before cumulative effect of change in accounting principle ............................. $ (189) 15,836 $ (0.01) $ 2,571 15,804 $ 0.16 ======== ========== Effect of dilutive securities: Stock options ......................................... -- -- -- 133 ------- ------ ------- ------ Diluted EPS: Income (loss) available to common stockholders before cumulative effect of change in accounting principle + assumed conversions ................................. $ (189) 15,836 $ (0.01) $ 2,571 15,937 $ 0.16 ======= ====== ======== ======= ====== ==========
(5) INVENTORIES Inventories consisted of the following amounts:
SEPTEMBER 30, DECEMBER 31, 2003 2002 ---- ---- (UNAUDITED) (IN THOUSANDS) Finished goods................. $ 14,964 $13,088 Work-in-process................ 8,549 6,486 Raw materials and supplies..... 16,044 14,362 -------- ------- Inventories at FIFO.......... 39,557 33,936 Excess of FIFO over LIFO cost.. (1,581) (1,536) -------- ------- $ 37,976 $32,400 ======== =======
(6) COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS Cost and estimated earnings on uncompleted contracts were as follows:
SEPTEMBER 30, DECEMBER 31, 2003 2002 ------------- ----------- (UNAUDITED) (IN THOUSANDS) Cost incurred on uncompleted contracts............... $ 94,242 $87,586 Estimated earnings................................... 25,480 19,656 -------- ------- 119,722 107,242 Less billings to date................................ 100,213 87,187 -------- ------- $ 19,509 $20,055 ======== ======= Included in the accompanying balance sheet under the captions: Trade accounts receivable.......................... $ 20,549 $20,262 Advance payments................................... (1,040) (207) -------- ------- $ 19,509 $20,055 ======== =======
10 (7) CLOSURE AND OTHER In September 2003, the Company recorded expenses of $722,000 associated with a management-approved restructuring plan, which included the involuntary termination of certain administrative and operating personnel in connection with the closure of a manufacturing facility in Covington, Louisiana, the Company's corporate headquarters, the Company's research and development facility in Tulsa, Oklahoma, and the consolidation of operations in the U.K. As a result of this restructuring plan, the Company incurred post-employment costs for these terminated employees, as provided by the Company's severance policy, in accordance with SFAS No. 112, "Employers' Accounting for Post-employment Benefits, an amendment of FASB Statements No. 5 and 43." These post-employment costs totaled $640,000, of which $290,000 was paid during September 2003. The Company accrued the remaining $350,000 of post-employment costs as of September 30, 2003, and expects to pay this amount during the fourth quarter. In addition, the Company incurred $78,000 related to consultant's fees, equipment moving costs and employee relocations. Approximately $300,000 of additional costs related to this restructuring are expected during the fourth quarter of 2003 and will be expensed as incurred in accordance with SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." As of December 31, 2002, the Company had recorded a liability totaling $304,000, related to certain restructuring costs incurred in connection with the closure of a manufacturing facility in Edmonton, Alberta, Canada. As of September 30, 2003, this liability totaled $84,000. The following table summarizes changes to the restructuring liability by cost type:
BALANCE AT EFFECT OF BALANCE AT DECEMBER 31, AMOUNTS PAID EXCHANGE RATE SEPTEMBER 2002 AND ADJUSTMENTS CHANGES 30, 2003 ----------- --------------- ------------- ---------- (UNAUDITED, IN THOUSANDS) Employee severance .................................... $ 21 $ (23) $ 2 $-- Lease termination and other ........................... 283 (234) 35 84 ----- ----- ----- ----- Total .............................................. $ 304 $(257) $ 37 $ 84 ===== ===== ===== =====
The portion of the accrual related to lease termination and other during the nine months ended September 30, 2003, was reduced by approximately $234,000, of which $110,000 related to amounts paid and $124,000 related to a change in the assessment of liability under the lease arrangement for this facility. During the nine months ended September 30, 2003, the Company recorded closure and other expense associated with the Canadian restructuring plan of $229,000, related to equipment moving costs and employee relocations, including severance costs of $125,000 that was not identified as a restructuring cost as of the plan measurement date. (8) LONG-TERM DEBT The consolidated borrowings of the Company were as follows:
SEPTEMBER 30, DECEMBER 31, 2003 2002 ------------- ------------ (UNAUDITED) (IN THOUSANDS, EXCEPT PERCENTAGES) BANK DEBT Term loan with variable interest rate (3.99% at September 30, 2003 and 4.21% at December 31, 2002) and quarterly payments of principal ($1,750) and interest, due March 31, 2006.................................................................... $ 32,500 $ 37,750 Revolving credit bank loans with variable interest rate (4.90% at September 30, 2003 and 4.43% at December 31, 2002) and quarterly interest payments, due March 31, 2004.................................................................................. 9,895 8,967 Promissory note with variable interest rate (4.55% at September 30, 2003 and 4.65% at December 31, 2002) and quarterly payments of principal ($24) and interest, due February 8, 2007.............................. 1,313 1,387 Revolving credit bank loans (export sales facility) with variable interest rate (4.25% December 31, 2002) and monthly interest payments, due July 23, 2004............ -- 4,250 -------- -------- Total............................................................................... $ 43,708 $ 52,354 Less current installments........................................................... (16,992) (7,097) -------- -------- Long-term debt................................................................... $ 26,716 $ 45,257 ======== ========
11 The Company maintains a credit facility that consists of a $50.0 million term loan, a $30.0 million U.S. revolving facility, a $10.0 million Canadian revolving facility and a $10.0 million U.K. revolving facility. The term loan matures on March 31, 2006, and each of the revolving facilities matures on March 31, 2004. In July 2002, the Company's lenders approved the amendment of various provisions of the term loan and revolving credit facility agreement, effective April 1, 2002. This amendment revised certain restrictive debt covenants, modified certain defined terms, allowed for future capital investment in the Company's Sacroc CO2 processing facility in West Texas, facilitates the issuance of up to $7.5 million of subordinated indebtedness, increased the aggregate amount of operating lease expense allowed during a fiscal year and permitted an increase in borrowings under the export sales credit facility, without further consent, up to a maximum of $20.0 million. These modifications resulted in higher commitment fee percentages and interest rates than in the original loan agreement, based on the Funded Debt to EBITDA ratio, as defined in the underlying agreement, as amended. In July 2003, the Company's lenders approved an amendment of the existing term loan and revolving credit facility, effective April 1, 2003, and as of September 30, 2003, the Company was in compliance with all restrictive debt covenants, as amended. The amendment modified several restrictive covenant terms, including the Fixed Charge Coverage Ratio and Funded Debt to EBITDA Ratio, each as defined in the agreement. Under the Company's term loan and revolving credit facility agreement, certain debt covenants become more restrictive during the fourth quarter of 2003, and the Company may not be in compliance with these or certain other debt covenants at December 31, 2003. The Company may be required to request amendments or waivers of some or all of these covenants in the future, which management believes would be obtainable from the majority banks upon reasonable terms. Amounts borrowed under the term loan bear interest at a rate of 3.99% per annum as of September 30, 2003. Amounts borrowed under the revolving portion of the facility bear interest at a rate based upon the ratio of Funded Debt to EBITDA and ranging from, at the Company's election, a high of the London Inter-bank Borrowing Rate ("LIBOR") plus 3.00% to a low of LIBOR plus 1.75% or, a high of a base rate plus 1.50% to a low of a base rate plus 0.25%. NATCO is required to pay commitment fees of 0.30% to 0.625% per year depending upon the ratio of Funded Debt to EBITDA, on the undrawn portion of the facility. As of September 30, 2003, the Company's commitment fees were calculated at a rate of 0.625%. The revolving credit facilities are guaranteed by the Company and its operating subsidiaries and are secured by a first lien or first priority security interest in or pledge of substantially all of the assets of the borrowers, including accounts receivable, inventory, equipment, intangibles, equity interests in U.S. subsidiaries and 65% of the equity interest in active, non-U.S. subsidiaries. Assets of the Company and its active U.S. subsidiaries secure the U.S. facility, assets of the Company's Canadian subsidiary secure the Canadian facility and assets of the Company's U.K. subsidiaries secure the U.K. facility. The U.S. facility is guaranteed by each U.S. subsidiary of the Company, while the Canadian and U.K. facilities are guaranteed by the Company, each of its U.S. subsidiaries and the Canadian subsidiary or the U.K. subsidiaries, as applicable. On February 6, 2002, the Company borrowed $1.5 million under a long-term promissory note to finance the purchase of a manufacturing facility in Magnolia, Texas. This note accrues interest at the 90-day LIBOR plus 3.25% per annum, and requires quarterly payments of principal of approximately $24,000 and interest for five years beginning May 2002, with a final balloon payment due February 2007. This promissory note is collateralized by the manufacturing facility in Magnolia, Texas acquired in the fourth quarter of 2001. 12 The Company maintains a working capital facility for export sales that provides for aggregate borrowings of $10.0 million, subject to borrowing base limitations, under which no borrowings were outstanding at September 30, 2003. Letters of credit outstanding under this facility as of September 30, 2003 totaled $1.0 million. Fees related to these letters of credit at September 30, 2003, were approximately 1% of the outstanding balance. The export sales credit facility is secured by specific project inventory and receivables, and is partially guaranteed by the EXIM Bank. The facility loans mature in July 2004. NATCO had letters of credit outstanding under the revolving credit facilities totaling $19.5 million at September 30, 2003. Fees related to these letters of credit at September 30, 2003, ranged from approximately 1% to 3.25% of the outstanding balance. These letters of credit support contract performance and warranties and expire at various dates through April 2007. The Company also had unsecured letters of credit and bonds totaling $564,000 and guarantees totaling $7.4 million at September 30, 2003. (9) INCOME TAXES NATCO's effective income tax rate for the nine months ended September 30, 2003 was 46%, which exceeded the amount that would have resulted from applying the U.S. federal statutory tax rate due to the impact of state income taxes, foreign income tax rate differentials, losses in foreign subsidiaries and certain permanent book-to-tax differences. (10) INDUSTRY SEGMENTS The Company's operations are organized into three separate business segments: North American Operations, which primarily provides traditional, standard and small custom production equipment and components, replacement parts, used equipment and components, equipment servicing and field operating support including operations of our domestic membrane facility; Engineered Systems, which primarily provides customized and more complex technological equipment, large scale integrated oil and gas production systems, and equipment and services provided by certain international operations, including Axsia; and Automation and Control Systems, which provides control panels and systems that monitor and control oil and gas production, as well as installation and start-up and other field services related to instrumentation and electrical systems. The accounting policies of the reportable segments were consistent with the policies used to prepare the Company's condensed consolidated financial statements for the respective periods presented. The Company evaluates the performance of its operating segments based on income before net interest expense, income taxes, depreciation and amortization, closure and other, other, net and accounting changes. In September 2003, the Company changed the presentation of its reportable segments by reclassifying certain research and development costs and bonus expenses among the business segments from the "Corporate and Other" segment. In addition, Other, net was excluded from the determination of segment profit (loss). These changes were made as a result of a change in management's internal reporting to better state total costs and profits of each segment and have been retroactively reflected in all periods presented. Summarized financial information concerning the Company's reportable segments is shown in the following table.
NORTH AUTOMATION AMERICAN ENGINEERED & CONTROL CORPORATE & OPERATIONS SYSTEMS SYSTEMS OTHER TOTAL ---------- ---------- ---------- ----------- --------- (UNAUDITED, IN THOUSANDS) THREE MONTHS ENDED SEPTEMBER 30, 2003 Revenues from unaffiliated customers.. $ 32,553 $ 20,528 $ 12,720 $ -- $ 65,801 Inter-segment revenues................ 165 308 684 (1,157) -- Segment profit (loss)................. 2,891 192 1,254 (960) 3,377 Total assets.......................... 100,319 103,543 21,521 9,808 235,191 Capital expenditures.................. 1,616 348 2 4 1,970 Depreciation and amortization......... 669 375 28 95 1,167
13 THREE MONTHS ENDED SEPTEMBER 30, 2002 Revenues from unaffiliated customers.. $ 31,230 $ 23,484 $ 11,849 $ -- $ 66,563 Inter-segment revenues................ 306 210 1,016 (1,532) -- Segment profit (loss)................. 1,608 (168) 1,016 (847) 1,609 Total assets.......................... 102,079 103,905 19,871 10,443 236,298 Capital expenditures.................. 521 349 103 50 1,023 Depreciation and amortization......... 660 477 138 13 1,288 NINE MONTHS ENDED SEPTEMBER 30, 2003 Revenues from unaffiliated customers.. $ 91,297 $ 73,769 $ 39,361 $ -- $204,427 Inter-segment revenues................ 992 375 3,291 (4,658) -- Segment profit (loss)................. 6,923 2,250 3,821 (2,903) 10,091 Total assets.......................... 100,319 103,543 21,521 9,808 235,191 Capital expenditures.................. 7,034 1,157 132 24 8,347 Depreciation and amortization......... 1,831 1,312 223 285 3,651 NINE MONTHS ENDED SEPTEMBER 30, 2002 Revenues from unaffiliated customers.. $102,032 $ 78,190 $ 34,315 $ -- $214,537 Inter-segment revenues................ 616 923 3,545 (5,084) -- Segment profit (loss)................. 7,762 2,418 3,282 (2,492) 10,970 Total assets.......................... 102,079 103,905 19,871 10,443 236,298 Capital expenditures.................. 1,536 1,803 381 162 3,882 Depreciation and amortization......... 1,774 1,381 332 153 3,640
The following table reconciles total segment profit to net income before cumulative effect of change in accounting principle:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------- -------------------------- 2003 2002 2003 2002 ---- ---- ---- ---- (UNAUDITED, IN THOUSANDS) Total segment profit $ 3,377 $ 1,609 $ 10,091 $ 10,970 Net interest expense 1,117 1,355 3,576 3,616 Depreciation and amortization 1,167 1,288 3,651 3,640 Closure and other 722 -- 947 -- Other, net (74) (271) 830 (236) ------- ------- -------- -------- Net income (loss) before income taxes and cumulative effect of change in accounting principle 445 (763) 1,087 3,950 Income tax provision (benefit) 255 (427) 499 1,379 ------- ------- -------- -------- Net income (loss) before cumulative effect of change in accounting principle $ 190 $ (336) $ 588 $ 2,571 ======= ======= ======== ========
The impact on segment profit (loss) of the September 2003 change in measurement method used was as follows:
THREE MONTHS ENDED SEPTEMBER 30, 2003 --------------------------------------------------------------------------------- NORTH AMERICAN ENGINEERED AUTOMATION & CORPORATE OPERATIONS SYSTEMS CONTROL SYSTEMS & OTHER TOTAL ---------- ------- --------------- ------- ----- (UNAUDITED, IN THOUSANDS) Original segment profit (loss): $ 2,961 $ (161) $ 1,253 $(1,324) $ 2,729 Other expense, net and closure 52 39 -- 557 648 R&D and other (122) 314 1 (193) -- ------- ------ ------- ------- ------- Segment profit (loss) $ 2,891 $ 192 $ 1,254 $ (960) $ 3,377 ======= ====== ======= ======= =======
14
THREE MONTHS ENDED SEPTEMBER 30, 2002 -------------------------------------------------------------------------------- NORTH AMERICAN ENGINEERED AUTOMATION & CORPORATE OPERATIONS SYSTEMS CONTROL SYSTEMS & OTHER TOTAL ---------- ------- --------------- ------- ----- (UNAUDITED, IN THOUSANDS) Original segment profit (loss): $ 2,247 $ (771) $ 1,049 $ (645) $ 1,880 Other expense, net (122) 160 7 (316) (271) R&D and other (517) 443 (40) 114 -- ------- ------ ------- ------ ------- Segment profit (loss) $ 1,608 $ (168) $ 1,016 $ (847) $ 1,609 ======= ====== ======= ====== =======
NINE MONTHS ENDED SEPTEMBER 30, 2003 ---------------------------------------------------------------------------------- NORTH AMERICAN ENGINEERED AUTOMATION & CORPORATE OPERATIONS SYSTEMS CONTROL SYSTEMS & OTHER TOTAL --------- ------- --------------- ------- ----- (UNAUDITED, IN THOUSANDS) Original segment profit (loss): $ 6,596 $ 1,103 $ 3,821 $(3,206) $ 8,314 Other expense, net and closure 805 124 -- 848 1,777 R&D and other (478) 1,023 -- (545) -- ------- ------- ------- ------- ------- Segment profit (loss) $ 6,923 $ 2,250 $ 3,821 $(2,903) $10,091 ======= ======= ======= ======= =======
NINE MONTHS ENDED SEPTEMBER 30, 2002 ---------------------------------------------------------------------------------- NORTH AMERICAN ENGINEERED AUTOMATION & CORPORATE OPERATIONS SYSTEMS CONTROL SYSTEMS & OTHER TOTAL --------- ------- --------------- ------- ----- (UNAUDITED, IN THOUSANDS) Original segment profit (loss): $ 8,847 $ 1,456 $ 3,465 $ (2,562) $ 11,206 Other expense, net (254) (41) -- 59 (236) R&D and other (831) 1,003 (183) 11 -- ------- ------- ------- -------- -------- Segment profit (loss) $ 7,762 $ 2,418 $ 3,282 $ (2,492) $ 10,970 ======= ======= ======= ======== ========
(11) COMMITMENTS AND CONTINGENCIES The Porta-Test International, Inc. purchase agreement, executed in January 2000, contains a provision to calculate a payment to certain former stockholders of Porta-Test Systems, Inc. for a three-year period ended January 23, 2003, based upon sales of a limited number of specified products designed by or utilizing technology that existed at the time of the acquisition. Liability under this arrangement was contingent upon attaining certain performance criteria, including gross margins and sales volumes for the specified products. If applicable, payment was required annually. In August 2002, the Company paid $197,000 under this arrangement for the twelve-month period ended January 23, 2002, resulting in an increase in goodwill. Because the performance criteria was not met, the Company did not record additional liability under this arrangement for the twelve-month period ended January 23, 2003. (12) GOODWILL IMPAIRMENT TESTING The Financial Accounting Standards Board ("FASB") approved SFAS No. 142, "Goodwill and Other Intangible Assets" in June 2001. This pronouncement required that intangible assets with indefinite lives, including goodwill, cease being amortized and be evaluated on an impairment basis. Intangible assets with a defined term, such as patents, would continue to be amortized over the useful life of the asset. 15 The Company adopted SFAS No. 142 on January 1, 2002. Intangible assets subject to amortization under the pronouncement as of September 30, 2003 and 2002 were:
AS OF SEPTEMBER 30, 2003 AS OF SEPTEMBER 30, 2002 --------------------------- ----------------------------- GROSS GROSS CARRYING ACCUMULATED CARRYING ACCUMULATED TYPE OF INTANGIBLE ASSET AMOUNT AMORTIZATION AMOUNT AMORTIZATION - ------------------------ ------ ------------ ------ ------------ (UNAUDITED, IN THOUSANDS) Deferred financing fees $ 3,528 $ 2,520 $ 3,300 $ 1,752 Patents 160 33 141 15 Other 361 254 257 165 ------- ------- -------- ------- Total $ 4,049 $ 2,807 $ 3,698 $ 1,932 ======= ======= ======= =======
Amortization and interest expense of $209,000 and $230,000 were recognized related to these assets for the three months ended September 30, 2003 and 2002, respectively, and $637,000 and $639,000 for the nine months ended September 30, 2003 and 2002, respectively. The estimated aggregate amortization and interest expense for these assets for each of the following five fiscal years is: 2003--$738,000; 2004--$478,000; 2005--$436,000; 2006--$143,000; and 2007--$31,000. For segment reporting purposes, these intangible assets and the related amortization expense were recorded under "Corporate and Other." Goodwill was the Company's only intangible asset that required no periodic amortization as of the date of the adoption of SFAS No. 142. Net goodwill at September 30, 2003 was $79.8 million. The increase in goodwill during 2003 was attributable primarily to currency exchange rate fluctuations. The Company tested impairment of goodwill at December 31, 2002 and management determined that goodwill was not impaired. The Company will test each business segment for goodwill impairment on December 31, 2003, in accordance with the annual testing requirements of SFAS No. 142. (13) CHANGE IN ACCOUNTING PRINCIPLE Effective January 1, 2003, NATCO recorded the cumulative effect of change in accounting principle related to the adoption of SFAS No. 143, "Accounting for Asset Retirement Obligations." This standard required the Company to record the fair value of an asset retirement obligation as a liability in the period in which a legal obligation associated with the retirement of tangible long-lived assets that result from acquisition, construction, development and/or normal use of the assets, was incurred. In addition, the standard requires the Company to record a corresponding asset that will be depreciated over the life of the asset that gave rise to the liability. Subsequent to the initial measurement of the asset retirement obligation, the Company will be required to adjust the related liability at each reporting date to reflect changes in estimated retirement cost and the passage of time. A loss of $34,000, net of tax, was recorded as of January 1, 2003, as a result of this change in accounting principle. The related asset retirement obligation and asset cost of $96,000, associated with an obligation to remove certain leasehold improvements upon termination of lease arrangements, including concrete pads and equipment. The asset cost will be depreciated over the remaining useful life of the related assets. There was no significant change in the asset or liability during the three or nine months ended September 30, 2003. 16 (14) NEW ACCOUNTING PRONOUNCEMENTS In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections." This statement amends existing guidance on reporting gains and losses on extinguishment of debt, prohibiting the classification of the gain or loss as extraordinary. SFAS No. 145 also amends SFAS No. 13 to require sale-leaseback accounting for certain lease modifications that have economic effects similar to sale-leaseback arrangements. The Company adopted SFAS No. 145 with respect to the revision of Statement No. 13 on May 15, 2002, and with respect to the amendment of SFAS No. 4, on January 1, 2003, with no material impact on the Company's financial condition or results of operations. In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal Activities," which addresses significant issues regarding the recognition, measurement and reporting of costs that are associated with exit and disposal activities, including restructuring activities that were previously accounted for pursuant to the guidance set forth in EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity." SFAS No. 146 became effective for the Company on January 1, 2003. The adoption of SFAS No. 146 had no material impact on the Company's financial condition or results of operations. In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34." This interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. The interpretation also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation taken. The initial recognition and measurement provisions of the interpretation are applicable to guarantees issued or modified after December 31, 2002. Application of this interpretation did not have a material impact on the Company's financial condition or results of operations. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure, an amendment to FASB Statement No. 123." This statement amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods to transition, on a volunteer basis, to the fair value method of accounting for stock-based employee compensation. Additionally, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements. Certain disclosure modifications are required for fiscal years ending after December 31, 2002, if a transition to SFAS No. 123 is elected. The Company has not elected transition to SFAS No. 123 as of September 30, 2003. See Note 2, Employee Stock Options. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This statement provides additional guidance to account for derivative instruments, including certain derivative instruments embedded in other contracts as well as hedging activities under SFAS No. 133. This pronouncement becomes effective for new contract arrangements and hedging transactions entered into after June 30, 2003, with exceptions for certain SFAS No. 133 implementation issues begun prior to June 15, 2003. The Company adopted this pronouncement on July 1, 2003, with no material impact on its financial condition or results of operations. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement provides guidance on how to classify and measure certain financial instruments that have characteristics of both liabilities and equity, and generally requires treatment of these instruments as liabilities, including certain obligations that the issuer can or must settle by issuing its own equity securities. This pronouncement, which was effective for all financial instruments entered into or modified after May 31, 2003, and otherwise became effective on July 1, 2003, required cumulative effect of a change in accounting principle treatment upon adoption. The Company adopted this pronouncement on July 1, 2003, with no material impact on its financial condition or results of operation. 17 (15) RELATED PARTY TRANSACTIONS Under the terms of an employment agreement in effect prior to 1999, the Company loaned its Chief Executive Officer $1.2 million in July 1999 to purchase 136,832 shares of common stock. During February 2000, after the Company completed the initial public offering of its Class A common stock, also pursuant to the terms of that employment agreement, the Company paid this executive officer a bonus equal to the principal and interest accrued under this note arrangement and recorded compensation expense of $1.3 million. The officer used the proceeds of this settlement, net of tax, to repay the Company approximately $665,000. In addition, on October 27, 2000, the Company's board of directors agreed to provide a full recourse loan to this executive officer to facilitate the exercise of certain outstanding stock options. The amount of the loan was equal to the cost to exercise the options plus any personal tax burdens that resulted from the exercise. The maturity of these loans was July 31, 2003, and interest accrued at rates ranging from 6% to 7.8% per annum. As of June 30, 2002, these outstanding notes receivable totaled $3.4 million, including principal and accrued interest. Effective July 1, 2002, the notes were reviewed by the Company's board and amended to extend the maturity dates to July 31, 2004, and to require interest to be calculated at an annual rate based on LIBOR plus 300 basis points, adjusted quarterly, applied to the notes balances as of June 30, 2002, including previously accrued interest. As of September 30, 2003, the balance of the notes (principal and accrued interest) due from this officer under these loan arrangements was $3.6 million. These loans to this executive officer, which were made on a full recourse basis in prior periods to facilitate direct ownership in the Company's common stock, are currently subject to and in compliance with provisions of the Sarbanes-Oxley Act of 2002. As previously agreed in 2001, the Company loaned an employee who is an executive officer and director $216,000 on April 15, 2002, under a full-recourse note arrangement which accrued interest at 6% per annum and was to mature on July 31, 2003. The funds were used to pay the exercise cost and personal tax burdens associated with stock options exercised during 2001. Effective July 1, 2002, the note was amended to extend the maturity date to July 31, 2004, and to require interest to be calculated at an annual rate based on LIBOR plus 300 basis points, adjusted quarterly, applied to the note balance as of June 30, 2002, including previously accrued interest. As of September 30, 2003, the balance of the note (principal and interest) due from this officer under this loan arrangement was approximately $230,000. This loan to this executive officer, which was made on a full recourse basis from in prior periods to facilitate direct ownership in the Company's common stock, is currently subject to and in compliance with provisions of the Sarbanes-Oxley Act of 2002. 18 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS Management's Discussion and Analysis includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The words "believe," "expect," "plan," "intend," "estimate," "project," "will," "could," "may" and similar expressions are intended to identify forward-looking statements. Forward-looking statements in this document include, but are not limited to, discussions regarding indicated trends in the level of oil and gas exploration and production and the effect of such conditions on the Company's results of operations (see "--Industry and Business Environment"), future uses of and requirements for financial resources (see "--Liquidity and Capital Resources"), and anticipated backlog levels for 2003 (see "--Liquidity and Capital Resources"). Our expectations about our business outlook, customer spending, oil and gas prices, our business environment and that of the industry in general are only our expectations regarding these matters. Actual results may differ materially from those expressed in the forward-looking statements for reasons including, but not limited to: market factors such as pricing and demand for petroleum related products, the level of petroleum industry exploration and production expenditures, the effects of competition, world economic conditions, the level of drilling activity, the legislative environment in the United States and other countries, policies of the Organization of Petroleum Exporting Countries ("OPEC"), conflict involving the United States or in major petroleum producing or consuming regions, acts of terrorism, the development of technology which could lower overall finding and development costs, weather patterns and the overall condition of capital and equity markets for countries in which we operate. The following discussion should be read in conjunction with the financial statements, related notes and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q. Readers also are urged to review and consider carefully the various disclosures advising interested parties of the factors that affect our business, including without limitation, the disclosures made under the caption "Risk Factors" and the other factors and risks discussed in our Annual Report on Form 10-K as of December 31, 2002, and in subsequent reports filed with the Securities and Exchange Commission. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statement to reflect any change in our expectations or any change in events, conditions or circumstances on which any forward-looking statement is based. OVERVIEW References to "NATCO," "we" and "our" are used throughout this document and relate collectively to NATCO Group Inc. and its consolidated subsidiaries. We organize our operations into three separate business segments: North American Operations, a segment that primarily provides traditional, standard and small custom production equipment and components, replacement parts, used equipment and components, equipment servicing and field operating support including operations of our domestic membrane facility; Engineered Systems, a segment that primarily provides customized and more complex technological equipment, large scale integrated oil and gas production systems, and equipment and services provided by certain international operations, including Axsia; and Automation and Control Systems, a segment that provides control panels and systems that monitor and control oil and gas production, as well as installation and start-up and other field services related to instrumentation and electrical systems. 19 CRITICAL ACCOUNTING POLICIES Our management makes certain estimates and assumptions in preparing our consolidated financial statements that affect the results reported in the accompanying notes. We base these estimates and assumptions on historical experience and on future expectations that we believe to be reasonable under the circumstances. Note 2 to the consolidated financial statements filed in our Annual Report on Form 10-K for the year ended December 31, 2002, contains a summary of our significant accounting policies. We believe the following accounting policies are the most critical in the preparation of our condensed consolidated financial statements: Revenue Recognition: Percentage-of-Completion Method. We recognize revenues from significant contracts (greater than $250,000 and longer than four months in duration) and certain automation and controls contracts and orders on the percentage-of-completion method of accounting. Earned revenue is based on the percentage that costs incurred to date relate to total estimated costs of the project, after giving effect to the most recent estimates of total cost. The timing of costs incurred, and therefore recognition of revenue, could be affected by various internal or external factors including, but not limited to: changes in project scope (change orders), changes in productivity, scheduling, the cost and availability of labor, the cost and availability of raw materials, the weather, client delays in providing approvals at benchmark stages of the project and the timing of deliveries from third-party providers of key components. The cumulative impact of revisions in total cost estimates during the progress of work is reflected in the period in which these changes become known. Earned revenues reflect the original contract price adjusted for agreed claims and change order revenues, if applicable. Losses expected to be incurred on the jobs in progress, after consideration of estimated probable minimum recoveries from claims and change orders, are charged to income as soon as such losses are known. Claims for additional contract revenue are recognized if it is probable that the claim will result in additional revenue and the amount can be reliably estimated. We generally recognize revenue and earnings to which the percentage-of-completion method applies over a period of two to six quarters. In the event a project is terminated by the customer before completion, our customer is liable for costs incurred under the contract. We believe that our operating results should be evaluated over a term of several years to evaluate performance under long-term contracts, after all change orders, scope changes and cost recoveries have been negotiated and realized. We record revenues and profits on all other sales as shipments are made or services are performed. Impairment Testing: Goodwill. As required by Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets," we evaluate goodwill annually for impairment by comparing the fair value of operating assets to the carrying value of those assets, including any related goodwill. As required by SFAS No. 142, we identify separate reportable units for purposes of this evaluation. In determining carrying value, we segregate assets and liabilities that, to the extent possible, are clearly identifiable by specific reportable unit. All inter-company receivables/payables are excluded. Certain corporate and other assets and liabilities, that are not clearly identifiable by specific reportable unit, are allocated based on the ratio of each unit's net assets relative to total net assets. The fair value is then compared to the carrying value of the reportable unit to determine whether or not impairment has occurred at the reportable unit level. In the event an impairment is indicated, an additional test is performed whereby an implied fair value of goodwill is determined through an allocation of the fair value to the reporting unit's assets and liabilities, whether recognized or unrecognized, in a manner similar to a purchase price allocation, in accordance with SFAS No. 141, "Business Combinations." Any residual fair value after this purchase price allocation would be assumed to relate to goodwill. If the carrying value of the goodwill exceeded the residual fair value, we would record an impairment charge for that amount. No impairment charge was recorded at December 31, 2002. While no indications of impairment were noted during the three-month or nine-month periods ended September 30, 2003, we will test each business segment for goodwill impairment on December 31, 2003, in accordance with the annual testing requirements of SFAS No. 142. Net goodwill was $79.8 million and $79.0 million at September 30, 2003 and December 31, 2002, respectively. The increase in goodwill during 2003 was attributable primarily to currency exchange rate fluctuations. 20 RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." This standard provides guidance on reporting and accounting for obligations associated with the retirement of long-lived tangible assets and the related retirement costs. This standard is effective for financial statements issued for fiscal years beginning after June 15, 2002. On January 1, 2003, we adopted this pronouncement and recorded a loss of $34,000, net of tax effect, as the cumulative effect of change in accounting principle. In addition, we recorded an asset retirement obligation liability and asset cost of $96,000, associated with an obligation to remove certain leasehold improvements upon termination of lease arrangements, including concrete pads and equipment. We will depreciate the asset cost over the remaining useful life of the related assets. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections." This statement provides guidance for income statement classification of gains and losses on extinguishment of debt and accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 became effective and was adopted on January 1, 2003, with no material impact on our financial condition or results of operations. In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal Activities," which addresses significant issues regarding the recognition, measurement and reporting of costs that are associated with exit and disposal activities, including restructuring activities that were previously accounted for pursuant to the guidance set forth in EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity." SFAS No. 146 became effective on January 1, 2003. The adoption of SFAS No. 146 had no material impact on our financial condition or results of operations. In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34." This interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. The interpretation also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation taken. The initial recognition and measurement provisions of the interpretation are applicable to guarantees issued or modified after December 31, 2002. Application of this interpretation did not have a material impact on our financial condition or results of operations. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This statement provides additional guidance to account for derivative instruments, including certain derivative instruments embedded in other contracts as well as hedging activities under SFAS No. 133. This pronouncement became effective for new contract arrangements and hedging transactions entered into after June 30, 2003, with exceptions for certain SFAS No. 133 implementation issues begun prior to June 15, 2003. We adopted this pronouncement on July 1, 2003, with no material impact on our financial condition or results of operations. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement provides guidance on how to classify and measure certain financial instruments that have characteristics of both liabilities and equity, and generally requires treatment of these instruments as liabilities, including certain obligations that the issuer can or must settle by issuing its own equity securities. This pronouncement, which was effective for all financial instruments entered into or modified after May 31, 2003, and otherwise became effective on July 1, 2003, required cumulative effect of a change in accounting principle treatment upon adoption. We adopted this pronouncement on July 1, 2003, with no material impact on our financial condition or results of operation. 21 INDUSTRY AND BUSINESS ENVIRONMENT As a leading provider of wellhead process equipment, systems and services used in the production of crude oil and natural gas, our revenues and results of operations are closely tied to demand for oil and gas products and spending by oil and gas companies for exploration and development of oil and gas reserves. These companies generally invest more in exploration and development efforts during periods of favorable oil and gas commodity prices, and invest less during periods of unfavorable oil and gas prices. As supply and demand change, commodity prices fluctuate producing cyclical trends in the industry. During periods of lower demand, revenues for service providers such as NATCO generally decline, as existing projects are completed and new projects are postponed. During periods of recovery, revenues for service providers can lag behind the industry due to the timing of new project awards. Changes in commodity prices have impacted our business over the past several years. The following table summarizes the price of domestic crude oil per barrel and the wellhead price of natural gas per thousand cubic feet ("mcf") for the nine months ended September 30, 2003 and 2002, as well as averages for the years ended December 31, 2002 and 2001, derived from published reports by the U.S. Department of Energy, and the rotary rig count, as published by Baker Hughes Incorporated.
NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, DECEMBER 31, ----------------------- ---------------------- 2003 2002 2002 2001 ---- ---- ---- ---- Average price of domestic first-purchase crude oil per barrel in the U.S. $ 27.84 (a) $ 21.82 $ 22.51 $ 21.86 Average wellhead price of natural gas per mcf in the U.S. $ 5.09 (b) $ 2.74 $ 2.95 $ 4.12 Average North American rig count 1,363 1,081 1,093 1,497
- -------------------- (a) Calculated using published data from the U.S. Department of Energy for the eight months ended August 31, 2003; data for September 2003 was not yet available. (b) Calculated based upon estimates by the U.S. Department of Energy, Energy Information Administration for the nine months ended September 30, 2003. At September 30, 2003, the spot price of West Texas Intermediate crude oil was $27.73 per barrel, the price of Henry Hub natural gas was $4.67 per mcf per the New York Mercantile Exchange ("NYMEX") and the North American rig count was 1,403, per Baker Hughes Incorporated. At October 31, 2003, the spot price of West Texas Intermediate crude oil was $29.28 per barrel, the price of Henry Hub natural gas was $4.00 per mcf per the NYMEX, and the North American rig count was 1,479, per Baker Hughes Incorporated. These spot prices reflect the overall volatility of oil and gas commodity prices in the current and recent periods. Historically, we have viewed operating rig counts as a benchmark of spending in the oil and gas industry for exploration and development efforts. Our traditional equipment sales and services business generally correlates to changes in rig activity, but tends to lag behind the North American rig count trend. With the North American rig count increasing during the nine months ended September 30, 2003, we expect our traditional equipment and services business in the U.S. and Canada to continue to show improving results based upon our past experience in the industry. Our Engineered Systems business is impacted largely by the awarding and completion of larger, more complex oil and gas projects, primarily for international offshore locations. These projects typically have a longer bidding, evaluation, awarding and construction period than our traditional equipment and services business and are more subject to our customers' long-term view of the oil and gas supply and demand outlook for the related region, as well as expected commodity prices and political or governmental situations. In recent periods, we have experienced the absence of, delays in, or lack of large international projects with favorable economic terms, which has impacted our Engineered Systems business results as well as our current level of project bookings for this segment. The following discussion of our historical results of operations and financial condition should be read in conjunction with our condensed consolidated financial statements and related notes. 22 RESULTS OF OPERATIONS Three Months Ended September 30, 2003 Compared to Three Months Ended September 30, 2002 (unaudited) Revenues. Revenues of $65.8 million for the three months ended September 30, 2003 decreased $762,000, or 1%, from $66.6 million for the three months ended September 30, 2002. The following table summarizes revenues by business segment for the three-month periods ended September 30, 2003 and 2002, respectively.
THREE MONTHS ENDED SEPTEMBER 30, ------------- PERCENTAGE 2003 2002 CHANGE CHANGE ---- ---- ------ ------ (UNAUDITED) (IN THOUSANDS, EXCEPT PERCENTAGE CHANGE) North American Operations......... $ 32,718 $ 31,536 $ 1,182 4% Engineered Systems................ 20,836 23,694 (2,858) (12%) Automation and Control Systems.... 13,404 12,865 539 4% Corporate and Other............... (1,157) (1,532) 375 (24%) -------- -------- ------- Total................... $ 65,801 $ 66,563 $ (762) (1%) ======== ======== =======
North American Operations revenues increased $1.2 million, or 4%, for the three months ended September 30, 2003, compared to the three months ended September 30, 2002, which correlates to an increase in the average number of operating rotary rigs in North America, from 1,102 for the three months ended September 30, 2002 to 1,473 for the three months ended September 30, 2003. The increase in revenues was primarily due to higher sales for our North American parts and services business, due partially to the increase in operating rig counts. Inter-segment revenues for this business segment were $165,000 for the three months ended September 30, 2003, compared to $306,000 for the three months ended September 30, 2002. Revenues for the Engineered Systems segment decreased $2.9 million, or 12%, for the three months ended September 30, 2003, compared to the three months ended September 30, 2002. This decrease was primarily due to reduced sales of larger international production system jobs for the three months ended September 30, 2003 relative to the comparable period in 2002, reflecting project bid and award delays, increased competition and the completion of several large jobs for our U.K.-based operations that were in progress during the three months ended September 30, 2002, but completed prior to the three months ended September 30, 2003. Engineered Systems revenues of $20.8 million for the three months ended September 30, 2003 included approximately $308,000 of inter-segment revenues, compared to $210,000 of inter-segment revenues for the three months ended September 30, 2002. Revenues for the Automation and Control Systems segment increased $539,000, or 4%, for the three months ended September 30, 2003, compared to the three months ended September 30, 2002. Activity levels for the three months ended September 30, 2003 remained high with a relatively large number of jobs in progress, consistent with the results for the quarter ended September 30, 2002. Inter-segment sales decreased from $1.0 million for the three months ended September 30, 2002 to $684,000 for the three months ended September 30, 2003. The change in revenues for Corporate and Other represents the elimination of inter-segment revenues discussed above. 23 Gross Profit. Gross profit for the three months ended September 30, 2003 increased $1.1 million, or 7%, to $16.0 million, compared to $14.9 million for the three months ended September 30, 2002. As a percentage of revenue, gross profit increased from 22% for the three months ended September 30, 2002 to 24% for the three months ended September 30, 2003. The following table summarizes gross profit by business segment for the three-month periods then ended:
THREE MONTHS ENDED SEPTEMBER 30, ------------- PERCENTAGE 2003 2002 CHANGE CHANGE ---- ---- ------ ------ (UNAUDITED) (IN THOUSANDS, EXCEPT PERCENTAGE CHANGE) North American Operations......... $ 8,566 $ 8,092 $ 474 6% Engineered Systems................ 5,029 4,599 430 9% Automation and Control Systems.... 2,429 2,217 212 10% -------- ------- ------ Total................... $ 16,024 $14,908 $1,116 7% ======== ======= ======
Gross profit for the North American Operations business segment increased $474,000, or 6%, for the three months ended September 30, 2003, compared to the three months ended September 30, 2002, primarily due to a 4% increase in revenues for the respective periods. As a percentage of revenue, gross margins were 26% for the three-month periods ended September 30, 2003 and 2002. Gross profit for the Engineered Systems segment for the three months ended September 30, 2003 increased $430,000, or 9%, compared to the three months ended September 30, 2002, despite a 12% decline in revenues for the segment for the respective periods. This increase in gross margin was primarily due to favorable performance on several large West African jobs that were near completion at September 30, 2003, and improved utilization of engineering resources relative to the respective period in 2002. Gross margin as a percentage of revenues for Engineered Systems was 24% and 19% for the three-month periods ended September 30, 2003 and 2002, respectively. Gross profit for the Automation and Control Systems segment increased $212,000, or 10%, for the three months ended September 30, 2003, compared to the three months ended September 30, 2002, due to a 4% increase in revenues for the segment during the period, and more favorable margins on several quote job projects during the three months ended September 30, 2003. Gross margin as a percentage of revenue for the three-month periods ended September 30, 2003 and 2002, was 18% and 17%, respectively. Selling, General and Administrative Expense. Selling, general and administrative expense of $12.6 million for the three months ended September 30, 2003, declined $652,000, or 5%, compared to the results for the three months ended September 30, 2002. Overall expense declines related to cost savings attributable to a decrease in variable compensation based on operating results and the impact of restructuring activities in the United States and Canada during late 2002 and the third quarter of 2003. These expense decreases were partially offset by higher employee medical costs, professional fees and corporate insurance policies. Overall headcount declined from 1,774 employees at September 30, 2002 to 1,645 employees at September 30, 2003. Depreciation and Amortization Expense. Depreciation and amortization expense of $1.2 million for the three months ended September 30, 2003, decreased $121,000, or 9%, compared to the results for the three months ended September 30, 2002. Depreciation expense of $1.1 million for the three months ended September 30, 2003, decreased $137,000, or 11%, compared to the respective period for 2002. This decrease reflected the run-off of depreciation associated with older assets that became fully depreciated prior to September 30, 2003. We expect depreciation to increase in the fourth quarter with the Sacroc CO2 expansion placed into service. Amortization expense of $33,000 for the three months ended September 30, 2003 increased 94% from $17,000 for the three months ended September 30, 2002, and related primarily to the amortization of certain intangibles placed in service during late 2002 and 2003. 24 Closure and Other. Closure and Other expense of $722,000 for the three months ended September 30, 2003 resulted from certain restructuring activities, including the closure of a manufacturing facility in Covington, Louisiana and the consolidation of operations in the U.K., and related primarily to post-employment benefits for terminated personnel. We expect to incur an additional $300,000 of costs related to these restructuring activities primarily during the fourth quarter of 2003. These restructuring efforts are expected to generate approximately $4.0 million of annual savings beginning in 2004. Interest Cost on Postretirement Benefit Liability. Interest cost on postretirement liability of $209,000 for the three months ended September 30, 2003, increased $87,000, or 71%, compared to the three months ended September 30, 2002. This increase in expense was due to a change in the discount rate used to actuarially determine our obligation under this arrangement. Other, net. Other, net was a gain of $74,000 and $271,000 for the three-month periods ended September 30, 2003 and 2002, respectively, and primarily related to net unrealized foreign exchange transaction gains for our U.K.-based operations. Other, net was a gain of $271,000 for the three months ended September 30, 2002, and was primarily attributable to unrealized gains on foreign currency exchange transactions associated with our Canadian and U.K-based operations. Provision for Income Taxes. Income tax expense for the three months ended September 30, 2003 was $255,000 compared to a tax benefit of $427,000 for the three months ended September 30, 2002. The primary reason for this increase in tax expense was an increase in income before income taxes from a loss of $763,000 for the three months ended September 30, 2002 to income of $445,000 for the three months ended September 30, 2003. The effective tax rate increased from 56% for the three months ended September 30, 2002 to 57% for the three months ended September 30, 2003. Nine Months Ended September 30, 2003 Compared to Nine Months Ended September 30, 2002 (unaudited) Revenues. Revenues of $204.4 million for the nine months ended September 30, 2003 decreased $10.1 million, or 5%, from $214.5 million for the nine months ended September 30, 2002. The following table summarizes revenues by business segment for the nine-month periods ended September 30, 2003 and 2002, respectively.
NINE MONTHS ENDED SEPTEMBER 30, ------------- PERCENTAGE 2003 2002 CHANGE CHANGE ---- ---- ------ ------ (UNAUDITED) (IN THOUSANDS, EXCEPT PERCENTAGE CHANGE) North American Operations......... $ 92,289 $102,648 $(10,359) (10%) Engineered Systems................ 74,144 79,113 (4,969) (6%) Automation and Control Systems.... 42,652 37,860 4,792 13% Corporate and Other............... (4,658) (5,084) 426 (8%) -------- -------- -------- Total................... $204,427 $214,537 $(10,110) (5%) ======== ======== ========
25 North American Operations revenues decreased $10.4 million, or 10%, for the nine months ended September 30, 2003, compared to the nine months ended September 30, 2002, despite an increase in the average North American operating rotary rig count from 1,081 to 1,363 for the nine months ended September 30, 2002 and 2003, respectively. We experienced a reduction in sales primarily for our traditional equipment as well as certain project delays for our operations in Mexico, partially offset by an increase in sales for our North American parts and service business and CO2 field service operations. Inter-segment revenues for this business segment were $992,000 for the nine months ended September 30, 2003, compared to $616,000 for the nine months ended September 30, 2002. Revenues for the Engineered Systems segment decreased $5.0 million, or 6%, for the nine months ended September 30, 2003, compared to the nine months ended September 30, 2002. This decrease was primarily due to a decline in the number of large international production system jobs in 2003 relative to 2002, partially due to project delays and increased competition. Furthermore, several large jobs were nearing completion at September 30, 2002. Partially offsetting this decrease was an increase in revenues provided by our U.K.-based operations and our operations in Southeast Asia. Engineered Systems revenues of $74.1 million for the nine months ended September 30, 2003 included approximately $375,000 of inter-segment revenues, as compared to $923,000 of inter-segment revenues for the nine months ended September 30, 2002. Revenues for the Automation and Control Systems segment increased $4.8 million, or 13%, for the nine months ended September 30, 2003, compared to the nine months ended September 30, 2002. This increase was primarily related to a general increase in the number of jobs in progress for the nine months ended September 30, 2003 relative to the comparable period in 2002. Inter-segment sales decreased from $3.5 million for the nine months ended September 30, 2002 to $3.3 million for the nine months ended September 30, 2003. The change in revenues for Corporate and Other represents the elimination of inter-segment revenues discussed above. Gross Profit. Gross profit for the nine months ended September 30, 2003 decreased $2.5 million, or 5%, to $48.4 million, compared to $50.8 million for the nine months ended September 30, 2002. As a percentage of revenue, gross profit was 24% for the nine months ended September 30, 2003 and 2002. The following table summarizes gross profit by business segment for the periods then ended:
NINE MONTHS ENDED SEPTEMBER 30, ------------- PERCENTAGE 2003 2002 CHANGE CHANGE ---- ---- ------ ------ (UNAUDITED) (IN THOUSANDS, EXCEPT PERCENTAGE CHANGE) North American Operations......... $ 24,180 $26,972 $(2,792) (10%) Engineered Systems................ 16,819 16,923 (104) (1%) Automation and Control Systems.... 7,383 6,938 445 6% -------- ------- ------- Total................... $ 48,382 $50,833 $(2,451) (5%) ======== ======= =======
26 Gross profit for the North American Operations business segment decreased $2.8 million, or 10%, for the nine months ended September 30, 2003, compared to the nine months ended September 30, 2002, due to a 10% decline in revenues for the respective periods. As a percentage of revenue, gross margins were 26% for the nine-month periods ended September 30, 2003 and 2002. Gross profit for the Engineered Systems segment for the nine months ended September 30, 2003 decreased $104,000, or 1%, compared to the nine months ended September 30, 2002, despite a 7% decline in revenues for the respective periods. Gross margin as a percentage of revenues for Engineered Systems was 23% for the nine-month period ended September 30, 2003, compared to 21% for the nine-month period ended September 30, 2002. Margin improvements were largely attributable to several West African projects. Gross profit for the Automation and Control Systems segment increased $445,000, or 6%, for the nine months ended September 30, 2003, as compared to the nine months ended September 30, 2002, due to a 13% increase in revenues for the respective period, partially offset by lower margins due to the mix of sales jobs for the nine months ended September 30, 2003 relative to the comparable period in 2002, and competition for jobs in the Gulf of Mexico. Gross margin as a percentage of revenue for the nine-month periods ended September 30, 2003 and 2002, was 17% and 18%, respectively. Selling, General and Administrative Expense. Selling, general and administrative expense of $38.3 million decreased $1.6 million, or 4%, for the nine months ended September 30, 2003, compared to the nine months ended September 30, 2002. This decrease was primarily related to cost savings from the impact of restructuring activities in the U.S. and Canada as well as a decline in variable compensation based on operating results, partially offset by higher employee medical costs, professional fees and corporate insurance policies. Overall headcount declined from 1,774 employees at September 30, 2002 to 1,645 employees at September 30, 2003. Closure and Other. Closure and Other expense was $947,000 for the nine months ended September 30, 2003, of which $718,000 related primarily to post-employment benefits for employees terminated in connection with certain restructuring activities in September 2003, including the closure of a manufacturing facility in Covington, Louisiana and the consolidation of operations in the U.K., and $229,000 related to certain employee relocation and equipment moving costs associated with the closure of a manufacturing facility in Edmonton, Alberta, Canada, in the fourth quarter of 2002. We expect to incur an additional $300,000 of costs related to these restructuring activities, primarily in the fourth quarter of 2003. These restructuring efforts are expected to generate approximately $4.0 million of annual savings beginning in 2004. Interest Cost on Postretirement Benefit Liability. Interest cost on postretirement benefit liability of $628,000 for the nine months ended September 30, 2003, increased $261,000, or 71%, compared to the nine months ended September 30, 2002. This increase in expense was due to a change in the discount rate used to actuarially determine our obligation under this arrangement. Other, net. Other, net was an expense of $830,000 for the nine months ended September 30, 2003 and related primarily to net foreign exchange transaction losses on inter-company balances with our Canadian subsidiary and on transaction balances at our U.K.-based operations. Other, net for the nine months ended September 30, 2002, primarily represented net foreign currency exchange transaction gains of $236,000. Provision for Income Taxes. Income tax expense for the nine months ended September 30, 2003 was $499,000 compared to $1.4 million for the nine months ended September 30, 2002. The primary reason for this decrease was a decline in income before income taxes from $4.0 million for the nine months ended September 30, 2002 to $1.1 million for the nine months ended September 30, 2003. The effective tax rate was 35% for the nine months ended September 30, 2002, compared to 46% for the nine months ended September 30, 2003. The increase in the effective tax rate relates primarily to a change in the composition of the sources of income and the impact of permanent book-to-tax differences as a percentage of net income. Cumulative Effect of Change in Accounting Principle. The cumulative effect of change in accounting principle of $34,000, net of tax effect, related to the adoption of SFAS No. 143, "Accounting for Asset Retirement Obligations," on January 1, 2003. See Recent Accounting Pronouncements. 27 LIQUIDITY AND CAPITAL RESOURCES As of September 30, 2003, we had cash and working capital of $1.1 million and $27.6 million, respectively, as compared to cash and working capital of $1.7 million and $34.6 million, respectively, at December 31, 2002. The decline in working capital was primarily attributable to an increase in the current portion of long-term debt. Net cash provided by operating activities for the nine months ended September 30, 2003 was $6.0 million, compared to $1.0 million for the nine months ended September 30, 2002. Factors that contributed to the increase in cash provided by operating activities during 2003 included an decrease in trade accounts receivable and an increase in trade accounts payable and customer advances, partially offset by an increase in inventory, a decrease in accrued expenses and a decrease in net income. Net cash used in investing activities for the nine months ended September 30, 2003 was $7.7 million, of which $8.3 million was used for capital expenditures, primarily related to the expansion of our Sacroc CO2 gas-processing facility, partially offset by proceeds from the sale of fixed assets totaling $670,000, which related primarily to the sale of a building in the U.K. For the nine months ended September 30, 2002, cash used in investing activities was $4.3 million and related primarily to capital expenditures. Net cash provided by financing activities for the nine months ended September 30, 2003 was $382,000. The primary source of funds for financing activities for the nine months ended September 30, 2003 was proceeds from the issuance of our Series B Convertible Preferred Stock of $14.1 million, net of issuance costs, offset by repayments of long-term borrowings and revolving credit borrowings of $5.3 million and $3.9 million, respectively, as well as a decline in bank overdrafts of $3.5 million and payments on postretirement benefit obligations of $1.3 million. Net cash provided by financing activities for the nine months ended September 30, 2002 was $2.0 million. The primary source of funds for financing activities during the nine months ended September 30, 2002 was borrowings of $6.6 million under our revolving credit facilities and borrowings of $1.5 million under a long-term promissory note arrangement related to the purchase of our Magnolia manufacturing facility, partially offset by repayments of $5.3 million under our long-term facilities and post-retirement benefit payments of $1.4 million. We borrowed $1.5 million under a long-term promissory note arrangement on February 6, 2002, to finance the purchase of a manufacturing facility in Magnolia, Texas. This note accrues interest at the 90-day London Inter-bank Offered Rate ("LIBOR") plus 3.25% per annum, and requires quarterly payments of principal of approximately $24,000 and interest for five years beginning May 2002, with a final balloon payment due February 2007. This promissory note is collateralized by our manufacturing facility in Magnolia, Texas, acquired in the fourth quarter of 2001. We maintain a credit facility that consists of a $50.0 million term loan, a $30.0 million U.S. revolving facility, a $10.0 million Canadian revolving facility and a $10.0 million U.K. revolving facility. The term loan matures on March 31, 2006, and each of the revolving facilities matures on March 31, 2004. On or before March 31, 2004, we expect to extend or refinance our loan agreements to have continued access to comparable credit facilities on reasonable terms. In July 2002, our lenders approved the amendment of various provisions of the term loan and revolving credit facility agreement, effective April 1, 2002. This amendment revised certain restrictive debt covenants, modified certain defined terms, allowed for future capital investment in our Sacroc CO2 processing facility in West Texas, facilitates the issuance of $7.5 million of subordinated debt, increased the aggregate amount of operating lease expense allowed during a fiscal year and permitted an increase in borrowings under the export sales credit facility, without further consent, up to a maximum of $20.0 million. These modifications resulted in higher commitment fee percentages and interest rates than in the original agreements, based on the Funded Debt to EBITDA ratio, as defined in the underlying agreement, as amended. 28 In July 2003, the Company's lenders approved an amendment of the existing term loan and revolving credit facilities, effective April 1, 2003, and as of September 30, 2003, we were in compliance with all restrictive debt covenants, as amended. The amendment modified several restrictive covenant terms, including the Fixed Charge Coverage Ratio and Funded Debt to EBITDA Ratio, each as defined in the agreement. Under our term loan and revolving credit facility agreement, certain of our debt covenants become more restrictive during the fourth quarter of 2003, and we may not be in compliance with these or certain other debt covenants at December 31, 2003. We may be required to request amendments or waivers of some or all of these covenants in the future, which we believe would be obtainable from the majority banks upon reasonable terms. Borrowings outstanding under the term loan facility totaled $32.5 million at September 30, 2003, and bear interest at 3.99% per annum. Amounts borrowed under the revolving facilities bear interest at a rate based upon the ratio of Funded Debt to EBITDA and ranging from, at our election, a high of LIBOR plus 3.00% to a low of LIBOR plus 1.75% or a high of a base rate plus 1.50% to a low of a base rate plus 0.25%. As of September 30, 2003, the weighted average interest rate of our borrowings under the revolving credit facilities was 4.90%. We are required to pay commitment fees of 0.30% to 0.625% per year, depending upon the ratio of Funded Debt to EBITDA, on the undrawn portion of the facility. As of September 30, 2003, our commitment fees were calculated at a rate of 0.625%. We and our operating subsidiaries guarantee our revolving credit facilities, which are secured by a first lien or first priority security interest in or pledge of substantially all of the assets of the borrowers, including accounts receivable, inventory, equipment, intangibles, equity interests in U.S. subsidiaries and 65% of the equity interest in active, non-U.S. subsidiaries. Our assets and those of our active U.S. subsidiaries secure the U.S. facility, assets of our Canadian subsidiary secure the Canadian facility and assets of our U.K. subsidiaries secure the U.K. facility. The U.S. facility is guaranteed by each of our U.S. subsidiaries, while the Canadian and U.K. facilities are guaranteed by us, each of our U.S. subsidiaries and the Canadian subsidiary or the U.K. subsidiaries, as applicable. We had letters of credit outstanding under the revolving credit facilities of $19.5 million at September 30, 2003. Fees related to these letters of credit at September 30, 2003, ranged from approximately 1% to 3.25% of the outstanding balance. These letters of credit support contract performance and warranties and expire at various dates through April 2007. We maintain a working capital facility for export sales that provides for aggregate borrowings of $10.0 million, subject to borrowing base limitations, under which no borrowings were outstanding as of September 30, 2003. Letters of credit outstanding under this facility at September 30, 2003 totaled $1.0 million. Fees related to these letters of credit at September 30, 2003, were approximately 1% of the outstanding balance. The export sales credit facility is secured by specific project inventory and receivables, and is partially guaranteed by the EXIM Bank. The facility loans mature in July 2004. We had unsecured letters of credit and bonds totaling $564,000 and guarantees totaling $7.4 million at September 30, 2003. Our sales backlog at September 30, 2003 was $71.5 million, compared to $108.3 million at September 30, 2002. Backlog decreased primarily in Engineered Systems, due to several large project bookings in 2002, which were substantially completed prior to September 30, 2003, partially offset by increased bookings for North American Operations and Automation and Control Systems. On March 25, 2003, we issued 15,000 shares of Series B Convertible Preferred Stock ("Series B Preferred Shares"), and warrants to purchase 248,800 shares of our common stock, to Lime Rock Partners II, L.P., a private investment fund, for an aggregate price of $15.0 million. Approximately $99,000 of the aggregate purchase price was allocated to the warrants. Proceeds from the issuance of these securities, net of related estimated issuance costs of approximately $800,000, were used to reduce our outstanding revolving debt balances and for other general corporate purposes. 29 Each of the Series B Preferred Shares has a face value of $1,000 and pays a cumulative dividend of 10% per annum of face value, which is payable semi-annually on June 15 and December 15 of each year, except the initial dividend payment which was payable on July 1, 2003. Each of the Series B Preferred Shares is convertible, at the option of the holder, into (i) a number of shares of common stock equal to the face value of such Series B Preferred Share divided by the conversion price, which was $7.805 (or an aggregate of 1,921,845 shares at September 30, 2003), and (ii) a cash payment equal to the amount of dividends on such share that have accrued since the prior semi-annual dividend payment date. As of September 30, 2003, we had accrued dividends payable of $378,000 related to the Series B Preferred Shares. We paid dividends totaling $399,000 on July 1, 2003. In the event of a change in control, as defined in the certificate of designations for the preferred shares, each holder of the Series B Preferred Shares has the right to convert the Series B Preferred Shares into common stock or to cause the Company to redeem for cash some or all of the Series B Preferred Shares at an aggregate redemption price equal to the sum of (i) $1,000 (adjusted for stock splits, stock dividends, etc.) multiplied by the number of shares to be redeemed, plus (ii) an amount (not less than zero) equal to the product of $500 (adjusted for stock splits, stock dividends, etc.) multiplied by the aggregate number of Series B Preferred Shares to be redeemed less the sum of the aggregate amount of dividends paid in cash since the issuance date, plus any gain on the related stock warrants. If the holder of the Series B Preferred Shares converts upon a change in control occurring on or before March 25, 2006, the holder would also be entitled to receive cash in an amount equal to the dividends that would have accrued through March 25, 2006 less the sum of the aggregate amount of dividends paid in cash through the date of conversion, and the aggregate amount of dividends accrued in prior periods but not yet paid. We have the right to redeem the Series B Preferred Shares for cash on or after March 25, 2008, at a redemption price per share equal to the face value of the Series B Preferred Shares plus the amount of dividends that have been accrued but not paid since the most recent semi-annual dividend payment date. We adopted SFAS No. 150, "Accounting for Certain Instruments with Characteristics of both Liabilities and Equity," on July 1, 2003. Under SFAS No. 150, the Series B Preferred Shares would be classified as permanent equity. However, due to the cash redemption features upon a change in control as described above, the Series B Preferred Shares do not qualify for permanent equity treatment in accordance with the Emerging Issues Task Force Topic D-98: "Classification and Measurement of Redeemable Securities," which specifically requires that permanent equity treatment be precluded for any security with redemption features that are not solely within the control of the issuer. Therefore, we have accounted for the Series B Preferred Shares as temporary equity in the accompanying balance sheet, and have not assigned any value to our right to redeem the Series B Preferred Shares on or after March 25, 2008. If the Series B Preferred Shares are redeemed under contingent redemption features, any redemption amount greater than carrying value would be recorded as a reduction of income available to common shareholders when the event becomes probable. If we fail to pay dividends for two consecutive periods or any redemption price due with respect to the Series B Preferred Shares for a period of 60 days following the payment date, we will be in default under the terms of such shares. During a default period, (1) the dividend rate on the Series B Preferred Shares would increase to 10.25%, (2) the holders of the Series B Preferred Shares would have the right to elect or appoint a second director to the Board of Directors and (3) we would be restricted from paying dividends on, or redeeming or acquiring our common or other outstanding stock, with limited exceptions. If we fail to set aside or make payments in cash of any redemption price due with respect to the Series B Preferred Shares, and the holders elect, our right to redeem the shares may be terminated. 30 The warrants issued to Lime Rock Partners II, L.P. have an exercise price of $10.00 per share of common stock and expire on March 25, 2006. We can force the exercise of the warrants if our common stock trades above $13.50 per share for 30 consecutive days. The warrants contain a provision whereby the holder could require us to make a net-cash settlement for the warrants in the case of a change in control. The warrants were deemed to be derivative instruments and, therefore, the warrants were recorded at fair value as of the issuance date. Fair value, as agreed with the counter-party to the agreement, was calculated by applying a pricing model that included subjective assumptions for stock volatility, expected term that the warrants would be outstanding, a dividend rate of zero and an overall liquidity factor. The resulting liability, originally recorded at $99,000, was decreased to $84,000 as of September 30, 2003, as a result of the change in fair value of the warrants. Similarly, changes in fair value in future periods will be recorded as charges or credits to net income during the period of the change. Our revolving credit facilities expire on March 31, 2004 and our term loan facility expires on March 31, 2006. We are evaluating our alternatives with regard to extinguishing this debt or replacing these facilities. If we extinguish the debt or materially modify the terms of the facilities, we may incur a charge related to our unamortized deferred financing costs, which totaled $1.0 million at September 30, 2003. We believe our credit facilities can be extended or replaced, and that we will have adequate borrowing capacity in the future to meet our debt requirements. However, there can be no assurance as to the terms and provisions of any future financing arrangements. At September 30, 2003, available borrowing capacity under the term loan and revolving credit agreement and the export sales credit agreement were $14.6 million and $1.4 million, respectively. We were in compliance with all restrictive debt covenants in our loan agreements, as amended, as of September 30, 2003. Under our agreement, certain of our debt covenants become more restrictive at December 31, 2003, and we may not be in compliance with such covenants at that date. We may be required to request amendments or waivers of some or all of these covenants in the future. Although no assurances can be given, we believe that our operating cash flow, supported by our borrowing capacity, will be adequate to fund operations for at least the next twelve months. Should we decide to pursue acquisition opportunities, the determination of our ability to finance these acquisitions will be a critical element of the analysis of the opportunities. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our operations are conducted around the world in a number of different countries. Accordingly, future earnings are exposed to changes in foreign currency exchange rates. The majority of our foreign currency transactions relate to operations in Canada and the U.K. In Canada, most contracts are denominated in Canadian dollars, and most of the costs incurred are in Canadian dollars, which mitigates risks associated with currency fluctuations. In the U.K., many of our sales contracts and material purchases are denominated in a currency other than British pounds sterling, primarily U.S. dollars and euros, whereas our engineering and overhead costs are principally denominated in British pounds sterling. Consequently, we have currency risk in our U.K. operations. No forward contracts or other currency-related derivative hedge arrangements existed at September 30, 2003, and we do not currently intend to enter into such contracts or arrangements as part of our currency risk management strategy. The warrants issued to the holders of our Series B Preferred Shares provide for a net-cash settlement in the event of a change in control, as defined in the warrants. Consequently, we use derivative accounting to record the warrant transaction. The liability representing the fair value of this derivative arrangement was recorded at $99,000 as of March 31, 2003, and was adjusted to $84,000 as of September 30, 2003, to reflect the projected change in fair value of the warrants during the period, resulting in a $15,000 revaluation gain for the six months then ended. Fair value, as agreed with the counter-party to the agreement, was based on a pricing model that included subjective assumptions concerning the volatility of our common stock, the expected term that the warrants would be outstanding, an expected dividend rate of zero and an overall liquidity factor. At each reporting date, the liability will be adjusted to current fair value with any changes in fair value reported in earnings during the period of change. As such, we may be exposed to certain income fluctuations based upon changes in the fair market value of this liability due to changes in the price of our common stock, as well as other factors. 31 Our financial instruments are subject to changes in interest rates, including our revolving credit and term loan facilities and our working capital facility for export sales. At September 30, 2003, we had borrowings of $32.5 million outstanding under the term loan portion of the revolving credit and term loan facilities, at an interest rate of 3.99%. Borrowings, which bear interest at floating rates, outstanding under the revolving credit agreement at September 30, 2003, totaled $9.9 million. As of September 30, 2003, the weighted average interest rate of our borrowings under revolving credit facilities was 4.90%. No borrowings were outstanding under the working capital facility for export sales at September 30, 2003. Borrowings under the long-term arrangement secured by our Magnolia manufacturing facility totaled $1.3 million and accrued interest at 4.55%. Based on past market movements and possible near-term market movements, we do not believe that potential near-term losses in future earnings, fair values or cash flows from changes in interest rates are likely to be material. Assuming our current level of borrowings, a 100 basis point increase in interest rates under our variable interest rate facilities would decrease our current quarter net income and cash flow from operations by less than $100,000. In the event of an adverse change in interest rates, we could take action to mitigate our exposure. However, due to the uncertainty of actions that could be taken and the possible effects, this calculation assumes no such actions. Furthermore, this calculation does not consider the effects of a possible change in the level of overall economic activity that could exist in such an environment. ITEM 4. CONTROLS AND PROCEDURES CONTROLS AND PROCEDURES Members of our management team, including our Chief Executive Officer and our Chief Financial Officer, have reviewed our disclosure controls and procedures, as defined by the Securities and Exchange Commission in Rule 13(a)-15(e) of the Securities Exchange Act of 1934, as of September 30, 2003, in an effort to evaluate the effectiveness of the design and operation of these controls. Based upon this review, our management has determined that, as of the end of the period covered by this Quarterly Report on Form 10-Q, our disclosure controls and procedures operate such that important information is collected in a timely manner, provided to management and made known to our Chief Executive Officer and Chief Financial Officer to allow timely decisions regarding disclosure in our public filings. Furthermore, no significant changes have been made to our internal controls and procedures during the three months ended September 30, 2003, or prior to filing this Quarterly Report on Form 10-Q, and no corrective actions are anticipated, as we noted no significant deficiencies or material weaknesses in our internal control structure. 32 PART II ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K Reports on Form 8-K. - Report on Form 8-K filed August 5, 2003 to report Second Quarter 2003 Results. - Report on Form 8-K filed September 8, 2003 to announce changes to our organization and steps to reduce our cost structure. - Report on Form 8-K filed November 4, 2003 to report Third Quarter 2003 Results. Index of Exhibits EXHIBIT NO. DESCRIPTION 10.35 - Senior Management Change in Control Agreement dated October 7, 2003, between Katherine P. Ellis and NATCO Group Inc. 10.36 - Senior Management Change in Control Agreement dated October 7, 2003, between Richard W. FitzGerald and NATCO Group Inc. 10.37 - Second Extension Agreement and Extension Agreement for the Second Amended and Restated Service and Reimbursement Agreement between Capricorn Management, G.P. and NATCO Group Inc. 31.1 - Certification of Chief Executive Officer of NATCO Group Inc. pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 31.2 - Certification of Chief Financial Officer of NATCO Group Inc. pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 32.1 - Certification of Chief Executive Officer and Chief Financial Officer of NATCO Group Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 33 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. NATCO Group Inc. By: /s/ Nathaniel A. Gregory -------------------------- Name: Nathaniel A. Gregory Chairman of the Board and Chief Executive Officer Date: November 14, 2003 By: /s/ Richard W. FitzGerald -------------------------- Name: Richard W. FitzGerald Senior Vice President and Chief Financial Officer Date: November 14, 2003 34 EXHIBIT INDEX EXHIBIT NO. DESCRIPTION 10.35 - Senior Management Change in Control Agreement dated October 7, 2003, between Katherine P. Ellis and NATCO Group Inc. 10.36 - Senior Management Change in Control Agreement dated October 7, 2003, between Richard W. FitzGerald and NATCO Group Inc. 10.37 - Second Extension Agreement and Extension Agreement for the Second Amended and Restated Service and Reimbursement Agreement between Capricorn Management, G.P. and NATCO Group Inc. 31.1 - Certification of Chief Executive Officer of NATCO Group Inc. pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 31.2 - Certification of Chief Financial Officer of NATCO Group Inc. pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 32.1 - Certification of Chief Executive Officer and Chief Financial Officer of NATCO Group Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 35 EX-10.35 3 h10469exv10w35.txt SR.MGT CHANGE IN CONTROL AGMT.- KATHERINE ELLIS EXHIBIT 10.35 NATCO GROUP INC. SENIOR MANAGEMENT CHANGE IN CONTROL AGREEMENT THIS AGREEMENT is entered into this 7th day of October, 2003 by and between NATCO GROUP INC., a Delaware corporation (the "Company"), and Katherine P. Ellis (the "Executive"). WHEREAS, the Company's Board of Directors (the "Board") has determined that it is in the best interests of the Company and its stockholders to ensure that the Company and its affiliates will have the continued dedication of the Executive, notwithstanding the possibility, threat or occurrence of a termination of the Executive's employment in certain circumstances, including following a Change in Control as defined herein. The Board believes it is imperative to diminish the inevitable distraction of the Executive by virtue of the personal uncertainties and risks created by a pending or threatened termination of the Executive's employment in such circumstances and to provide the Executive with compensation and benefits arrangements upon such a termination which ensure that the compensation and benefits expectations of the Executive will be satisfied and which are competitive with those of other corporations who may seek to employ the Executive. NOW, THEREFORE, in order to accomplish these objectives, the Board has caused the Company to enter into this Agreement with the Executive, and it is hereby agreed as follows: 1. Definitions. For purposes of this Agreement, the following terms will have the following meanings unless otherwise expressly provided in this Agreement: (a) Board. "Board" means the Board of Directors of the Company. (b) Cause. "Cause" means: (i) the Executive's willful and continued failure to substantially perform the Executive's duties with the Company or its affiliates (other than any such failure resulting from the Executive's incapacity due to physical or mental illness), after a written demand for substantial performance is delivered to the Executive by the Company which specifically identifies the manner in which the Company believes that the Executive has not substantially performed his or her duties; (ii) the final conviction of the Executive of, or an entering of a guilty plea or a plea of no contest by the Executive, to a felony or of a misdemeanor involving moral turpitude; or 1 (iii) the willful engaging by the Executive in illegal conduct or gross misconduct which is materially and demonstrably injurious to the Company. For purposes of this definition, no act or failure to act on the part of the Executive shall be considered "willful" unless it is done, or omitted to be done, by the Executive in bad faith or without a reasonable belief that the action or omission was in the best interests of the Company or its affiliates. Any act, or failure to act, based on authority given pursuant to a resolution duly adopted by the Board, the instructions of a more senior officer of the Company or the advice of counsel to the Company or its affiliates will be conclusively presumed to be done, or omitted to be done, by the Executive in good faith and in the best interests of the Company and its affiliates. (c) Change in Control. A "Change in Control" means the occurrence of any one of the following events: (i) the Company is not the surviving entity in any merger or consolidation (or survives only as a subsidiary of an entity); (ii) the Company sells, leases or exchanges or agrees to sell, lease or exchange all or substantially all of its assets to any other person or entity; (iii) the Company is to be dissolved and liquidated; (iv) any person or entity, including a "group" as contemplated by Section 13(d)(3) of the Securities Exchange Act of 1934, as amended, acquires or gains ownership or control (including, without limitation, power to vote) of more than 50% of the outstanding shares of the Company's voting stock (based upon voting power); or (v) as a result of or in connection with a contested election of Directors, the persons who were Directors of the Company before such election shall cease to constitute a majority of the Board. (d) Date of Termination means the date specified in a Notice of Termination pursuant to paragraph 3 hereof, or the Executive's last date as an active employee of the Company and its affiliates before a termination of employment due to death, Disability, or other reason, as the case may be. (e) Director. "Director" means an individual elected to the Board by the stockholders of the Company or by the Board under applicable corporate law who is serving on the Board on the date of this Agreement or who is elected to the Board after such date. 2 (f) Disability. "Disability" means the Executive's total and permanent disability as defined under the terms of the Company's long-term disability plan in effect on the Date of Termination. (g) Effective Period. The "Effective Period" means the 24-month period following any Change in Control. (h) Good Reason. "Good Reason" means, unless the Executive has consented in writing thereto, the occurrence of any of the following: (i) the assignment to the Executive of any duties inconsistent with the Executive's position, including any material change in status, title, authority, duties or responsibilities or any other action which results in a material diminution in such status, title, authority, duties or responsibilities, excluding for this purpose an isolated, insubstantial and inadvertent action not taken in bad faith and which is remedied by the Company or the Executive's employer promptly after receipt of notice thereof given by the Executive; (ii) a reduction by the Company or the Executive's employer of the Executive's base salary; (iii) the relocation of the Executive's office to a location more than 35 miles from its location as of the Commencement Date; (iv) following a Change in Control, unless a plan providing a substantially similar compensation or benefit is substituted, (A) the failure by the Company or any of its affiliates or successors to continue in effect any material fringe benefit or compensation plan, retirement plan, life insurance plan, health and accident plan or disability plan in which the Executive is participating prior to the Change in Control, or (B) the taking of any action by the Company or any of its affiliates or successors which would adversely affect the Executive's participation in or materially reduce his benefits under any of such plans or deprive him of any material fringe benefit; or (v) following a Change in Control, the failure of the Company or the affiliate of the Company by which the Executive is employed, or any affiliate which directly or indirectly owns or controls any affiliate by which the Executive is employed, to obtain the assumption in writing of the Company's obligation to perform this Agreement by any successor to all or substantially all of the assets of the Company or such affiliate within fifteen (15) days after a reorganization, merger, consolidation, sale or other disposition of assets of the Company or such affiliate. 3 (vi) any purported termination of the Executive's employment by the Company which is not effected pursuant to a Notice of Termination satisfying the requirements of paragraph 3 hereof; and for purposes of this Agreement, no such purported termination shall be effective. For purposes of this Agreement, any determination of "Good Reason" made by the Executive in good faith based upon his reasonable belief and understanding shall be conclusive. 2. Term. The term ("Term") of this Agreement shall commence on the date first above written (the "Commencement Date") and, unless terminated earlier as provided hereunder, shall continue through the third anniversary of the Commencement Date (the "Termination Date"); provided, however, that commencing on the anniversary of the Commencement Date (the "Extension Date") and on each subsequent Extension Date each year thereafter, the term of this Agreement shall automatically be extended for one additional year, unless at least 90 days prior to such Extension Date, the Company shall have given notice that it does not wish to extend this Agreement. Upon the occurrence of a Change in Control during the term of this Agreement, including any extensions thereof, this Agreement shall automatically be extended until the end of the Effective Period and may not be terminated by the Company during such time. 3. Notice of Termination. (a) Any termination of the Executive's employment by the Company, or by any affiliate of the Company by which the Executive is employed, for Cause, or by the Executive for Good Reason shall be communicated by Notice of Termination to the other party hereto given in accordance with paragraph 11 of this Agreement. For purposes of this Agreement, a "Notice of Termination" for termination of employment for Cause or for Good Reason means a written notice which (i) is given at least thirty (30) days prior to the Date of Termination; (ii) indicates the specific termination provision in this Agreement relied upon, (iii) to the extent applicable, sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated, (iv) specifies the employment termination date; and (v) allows the recipient of the Notice of Termination at least thirty (30) days to cure the act or omission relied upon in the Notice of Termination. The failure to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason or Cause will not waive any right of the party giving the Notice of Termination hereunder or preclude such party from asserting such fact or circumstance in enforcing its rights hereunder. (b) A Termination of Employment of the Executive will not be deemed to be for Cause unless and until there has been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of not less than three-quarters of the entire membership of the Board at a meeting of the Board called and held for such purpose (after reasonable notice is provided to the Executive and the Executive is given an opportunity, together with counsel, to be heard before the Board), finding that, in the 4 good faith opinion of the Board, the Executive has engaged in the conduct described in paragraph 1(b) hereof, and specifying the particulars of such conduct. (c) A Termination of Employment of the Executive will not be deemed to be for Good Reason unless the Executive gives the Notice of Termination provided for herein within twelve (12) months after the Executive has actual knowledge of the act or omission of the Company constituting such Good Reason. 4. Obligations of the Company Upon Termination of Executive's Employment Following a Change in Control (a) If, during the Effective Period, the Company terminates the Executive's employment other than for Cause or the Executive terminates employment with the Company for Good Reason, the Company will pay the following to the Executive as soon as practicable following the Date of Termination, but in no event later than thirty (30) days, or such period otherwise specifically provided, thereafter: (i) cash in the amount of the Executive's annual base salary through the Date of Termination to the extent not theretofore paid, including amounts due for accrued but unused vacation time; (ii) cash in the amount of the annual bonus earned by the Executive through the Date of Termination based on the Company's performance through such date and prorationed by multiplying such bonus amount by the fraction obtained by dividing the number of days in the year through the Date of Termination by 365, payable no later than sixty (60) days following the Date of Termination; (iii) cash in an amount equal to the product of two times the Executive's annual base salary at the greater of (A) the rate in effect at the time Notice of Termination is given or (B) the rate in effect immediately preceding the Change in Control, payable in a lump sum; (iv) a lump sum cash amount equal to the product of two times the target annual bonus at the greater of (A) the target annual bonus in effect at the time Notice of Termination is given or (B) the target annual bonus in effect immediately preceding the Change in Control; (v) the continuation of the provision of health insurance, dental insurance and life insurance benefits for a period of two years following the Date of Termination to the Executive and the Executive's family at least equal to and to the same extent as those which would have been provided to them in accordance with the plans, programs, practices and policies of the Company as in effect and applicable generally to other peer executives and their families during the 90-day period immediately preceding the Effective Period or on the Date of Termination, at the election of the 5 Executive; provided, however, that if the Executive becomes re-employed with another employer and is eligible to receive medical or other welfare benefits under another employer provided plan, the medical and other welfare benefits described herein will be secondary to those provided under such other plan during such applicable period of eligibility. (b) "Compensation" Under Retirement Plans. Any and all amounts paid under this Agreement in the amount of or otherwise in respect of the Executive's annual base salary and bonuses, whether or not deferred under a deferred compensation plan or program, are intended to be and will be "Compensation" for purposes of determining Compensation under any and all retirement plans sponsored or maintained by the Company or by any affiliate controlled by the Company. (c) Deferred Bonus Under Natco Group Inc. Target Bonus Plan. The benefits provided under this paragraph 4 are intended to be in addition to and separate from any and all bonus compensation amounts earned under the Natco Group Inc. Target Bonus Plan ("Target Bonus Plan"), the payment of which has been deferred under the terms of the Target Bonus Plan. Any and all such deferred bonus compensation shall be payable at the time and in the manner provided for (or elected) under the terms of the Target Bonus Plan. (d) Effect of Death or Disability. If the Executive's employment is terminated by reason of the Executive's death or Disability during the Term of this Agreement, this Agreement shall terminate automatically on the date of death or, in the event of Disability, on the Date of Termination. In the event of the Executive's death following the Executive's Date of Termination, but prior to the payment of the severance payments and benefits provided under paragraph 4 hereof, if any, such payments and benefits will be paid to the Executive's surviving spouse, or if the Executive has no surviving spouse, then to the Executive's estate. (e) Exclusivity of Severance. The severance payments and benefits provided for under this Agreement are separate and apart from and, to the extent they are actually paid, will be in lieu of any payment under any policy or plan of the Company or any of its affiliates regarding severance payments generally. 5. Mitigation of Damages. The Executive will not be required to mitigate damages or the amount of any payment provided for under this Agreement by seeking other employment or otherwise. Except as otherwise specifically provided in this Agreement, the amount of any payment provided for under this Agreement will not be reduced by any compensation earned by the Executive as the result of self-employment or employment by another employer or otherwise. 6. Stock Options. The benefits provided under paragraph 4 above are intended to be in addition to the value of any options to acquire common stock of the Company awarded under the Natco Group Inc. 2001 Stock Incentive Plan (the "Stock Plan") and any other incentive or similar plan heretofore or hereafter adopted by the Company. Notwithstanding the terms of the Stock Plan, any award agreement entered into pursuant to the Stock Plan or any other incentive 6 plan or agreement, all outstanding stock options held by the Executive shall fully vest as of the date of the Change in Control and become immediately exercisable in accordance with their terms; provided, however, that if the Company terminates the Executive's employment other than for Cause or the Executive terminates employment with the Company for Good Reason during the Effective Period, then such stock options shall be exercisable for the longer period of (a) three months after the Executive's Date of Termination or (b) eighteen months after the effective date of the Change in Control, unless the term of the stock option expires before the end of such longer period, in which case the stock option shall be exercisable until the expiration of its term. 7. Limitation of Benefits. (a) Anything in this Agreement to the contrary notwithstanding, in the event it shall be determined that any benefit, payment or distribution by the Company to or for the benefit of the Executive (whether payable or distributable pursuant to the terms of this Agreement or otherwise) (a "Payment") would, if paid, be subject to the excise tax imposed by Section 4999 of the Code (the "Excise Tax"), then the Payment shall be reduced to the extent necessary to avoid the imposition of the Excise Tax. The Executive may select the Payments to be limited or reduced. (b) All determinations required to be made under this Section 7, including whether an Excise Tax would otherwise be imposed and the assumptions to be utilized in arriving at such determination, shall be made by Independent Tax Counsel which shall provide detailed supporting calculations both to the Company and the Executive within fifteen (15) business days of the receipt of notice from the Executive that a Payment is due to be made, or such earlier time as is requested by the Company. For purposes of this paragraph, "Independent Tax Counsel" will mean a lawyer, a certified public accountant with a nationally recognized accounting firm, or a compensation consultant with a nationally recognized actuarial and benefits consulting firm with expertise in the area of executive compensation, who will be selected by the Company and will be reasonably acceptable to the Executive, and whose fees and disbursements will be paid by the Company. Any determination by the Independent Tax Counsel shall be binding upon the Company and the Executive. If, as a result of any uncertainty in the application of Section 4999 of the Code at the time the initial determination is made by the Independent Tax Counsel hereunder, Payments hereunder have been unnecessarily limited by this Section 7 ("Underpayment"), consistent with the calculations required to be made hereunder, then the Independent Tax Counsel shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be properly paid by the Company to or for the benefit of the Executive. . If, however, Payments hereunder have not been sufficiently limited by this Section 7, consistent with the calculations required to be made hereunder, to prevent the imposition of an Excise Tax upon the Executive (the "Overpayment"), then the Executive shall notify the Company in writing within fifteen (15) days of any claim by the Internal Revenue Service, that, if successful, would require the payment by the Executive of any Excise Tax, and the Independent Tax Counsel shall determine the amount of Overpayment that has occurred and any such 7 Overpayment shall be properly refunded by the Executive by or for the benefit of the Company so as to properly prevent the imposition of the Excise Tax. 8. Confidential Information; Non-Solicitation. For the Term of this Agreement, and for the period of time during which the Executive receives benefits pursuant to paragraph 4(a)(v) hereof, the Executive covenants and agrees as follows: (a) To hold in a fiduciary capacity for the benefit of the Company and its affiliates all secret, proprietary or confidential material, knowledge, data or any other information relating to the Company or any of its affiliated companies and their respective businesses ("Confidential Information"), which has been obtained by the Executive during the Executive's employment by the Company or any of its affiliated companies and that has not been, is not now and hereafter does not become public knowledge (other than by acts by the Executive or representatives of the Executive in violation of this Agreement), and will not, without the prior written consent of the Company or as may otherwise be required by law or legal process, communicate or divulge any such information, knowledge or data to anyone other than the Company and those designated by it; the Executive further agrees to return to the Company any and all records and documents (and all copies thereof) and all other property belonging to the Company or relating to the Company, its affiliates or their businesses, upon termination of Executive's employment with the Company and its affiliates; and, (b) Not to solicit or entice any other employee of the Company or its affiliates to leave the Company or its affiliates to go to work for any other business or organization which is in direct or indirect competition with the Company or any of its affiliates, nor request or advise a customer or client of the Company or its affiliates to curtail or cancel such customer's business relationship with the Company or its affiliates. 9. Rights and Remedies Upon Breach. (a) The Executive hereby acknowledges and agrees that the provisions contained in paragraph 8 of this Agreement (the "Restrictive Covenants"), are reasonable and valid in duration and in all other respects. If any court of competent jurisdiction determines that any of the Restrictive Covenants, or any part thereof, is invalid or unenforceable, the remainder of the Restrictive Covenants will not thereby be affected and will be given full effect without regard to the invalid portions. (b) If the Executive breaches, or threatens to commit a breach of, any of the Restrictive Covenants, the Company will have the following rights and remedies, each of which rights and remedies will be independent of the others and severally enforceable, and each of which is in addition to, and not in lieu of, any other rights and remedies available to the Company under law or in equity: (i) Specific Performance. The right and remedy to have the Restrictive Covenants specifically enforced by any court of competent jurisdiction, it being agreed that any breach or threatened breach of the Restrictive 8 Covenants would cause irreparable injury to the Company and that money damages would not provide an adequate remedy to the Company. (ii) Accounting. The right and remedy to require the Executive to account for and pay over to the Company all compensation, profits, monies, accruals, increments or other benefits derived or received by the Executive as the result of any action constituting a breach of the Restrictive Covenants. (iii) Cessation of Severance Benefits. The right and remedy to cease any further severance, benefit or other compensation payments under this Agreement to the Executive or the Executive's beneficiary from and after the commencement of such breach by the Executive. 10. Arbitration. The Company and Executive agree that any claim, dispute or controversy arising under or in connection with this Agreement (including, without limitation, any such claim, dispute or controversy arising under any federal, state or local statute, regulation or ordinance or any of the Company's employee benefit plans, policies or programs) shall be resolved solely and exclusively by binding arbitration. The arbitration shall be held in the city of Houston, Texas (or at such other location as shall be mutually agreed by the parties). The arbitration shall be conducted in accordance with the Expedited Employment Arbitration Rules (the "Rules") of the American Arbitration Association (the "AAA") in effect at the time of the arbitration, except that the arbitrator shall be selected by alternatively striking from a list of five arbitrators supplied by the AAA. All fees and expenses of the arbitration, including a transcript if either requests, shall be borne equally by the parties. If Executive prevails as to any material issue presented to the arbitrator, the entire cost of such proceedings (including, without limitation, Executive's reasonable attorneys fees) shall be borne by the Company. If Executive does not prevail as to any material issue, each party will pay for the fees and expenses of its own attorneys, experts, witnesses, and preparation and presentation of proofs and post-hearing briefs (unless the party prevails on a claim for which attorney's fees are recoverable under the Rules). Any action to enforce or vacate the arbitrator's award shall be governed by the Federal Arbitration Act, if applicable, and otherwise by applicable state law. If either the Company or Executive pursues any claim, dispute or controversy against the other in a proceeding other than the arbitration provided for herein, the responding party shall be entitled to dismissal or injunctive relief regarding such action and recovery of all costs, losses and attorney's fees related to such action. Notwithstanding the provisions of this paragraph, either party may seek injunctive relief in a court of competent jurisdiction, whether or not the case is then pending before the panel of arbitrators. Following the court's determination of the injunction issue, the case shall continue in arbitration as provided herein. 11. Notices. Any notice provided for in this Agreement will be given in writing and will be delivered personally, telegraphed, telexed, sent by facsimile transmission or sent by certified, registered or express mail, postage prepaid. Any such notice will be deemed given when so delivered personally, telegraphed, telexed or sent by facsimile transmission, or, if mailed, on the date of actual receipt thereof. Notices will be properly addressed to the parties at their respective 9 addresses set forth below or to such other address as either party may later specify by notice to the other in accordance with the provisions of this paragraph: If to the Company: Natco Group Inc. Brookhollow Central III 2950 North Loop West, Suite 750 Houston, Texas 77092 Attention: Chief Executive Officer If to the Executive: Katherine P. Ellis 4910 Kaylan Court Richmond, TX 77469 12. Entire Agreement. This Agreement contains the entire agreement between the parties with respect to the subject matter hereof and supersedes all prior agreements, written or oral, with respect thereto, and any and all prior employment or severance agreements and related amendments entered into between the Company and the Executive. 13. Waivers and Amendments. This Agreement may be amended, superseded, canceled, renewed or extended, and the terms and conditions hereof may be waived, only by a written instrument signed by the parties hereto or, in the case of a waiver, by the party waiving compliance. No delay on the part of any party in exercising any right, power or privilege hereunder will operate as a waiver thereof, nor will any waiver on the part of any party of any such right, power or privilege hereunder, nor any single or partial exercise of any right, power or privilege hereunder, preclude any other or further exercise thereof or the exercise of any other right, power or privilege hereunder. 14. Governing Law. This Agreement will be governed by and construed in accordance with the laws of the state of Texas (without giving effect to the choice of law provisions thereof), where the employment of the Executive will be deemed, in part, to be performed, and enforcement of this Agreement or any action taken or held with respect to this Agreement will be taken in the courts of appropriate jurisdiction in Houston, Texas. 15. Assignment. This Agreement, and any rights and obligations hereunder, may not be assigned by the Executive and may be assigned by the Company only to any successor in interest, whether by merger, consolidation, acquisition or the like, or to purchasers of substantially all of the assets of the Company. 16. Binding Agreement. This Agreement will inure to the benefit of and be binding upon the Company and its respective successors and assigns and the Executive and his legal representatives. 10 17. Counterparts. This Agreement may be executed in separate counterparts, each of which when so executed and delivered will be deemed an original, but all of which together will constitute one and the same instrument. 18. Headings. The headings in this Agreement are for reference purposes only and will not in any way affect the meaning or interpretation of this Agreement. 19. Authorization. The Company represents and warrants that the Board of Directors of the Company has authorized the execution of this Agreement. 20. Validity. The invalidity or unenforceability of any provisions of this Agreement will not affect the validity or enforceability of any other provisions of this Agreement, which will remain in full force and effect. 21. Tax Withholding. The Company will have the right to deduct from all benefits and/or payments made under this Agreement to the Executive any and all taxes required by law to be paid or withheld with respect to such benefits or payments. 22. No Contract of Employment. Nothing contained in this Agreement will be construed as a contract of employment between the Company or any of its affiliates and the Executive, as a right of the Executive to be continued in the employment of the Company or any of its affiliates, or as a limitation of the right of the Company or any of its affiliates to discharge the Executive with or without cause. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. The Company NATCO GROUP INC. THE EXECUTIVE By /s/ NATHANIEL A. GREGORY /s/ KATHERINE P. ELLIS ---------------------------- ----------------------- Title: Chief Executive Officer Katherine P. Ellis NATCO 11 EX-10.36 4 h10469exv10w36.txt SR.MGT CHANGE IN CONTROL AGMT.- RICHARD FITZGERALD EXHIBIT 10.36 NATCO GROUP INC. CHANGE IN CONTROL AGREEMENT THIS AGREEMENT is entered into this 7th day of June, 2003 by and between NATCO GROUP INC., a Delaware corporation (the "Company"), and Richard W. FitzGerald (the "Executive"). WHEREAS, the Company's Board of Directors (the "Board") has determined that it is in the best interests of the Company and its stockholders to ensure that the Company and its affiliates will have the continued dedication of the Executive, notwithstanding the possibility, threat or occurrence of a termination of the Executive's employment in certain circumstances, including following a Change in Control as defined herein. The Board believes it is imperative to diminish the inevitable distraction of the Executive by virtue of the personal uncertainties and risks created by a pending or threatened termination of the Executive's employment in such circumstances and to provide the Executive with compensation and benefits arrangements upon such a termination which ensure that the compensation and benefits expectations of the Executive will be satisfied and which are competitive with those of other corporations who may seek to employ the Executive. NOW, THEREFORE, in order to accomplish these objectives, the Board has caused the Company to enter into this Agreement with the Executive, and it is hereby agreed as follows: 1. Definitions. For purposes of this Agreement, the following terms will have the following meanings unless otherwise expressly provided in this Agreement: (a) Board. "Board" means the Board of Directors of the Company. (b) Cause. "Cause" means: (i) the Executive's willful and continued failure to substantially perform the Executive's duties with the Company or its affiliates (other than any such failure resulting from the Executive's incapacity due to physical or mental illness), after a written demand for substantial performance is delivered to the Executive by the Company which specifically identifies the manner in which the Company believes that the Executive has not substantially performed his or her duties; (ii) the final conviction of the Executive of, or an entering of a guilty plea or a plea of no contest by the Executive, to a felony or of a misdemeanor involving moral turpitude; or (iii) the willful engaging by the Executive in illegal conduct or gross misconduct which is materially and demonstrably injurious to the Company. 1 For purposes of this definition, no act or failure to act on the part of the Executive shall be considered "willful" unless it is done, or omitted to be done, by the Executive in bad faith or without a reasonable belief that the action or omission was in the best interests of the Company or its affiliates. Any act, or failure to act, based on authority given pursuant to a resolution duly adopted by the Board, the instructions of a more senior officer of the Company or the advice of counsel to the Company or its affiliates will be conclusively presumed to be done, or omitted to be done, by the Executive in good faith and in the best interests of the Company and its affiliates. (c) Change in Control. A "Change in Control" means the occurrence of any one of the following events: (i) the Company is not the surviving entity in any merger or consolidation (or survives only as a subsidiary of an entity); (ii) the Company sells, leases or exchanges or agrees to sell, lease or exchange all or substantially all of its assets to any other person or entity; (iii) the Company is to be dissolved and liquidated; (iv) any person or entity, including a "group" as contemplated by Section 13(d)(3) of the Securities Exchange Act of 1934, as amended, acquires or gains ownership or control (including, without limitation, power to vote) of more than 50% of the outstanding shares of the Company's voting stock (based upon voting power); or (v) as a result of or in connection with a contested election of Directors, the persons who were Directors of the Company before such election shall cease to constitute a majority of the Board. (d) Date of Termination means the date specified in a Notice of Termination pursuant to paragraph 3 hereof, or the Executive's last date as an active employee of the Company and its affiliates before a termination of employment due to death, Disability, or other reason, as the case may be. (e) Director. "Director" means an individual elected to the Board by the stockholders of the Company or by the Board under applicable corporate law who is serving on the Board on the date of this Agreement or who is elected to the Board after such date. (f) Disability. "Disability" means the Executive's total and permanent disability as defined under the terms of the Company's long-term disability plan in effect on the Date of Termination. 2 (g) Effective Period. The "Effective Period" means the 24-month period following any Change in Control. (h) Good Reason. "Good Reason" means, unless the Executive has consented in writing thereto, the occurrence of any of the following: (i) the assignment to the Executive of any duties inconsistent with the Executive's position, including any material change in status, title, authority, duties or responsibilities or any other action which results in a material diminution in such status, title, authority, duties or responsibilities, excluding for this purpose an isolated, insubstantial and inadvertent action not taken in bad faith and which is remedied by the Company or the Executive's employer promptly after receipt of notice thereof given by the Executive; (ii) a reduction by the Company or the Executive's employer of the Executive's base salary; (iii) the relocation of the Executive's office to a location more than 35 miles from its location as of the Commencement Date; (iv) following a Change in Control, unless a plan providing a substantially similar compensation or benefit is substituted, (A) the failure by the Company or any of its affiliates or successors to continue in effect any material fringe benefit or compensation plan, retirement plan, life insurance plan, health and accident plan or disability plan in which the Executive is participating prior to the Change in Control, or (B) the taking of any action by the Company or any of its affiliates or successors which would adversely affect the Executive's participation in or materially reduce his benefits under any of such plans or deprive him of any material fringe benefit; or (v) following a Change in Control, the failure of the Company or the affiliate of the Company by which the Executive is employed, or any affiliate which directly or indirectly owns or controls any affiliate by which the Executive is employed, to obtain the assumption in writing of the Company's obligation to perform this Agreement by any successor to all or substantially all of the assets of the Company or such affiliate within fifteen (15) days after a reorganization, merger, consolidation, sale or other disposition of assets of the Company or such affiliate. (vi) any purported termination of the Executive's employment by the Company which is not effected pursuant to a Notice of Termination satisfying the requirements of paragraph 3 hereof; and for purposes of this Agreement, no such purported termination shall be effective. 3 For purposes of this Agreement, any determination of "Good Reason" made by the Executive in good faith based upon his reasonable belief and understanding shall be conclusive. (i) Person. "Person" means any corporation, partnership, joint venture, trust, sole proprietorship, limited liability company, unincorporated business association, individual or other entity. 2. Term. The term ("Term") of this Agreement shall commence on the date first above written (the "Commencement Date") and, unless terminated earlier as provided hereunder, shall continue through the third anniversary of the Commencement Date (the "Termination Date"); provided, however, that commencing on the anniversary of the Commencement Date (the "Extension Date") and on each subsequent Extension Date each year thereafter, the term of this Agreement shall automatically be extended for one additional year, unless at least 90 days prior to such Extension Date, the Company shall have given notice that it does not wish to extend this Agreement. Upon the occurrence of a Change in Control during the term of this Agreement, including any extensions thereof, this Agreement shall automatically be extended until the end of the Effective Period and may not be terminated by the Company during such time. 3. Notice of Termination. (a) Any termination of the Executive's employment by the Company, or by any affiliate of the Company by which the Executive is employed, for Cause, or by the Executive for Good Reason shall be communicated by Notice of Termination to the other party hereto given in accordance with paragraph 12 of this Agreement. For purposes of this Agreement, a "Notice of Termination" for termination of employment for Cause or for Good Reason means a written notice which (i) is given at least thirty (30) days prior to the Date of Termination; (ii) indicates the specific termination provision in this Agreement relied upon, (iii) to the extent applicable, sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated, (iv) specifies the employment termination date; and (v) allows the recipient of the Notice of Termination at least thirty (30) days to cure the act or omission relied upon in the Notice of Termination. The failure to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason or Cause will not waive any right of the party giving the Notice of Termination hereunder or preclude such party from asserting such fact or circumstance in enforcing its rights hereunder. (b) A Termination of Employment of the Executive will not be deemed to be for Cause unless and until there has been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of not less than three-quarters of the entire membership of the Board at a meeting of the Board called and held for such purpose (after reasonable notice is provided to the Executive and the Executive is given an opportunity, together with counsel, to be heard before the Board), finding that, in the good faith opinion of the Board, the Executive has engaged in the conduct described in paragraph 1(b) hereof, and specifying the particulars of such conduct. 4 (c) A Termination of Employment of the Executive will not be deemed to be for Good Reason unless the Executive gives the Notice of Termination provided for herein within twelve (12) months after the Executive has actual knowledge of the act or omission of the Company constituting such Good Reason. 4. Obligations of the Company Upon Termination of Executive's Employment Following a Change in Control (a) If, during the Effective Period, the Company terminates the Executive's employment other than for Cause or the Executive terminates employment with the Company for Good Reason, the Company will pay the following to the Executive as soon as practicable following the Date of Termination, but in no event later than thirty (30) days, or such period otherwise specifically provided, thereafter: (i) cash in the amount of the Executive's annual base salary through the Date of Termination to the extent not theretofore paid, including amounts due for accrued but unused vacation time; (ii) cash in the amount of the annual bonus earned by the Executive through the Date of Termination based on the Company's performance through such date and prorationed by multiplying such bonus amount by the fraction obtained by dividing the number of days in the year through the Date of Termination by 365, payable no later than sixty (60) days following the Date of Termination; (iii) cash in an amount equal to the Executive's annual base salary at the greater of (A) the rate in effect at the time Notice of Termination is given or (B) the rate in effect immediately preceding the Change in Control, payable in a lump sum; (iv) a lump sum cash amount equal to the product of two times the target annual bonus at the greater of (A) the target annual bonus in effect at the time Notice of Termination is given or (B) the target annual bonus in effect immediately preceding the Change in Control; (v) the continuation of the provision of health insurance, dental insurance and life insurance benefits for a period of two years following the Date of Termination to the Executive and the Executive's family at least equal to and to the same extent as those which would have been provided to them in accordance with the plans, programs, practices and policies of the Company as in effect and applicable generally to other peer executives and their families during the 90-day period immediately preceding the Effective Period or on the Date of Termination, at the election of the Executive; provided, however, that if the Executive becomes re-employed with another employer and is eligible to receive medical or other welfare benefits under another employer provided plan, the medical and other 5 welfare benefits described herein will be secondary to those provided under such other plan during such applicable period of eligibility. (b) "Compensation" Under Retirement Plans. Any and all amounts paid under this Agreement in the amount of or otherwise in respect of the Executive's annual base salary and bonuses, whether or not deferred under a deferred compensation plan or program, are intended to be and will be "Compensation" for purposes of determining Compensation under any and all retirement plans sponsored or maintained by the Company or by any affiliate controlled by the Company. (c) Deferred Bonus Under Natco Group Inc. Target Bonus Plan. The benefits provided under this paragraph 4 are intended to be in addition to and separate from any and all bonus compensation amounts earned under the Natco Group Inc. Target Bonus Plan ("Target Bonus Plan") the payment of which has been deferred under the terms of the Target Bonus Plan. Any and all such deferred bonus compensation shall be payable at the time and in the manner provided for (or elected) under the terms of the Target Bonus Plan. (d) Effect of Death or Disability. If the Executive's employment is terminated by reason of the Executive's death or Disability during the Term of this Agreement, this Agreement shall terminate automatically on the date of death or, in the event of Disability, on the Date of Termination. In the event of the Executive's death following the Executive's Date of Termination, but prior to the payment of the severance payments and benefits provided under paragraph 4 hereof, if any, such payments and benefits will be paid to the Executive's surviving spouse, or if the Executive has no surviving spouse, then to the Executive's estate. (e) Exclusivity of Severance. The severance payments and benefits provided for under this Agreement are separate and apart from and, to the extent they are actually paid, will be in lieu of any payment under any policy or plan of the Company or any of its affiliates regarding severance payments generally. 5. Mitigation of Damages. The Executive will not be required to mitigate damages or the amount of any payment provided for under this Agreement by seeking other employment or otherwise. Except as otherwise specifically provided in this Agreement, the amount of any payment provided for under this Agreement will not be reduced by any compensation earned by the Executive as the result of self-employment or employment by another employer or otherwise. 6. Stock Options. The benefits provided under paragraph 4 above are intended to be in addition to the value of any options to acquire common stock of the Company awarded under the Natco Group Inc. 2001 Stock Incentive Plan (the "Stock Plan") and any other incentive or similar plan heretofore or hereafter adopted by the Company. Notwithstanding the terms of the Stock Plan, any award agreement entered into pursuant to the Stock Plan or any other incentive plan or agreement, all outstanding stock options held by the Executive shall fully vest as of the date of the Change in Control and become immediately exercisable in accordance with their terms; provided, however, that if the Company terminates the Executive's employment other than for Cause or the Executive terminates employment with the Company for Good Reason 6 during the Effective Period, then such stock options shall be exercisable for the longer period of (a) three months after the Executive's Date of Termination or (b) eighteen months after the effective date of the Change in Control, unless the term of the stock options expires before the end of such longer period, in which case the stock option shall be exercisable until the expiration of its term. 7. Limitation of Benefits. (a) Anything in this Agreement to the contrary notwithstanding, in the event it shall be determined that any benefit, payment or distribution by the Company to or for the benefit of the Executive (whether payable or distributable pursuant to the terms of this Agreement or otherwise) (a "Payment") would, if paid, be subject to the excise tax imposed by Section 4999 of the Code (the "Excise Tax"), then the Payment shall be reduced to the extent necessary to avoid the imposition of the Excise Tax. The Executive may select the Payments to be limited or reduced. (b) All determinations required to be made under this Section 7, including whether an Excise Tax would otherwise be imposed and the assumptions to be utilized in arriving at such determination, shall be made by Independent Tax Counsel which shall provide detailed supporting calculations both to the Company and the Executive within fifteen (15) business days of the receipt of notice from the Executive that a Payment is due to be made, or such earlier time as is requested by the Company. For purposes of this paragraph, "Independent Tax Counsel" will mean a lawyer, a certified public accountant with a nationally recognized accounting firm, or a compensation consultant with a nationally recognized actuarial and benefits consulting firm with expertise in the area of executive compensation, who will be selected by the Company and will be reasonably acceptable to the Executive, and whose fees and disbursements will be paid by the Company. Any determination by the Independent Tax Counsel shall be binding upon the Company and the Executive. If, as a result of any uncertainty in the application of Section 4999 of the Code at the time the initial determination is made by the Independent Tax Counsel hereunder, Payments hereunder have been unnecessarily limited by this Section 7 ("Underpayment"), consistent with the calculations required to be made hereunder, then the Independent Tax Counsel shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be properly paid by the Company to or for the benefit of the Executive. If, however, Payments hereunder have not been sufficiently limited by this Section 7, consistent with the calculations required to be made hereunder, to prevent the imposition of an Excise Tax upon the Executive (the "Overpayment"), then the Executive shall notify the Company in writing within fifteen (15) days of any claim by the Internal Revenue Service, that, if successful, would require the payment by the Executive of any Excise Tax, and the Independent Tax Counsel shall determine the amount of Overpayment that has occurred and any such Overpayment shall be properly refunded by the Executive by or for the benefit of the Company so as to properly prevent the imposition of the Excise Tax. 7 8. Noncompete. (a) In view of the unique and valuable services it is expected the Executive will render to the Company, Executive's knowledge of the customers, trade secrets, and other proprietary information relating to the business of the Company and its customers and suppliers and similar knowledge regarding the Company it is expected that the Executive will obtain, and in consideration of the compensation to be received under this Section 8, Executive agrees that in the event his employment with the Company is terminated by the Company without Cause hereof or by the Executive for Good Reason during the Effective Period, he will not, directly or indirectly, for a period beginning on the Date of Termination and ending on the first anniversary of such Date of Termination: (i) serve as an officer, director, employee, principal, partner, agent, independent contractor or consultant of or for, or otherwise have a financial interest in, any Prohibited Business (as defined below) which sells or offers to sell products or services in competition with the Company or any of its subsidiaries or affiliates in the Geographic Territory (as defined below); provided that this covenant will not prevent Executive from purchasing or owning not more than one percent (1%) of any class of securities of any corporation, whether or not such corporation is a Prohibited Business; (ii) sell or offer to sell to any Person in the Geographic Territory any goods or services of any type then sold or offered by the Company or any of its subsidiaries or affiliates; (iii) otherwise intentionally interfere with or cause a reduction or termination of the business between the Company or any of its subsidiaries or affiliates and any customer or prospective customer of the Company or any of its subsidiaries or affiliates; (iv) hire or attempt to hire any person employed or engaged by the Company or any of its subsidiaries or affiliates or encourage or solicit any such person to terminate his or her employment or engagement with the Company or such subsidiary or affiliate of the Company; (v) intentionally interfere with or cause a reduction or termination of the business relationship between the Company or any of its subsidiaries or affiliates and any business which supplies or supplied goods or services to the Company or its subsidiaries or affiliates; or (vi) make any public statement which is either intended to be or reasonably likely to be injurious or detrimental to the Company or any of its subsidiaries or affiliates or which is derogatory to any current or former director, officer or employee of the Company or any of its subsidiaries or affiliates. 8 (b) The Executive acknowledges and agrees that, given the nature of the businesses in which the Company and its subsidiaries and affiliates are engaged and given his past service as Senior Vice President and Chief Financial Officer of the Company, the restrictive covenants contained above are reasonable in the sense that they are no greater than is necessary to protect the legitimate interests of the Company and not unduly harsh and oppressive in curtailing the Executive's legitimate efforts to earn a livelihood. The parties therefore intend that these restrictive covenants be enforced to the fullest extent permitted by applicable law. Each of these restrictive covenants is a separate and independent contractual provision. (c) For purpose of this Agreement, "Prohibited Business" means any Person that is in competition with the Company or any of its subsidiaries or affiliates in the oil and gas process equipment business; and "Geographic Territory" means the United States of America. (d) In consideration of the restrictive covenants set forth in this Section 8, the Company shall pay in a lump sum to the Executive, on or within thirty (30) days after the Executive's Date of Termination, cash in an amount equal to the Executive's annual base salary in effect on the Date of Termination. 9. Confidential Information; Non-Solicitation. For the Term of this Agreement, and for the period of time during which the Executive receives benefits pursuant to paragraph 4(a)(v) hereof, the Executive covenants and agrees to hold in a fiduciary capacity for the benefit of the Company and its affiliates all secret, proprietary or confidential material, knowledge, data or any other information relating to the Company or any of its affiliated companies and their respective businesses ("Confidential Information"), which has been obtained by the Executive during the Executive's employment by the Company or any of its affiliated companies and that has not been, is not now and hereafter does not become public knowledge (other than by acts by the Executive or representatives of the Executive in violation of this Agreement), and will not, without the prior written consent of the Company or as may otherwise be required by law or legal process, communicate or divulge any such information, knowledge or data to anyone other than the Company and those designated by it; the Executive further agrees to return to the Company any and all records and documents (and all copies thereof) and all other property belonging to the Company or relating to the Company, its affiliates or their businesses, upon termination of Executive's employment with the Company and its affiliates. 9 10. Rights and Remedies Upon Breach. (a) The Executive hereby acknowledges and agrees that the provisions contained in paragraphs 8 and 9 of this Agreement (the "Restrictive Covenants"), are reasonable and valid in duration and in all other respects. If any court of competent jurisdiction determines that any of the Restrictive Covenants, or any part thereof, is invalid or unenforceable, the remainder of the Restrictive Covenants will not thereby be affected and will be given full effect without regard to the invalid portions. If any restriction contained in paragraphs 8 or 9 hereof is deemed to be invalid, illegal or unenforceable by reason of the extent, duration or geographical scope thereof, or otherwise, then the court making such termination shall have the right to reduce such extent, duration, geographical scope or other provisions hereof, and in its reduced form such restriction shall then be enforceable in the manner contemplated hereby. (b) If the Executive breaches, or threatens to commit a breach of, any of the Restrictive Covenants, the Company will have the following rights and remedies, each of which rights and remedies will be independent of the others and severally enforceable, and each of which is in addition to, and not in lieu of, any other rights and remedies available to the Company under law or in equity: (i) Specific Performance. The right and remedy to have the Restrictive Covenants specifically enforced by any court of competent jurisdiction, it being agreed that any breach or threatened breach of the Restrictive Covenants would cause irreparable injury to the Company and that money damages would not provide an adequate remedy to the Company. (ii) Accounting. The right and remedy to require the Executive to account for and pay over to the Company all compensation, profits, monies, accruals, increments or other benefits derived or received by the Executive as the result of any action constituting a breach of the Restrictive Covenants. (iii) Cessation of Severance Benefits. The right and remedy to cease any further severance, benefit or other compensation payments under this Agreement to the Executive or the Executive's beneficiary from and after the commencement of such breach by the Executive. 11. Arbitration. The Company and Executive agree that any claim, dispute or controversy arising under or in connection with this Agreement (including, without limitation, any such claim, dispute or controversy arising under any federal, state or local statute, regulation or ordinance or any of the Company's employee benefit plans, policies or programs) shall be resolved solely and exclusively by binding arbitration. The arbitration shall be held in the city of Houston, Texas (or at such other location as shall be mutually agreed by the parties). The arbitration shall be conducted in accordance with the Expedited Employment Arbitration Rules (the "Rules") of the American Arbitration Association (the "AAA") in effect at the time of the arbitration, except that the arbitrator shall be selected by alternatively striking from a list of five arbitrators supplied by the AAA. All fees and expenses of the arbitration, including a transcript if 10 either requests, shall be borne equally by the parties. If Executive prevails as to any material issue presented to the arbitrator, the entire cost of such proceedings (including, without limitation, Executive's reasonable attorneys fees) shall be borne by the Company. If Executive does not prevail as to any material issue, each party will pay for the fees and expenses of its own attorneys, experts, witnesses, and preparation and presentation of proofs and post-hearing briefs (unless the party prevails on a claim for which attorney's fees are recoverable under the Rules). Any action to enforce or vacate the arbitrator's award shall be governed by the Federal Arbitration Act, if applicable, and otherwise by applicable state law. If either the Company or Executive pursues any claim, dispute or controversy against the other in a proceeding other than the arbitration provided for herein, the responding party shall be entitled to dismissal or injunctive relief regarding such action and recovery of all costs, losses and attorney's fees related to such action. Notwithstanding the provisions of this paragraph, either party may seek injunctive relief in a court of competent jurisdiction, whether or not the case is then pending before the panel of arbitrators. Following the court's determination of the injunction issue, the case shall continue in arbitration as provided herein. 12. Notices. Any notice provided for in this Agreement will be given in writing and will be delivered personally, telegraphed, telexed, sent by facsimile transmission or sent by certified, registered or express mail, postage prepaid. Any such notice will be deemed given when so delivered personally, telegraphed, telexed or sent by facsimile transmission, or, if mailed, on the date of actual receipt thereof. Notices will be properly addressed to the parties at their respective addresses set forth below or to such other address as either party may later specify by notice to the other in accordance with the provisions of this paragraph: If to the Company: Natco Group Inc. Brookhollow Central III 2950 North Loop West, Suite 750 Houston, Texas 77092 Attention: General Counsel If to the Executive: Richard W. FitzGerald 5411 Mountain View Creek Court Spring, TX 77379 13. Entire Agreement. This Agreement contains the entire agreement between the parties with respect to the subject matter hereof and supersedes all prior agreements, written or oral, with respect thereto, and any and all prior employment or severance agreements and related amendments entered into between the Company and the Executive. 14. Waivers and Amendments. This Agreement may be amended, superseded, canceled, renewed or extended, and the terms and conditions hereof may be waived, only by a written instrument signed by the parties hereto or, in the case of a waiver, by the party waiving compliance. No delay on the part of any party in exercising any right, power or privilege 11 hereunder will operate as a waiver thereof, nor will any waiver on the part of any party of any such right, power or privilege hereunder, nor any single or partial exercise of any right, power or privilege hereunder, preclude any other or further exercise thereof or the exercise of any other right, power or privilege hereunder. 15. Governing Law. This Agreement will be governed by and construed in accordance with the laws of the state of Texas (without giving effect to the choice of law provisions thereof), where the employment of the Executive will be deemed, in part, to be performed, and enforcement of this Agreement or any action taken or held with respect to this Agreement will be taken in the courts of appropriate jurisdiction in Houston, Texas. 16. Assignment. This Agreement, and any rights and obligations hereunder, may not be assigned by the Executive and may be assigned by the Company only to any successor in interest, whether by merger, consolidation, acquisition or the like, or to purchasers of substantially all of the assets of the Company. 17. Binding Agreement. This Agreement will inure to the benefit of and be binding upon the Company and its respective successors and assigns and the Executive and his legal representatives. 18. Counterparts. This Agreement may be executed in separate counterparts, each of which when so executed and delivered will be deemed an original, but all of which together will constitute one and the same instrument. 19. Headings. The headings in this Agreement are for reference purposes only and will not in any way affect the meaning or interpretation of this Agreement. 20. Authorization. The Company represents and warrants that the Board of Directors of the Company has authorized the execution of this Agreement. 21. Validity. The invalidity or unenforceability of any provisions of this Agreement will not affect the validity or enforceability of any other provisions of this Agreement, which will remain in full force and effect. 22. Tax Withholding. The Company will have the right to deduct from all benefits and/or payments made under this Agreement to the Executive any and all taxes required by law to be paid or withheld with respect to such benefits or payments. 23. No Contract of Employment. Nothing contained in this Agreement will be construed as a contract of employment between the Company or any of its affiliates and the Executive, as a right of the Executive to be continued in the employment of the Company or any of its affiliates, or as a limitation of the right of the Company or any of its affiliates to discharge the Executive with or without cause. 12 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. THE COMPANY NATCO GROUP INC. THE EXECUTIVE By /s/ NATHANIEL A. GREGORY /s/ RICHARD W. FITZGERALD ---------------------------- ----------------------------- Title: Chief Executive Officer Richard W. Fitzgerald 13 EX-10.37 5 h10469exv10w37.txt 2ND EXTENSION AGMT.FOR 2ND SERVICE & REIMBURSEMENT EXHIBIT 10.37 SECOND EXTENSION AGREEMENT FOR THE SECOND AMENDED AND RESTATED SERVICE AND REIMBURSEMENT AGREEMENT This Agreement extends the term of the attached Extension Agreement dated as of June 30, 2003 and the Second Amended and Restated Service and Reimbursement Agreement dated June 30, 2001 by and between Capricorn Management, G.P., a Delaware general partnership and NATCO Group Inc., a Delaware corporation (the "Reimbursement Agreement"). The term of the Extension Agreement was to have expired on September 30, 2003 and the Reimbursement Agreement was to have expired on June 30, 2003. The parties mutually agree to amend Section 5 and to extend the term of the Reimbursement Agreement for a second time to December 31, 2003. As modified hereby, the Reimbursement Agreement remains in full force and effect on the date hereof. In witness whereof, the parties hereto have executed this Second Extension Agreement as of September 30, 2003. CAPRICORN MANAGEMENT, G.P. By Winokur & Associates, Inc. by /s/ Herbert S. Winokur, Jr. ---------------------------- Herbert S. Winokur, Jr., Managing General Partner NATCO Group Inc. by /s/ Nathaniel A. Gregory -------------------------- Nathaniel A. Gregory, Chairman and CEO EXTENSION AGREEMENT FOR THE SECOND AMENDED AND RESTATED SERVICE AND REIMBURSEMENT AGREEMENT This Agreement extends the term of the attached Second Amended and Restated Service and Reimbursement Agreement dated as of June 30, 2001 by and between Capricorn Management, G.P., a Delaware general partnership and NATCO Group Inc., a Delaware corporation (the "Reimbursement Agreement"). The term of the Extension Agreement was to have expired on June 30, 2003, pursuant to Section 5 of such agreement. The parties mutually agree to amend Section 5 and to extend the term of the Reimbursement Agreement to September 30, 2003. As modified hereby, the Reimbursement Agreement remains in full force and effect on the date hereof. In witness whereof, the parties hereto have executed this Extension Agreement as of June 30, 2003. CAPRICORN MANAGEMENT, G.P. By Winokur & Associates, Inc. by /s/ Herbert S. Winokur, Jr. --------------------------- Herbert S. Winokur, Jr., Managing General Partner NATCO Group Inc. by /s/ Nathaniel A. Gregory ------------------------ Nathaniel A. Gregory, Chairman and CEO EX-31.1 6 h10469exv31w1.txt CERTIFICATION OF CEO PURSUANT TO SECTION 302 EXHIBIT 31.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER OF NATCO GROUP INC. PURSUANT TO 15 U.S.C. Section 7241, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Nathaniel A. Gregory, certify that: 1. I have reviewed this quarterly report on Form 10-Q of NATCO Group Inc. ("the Registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a - 15(e) and 15d - 15(e)) for the registrant and we have: a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 14, 2003 /s/ NATHANIEL A. GREGORY ---------------------------------- Nathaniel A. Gregory Chief Executive Officer EX-31.2 7 h10469exv31w2.txt CERTIFICATION OF CFO PURSUANT TO SECTION 302 EXHIBIT 31.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER OF NATCO GROUP INC. PURSUANT TO 15 U.S.C. Section 7241, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Richard W. FitzGerald, certify that: 1. I have reviewed this quarterly report on Form 10-Q of NATCO Group Inc. ("the Registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a - 15(e) and 15d - 15(e)) for the registrant and we have: a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 14, 2003 /s/ RICHARD W. FITZGERALD ------------------------------ Richard W. FitzGerald Senior Vice President and Chief Financial Officer EX-32.1 8 h10469exv32w1.txt CERTIFICATION OF CEO & CFO PURSUANT TO SECTION 906 EXHIBIT 32.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER OF NATCO GROUP INC. PURSUANT TO 18 U.S.C. Section 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2003 filed with the Securities and Exchange Commission (the "Report"), I, Nathaniel A. Gregory, Chief Executive Officer of NATCO Group Inc. (the "Company"), and, I, Richard W. FitzGerald, Senior Vice President and Chief Financial Officer of the Company, hereby certify, to my knowledge, that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ NATHANIEL A. GREGORY ---------------------------------- Name: Nathaniel A. Gregory Date: November 14, 2003 /s/ RICHARD W. FITZGERALD ---------------------------------- Name: Richard W. FitzGerald Date: November 14, 2003 -----END PRIVACY-ENHANCED MESSAGE-----