10-Q 1 h89817e10-q.txt ICO, INC. - DATED JUNE 30, 2001 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended June 30, 2001 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 0-10068 ICO, INC. ------------------------------------------------------ (Exact name of registrant as specified in its charter) Texas 76-0566682 ------------------------ ------------------------------------ (State of incorporation) (IRS Employer Identification Number) 5333 Westheimer, Suite 600, Houston, Texas 77056 ------------------------------------------ ------------ (Address of principal executive offices) (Zip Code) (713) 351-4100 ------------------ (Telephone Number) 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 --- --- Common stock, without par value 22,956,987 shares outstanding as of August 8, 2001 2 ICO, INC. INDEX TO QUARTERLY REPORT ON FORM 10-Q PAGE ------ PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets as of June 30, 2001 and September 30, 2000.................................................................................. 3 Consolidated Statements of Operations for the Three and Nine Months Ended June 30, 2001 and 2000....................................................................... 4 Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended June 30, 2001 and 2000.................................................. 5 Consolidated Statements of Cash Flows for the Nine Months Ended June 30, 2001 and 2000............................................................ 6 Notes to Consolidated Financial Statements.......................................................... 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................................... 13 Item 3. Quantitative and Qualitative Disclosures About Market Risks......................................... 20 PART II. OTHER INFORMATION Item 1. Legal Proceedings................................................................................... 22 Item 2. Changes in Securities (no response required)........................................................ - Item 3. Defaults upon Senior Securities (no response required).............................................. - Item 4. Submission of Matters to a Vote of Security Holders................................................. 22 Item 5. Other Information (no response required)............................................................ - Item 6. Exhibits and Reports on Form 8-K.................................................................... 22
The accompanying notes are an integral part of these financial statements. -2- 3 ICO, INC. CONSOLIDATED BALANCE SHEETS (Unaudited and in thousands, except share data)
JUNE 30, SEPTEMBER 30, 2001 2000 ------------------- -------------------- ASSETS Current assets: Cash and cash equivalents $ 24,284 $ 38,955 Trade accounts receivables (less allowance for doubtful accounts of $2,307 and $1,995, respectively) 62,784 59,349 Inventories 24,548 29,412 Deferred tax asset 2,661 2,936 Prepaid expenses and other 6,510 4,320 -------- -------- Total current assets 120,787 134,972 -------- -------- Property, plant and equipment, net 100,154 104,749 Goodwill 48,768 50,293 Deferred tax asset 7,510 3,417 Debt offering costs 2,830 3,178 Other 1,685 2,568 -------- -------- Total assets $281,734 $299,177 ======== ======== LIABILITIES, STOCKHOLDERS' EQUITY AND ACCUMULATED OTHER COMPREHENSIVE LOSS Current liabilities: Short-term borrowings and current portion of long-term debt $ 9,103 $ 10,339 Accounts payable 26,538 25,307 Accrued interest 1,051 4,129 Accrued salaries and wages 1,469 3,070 Income taxes payable 1,189 2,809 Other accrued expenses 12,798 11,600 -------- -------- Total current liabilities 52,148 57,254 Deferred income taxes 5,192 5,143 Long-term liabilities 1,240 1,272 Long-term debt, net of current portion 137,976 140,236 -------- -------- Total liabilities 196,556 203,905 -------- -------- Commitments and contingencies Stockholders' equity: Preferred stock, without par value - 500,000 shares authorized; 322,500 shares issued and outstanding with a liquidation preference of $32,250 13 13 Junior participating preferred stock, without par value - 50,000 shares authorized; 0 shares issued and outstanding -- -- Common stock, without par value - 50,000,000 shares authorized; 22,716,987 and 22,678,107 shares issued and outstanding, respectively 40,294 40,236 Additional paid-in capital 105,333 105,333 Accumulated other comprehensive loss (15,003) (13,230) Accumulated deficit (45,459) (37,080) -------- -------- Total stockholders' equity 85,178 95,272 -------- -------- Total liabilities and stockholders' equity $281,734 $299,177 ======== ========
The accompanying notes are an integral part of these financial statements. -3- 4 ICO, INC. CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited and in thousands, except share data)
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ------------------------------- -------------------------------- 2001 2000 2001 2000 ------------- -------------- -------------- ------------- Revenues: Polymer processing sales and services $50,222 $58,178 $152,687 $165,057 Oilfield sales and services 32,332 27,278 97,419 76,106 ------- ------- -------- -------- Total net revenues 82,554 85,456 250,106 241,163 ------- ------- -------- -------- Cost and expenses: Cost of sales and services 64,657 66,198 194,425 184,872 Selling, general and administrative 11,873 10,092 34,304 30,905 Depreciation 3,272 3,502 9,858 10,468 Amortization of intangibles 590 600 1,814 1,903 Severance expenses 7,410 -- 7,953 -- Litigation reserve 500 -- 500 -- Loss on disposition of fixed assets 253 103 215 169 Impairment of long-lived assets -- -- 650 -- ------- - ------- -------- -------- 88,555 80,495 249,719 228,317 ------- ------- -------- -------- Operating income (loss) (6,001) 4,961 387 12,846 ------- - ------- -------- -------- Other income (expense): Interest income 387 559 1,515 1,664 Interest expense (3,580) (3,632) (10,870) (10,746) ------- ------- -------- -------- (3,193) (3,073) (9,355) (9,082) ------- ------- -------- -------- Income (loss) before taxes (9,194) 1,888 (8,968) 3,764 Provision (benefit) for income taxes (2,990) 894 (2,221) 2,184 ------- ------- -------- -------- Net income (loss) $(6,204) $ 994 $ (6,747) $ 1,580 ------- ------- -------- -------- Preferred dividends (544) (544) (1,632) (1,632) ------- ------- -------- --------- Net income (loss) applicable to common stock $(6,748) $ 450 $ (8,379) $ (52) ------- ======= ======== ======== Basic and diluted earnings (loss) per share (see Note 3) $ (0.30) $ 0.02 $ (0.37) $ (0.00) ======= ======= ======== ========
The accompanying notes are an integral part of these financial statements. -4- 5 ICO, INC. CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS) (Unaudited and in thousands)
THREE MONTHS NINE MONTHS ENDED JUNE 30 ENDED JUNE 30 ------------------------- -------------------------- 2001 2000 2001 2000 ----------- ----------- ----------- ------------ Net income (loss) $(6,204) $ 994 $(6,747) $ 1,580 Other comprehensive loss Foreign currency translation adjustment (356) -- (1,812) -- Unrealized gain (loss) on foreign currency hedges (66) (1,480) 39 (5,250) ------- ------ ------- ------ Comprehensive income (loss) $(6,626) $ (486) $(8,520) $(3,670) ------- ======== ======= =======
The accompanying notes are an integral part of these financial statements. -5- 6 ICO, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited and in thousands)
NINE MONTHS ENDED JUNE 30, ----------------------------------------- 2001 2000 --------------- --------------- Cash flows from operating activities: Net income (loss) $ (6,747) $ 1,580 Adjustments to reconcile net income to net cash provided by (used for) operating activities: Depreciation and amortization 11,672 12,371 Impairment of long-lived assets 650 -- Loss on disposition of fixed assets 215 169 Changes in assets and liabilities, net of the effects of business acquisitions: Receivables (4,306) (11,228) Inventories 4,198 (4,160) Prepaid expenses and other assets (1,983) (1,191) Income taxes payable (1,667) 1,567 Deferred taxes (3,373) 465 Accounts payable 1,836 5,850 Accrued interest (3,078) (3,102) Accrued expenses (590) (1,046) -------- -------- Total adjustments 3,574 (305) -------- -------- Net cash provided by (used for) operating activities (3,173) 1,275 -------- -------- Cash flows used for investing activities: Capital expenditures (8,227) (8,552) Dispositions of property, plant and equipment 788 462 -------- -------- Net cash used for investing activities (7,439) (8,090) -------- -------- Cash flows provided by (used for) financing activities: Common stock transactions 37 -- Payment of dividend on preferred stock (1,632) (1,632) Proceeds from debt 1,206 6,967 Reductions of debt (3,583) (2,173) -------- -------- Net cash provided by (used for) financing activities (3,972) 3,162 -------- -------- Effect of exchange rates on cash (87) (263) -------- -------- Net decrease in cash and equivalents (14,671) (3,916) Cash and equivalents at beginning of period 38,955 37,439 -------- -------- Cash and equivalents at end of period $ 24,284 $ 33,523 ======== ======== Supplemental disclosures of cash flow information: Cash received (paid) during the period for: Interest received $ 1,667 $ 1,664 Interest paid (13,934) (13,807) Income taxes paid (3,209) (541)
The accompanying notes are an integral part of these financial statements. -6- 7 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE 1. BASIS OF FINANCIAL STATEMENTS The accompanying unaudited consolidated financial statements have been prepared in accordance with Rule 10-01 of Regulation S-X, "Interim Financial Statements," and accordingly do not include all information and footnotes required under generally accepted accounting principles for complete financial statements. The financial statements have been prepared in conformity with the accounting principles and practices as disclosed in the Annual Report on Form 10-K for the year ended September 30, 2000 for ICO, Inc. (the "Company"). In the opinion of management, these interim financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the Company's financial position as of June 30, 2001, the results of operations for the three and nine months ended June 30, 2001 and 2000 and the changes in its cash position for the nine months ended June 30, 2001 and 2000. Results of operations for the nine-month period ended June 30, 2001 are not necessarily indicative of the results that may be expected for the year ending September 30, 2001. For additional information, refer to the consolidated financial statements and footnotes included in the Company's Annual Report on Form 10-K for the year ended September 30, 2000. NOTE 2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS At June 30, 2001, the Financial Accounting Standard Board issued Statement of Financial Accounting Standards No. 141 (SFAS 141), Business Combinations, which requires that all business combinations be accounted for using the purchase method. In addition, this Statement requires that intangible assets be recognized as assets apart from goodwill if certain criteria are met. As the provisions of this Statement apply to all business combinations initiated after June 30, 2001, Management will consider the impact of this statement for future combinations. At June 30, 2001, the Financial Accounting Standard Board issued Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Other Intangible Assets, which established Standards for reporting acquired goodwill and other intangible assets. This Statement accounts for goodwill based on the reporting units of the combined entity into which an acquired entity is integrated. In accordance with the statement goodwill and indefinite lived intangible assets will not be amortized, goodwill will be tested for impairment at least annually at the reporting unit level, intangible assets deemed to have an indefinite life will be tested for impairment at least annually, and the amortization period of intangible assets with finite lives will not be limited to forty years. The provisions of this Statement are required to be applied starting with fiscal years beginning after December 15, 2001 (October 1, 2002 for the Company) with early application permitted for entities with fiscal years beginning after March 15, 2001. The Company has $48,768,000 million of goodwill included in its balance sheet at June 30, 2001. Goodwill amortization for the nine months ended June 30, 2001 was approximately $1,072,000 and is currently expected to approximate $1,430,000 for the year ended September 30, 2001 before the provisions of SFAS 142 are applied. Implementation of SFAS 142 by the Company would result in elimination of amortization of goodwill from acquisition under the purchase method of accounting. -7- 8 NOTE 3. EARNINGS PER SHARE AND STOCKHOLDERS' EQUITY Earnings per share is based on earnings applicable to common shareholders and is calculated using the weighted average number of common shares outstanding. During the three and nine months ended June 30, 2001 and June 30, 2000, the potentially dilutive effects of the Company's exchangeable preferred stock (which would have an anti-dilutive effect) and common stock options and warrants, with exercise prices exceeding fair market value of the underlying common shares, have been excluded from diluted earnings per share. Additionally, the potentially dilutive effects of common stock options have been excluded from diluted earnings per share for those periods in which the Company generated a net loss. The total amount of anti-dilutive securities for both the three and nine months ended June 30, 2001 was 5,537,000 compared to 5,642,000 and 5,694,000 for the three and nine months ended June 30, 2000, respectively.
THREE MONTHS ENDED JUNE 30, --------------------------------------------------------------------------------------- 2001 2000 -------------------------------------- -------------------------------------------- (In thousands, except share data) Income Shares Amount Income Shares Amount --------- ----------- --------- -------- ---------- -------- Net income (loss) $(6,204) $ 994 Less: Preferred stock dividends 544 544 ------- ------- BASIC EPS $(6,748) 22,708,383 $ (.30) $ 450 22,406,506 $ .02 EFFECT OF DILUTIVE SECURITIES Options -- -- -- -- 52,034 -- ------- ------------ --------- ------- ---------- -------- DILUTED EPS $(6,748) 22,708,383 $ (.30) $ 450 22,458,540 $ .02 ======= ============ ========= ======= ========== ========
NINE MONTHS ENDED JUNE 30, --------------------------------------------------------------------------------------- 2001 2000 ------------------------------------- -------------------------------------------- (In thousands, except share data) Income Shares Amount Income Shares Amount --------- ----------- --------- -------- ---------- -------- Net income (loss) $(6,747) $ 1,580 Less: Preferred stock dividends 1,632 1,632 ------- ------- BASIC EPS $(8,379) 22,694,119 $ (.37) $ (52) 22,406,506 $ (0.00) EFFECT OF DILUTIVE SECURITIES Options -- -- -- -- -- -- ------- ---------- -------- ------- ---------- ------- DILUTED EPS $(8,379) 22,694,119 $ (.37) $ (52) 22,406,506 $ (0.00) ======= ========== ======== ======= ========== =======
NOTE 4. INVENTORIES Inventories consisted of the following:
JUNE 30, 2001 SEPTEMBER 30, 2000 ------------- ------------------ (In thousands) Finished Goods $11,529 $13,073 Raw Materials 9,152 11,668 Supplies 3,247 3,441 Work in Progress 620 1,230 ------- ------- $24,548 $29,412 ======= =======
-8- 9 NOTE 5. SEGMENT AND FOREIGN OPERATIONS INFORMATION The Company's two reportable segments consist of the primary products and services provided by the Company to customers: Polymer Processing Services and Oilfield Services. The Polymer Processing segment provides size reduction, compounding, concentrates manufacturing, distribution and related services. The primary customers of the Polymer Processing segment include large producers of polymers and end users such as rotational molders and polymer distributors. The Oilfield Service business segment provides oilfield tubular and sucker rod inspection, reconditioning and coating services and also sells equipment to customers. This segment's customers include leading integrated oil companies, large independent oil and gas exploration and production companies, drilling contractors, steel producers and processors and oilfield supply companies. There are no material inter-segment revenues included in the segment information disclosed below. The Company evaluates the performance of its segments based upon revenues and operating income. Summarized financial information of the Company's reportable segments for the three and nine months ended June 30, 2001 and 2000 is shown in the following tables.
POLYMER OTHER PROCESSING OILFIELD RECONCILING SERVICES SERVICES ITEMS* TOTAL ------------------- ------------------ ---------------- --------------- (in thousands) THREE MONTHS ENDED JUNE 30, 2001 Revenues $50,222 $32,332 -- $82,554 Operating income (loss) 165 5,028 $(11,194) (6,001) Depreciation 1,970 1,198 104 3,272 Amortization of intangibles 403 63 124 590 Severance expenses 10 -- 7,400 7,410 Impairment of long-lived assets -- -- -- -- (Gain)/loss on sale of fixed assets 684 (431) -- 253 THREE MONTHS ENDED JUNE 30, 2000 Revenues $58,178 $27,278 -- $85,456 Operating income (loss) 3,715 3,390 $ (2,144) 4,961 Depreciation 2,031 1,337 134 3,502 Amortization of intangibles 422 64 114 600 (Gain)/loss on sale of fixed assets 49 52 2 103 NINE MONTHS ENDED JUNE 30, 2001 Revenues $152,687 $97,419 -- $250,106 Operating income (loss) 1,558 15,506 $(16,677) 387 Depreciation 5,852 3,685 321 9,858 Amortization of intangibles 1,253 190 371 1,814 Severance expenses 553 -- 7,400 7,953 Impairment of long-lived assets 650 -- -- 650 (Gain)/loss on sale of fixed assets 678 (463) -- 215 NINE MONTHS ENDED JUNE 30, 2000 Revenues $165,057 $76,106 -- $241,163 Operating income (loss) 11,401 8,538 $ (7,093) 12,846 Depreciation 6,170 3,948 350 10,468 Amortization of intangibles 1,338 193 372 1,903 (Gain)/loss on sale of fixed assets 125 42 2 169
* Consists primarily of corporate overhead expenses.
POLYMER OTHER PROCESSING OILFIELD RECONCILING SERVICES SERVICES ITEMS ** TOTAL ------------------- ------------------ ---------------- --------------- (in thousands) AS OF JUNE 30, 2001 Total Assets $161,733 $82,467 $37,534 $281,734
** Consists of unallocated corporate assets including: cash, deferred tax assets, unamortized bond offering expenses, and corporate furniture and equipment. -9- 10 A reconciliation of total segment operating income (loss) to consolidated income (loss) before taxes is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ------------------------------------- -------------------------------------- 2001 2000 2001 2000 ---------------- ---------------- ---------------- ----------------- (in thousands) Total operating income (loss) for reportable segments $(6,001) $ 4,961 $ 387 $ 12,846 Interest income 387 559 1,515 1,664 Interest expense (3,580) (3,632) (10,870) (10,746) ------- ------- -------- -------- Consolidated income (loss) before income taxes $(9,194) $ 1,888 $ (8,968) $ 3,764 ======= ======= ======== ========
NOTE 6. FISCAL 2001 CHARGES During the third quarter of fiscal 2001, the Company recognized (i.) a $7,410,000 charge for severance obligations relating to the termination of Asher Pacholder (Chairman and Chief Financial Officer), Sylvia Pacholder (President and Chief Executive Officer), Robin Pacholder (President-Wedco North America), David Gerst (Senior Vice President and General Counsel) and Tom Pacholder (Senior Vice President- Wedco) (collectively referred to as the "Pacholder Group"), such terminations being discussed in the Company's press release dated June 7, 2001, and (ii.) a $500,000 charge for litigation relating to one of the personal injury claims alleging exposure to silica, resulting in silicosis-related disease. See "Note 7. Legal Proceedings". In connection with the termination of the Pacholder Group, the Company established and funded an escrow account containing $3,113,000 in cash. The purpose of the escrow account is to pay federal excise tax pursuant to IRS Code Sec. 280(g) in the event there is a "change of control", as defined by the IRS regulations, within one year of the Pacholder Group's termination. Due to the uncertainty surrounding whether the excise tax will be due, the $3,113,000 has not been reflected as an expense during the nine months ended June 30, 2001 and Also, the escrow balance has been reclassified to "prepaid expenses and other current assets" from cash on the Company's June 30, 2001 balance sheet. Also, should a "change of control", as defined, occur within one year of the severance date, a significant portion of the tax asset the Company has recognized, relating to the future benefit of deducting the $7,400,000 severance charge, will no longer be an allowable deduction for tax purposes. During the second quarter of fiscal 2001, the Company closed a non-core polymer processing operation and recognized a $650,000 charge for the difference between the book value of the operation's net assets and expected liquidation value. Also, during the second quarter of fiscal 2001, the Company terminated certain polymer processing employees and recognized related severance expenses of $543,000. NOTE 7 LEGAL PROCEEDINGS The Company is a named defendant in four cases involving four plaintiffs for personal injury claims alleging exposure to silica resulting in silicosis-related disease. The first three of these cases were initiated, respectively, on May 13, 1991 (by Odilon Martinez, et al., in Texas state court in Ector County), November 21, 1991 (by Roberto Bustillos, et al., in Texas state court in Ector County), and January 4, 2000 (by Pilar Olivas, et al., in Texas state court in Harris County). The fourth case was filed (in Texas state court in Harris County) by James Petty, who intervened as a plaintiff in litigation filed by Paul Roark (the "Roark litigation," described below). Plaintiff Paul Roark's claims against the Company and Baker Hughes, Inc. ("Baker Hughes") were settled during the fourth quarter of fiscal 2000, but Roark's case against the remaining defendants had not yet been resolved at the time of Petty's intervention. The Company consented to service by Petty during the second quarter of fiscal 2001. Generally, the Company is protected under -10- 11 workers' compensation law from claims under these suits except to the extent a judgment is awarded against the Company for an intentional tort. The standard of liability applicable to all but one of the Company's pending personal injury cases alleging exposure to silica is intentional tort, a stricter standard than the gross neglect standard applicable to wrongful death cases. As with the Roark litigation, the pending claim of Petty (the "Petty litigation") involves negligence claims that, in theory, could circumvent the Company's immunity protections under the workers' compensation law. Like the Roark litigation, the Petty litigation names the Company and Baker Hughes, among others, as defendants, and falls within the provisions of a December 1996 agreement between the Company and Baker Hughes (described below) that limits the Company's obligations in the litigation. The terms of the settlement in the Roark litigation did not have a material adverse effect on the Company's financial condition or results of operations. It is not anticipated that the Petty litigation will have a material adverse effect on the Company's financial condition. The Company currently has one pending silicosis-related suit in which wrongful death is alleged. This case was filed on April 4, 2000 by Delma Orozco, individually and as representative of the estate of Lazaro Orozco, et al., in Texas state court in Ector County. In fiscal 1993, the Company settled two other silicosis-related suits, both of which alleged wrongful death caused by silicosis-related diseases, which resulted in a total charge of $605,000. In fiscal 1993, the Company was dismissed without liability from two suits alleging intentional tort against the Company for silicosis-related disease. In fiscal 1994, the Company received an instructed verdict (i.e., no liability was found) in two claims alleging intentional tort against the Company for silicosis-related disease. In fiscal 1995, the Company was dismissed without liability in three cases alleging intentional tort against the Company for silicosis-related disease, and the Company received an instructed verdict in two other intentional tort cases. In fiscal 1996, the Company obtained a non-suit in two intentional tort cases. In fiscal 1997, the Company was non-suited in two additional tort cases. In fiscal 1998, two cases involving alleged silicosis-related deaths were settled, and in fiscal 1999 an additional case alleging a silicosis-related death was settled. The Company was fully insured for all three of these settled cases and, as a result, did not incur any settlement costs. During fiscal 1998, the Company was non-suited in one intentional tort case, and during fiscal 1999, the Company was non-suited in three intentional tort cases. During the third quarter of fiscal 2000, the Company was non-suited in two silicosis-related intentional tort cases. During the second quarter of fiscal 2001, the Company was non-suited in a silicosis-related intentional tort case. The Company and its counsel cannot, at this time, predict with any reasonable certainty the outcome of any of the remaining silicosis-related suits or whether or in what circumstances additional suits may be filed. Except as described below, the Company does not believe, however, that such suits will have a material adverse effect on its financial condition, results of operations or cash flows. The Company has in effect, in some instances, general liability and employer's liability insurance policies applicable to the referenced suits; however, the extent and amount of coverage is limited and the Company has been advised by certain insurance carriers of a reservation of rights with regard to policy obligations pertaining to the suits because of various exclusions in the policies. If an adverse judgment is obtained against the Company in any of the referenced suits which is ultimately determined not to be covered by insurance, the amount of such judgment could have a material adverse effect on the financial condition, results of operations or cash flows of the Company. The Company's agreement with Baker Hughes, pursuant to which Baker Hughes Tubular Services ("BHTS") was acquired by the Company, provides that Baker Hughes will reimburse the Company for 50% of the BHTS environmental remediation costs in excess of $318,000, with Baker Hughes' total reimbursement obligation being limited to $2,000,000 (current BHTS obligation is limited to $1,650,000). BHTS is a responsible party at two hazardous waste disposal sites that are currently undergoing remediation pursuant to the Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA"). Under CERCLA, persons who were responsible for generating the hazardous waste disposed of at a site where hazardous substances are being released into the environment are jointly and severally liable for the costs of cleaning up environmental contamination, and it is not uncommon for neighboring landowners and other third parties to file claims for personal injuries and property damage allegedly caused by hazardous substances released into the environment. The two sites where BHTS is a responsible party are the French Limited site northeast of Houston, Texas and the Sheridan site near Hempstead, Texas. Remediation of the French Limited site has been completed, with only natural attenuation of contaminants in groundwater occurring at this time. Remediation has not yet commenced at the Sheridan site. Current plans for cleanup of this site, as set forth in the federal Record of Decision, call for on-site bioremediation of the soils in tanks and natural attenuation of contaminants in the groundwater. However, treatability studies to evaluate possible new remedies for the soils, such as in-place bioremediation, are being conducted as part of a Remedial Technology Review Program. Based on the completed status of the remediation at the French Limited site and BHTS's minimal contribution of wastes at both of the sites, the Company believes that its future liability under the agreement with Baker Hughes with respect to these two sites will not be material to the Company's financial condition, -11- 12 results of operations or cash flows. During December 1996, an agreement was signed by the Company and Baker Hughes to settle the litigation of a dispute concerning the assumption of certain liabilities in connection with the acquisition of BHTS in 1992. The agreement stipulates that with regard to future occupational health claims, the parties shall share costs equally with the Company's obligations being limited to $500,000 for each claim and a maximum contingent liability of $5,000,000 ($4,500,000 net of payments the Company has made to date pursuant to the terms of the agreement) in the aggregate, for all claims. This agreement governed the Company's liability with respect to the Roark litigation, which involved occupational health claims arising out of Roark's employment at BHTS. This agreement also governs the Company's liability with respect to the Petty litigation, which involves occupational health claims arising out of Petty's employment at BHTS. On November 21, 1997, in an action initiated by the Company in October 1994, a Texas state court jury awarded the Company approximately $13,000,000 in the trial of its case against John Wood Group PLC relating to the 1994 contract for the purchase of the operating assets of NDT Systems, Inc. and certain related entities. The trial court subsequently entered a judgment for $15,750,000 in the Company's favor, which includes pre-judgment interest on the jury award. The Wood Group appealed the judgment. On March 9, 2000, the Court of Appeals for the First District of Texas reversed the judgment entered by the trial court and, as to all but one of ICO's claims, ordered that ICO have no recovery. As to that remaining breach of contract claim seeking recovery of a contract payment of $500,000, the Court of Appeals remanded the cause to the trial court for further proceedings. The Court of Appeals overruled ICO's motion for rehearing and rehearing en banc. ICO filed a petition for review in the Texas Supreme Court and the Texas Supreme Court denied ICO's petition for review on February 8, 2001. ICO filed a motion for rehearing from the Texas Supreme Court's denial of ICO's petition for review. On March 29, 2001, the Texas Supreme Court denied ICO's motion for rehearing from the Texas Supreme Court's denial of ICO's petition for review. ICO will seek further relief in the district court on the portion of the case remanded by the Court of Appeals. ICO Tubular Services, Inc., a now-defunct subsidiary of the Company, has been named as a Respondent in an arbitration claim made on August 7, 1998, by Oil Country Tubular Limited ("OCTL"), a company based in India. The claim arises out of a transaction between OCTL and BHTS whereby BHTS sold a plant in Canada to OCTL and entered into a separate Foreign Collaboration Agreement (FCA) to provide certain practical and technical assistance in setting up the plant and making it operational in India. OCTL paid $2,400,000 for the FCA and $2,800,000 for equipment for the plant. In its claim brought in the Court of Arbitration of the International Chamber of Commerce ("ICC"), OCTL claims, among other items, it did not receive technical assistance, technical data, spare parts and certain raw materials that were necessary for its oilfield tubular services plant in India and that BHTS owed it under the FCA. The Company is involved by virtue of its acquisition in 1992 of BHTS. The Company had only peripheral knowledge of the dispute between OCTL and Baker Hughes prior to the filing of OCTL's claim. The Company objected to the jurisdiction of the arbitration tribunal on the ground that the Company is not a party to the FCA, the FCA having been assigned to Tuboscope Incorporated prior to ICO's purchase of BHTS. After a hearing on that objection, the arbitral tribunal entered a decision in March 2000, holding that it did have jurisdiction over the Company. OCTL submitted an Amended Statement of Claim in November 2000, in which it claimed nine different breaches of the FCA. Although the Company was not involved in the actions made the basis of OCTL's claims, its reconstruction of events indicates that BHTS supplied OCTL with a fully operational plant and that OCTL's difficulties, such as they were, resulted from external causes. The total amount of OCTL's claims exceeds $30,000,000. It has alleged approximately $8,700,000 in losses due to past contractual breaches, plus approximately $7,900,000 in "liquidated damages" it claims to have paid to third parties because of production losses that allegedly resulted from contractual breaches and an unspecified amount of damages from lost sales. While the outcome of this arbitration matter cannot be predicted, the Company plans to continue to contest the claims vigorously. Regardless of the liability of facts, the Company believes the damage claim is exaggerated. If the ICC arbitral panel should enter an award against the Company, the Company, Baker Hughes and Tuboscope have entered into a separate agreement to arbitrate which entity would be responsible to pay the award. On May 11, 2001, an individual shareholder filed a lawsuit in Texas state court in Harris County against the Company, its directors, two of the Company's former officers/directors, and Travis Street Partners, L.L.C. ("TSP"), alleging breach of fiduciary duty in connection with TSP's offer to buy the Company. The lawsuit also alleges that certain severance payments made by the Company to two of the Company's former officers/directors constitutes a -12- 13 misappropriation of assets. The individual shareholder plaintiff filed suit on behalf of himself and derivatively on behalf of the Company, and has requested that the suit be maintained as a class action and that he be certified as the class representative. Plaintiff seeks an unspecified amount of damages. The Company has entered into an agreement with the plaintiff which, for now, indefinitely extends the time for the Company to file a responsive answer to the lawsuit. The Company is also named as a defendant in certain other lawsuits arising in the ordinary course of business. The outcome of these lawsuits cannot be predicted with certainty. NOTE 8. LETTER OF INTENT TO SELL THE OILFIELD SERVICES BUSINESS On March 26, 2001, the Company issued a press release announcing that it had signed a non-binding letter of intent with Varco International, Inc. ("Varco"), providing for Varco's proposed acquisition of ICO's Oilfield Services business segment for $165 million in cash. This letter of intent has expired by its terms, however, the Company and Varco are continuing at this time to discuss the terms of a possible transaction. Any such transaction is subject to negotiation of mutually agreeable terms, execution of definitive agreements, receipt of regulatory approvals and other customary conditions. In addition, the execution of any definitive agreement would be subject to Varco's satisfactory completion of its due diligence, board of directors approval and the obtaining of appropriate financing. NOTE 9. ACQUISITION PROPOSAL Travis Street Partners, LLC ("TSP") has made various proposals to acquire the Company or certain of its operations. In a letter dated May 9, 2001, TSP proposed to pay $3.10 for each issued and outstanding share of the common stock of the Company, subject to the terms and conditions set forth in TSP's letter. TSP's three nominees were elected to the Company's board of directors at the 2001 Annual Meeting. These directors are A. John Knapp, Charles T. McCord, III. and James D. Calaway, each of whom is a member of TSP. Also on June 7, 2001, Christopher N. O'Sullivan was named as Vice Chairman and Chief Financial Officer of the Company and Timothy J. Gollin was named President and Chief Executive Officer of the Company. Messrs. O'Sullivan and Gollin are representatives of and have an equity interest in TSP. On June 8, 2001, the Company established a Special Committee consisting of the independent directors to consider the acquisition proposal from TSP and any other acquisition proposals that may be received by ICO. The Special Committee has retained legal counsel and financial advisors to assist in the evaluation and review of the TSP proposal. In an August 3, 2001 letter to TSP, the Special Committee said it was recommending against the TSP proposal dated May 9, 2001 as currently constructed because the proposal was contingent on the successful completion of the previously-announced sale of ICO's Oilfield Services division to Varco, International, Inc. on terms acceptable to TSP. Additionally, the special committee objected to TSP's proposed breakup fee. The Special Committee requested TSP to revise its offer to eliminate the contingencies and provide a financing commitment letter to the committee to enable it to make a reasonable evaluation. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The statements contained in all parts of this document, including, but not limited to, timing of new services or facilities, ability to compete, effects of compliance with laws, matters relating to operating facilities, effect and cost of litigation and remediation, future liquidity, future capital expenditures, future acquisitions, future market conditions, reductions in expenses, derivative transactions, marketing plans, demand for the Company's products and services, future growth plans, oil and gas company spending, completion, timing or effect of the sale of the Company's Oilfield Service business segment, financial results, and any other statements which are not historical facts are forward-looking statements within the meaning of section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that involve substantial risks and uncertainties. When words such as "anticipate," "believe," "estimate," "intend," "expect," "plan" and similar expressions are used, they are intended to identify the statements as forward-looking. Actual results, performance or achievements can differ materially from results suggested by these forward-looking statements due to a number of factors, including effects of the Company's indebtedness, the state of the oil and gas industry, demand for the Company's products and services, oil and gas prices, the rig count, the effect of the business cycle and the level of business activity, the Company's proprietary technology, risks relating to acquisitions, the Company's ability to integrate -13- 14 specialty chemical operations and to manage any growth, the risks of international operations and currency risks, operations risks and risks regarding regulation, risks related to the proposed sale of Oilfield Services including the risk that the Company and Varco will not be able to agree upon mutually acceptable terms or a binding definitive agreement, the ability of Varco to obtain financing for the transaction, receipt of necessary regulatory approvals and satisfaction of closing conditions as well as those described in the Company's annual report on Form 10-K for the fiscal year ended September 30, 2000. INTRODUCTION The Company has two operating segments: Polymer Processing and Oilfield Services. Polymer Processing revenues are derived from (1) grinding polymers and other materials into powders (size reduction) using a variety of methods, including ambient grinding, cryogenic grinding and jet milling, providing ancillary services and selling grinding and other equipment manufactured by the Company, (2) compounding sales and services, which include the manufacture and sale of concentrates and (3) distributing plastic powders. The Company's distribution operations typically utilize the Company's size reduction and compounding facilities to process polymer products prior to sale. Oilfield Service revenues include revenues derived from (1) exploration sales and services (new tubular goods inspection), (2) production sales and services (reclamation, reconditioning and inspection of used tubular goods and sucker rods), (3) corrosion control services (coating of tubular goods and sucker rods) and (4) other sales and services (transportation services and oilfield engine sales and services in Canada). Service revenues in both of the Company's business segments are recognized as the services are performed or, in the case of product sales, revenues are generally recognized upon shipment to third parties. Cost of sales and services for the Polymer Processing and Oilfield Services segments is primarily comprised of compensation and benefits to non-administrative employees, occupancy costs, repair and maintenance, electricity and equipment costs and supplies, and, in the case of concentrate manufacturing operations and the Company's distribution business, purchased raw materials. Selling, general and administrative expenses consist primarily of compensation and related benefits to the sales and marketing, executive management, management information system support, accounting, legal, human resources and other administrative employees of the Company, other sales and marketing expenses, communications costs, systems costs, insurance costs and legal and accounting professional fees. Gross profits as a percentage of revenue for the distribution and concentrate manufacturing businesses generally are significantly lower than those generated by the Company's size reduction services. Several of the Company's polymer processing subsidiaries, including the Company's concentrate manufacturing and distribution operations, typically buy raw materials, improve the material and then sell the finished product. In contrast, many of the Company's size reduction operations, particularly the U.S. locations, typically involve processing customer-owned material (referred to as toll processing). The Company's distribution businesses are, however, less capital intensive relative to the Company's other polymer businesses, and both the distribution and concentrate manufacturing businesses generally generate good returns on invested capital. Performing distribution activities also allows the Company's processing operations to be scheduled more efficiently and enhances the Company's relationships with the end users of the processed material. Demand for the Company's polymer processing products and services tends to be driven by overall economic factors and, particularly, consumer spending. The trend of applicable resin prices also impacts customer demand. As resin prices are falling, customers tend to reduce their inventories and, therefore, reduce their need for the Company's products and services. Conversely, as resin prices are rising, customers often increase their inventories and accelerate their purchases of products and services from the Company. Additionally, demand for the Company's Polymer Processing revenues tends to be seasonal, with customer demand being weakest during the Company's first fiscal quarter due to the holiday season and also due to property taxes levied in the U.S. on customers' inventories on December 31. The Company's fourth fiscal quarter also tends to be softer compared to the Company's second and third fiscal quarters, in terms of customer demand, due to vacation periods in the Company's European markets. The demand for the Company's Oilfield products and services depends upon oil and natural gas prices and the level of oil and natural gas production and exploration activity. In addition to changes in commodity prices, exploration and production activities are affected by worldwide economic conditions, supply and demand for oil and natural gas, seasonal trends and the political stability of oil-producing countries. The oil and gas industry has been highly volatile over the past several years, due primarily to the volatility of oil and natural gas prices. During fiscal 1996 and 1997, the oil and gas service industry generally experienced increased demand and improved product and service pricing as a result of improved commodity prices and greater levels of oil and gas exploration and production activity, due largely to a strong -14- 15 world economy. In fiscal 1998, however, oil prices declined significantly versus fiscal 1997 levels. While gas prices also declined during this period, they declined to a lesser extent. These trends were attributed to, among other factors, an excess worldwide oil supply, lower domestic energy demand resulting from an unseasonably warm winter and a decline in demand due to the economic downturn in Southeast Asia. As oil and, to a lesser extent, natural gas prices declined during this period, demand for oilfield products and services, including those provided by the Company, softened. Oil and gas prices continued to fall sharply in the first half of fiscal 1999, with oil prices (as measured by the spot market price for West Texas Intermediate Crude) reaching a low of less than $11.00 per barrel and natural gas prices (as measured by the Henry Hub spot market price) reaching a low of $1.65 per mcf during the first quarter of fiscal 1999. This 25-year low, in real dollar terms, resulted in extremely depressed levels of oilfield exploration and production activity with the U.S. drilling rig count falling to an average of only 523 rigs during the third quarter of fiscal 1999. The Company's oilfield service revenues and income were adversely impacted by these factors. Over the course of fiscal 2000, oil and gas prices generally increased. During the first half of fiscal 2001 average oil and gas prices rose significantly compared to the same period in fiscal 2000. These trends have resulted in a strong recovery in demand for oilfield services generally, including those provided by the Company, with the U.S. rig count rising to an average of 1,237 during the third quarter of fiscal 2001. LIQUIDITY AND CAPITAL RESOURCES The following are considered by management as key measures of liquidity applicable to the Company:
JUNE 30, 2001 SEPTEMBER 30, 2000 ------------- ------------------ Cash and cash equivalents $24,284,000 $38,955,000 Working capital 68,639,000 77,718,000 Current ratio 2.3 2.4 Debt-to-capitalization .63 to 1 .61 to 1
Cash and cash equivalents decreased $14,671,000 and net working capital declined $9,079,000 during the nine months ended June 30, 2001 due to the factors described below. Net working capital, excluding cash, increased $5,592,000 during the nine months ended June 30, 2001. For the nine months ended June 30, 2001, cash used for operating activities was $3,173,000 compared to cash provided by operating activities of $1,275,000 for the nine months ended June 30, 2000. This change occurred due to lower net income and the various changes in working capital accounts. Capital expenditures totaled $8,227,000 during the nine months ended June 30, 2001, of which $4,361,000 related to the polymer processing business, and $3,866,000 related to the oilfield services business. These expenditures were made primarily to expand the Company's operating capacity. The Company anticipates that available cash and/or existing credit facilities will be sufficient to fund remaining fiscal 2001 capital expenditure requirements. Cash used for financing activities was $3,972,000 during the nine months ended June 30, 2001 compared to cash provided of $3,162,000 during the nine months ended June 30, 2000. The change was primarily the result of lower borrowings. As of June 30, 2001, the Company had approximately $10,438,000 of additional borrowing capacity available under various foreign credit arrangements. Currently, the Company does not have a domestic credit facility. The Company anticipates that existing cash balances and the additional borrowing capacity provided under the foreign credit facilities will provide adequate liquidity for the remainder of fiscal 2001. The terms of the Senior Notes indenture restrict the Company's ability to pay dividends on preferred and common stock; however, the terms of the Senior Notes do allow for dividend payments on currently outstanding preferred stock, in accordance with the terms of the preferred stock, and up to $.22 per share, per annum on common stock, in the absence of any default or event of default on the Senior Notes. The above limitations may not be decreased, but may be increased based upon the Company's results of operations and other factors. The Company's foreign credit facilities are generally secured by assets owned by subsidiaries of the Company and also carry various financial covenants. -15- 16 The Senior Notes indenture contains a number of covenants including: a limitation on the incurrence of indebtedness and the issuance of stock that is redeemable or is convertible or exchangeable for debt, provided that the Company may incur additional indebtedness if the consolidated interest coverage ratio, as defined in the indenture, will be at least 2.0 to 1.0 after such indebtedness is incurred; or if the indebtedness qualifies as "Permitted Indebtedness" under the indenture; a limitation on certain restricted payments, including, among others, the payment of any dividends, the purchase or redemption of any capital stock or the early retirement of any debt subordinate to the Senior Notes, subject to certain exceptions; certain limitations on creating liens on the Company's assets unless the Senior Notes are equally and ratably secured; limitations on transactions with affiliates; a limitation against restrictions on the ability of the Company's subsidiaries to pay dividends or make certain distributions, payments or advances to the Company; restrictions on the sale of assets of the Company unless (i) the Company receives the fair market value of such properties or assets, determined pursuant to the indenture, (ii) the Company receives 75% of the purchase price for such assets in cash or cash equivalents and (iii) the proceeds of such sale are applied pursuant to the indenture; a change of control provision that requires the Company to repurchase all of the Senior Notes at a repurchase price in cash equal to 101% of the principal amount of the Senior Notes upon the occurrence of a change of control ("change of control" means (i) the sale, lease or other disposition of all or substantially all of the assets of the Company and its restricted subsidiaries, (ii) the adoption of a plan relating to the liquidation or dissolution of the Company, (iii) any person or group becoming the beneficial owner of more than 50% of the total voting power of the voting stock of the Company or (iv) a majority of the members of the Board of Directors no longer being "continuing directors" where "continuing directors" means the members of the Board of Directors on the date of the indenture and members that were nominated for election or elected to the Board of Directors with the affirmative vote of a majority of the "continuing directors" who were members of the Board at the time of such nomination or election); a limitation of certain sale/leaseback transactions; and restrictions on guarantees of certain indebtedness by the Company's restricted subsidiaries. The indenture also restricts certain mergers, consolidations or dispositions of all or substantially all of the Company's assets. RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, NINE MONTHS ENDED JUNE 30, ------------------------------------------ -------------------------------------------- % of % of % of % of NET REVENUES (000'S) 2001 Total 2000 Total 2001 Total 2000 Total ----------- -------- ---------- -------- ----------- -------- ----------- --------- Distribution $20,361 41 $24,221 42 $ 60,298 39 $ 69,110 42 Size Reduction Services and Other Sales and Services 9,650 19 12,323 21 31,550 21 35,551 21 Compounding Sales and Services 20,211 40 21,634 37 60,839 40 60,396 37 ------- --- ------- --- -------- --- -------- --- Total Polymer Processing Revenues 50,222 100 58,178 100 152,687 100 165,057 100 ------- ------- -------- -------- Exploration Sales and Services 11,481 36 10,614 39 33,957 35 25,966 34 Production Sales and Services 10,651 33 9,350 34 30,354 31 26,723 35 Corrosion Control Sales and Services 7,820 24 5,684 21 23,204 24 15,981 21 Other Sales and Services 2,380 7 1,630 6 9,904 10 7,436 10 ------- ---- ------- ---- -------- --- -------- --- Total Oilfield Services Revenues 32,332 100 27,278 100 97,419 100 76,106 100 ------- ------- -------- -------- Total $82,554 $85,456 $250,106 $241,163 ======= ======= ======== ========
THREE MONTHS ENDED JUNE 30, NINE MONTHS ENDED JUNE 30, ------------------------------------------ -------------------------------------------- % of % of % of % of OPERATING PROFIT (LOSS) (000'S) 2001 Total 2000 Total 2001 Total 2000 Total ----------- -------- ---------- -------- ----------- -------------------- --------- Polymer Processing $ 165 3 $ 3,715 52 $ 1,558 9 $ 11,401 57 Oilfield Services 5,028 97 3,390 48 15,506 91 8,538 43 -------- ---- ------- --- -------- --- -------- ---- Total Operations 5,193 100 7,105 100 17,064 100 19,939 100 General Corporate Expenses (11,194) (2,144) (16,677) (7,093) -------- ------- -------- -------- Total $ (6,001) $ 4,961 $ 387 $ 12,846 ======== ======= ======== ========
-16- 17 Three and Nine Months Ended June 30, 2001 Compared to the Three and Nine Months Ended June 30, 2000 REVENUES Consolidated revenues increased $8,943,000 (4%) during the nine months ended June 30, 2001 compared to the same period of fiscal 2000 and decreased $2,902,000 (3%) during the quarter ended June 30, 2001 compared to the year earlier quarter. These changes were due to an increase in Oilfield Service revenues offset by lower Polymer Processing revenues. Polymer Processing revenues declined $7,956,000 (14%) and $12,370,000 (7%) during the three and nine months ended June 30, 2001 compared to the same periods of fiscal 2000. These declines resulted primarily from lower distribution revenues and, to a lesser extent, lower size reduction revenues. Size reduction revenues declined $2,673,000 (22%) and $4,001,000 (11%) during the three and nine months ended June 30, 2001 compared to the same periods of fiscal 2000. These declines were primarily the result of lower U.S. grinding revenues due to lower processing volumes. The volume decline was due to competitive pressures, an inadequate marketing strategy and to a lesser extent, the weakness of the US manufacturing economy . European grinding revenues also declined during the third quarter due to a less favorable revenue mix and the effect of the strengthening U.S. Dollar relative to the Euro and other European currencies. The nine month decline was due to a decline in European revenues and lower domestic grinding revenues resulting from lower processing volumes. In the case of the Company's European market, lower European currency values compared to the U.S. Dollar also had the effect of reducing revenues compared to the prior year. Compounding revenues declined $1,423,000 (7%) during the third quarter of fiscal 2001, compared to the third quarter of fiscal 2000. This decline was mostly due to a decline in domestic concentrate manufacturing revenues during the quarter. During the nine months ended June 30, 2001, compounding revenues increased $443,000 (1%). This increase was the result of year over year growth of the Company's domestic concentrate manufacturing business operation, partially offset by lower European compounding revenues. The European decline was primarily the result of the weak Euro and other European currencies and lower compounding volumes in the Company's UK market. Distribution revenues declined $3,860,000 (16%) and $8,812,000 (13%) during the three and nine months ended June 30, 2001, compared to the same periods of fiscal 2000. These declines were primarily the result of lower distribution sales volumes in the U.S. and European markets, the effect of the strengthening of the U.S. Dollar, versus European currencies and the Australian and New Zealand Dollars, and lower average sales prices in Europe. Oilfield Services revenues increased $5,054,000 (19%)and $21,313,000 (28%) to $32,332,000 and $97,419,000 during the three and nine months ended June 30, 2001 compared to the same periods of fiscal 2000. All major product lines within Oilfield Services experienced revenue growth during the quarter and the fiscal year-to-date periods. Strong customer demand for the Company's Oilfield Services is being driven by higher oil and gas prices and, in turn, higher rig counts. During the third quarter the average U.S. benchmark oil price was relatively high at $27.63 per barrel. Compared to the third quarter of fiscal 2000, the average benchmark natural gas price increased 5% to $3.82. As a result of the increase in oil and gas prices during fiscal 2000 and the first half of fiscal 2001, the average U.S. drilling rig count increased 47% to 1,237 and the average workover rig count increased 14% to 1,226, during the third quarter of fiscal 2001 compared to the same quarter of fiscal 2000. These trends have resulted in improved demand for the Company's oilfield services during fiscal year 2001. During the third quarter of fiscal year 2001, however, both oil and gas prices declined. Should the trend of declining commodity prices continue, oilfield activity levels would be expected to decline and as a result, demand for the Company's Oilfield Services would likewise decline. The Company is, however, optimistic that, if oil and gas prices remain at or near their present levels, market conditions will remain favorable for the Company's oilfield service business. COST AND EXPENSES Gross margins (calculated as the difference between net revenues and cost of sales, divided by net revenues) declined to 21.7% during the three months ended June 30, 2001 compared to 22.5%, during the same quarter last year. During the nine months ended June 30, 2001, gross margins were 22.3% compared to 23.3% last year. The margin erosion occurred due to a decline in Polymer Processing gross margins, partially offset by gross margin improvement within the Oilfield Service business. Polymer Processing gross margins declined to 16.8% and 17.4% during the three and nine months ended June 30, 2001 compared to 19.6% and 21.0% during the same periods of fiscal 2000. The gross margin decline was the result of a less favorable revenue mix in the Company's domestic concentrate manufacturing business, lower processing volumes -17- 18 in the Company's domestic and European markets and lower distribution sales volumes. Distribution gross margins declined in part due to falling polymer prices and competitive pressures, particularly in Europe. Following the change in the Company's management and in response to the continued deterioration of Polymer profitability margins, management is currently reviewing the critical issues and opportunities within the Polymer Processing business. Management's changes are focused on making improvements in the areas of total quality management, inventory management, working capital management in general, resin procurement and IT systems, among others. Oilfield Service gross margins improved to 29.2% and 29.8% during the three and nine months ended June 30, 2001 compared to 28.8% and 28.5% during the same periods of fiscal 2000. These improvements are mostly due to the benefits of higher volumes, resulting from increased customer demand and, to a lesser extent, modest pricing improvements. Depreciation and amortization expenses decreased to $3,862,000 and $11,672,000 during the three and nine months ended June 30, 2001 from $4,102,000 and $12,371,000 during the same periods of fiscal 2000. This decline was the result of the effects of the strengthening U.S. Dollar, which has the effect of reducing reported non-U.S. depreciation in U.S. Dollar terms, partially offset by the impact of capital expenditures. Selling, general and administrative expenses increased to $11,873,000 and $34,304,000 during the three and nine months ended June 30, 2001, compared to $10,092,000 and $30,905,000 during the same periods of fiscal 2000. The quarterly increase was primarily the result of $546,000 of proxy contest expenses relating to the fiscal 2001 annual meeting, higher Oilfield Service expenses commensurate with the increase in revenues, an increase in legal expenses and an increase in costs related to the potential sale of the Company's Oilfield Service business. In the case of the year-to-date increase, higher Oilfield Service selling, general and administrative expenses consistent with the increase in revenues, and $1,660,000 of proxy contest expenses explains most of the increase. FISCAL 2001 CHARGES During the third quarter of fiscal 2001, the Company recognized (i.) a $7,410,000 charge for severance obligations relating to the termination of Asher Pacholder (Chairman and Chief Financial Officer), Sylvia Pacholder (President and Chief Executive Officer), Robin Pacholder (President Wedco North America), David Gerst (Senior Vice President and General Counsel) and Tom Pacholder (Senior Vice President- Wedco) (collectively referred to as the "Pacholder Group"), such terminations being discussed in the Company's press release dated June 7, 2001, and (ii.) a $500,000 charge for litigation relating to one of the personal injury claims alleging exposure to silica, resulting in silicosis- related disease. See "Note 7. Legal Proceedings". In connection with the termination of the Pacholder Group, the Company established and funded an escrow account containing $3,113,000 in cash. The purpose of the escrow account is to pay federal excise tax pursuant to IRS Code Sec. 280(g) in the event there is a "change of control", as defined by the IRS regulations, within one year of the Pacholder Group's termination. Due to the uncertainty surrounding whether the excise tax will be due, the $3,113,000 has not been reflected as an expense during the nine months ended June 30, 2001 and additionally, the escrow balance has been reclassified to "prepaid expenses and other current assets" from cash on the Company's June 30, 2001 balance sheet. Additionally, should a "change of control", as defined, occur within one year of the severance date, a significant portion of the tax asset the Company has recognized, relating to the future benefit of deducting the $7,400,000 severance charge, will no longer be an allowable deduction for tax purposes. During the second quarter of fiscal 2001, the Company closed a non-core polymer processing operation and recognized a $650,000 charge for the difference between the book value of the operation's net assets and expected liquidation value. Also, during the second quarter of fiscal 2001, the Company terminated certain polymer processing employees and recognized related severance expenses of $543,000. OPERATING INCOME (LOSS) Operating income (loss) decreased from $4,961,000 and $12,846,000 for the three and nine months ended June 30, 2001, to $(6,001,000) and $387,000 for the three and nine months ended June 30, 2001. These decreases were due to the changes in revenues and costs and expenses discussed above. -18- 19 INCOME TAXES The Company's effective income tax rates were 33% and 25% during the three and nine months ended June 30, 2001 compared to 47% and 58% during the same periods of fiscal 2000. The tax rate changes were due to the relation between pre-tax income and permanent differences, as well as a change in the mix of pre-tax income or loss generated by the Company's operations in various taxing jurisdictions. NET INCOME (LOSS) For the three and nine months ended June 30, 2001, the Company had net losses of $6,204,000 and $6,747,000 compared to net income of $994,000 and $1,580,000 for the same periods in fiscal 2000, due to the factors described above. FOREIGN CURRENCY TRANSLATION The fluctuations of the U.S. dollar against the Euro, Swedish krona, British pound, Canadian dollar, New Zealand dollar, and the Australian dollar have impacted the translation of revenues and expenses of the Company's international operations. The table below summarizes the impact of changing exchange rates for these currencies for the three and nine months ended June 30, 2001 compared to the exchange rates used to translate the three and nine months ended June 30, 2001.
THREE MONTHS NINE MONTHS --------------------------- ------------------------- Net revenues $(3,524,602) $(10,589,318) Earnings before interest, taxes, depreciation and amortization (241,622) (879,891) Operating income (78,304) (396,790) Pre-tax income (14,546) (207,363) Net income (27,629) (158,887)
-19- 20 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's primary market risk exposures include debt obligations carrying variable interest rates and forward purchase contracts intended to hedge accounts payable obligations denominated in currencies other than a given operation's functional currency. The Company's strategy has typically been to finance only working capital with variable interest rate debt and to fix interest rates for the financing of long-term assets. Forward currency contracts are used by the Company as a method to establish a fixed functional currency cost for certain raw material purchases denominated in non-functional currency (usually the U.S. dollar). The following table summarizes the Company's market-sensitive financial instruments. These transactions are considered non-trading activities.
ON-BALANCE SHEET FINANCIAL INSTRUMENTS JUNE 30, 2001 --------------------------------------------------------------------------------- Variable interest rate US$ EQUIVALENT WEIGHTED AVERAGE long-term debt: IN THOUSANDS INTEREST RATE EXPECTED MATURITY -------------- --------------- ----------------- CURRENCY DENOMINATION British Pounds Sterling $1,474 6.75% less than one year Italian Lira 3,576 5.24% less than one year New Zealand Dollar 625 7.76% less than one year Australia Dollar 122 8.75% less than one year
ANTICIPATED TRANSACTIONS AND RELATED DERIVATIVES Forward Exchange Agreements (000s): RECEIVE US$/PAY NZ$: Contract Amount US$929 Average Contractual Exchange Rate (US$/NZ$) .4144 Expected Maturity Dates July 2001 through September 2001 RECEIVE US$/PAY AUSTRALIAN $: Contract Amount US$1,038 Average Contractual Exchange Rate (US$/A$) .5184 Expected Maturity Dates July 2001 through September 2001 RECEIVE US$/PAY FRENCH FRANCS Contract Amount US$43 Average Contractual Exchange Rate (US$/FRF) .1378 Expected Maturity Date December 2001
ON-BALANCE SHEET FINANCIAL INSTRUMENTS JUNE 30, 2000 -------------------------------------------------------------------------------------- Variable interest rate US$ EQUIVALENT WEIGHTED AVERAGE long-term debt: IN THOUSANDS INTEREST RATE EXPECTED MATURITY -------------- --------------- ----------------- CURRENCY DENOMINATION Dutch Guilders $1,224 5.74% less than one year British Pounds Sterling 2,368 7.25% less than one year French Francs 39 5.14% 2001 Italian Lira 4,295 4.98% less than one year Canadian Dollar 3,373 8.75% less than one year New Zealand Dollar 149 7.76% less than one year
-20- 21 ANTICIPATED TRANSACTIONS AND RELATED DERIVATIVES Forward Exchange Agreements (in 000s): RECEIVE US$/PAY NZ$: Contract Amounts US$585 Average Contractual Exchange Rate (NZ$/US$) .4762 Expected Maturity Dates July 2000 through August 2000 RECEIVE US$/PAY AUSTRALIAN $: Contract Amounts US$1,170 Average Contractual Exchange Rate (A$/US$) .5692 Expected Maturity Dates July 2000 through September 2000 RECEIVE US$/PAY DUTCH GUILDER Contract Amounts US$10 Average Contractual Exchange Rate (NLG/US$) .4342 Expected Maturity Date July 13, 2000 RECEIVE GBP/PAY DUTCH GUILDER Contract Amounts GBP77 Average Contractual Exchange Rate (NLG/GBP) .2769 Expected Maturity Dates July 2000 through August 2000 RECEIVE US$/PAY FRENCH FRANCS Contract Amounts US$150 Average Contractual Exchange Rate (FRF/US$) .1462 Expiration Date On or before June 18, 2001 POTENTIAL SALE OF OILFIELD SERVICES BUSINESS SEGMENT The Company previously announced that it had entered into a letter of intent with Varco International, Inc. to sell its Oilfield Services business segment. This letter of intent has expired in accordance with its terms; however, the Company and Varco are continuing, at this time, to discuss the terms of a possible transaction. See Note 7 in the Notes to Consolidated Financial Statements. ACQUISITION PROPOSAL Travis Street Partners, LLC ("TSP") has made various proposals to acquire the Company or certain of its operations, has, in a letter dated May 9, 2001, proposed to pay $3.10 for each issued and outstanding share of the common stock of the Company, subject to the terms and conditions set forth in TSP's letter. TSP's three nominees were elected to the Company's board of directors at the 2001 Annual Meeting. These directors are John Knapp, Charles McCord and James Calaway, each of whom is a member of TSP. On June 8, 2001, the Company established a Special Committee consisting of the independent directors to consider the acquisition proposal from TSP and any other acquisition proposals that may be received by ICO. The Special Committee has retained legal counsel and financial advisors to assist in the evaluation and review of the TSP proposal. In an August 3, 2001 letter to TSP, the Special Committee said it was recommending against the TSP proposal dated May 9, 2001 as currently constructed because the proposal was contingent on the successful completion of the previously-announced sale of ICO's Oilfield Services division to Varco, International, Inc. on terms acceptable to TSP. Additionally, the special committee objected to TSP's proposed breakup fee. The Special Committee requested TSP to revise its offer to eliminate the contingencies and provide a financing commitment letter to the committee to enable it to make a reasonable evaluation. -21- 22 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS See Note 7 to the Consolidated Financial Statements included in Part I, Item 1, of this quarterly report on Form 10- Q. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Annual Meeting of Shareholders of the Company was held on April 25, 2001 for the following purposes: 1. The election of three Class I Directors to serve until the 2004 Annual Meeting of Shareholders and until their respective successors are elected and qualified; 2. To ratify and approve the selection of PricewaterhouseCoopers LLP as the Company's independent accountants for the ensuing fiscal year; and 3. To consider and act upon any matters incidental to the foregoing purposes and transact such other business as may properly come before the meeting or any adjournment or postponement thereof. At the Meeting, the vote on the election of Class I Directors was as follows:
IN FAVOR WITHHELD ---------- ---------- INCUMBENT BOARD NOMINEES William E. Cornelius 7,100,580 122,370 Howard P. Tuckman 7,105,413 117,537 George S. Sirusas 7,105,413 117,537 TRAVIS STREET PARTNERS' NOMINEES A. John Knapp 10,832,800 21,863 James D. Calaway 10,844,650 34,863 Charles T. McCord, III 10,844,974 23,013
At the Meeting, the vote on the proposal to ratify the appointment of PricewaterhouseCoopers LLP as ICO's auditor for fiscal 2001, was as follows: FOR AGAINST ABSTAIN --- ------- ------- 17,804,539 56,585 144,503 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits - Reference is hereby made to the exhibit index which appears on page 23. (b) On June 7, 2001, the Company filed a Form 8-K current report disclosing that certain executive officers had been terminated by the Company and that the Board of Directors of the Company established a Special Committee (consisting of independent directors) to consider the pending acquisition proposal from Travis Street Partners and any other acquisition proposals that may be received by ICO. (c) One June 21, 2001, the Company filed a Form 8-K current report making a regulation FD disclosure and announcing the resignation of William E. Willoughby as a director of the Company and the appointment of William C. Willoughby to the Board of Directors. -22- 23 The following instruments and documents are included as Exhibits to this Form 10-Q. Exhibits incorporated by reference are so indicated by parenthetical information.
EXHIBIT NO. EXHIBIT ----------- --------- 2.1 -- Plan of Merger of ICO Merger Sub, Inc. with and into ICO, Inc. (filed as Exhibit 2.4 to Form 10-Q dated August 13, 1998) 3.1 -- Articles of Incorporation of the Company dated March 20, 1998 (filed as Exhibit 3.1 to Form 10-Q dated August 13, 1998) 3.2 -- Statement of Resolution of $6.75 Convertible Exchangeable Preferred Stock dated March 30, 1998 (filed as Exhibit 3.2 to Form 10-K dated December 23, 1998) 3.3 -- Certificate of Designation of Junior Participating Preferred Stock of ICO Holdings, Inc. dated March 30, 1998 (filed as Exhibit 3.3 to Form 10-K dated December 23, 1998) 3.4 -- Amended and Restated By-Laws of the Company dated March 24, 2001 4.1 -- Indenture dated as of June 9, 1997 between the Company, as issuer, and Fleet National Bank, as trustee, relating to Senior Notes due 2007 (filed as Exhibit 4.1 to Form S-4 dated June 17, 1997) 4.2 -- First Supplemental Indenture and Amendment dated April 1,1998 between the Company, as issuer, and State Street and Trust Company (formerly Fleet National Bank), as trustee, relating to Senior Notes due 2007 (filed as Exhibit 4.2 to Form 10-Q dated May 15, 1998) 4.3 -- Second Supplemental Indenture and Amendment dated April 1, 1998 between ICO P&O, Inc., a wholly owned subsidiary of the Registrant, and State Street and Trust Company (formerly Fleet National Bank), as trustee, relating to Senior Notes due 2007 (filed as Exhibit 4.3 to Form 10-Q dated May 15, 1998) 4.4 -- Warrant Agreement -- Series A, dated as of September 1, 1992, between the Registrant and Society National Bank (filed as Exhibit 4 to the Registrant's Annual Report on Form 10-K for 1992) 4.5 -- Stock Registration Rights Agreement dated April 30, 1996 by and between the Company, a subsidiary of the Company and the Wedco Shareholders Group, as defined (filed as Exhibit 4.4 to Form S-4 dated March 15, 1996) 4.6 -- Shareholder Rights Agreement dated April 1, 1998 by and between the Registrant and Harris Trust and Savings Bank, as rights agent (filed as Exhibit 4.7 to Form 10-Q for the quarter ended March 31, 1998) 10.1 -- ICO, Inc. 1985 Stock Option Plan, as amended (filed as Exhibit B to the Registrant's Definitive Proxy Statement dated April 27, 1987 for the Annual Meeting of Shareholders) 10.2 -- Second Amended and Restated 1993 Stock Option Plan for Non-Employee Directors of ICO, Inc. (filed as Exhibit A to the Registrant's Definitive Proxy Statement dated January 26, 1999 for the Annual Meeting of Shareholders) 10.3 -- 1994 Stock Option Plan of ICO, Inc. (filed as Exhibit A to Registrant's Definitive Proxy Statement dated June 24, 1994 for the Annual Meeting of Shareholders) 10.4 -- ICO, Inc. 1995 Stock Option Plan (filed as Exhibit A to Registrant's Definitive Proxy Statement dated August 10, 1995 for the Annual Meeting of Shareholders) 10.5 -- ICO, Inc. 1996 Stock Option Plan (filed as Exhibit A to Registrant's Definitive Proxy Statement dated August 29, 1996 for the Annual Meeting of Shareholders) 10.6 -- ICO, Inc. 1998 Stock Option Plan (filed as Exhibit A to Registrant's Definitive Proxy Statement dated January 23, 1998 for the Annual Meeting of Shareholders) 10.7** -- Employment Agreement dated June 21, 2001 by and between the Registrant and Timothy Gollin. 10.8** -- Employment Agreement dated June 21, 2001 and between the Registrant and Christopher N. O'Sullivan. 10.9 -- Employment Agreement dated September 4, 1998 by and between the Registrant and Jon C. Biro (filed as Exhibit 10.20 to Form 10-K dated December 23, 1998)
-23- 24
EXHIBIT NO. Exhibit ----------- ------------- 10.10 -- Employment Agreement dated September 4, 1998 by and between the Registrant and Isaac H. Joseph (filed as Exhibit 10.21 to Form 10-K dated December 23, 1998)
----------- ** Filed herewith -24- 25 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. ICO, Inc. ----------------------------------------- (Registrant) /s/ Christopher N. O'Sullivan ----------------------------------------- August 13, 2001 Christopher N. O'Sullivan Vice Chairman and Chief Financial Officer (Principal Financial Officer) /s/ Jon C. Biro ----------------------------------------- Jon C. Biro Senior Vice President, Chief Accounting Officer and Treasurer (Principal Accounting Officer) -25- 26 EXHIBIT INDEX
EXHIBIT NO. EXHIBIT ----------- --------- 10.7** -- Employment Agreement dated June 21, 2001 by and between the Registrant and Timothy Gollin. 10.8** -- Employment Agreement dated June 21, 2001 and between the Registrant and Christopher N. O'Sullivan. 10.9 -- Employment Agreement dated September 4, 1998 by and between the Registrant and Jon C. Biro (filed as Exhibit 10.20 to Form 10-K dated December 23, 1998)