UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended November 30, 2005
OR
For the transition period to
Commission file number 0-9950
TEAM, INC.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
Registrant’s telephone number, including area code (281) 331-6154
Indicate by checkmark 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 a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
On January 3, 2006, there were 8,191,525 shares of the Registrant’s common stock outstanding.
INDEX
PART I.
Financial Statements
Consolidated Condensed Balance Sheets -- November 30, 2005 (Unaudited) and May 31, 2005
Consolidated Condensed Statements of Operations (Unaudited) -- Three Months and Six Months Ended November 30, 2005 and 2004
Consolidated Condensed Statements of Cash Flows (Unaudited) -- Six Months Ended November 30, 2005 and 2004
Notes to Unaudited Consolidated Condensed Financial Statements
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosure about Market Risk
Controls and Procedures
PART II.
Legal Proceedings
Submission of Matters to a Vote of Security Holders
Exhibits and Reports on Form 8-K
SIGNATURES
PART I - FINANCIAL INFORMATION
TEAM, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
November 30,
2005
May 31,
Current Assets:
Cash and cash equivalents
Accounts receivable, net
Inventories
Deferred income taxes
Prepaid expenses and other current assets
Current assets of discontinued operations
Total Current Assets
Property, plant and equipment, net of accumulated depreciation of $23,542,000 and $21,256,000
Intangible assets, net
Goodwill
Other assets
Non current assets of discontinued operations
Total Assets
Current Liabilities:
Current portion of long-term debt
Accounts payable
Accrued liabilities
Insurance notes payable
Income taxes payable
Current liabilities of discontinued operations
Total Current Liabilities
Long-term debt
Other long-term liabilities
Liabilities of discontinued operations
Total Liabilities
Minority interest
Commitments and Contingencies
Stockholders’ Equity:
Preferred stock, 500,000 shares authorized, none issued
Common stock, par value $.30 per share, 30,000,000 shares authorized, 9,389,520 and 9,259,742 shares issued
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income
Treasury stock at cost, 1,018,308 shares
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
See notes to unaudited consolidated condensed financial statements.
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CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
Six Months Ended
Revenues
Operating expenses
Gross Margin
Selling, general and administrative expenses
Non-cash G&A compensation cost
Operating income
Interest expense, net
Earnings from continuing operations before income taxes
Provision for income taxes
Income from continuing operations
Discontinued operations:
Income (loss) from operations of discontinued segment
Gain on sale of discontinued operations
Earnings from discontinued operations before income taxes
Income (loss) from discontinued operations
Net income
Earnings per common share:
Continuing operations
Basic
Diluted
Discontinued operations
Weighted average number of shares outstanding:
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CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
Cash Flows from Operating Activities:
Less income from discontinued operations
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization
Amortization of deferred financing costs
Allowance for doubtful accounts
Other
Change in assets and liabilities
(Increase) decrease:
Accounts receivable
Income tax receivable
Increase (decrease):
Net cash provided by (used in) operating activities from continuing operations
Cash Flows From Investing Activities:
Capital expenditures
Proceeds from sale of Equipment Sales and Rental segment
Proceeds from sale of assets
Business acquisitions, net of cash acquired
Decrease in other assets, net
Net cash used in investing activities
Cash Flows From Financing Activities:
Net borrowings under revolving credit agreement
Proceeds from term notes
Repayment of term and other notes
Loan financing fees
Insurance note borrowings
Insurance note payments
Issuance of common stock
Net cash provided by financing activities
Cash provided by (used in) discontinued operations
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest
Income taxes
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NOTES TO UNAUDITED CONSOLIDATED CONDENSED
FINANCIAL STATEMENTS
General
The interim financial statements are unaudited, but in the opinion of management, reflect all adjustments, consisting of normal recurring adjustments, except for adjustments related to the sale of a business segment as discussed in note 2, necessary for a fair presentation of results for such periods. The consolidated condensed balance sheet at May 31, 2005 is derived from the May 31, 2005 audited consolidated financial statements. The results of operations for any interim period are not necessarily indicative of results for the full year. These financial statements should be read in conjunction with the financial statements and notes thereto contained in Team, Inc.’s (“the Company”) annual report on Form 10-K for the fiscal year ended May 31, 2005.
Use of Estimates in Financial Statement Preparation
The preparation of the consolidated financial statements requires management of the Company to make a number of estimates and assumptions relating to the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Significant items subject to such estimates and assumptions include the carrying value of property, plant and equipment, intangible assets, and goodwill; valuation allowances for receivables, inventories and deferred income tax assets; environmental and legal liabilities as well as liabilities with respect to self insurance retentions in workers compensation, automobile liabilities and group health insurance. Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements of the Company include the financial statements of the Company and majority owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Minority interest is recognized for the portion not owned by the Company.
Discontinued Operations
On November 30, 2005, the Company sold its Equipment Sales and Rental business (Climax Portable Machine Tools, Inc., or “Climax”) for cash (see note 2). With respect to accounts associated with Climax, the balance sheet and cash flow amounts are reclassified from their historical presentation to assets and liabilities of discontinued operations and the operating results of Climax are presented as discontinued operations.
New Accounting Standards
In December 2004, the FASB issued SFAS No. 123 (revised 2004) “Share-Based Payment” (“SFAS 123(R)”). SFAS 123(R) addresses the accounting for transactions in which an enterprise exchanges its equity instruments for employee services. It also addresses transactions in which an enterprise incurs liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of those equity instruments in exchange for employee services. For public entities, the cost of employee services received in exchange for equity instruments, including employee stock options, is to be measured on the grant-date fair value of those instruments. That cost will be recognized as compensation expense over the service period, which would normally be the vesting period. The Company will be
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required to adopt the provisions of SFAS 123(R) in the first quarter of fiscal 2007. Management does not anticipate that adoption of this standard will have a material impact on the Company’s operating results.
In November 2004, FASB issued SFAS No. 151 “Inventory Costs” which amends the guidance in ARB No. 43, Chapter 4 “Inventory Pricing” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated “that under some circumstances, items such as idle facility expense, excessive spoilage, double freight and rehandling costs may be so abnormal as to require treatment as current period charges.” SFAS No. 151 requires that those items be recognized as current period charges regardless of whether they meet the criterion of “so abnormal.” In addition, SFAS No. 151 requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 shall be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted for inventory costs incurred during fiscal years beginning after the date SFAS No. 151 was issued. SFAS No. 151 shall be applied prospectively. The Company expects to adopt the provisions of SFAS No. 151 in the first quarter of fiscal 2007. The Company does not expect the adoption of SFAS No. 151 to have a material effect on its consolidated financial statements.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS No. 154 changes the requirements for the accounting and reporting of a change in accounting principle. The Statement eliminates the requirement in APB 20 to include the cumulative effect of changes in accounting principle in the income statement in the period of change, and instead requires that changes in accounting principle be retrospectively applied unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The Statement applies to all voluntary changes in accounting principle. SFAS No. 154 is effective for changes made in fiscal years beginning after December 15, 2005. The Company expects to adopt the provisions of SFAS No. 154 in the first quarter of fiscal 2007. The Company does not expect the adoption of SFAS No. 154 to have a material effect on its results of operations or financial position.
The Company has reviewed other new accounting standards not identified above and does not believe any other new standard will have a material impact on the Company’s financial position or operating results.
Stock-Based Compensation
The Company applies the intrinsic-value method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations including FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25, to account for its fixed-plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. FASB Statement No. 123, Accounting for Stock-Based Compensation and FASB Statement No. 148, Accounting for Stock-Based Compensation – Transitions and Disclosure, an amendment of FASB Statement No. 123, established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As permitted by existing standards, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of Statement 123, as amended. Pro forma information regarding net income and earnings per share is required by SFAS No. 123 and 148, which also requires that the information be determined as if the Company has accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method of that Statement.
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The fair value for the options granted after this date was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for the three months and six months ended November 30, 2005 and 2004:
Risk free interest rate
Volatility factor of the expected market price of the Company’s common stock
Expected dividend yield percentage
Weighted average expected life
The following table illustrates the effect on income from continuing operations if the fair-value-based method had been applied to all outstanding and unvested awards in each period:
Income from continuing operations, as reported
Stock-based employee compensation expense included in reported net income, net of tax
Stock-based employee compensation expense determined under fair value based method for all awards, net of tax
Pro forma income from continuing operations
Earnings per share—Continuing operations
Basic, as reported
Basic, pro-forma
Diluted, as reported
Diluted, pro-forma
On November 30, 2005, Team sold all of the outstanding stock of Climax Portable Machine Tools, Inc. (“Climax”), its equipment sales and rental segment for approximately $14.5 million in cash. The purchase price is subject to adjustments based on the actual final closing November 30, 2005 balance sheet of Climax to be delivered by January 15, 2006. Such adjustments are not expected to be material.
As a result of this transaction, the operating results of Climax are presented as a discontinued operation for all periods presented.
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Total assets sold to and liabilities assumed by the buyers of Climax as of November 30, 2005, as well as total assets and liabilities of Climax included in discontinued operations as of May 31, 2005 are as follows:
Receivables
Prepaid expenses and other current
Property, plant and equipment
Accounts Payable
Other accrued liabilities
Noncurrent liabilities
Net book value
The Company recognized a pre-tax gain on the sale of Climax of $1.5 million, net of costs and expenses associated with the transaction of approximately $0.9 million, including approximately $250,000 of cash bonuses paid to certain Climax personnel and $150,000 of non-cash compensation. Non-cash compensation expense is a result of the Company accelerating the vesting of stock options held by the management team of Climax covering 37,000 shares of Team stock.
For Federal income tax purposes, the stock sale provided the purchaser with a step-up in basis of the underlying assets of Climax under Section 338(h)(10) of the Internal Revenue Code. This treatment results in a significantly higher taxable gain to the Company than is reflected in the financial statements since the Company’s tax basis calculation is limited to the amount of the historic tax basis of Climax in its underlying assets. The total differential between book and tax gain is approximately $4.9 million resulting in approximately $1.7 million of current income tax. Deferred income taxes of approximately $0.8 million were provided for the tax-effect of the differential at the time of the Company’s purchase of Climax in 1998. An additional $0.9 million of income tax expense has been provided in the second quarter in the discontinued operations section of the income statement to reflect the additional tax obligation resulting from the Section 338(h)(10) election.
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The amounts of revenue and earnings before income taxes reported in discontinued operations pertaining to Climax are as follows:
Interest expense allocation
Earnings before income taxes
Interest allocated to discontinued operations represents approximately 21% and 23% of total interest expense in the 2005 and 2004 periods, respectively, and is based upon ratio of the debt required to be repaid upon the sale of Climax (approximately $14 million) to the total outstanding debt in the period.
Included in accrued liabilities is approximately $150,000 representing the Company’s best estimate of future costs to be incurred in connection with product liability, product warranty, litigation, and other matters associated with the operations of Climax before the sale. Any subsequent adjustments to such estimates will be reflected as discontinued operations in the period of change.
Subsequent to the sale the Company does not have any significant continuing involvement in the operations of Climax.
On August 11, 2004, the Company completed the acquisition of substantially all of the assets of International Industrial Services, Inc., a Delaware corporation (“IISI”), and Cooperheat-MQS, Inc., a Delaware corporation (“Cooperheat”), including the capital stock of certain subsidiaries of IISI and Cooperheat (together, “Cooperheat”).
Cooperheat was operating as debtor-in-possession in a Chapter 11 case pending in the United States Bankruptcy Court for the Southern District of Texas, Houston, Texas (the “Bankruptcy Court”) (Case Nos. 03-48272-H2-11 and 03-48273-H2-11). On August 6, 2004, the Bankruptcy Court entered an order approving the sale of the assets by Cooperheat to the Company pursuant to an Asset Purchase Agreement.
The transaction involved a cash consideration of $34.8 million, the assumption of certain liabilities including the assumption of $1.7 million in letters of credit and the issuance of warrants to purchase 100,000 shares of the common stock, $.30 par value per share, of Team. The warrants are exercisable at $65 cash per share and expire on August 11, 2007, unless sooner exercised.
The assets purchased from Cooperheat are associated with a non-destructive testing (NDT) inspection and field heat treating services business. The Company has integrated the purchased assets and associated business activity with its other industrial service activities.
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The transactions contemplated by the Asset Purchase Agreement, as well as a restructuring of the Company’s current indebtedness to Bank of America, N.A. (“Bank of America”), were financed with funds provided under a Credit Agreement dated as of August 11, 2004 (the “Credit Agreement”) by and among the Company, the other lenders party thereto and Bank of America, as Administrative Agent, Swing Line lender and L/C issuer.
The acquisition was accounted for using the purchase method of accounting. Accordingly, the consolidated financial statements subsequent to the effective dates of the acquisition reflect the purchase price, including transaction costs. As the acquisition of Cooperheat was effective August 11, 2004, the consolidated results of operations for the Company for the quarter and six months ended November 30, 2004, include the results for Cooperheat for the period August 11, 2004 to November 30, 2004. The purchase price of Cooperheat was allocated to the assets and liabilities of Cooperheat based on its estimated fair value. The goodwill associated with the acquisition is approximately $14.1 million. Information regarding the allocation of the purchase price is set forth below:
Cash and borrowings
Transaction costs
Fair value of net assets acquired
Excess purchase price to be allocated to Goodwill
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition:
Cash
Inventory
Other current assets
Total assets acquired
Accrued liabilities and other
Long-term liabilities
Total liabilities assumed
Net assets acquired
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The unaudited pro forma consolidated results of operations of the Company are shown below as if the acquisition occurred at the beginning of the fiscal period indicated. These results are not necessarily indicative of the results which would actually have occurred if the purchase had taken place at the beginning of the period, nor are they necessarily indicative of future results.
Six months ended
November 30, 2004
Net income (loss)—continuing operations
Earnings per share—continuing operations:
No dividends were paid during the six months ended November 30, 2005 or 2004. Pursuant to the Company’s Credit Agreement, the Company may not pay quarterly dividends without the consent of its senior lender. Future dividend payments will depend upon the Company’s financial condition and other relevant matters.
Basic earnings per share are computed by dividing net earnings by the weighted average number of common stock outstanding during the period. Diluted earnings per share are computed by dividing net earnings by the sum of (1) the weighted-average number of common stock outstanding during the period and (2) the dilutive effect of the assumed exercise of stock options using the treasury stock method. There is no difference, for any of the years presented, in the amount of net income (numerator) used in the computation of basic and diluted earnings per share. With respect to the number of weighted average shares outstanding (denominator), diluted shares reflects only the pro forma exercise of options to acquire common stock to the extent that the options’ exercise prices are less than the average market price of common shares during the period.
Options to purchase 96,500 and 101,500 were outstanding for the three-months and six-months ended November 30, 2004, respectively, but were not included in the computation of diluted EPS because the options’ exercise prices were greater than the average market price of the common stock. All outstanding options were “in the money” in the 2005 periods.
Receivables consist of:
Trade accounts receivable
Unbilled revenues
Other receivables, primarily employee receivables
Estimated receivable from sale of Climax
Total
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Inventories consists of:
Raw materials
Work in progress
Finished goods
Long-term debt consists of:
Credit facility:
Revolving loan
Term loan
Auto loans
Less current portion
On October 5, 2005, the Company amended the credit agreement (the “First Amendment”) with its banks to increase the allowable debt to EBITDA ratio at August 31, 2005 and thereafter. (EBITDA is earnings before interest, taxes, depreciation and amortization). The amended agreement requires that the debt to EBITDA ratio be no greater than 3.75 to 1 at November 30, 2005. The First Amendment also provided that proceeds from a sale of the Climax business would be applied to reduce amounts outstanding under the revolving loan, rather than the term loan, as provided in the original credit agreement. The First Amendment further provided that the maximum debt to EBITDA ratio would be reduced to 3.0 to 1 immediately upon the disposition of Climax.
On November 15, 2005, the Company further amended the credit agreement (the “Second Amendment”) to waive the required reduction in the debt to EBITDA ratio to 3.0 to 1 for the quarter ended November 30, 2005 if the sale of Climax occurred during the quarter then ended. The Second Amendment also increased the revolving credit facility by $5 million to a maximum amount of $60 million. The Company is in compliance with the amended covenants at November 30, 2005.
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Until the sale of Climax on November 30, 2005, the Company operated in two business segments, industrial services and equipment sales and rentals. As a result of the sale of Climax, the Company now operates in only one segment—industrial services. The industrial services segment consists of leak repair, hot tapping, emissions control monitoring, field machining and bolting and mechanical inspection services and is an aggregation of the Company’s two operating segments, TMS and TCM (see note 10).
Revenues from the United States and other countries are as follows:
Three Months Ended
United States
Canada
Other foreign countries
Total assets in the United States and other countries are as follows:
Comprehensive income represents the change in the Company’s equity from transactions and other events and circumstances from non-owner sources and includes all changes in equity except those resulting from investments by owners and distributions to owners.
Other comprehensive gain:
Foreign currency translation adjustment, net of tax
Comprehensive income
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There are two reporting units of the industrial services segment for purposes of the FASB Statement No. 142 impairment test – Team Mechanical Services (“TMS”) and Team Cooperheat-MQS (“TCM”). All of the Industrial Services goodwill of $26.5 million is attributable to TCM as a result of business acquisitions and the annual goodwill impairment test is performed at the TCM unit level. The Company completed the required annual impairment test for fiscal 2005 and determined that there was no impairment of goodwill as of May 31, 2005. The Company does not believe that any triggering events have occurred during the six months ended November 30, 2005 that would require a re-assessment of the recoverability of its goodwill balances. The impairment test for the current fiscal year will not be performed until the end of the fiscal year.
Intangible assets subject to amortization are as follows:
Non-compete agreement
Less accumulated amortization
Intangibles, net
Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with FASB Statement No. 144. Intangible assets consists of a non-compete agreement with an assigned value of $1,250,000 associated with the purchase of Thermal Solutions, Inc. in fiscal 2004. Amortization expense for the 6 months ended November 30, 2005 and 2004 was $125,000 for both periods. Estimated amortization expense based on intangibles as of November 30, 2005 is 125,000 for the remaining six months of fiscal 2006, $250,000 for fiscal years 2007 and 2008, and $208,000 for fiscal year 2009.
The following schedule summarizes the changes in common stock and additional paid-in capital:
Common
Stock
Additional
Paid-In Capital
Balance at May 31, 2005
Shares issued
Exercise of stock options
Tax benefit from exercise of stock options
Non cash compensation
Balance at November 30, 2005
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Overview:
The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in Item 1 of this report, and the consolidated financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations, including Critical Accounting Policies, included in our Annual Report on Form 10-K for the year ended May 31, 2005.
The Company is a professional, full-service provider of specialty industrial services. The Company’s industrial service offerings encompass:
All these services are required in maintaining high temperature, high pressure piping systems and vessels utilized extensively in the refining, petrochemical, power, pipeline, and other heavy industries. The Company’s inspection services also serve the aerospace and automotive industries. The Company operates in over 50 customer service locations throughout the Unites States. The Company also serves the international market through both its own seven international subsidiaries as well as through licensed arrangements in 14 countries. The Company’s raw materials are readily available, and the Company is not dependent on a single supplier or only a few suppliers. The Company has approximately 2,500 employees, including approximately 2,000 technical service employees.
The operations of the industrial services segment consist of into two related segments—Team Mechanical Services (“TMS”) and Team Cooperheat-MQS (“TCM”). TMS comprises Team’s previously existing mechanical services offerings (leak repair, hot tapping, field machining, technical bolting, field valve repair and fugitive emissions monitoring). TCM comprises field heat treatment and NDE inspection services. For reporting purposes, we aggregate the TMS and TCM segments because of their similar economic characteristics.
We believe the domestic market for our services is principally dictated by the population of process piping systems in industrial plants and facilities. On balance, we believe total demand for the services we offer in these markets does not change significantly. It can be characterized as flat, but steady. However, the timing of demand certainly can change in the short-term as plants accelerate or defer maintenance and project activities due to their own economic environment. We believe, therefore, that our growth has been as a result of capturing market share in the services we offer.
Prior to November 30, 2005, the Company also operated a separate business segment—Equipment Sales and Rentals. That business segment was comprised of a wholly-owned subsidiary, Climax Portable Machine Tools, Inc., which was sold on November 30, 2005 for approximately $14.5 million in cash, resulting in a pre-tax gain of approximately $1.5 million.
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Results of Operations
Three Months Ended November 30, 2005 Compared To Three Months Ended November 30, 2004
With the sale of Climax, the Company reports results from a single business segment— industrial services. Industrial services are the aggregate of the TCM and TMS operating segments. The Company measures the results of those segments using the metric, “operating income”, which excludes all costs for interest and income taxes, which we consider corporate costs and are not allocated to these operating segments. We believe that operating income is an appropriate performance measure to discuss since it allows investors to consider our operating performance without regard to financial leverage and capital structure.
The following sets forth the components of revenue and operating income from continuing operations for the three months ended November 30, 2005 and 2004 (in thousands):
Revenues:
Industrial services
TMS
TCM
Gross margin:
% of revenue
S, G & A expenses
Corporate costs
Operating income—continuing operations
Operating income—continuing operations comprised of:
Less corporate costs:
Total operating income—continuing operations
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Industrial Services Segment—Segment operating income was $9.4 million for the quarter, up 98% from the prior year quarter. Segment operating income as a percent of revenue was 14%, up 4 percentage points from the prior year quarter. Total industrial services revenues were $67.0 million in the current fiscal quarter, versus $48.4 million in the same quarter last year. Approximately 14% of industrial services revenues in the current year quarter are from foreign operations, primarily in Canada (9%) and the South America/Caribbean basin (5%). In last year’s quarter, only about 10% of industrial service revenues were foreign sourced.
Revenues and Gross Margins—Revenues for TMS increased $6.8 million or 31% over the three months ended November 2004. Nearly all TMS service lines contributed to this growth. On stream services (leak repair, hot tapping, and fugitive emissions monitoring) grew 19% over last year. Turnaround related services, (field machining, bolting and field valve repair) increased by over 50% from last year’s quarter. TCM experienced even stronger growth rates with revenues increasing $11.9 million over the same quarter last year, or 45%. That organic growth reflects the continuing rebound of the former Cooperheat business unit from its depressed revenue levels while operating in bankruptcy prior to its acquisition by Team as well as the strong market demand for its services.
The company believes that the growth in all of its industrial service offerings reflects strong market demand driven in part by very robust customer profit margins in several key segments combined with Team’s continued market share growth driven by outstanding service performance and ongoing customer strategies to consolidate service procurement with fewer, larger multi-service, multi-location service companies. For the quarter, Hurricanes Katrina and Rita depressed overall revenues slightly due to the disruptions and the inability to do any work at several major facilities. However, offsetting increases in work related to storm damage repairs are expected over the next several quarters.
The TMS operations earned a margin of 38% in the quarter, which was two percentage points less than the same quarter of last year, but consistent with the margins earned in the first quarter. TMS margins were slightly depressed due to the impact on costs of Hurricanes Katrina and Rita along the Louisiana Gulf Coast, as well as job performance issues in one of the segment’s geographic areas. TCM margins of 33% were the highest earned by TCM in any quarter since the acquisition of the Cooperheat business and reflects the operating leverage associated with the substantial increase in revenues during the quarter. TCM’s lower gross margin versus TMS is due to relatively higher labor and indirect costs as a percentage of sales.
Selling General, and Administrative Expenses—Industrial Services selling, general and administrative expenses increased $2.3 million, or 20% over last year’s quarter, which increase was to support the 39% increase in revenues. As a percentage of revenues, segment SG&A improved to 21% in the current year quarter from 24% in last year’s quarter.
Corporate costs—Total corporate costs were $2.4 million in the quarter ended November 31, 2005 versus $1.9 million for the same quarter last year. The increase of $0.5 million reflects the increased support associated with significantly larger operations.
Interest—Total interest expense was $1.1 million in the quarter ended November 30, 2005 as compared to $0.8 million for the same quarter last year, of which $0.2 million was allocated to discontinued operations in each period (see Note 2 to the Consolidated Condensed Financial Statements). The increase in interest reflects the growth in debt due to growth in working capital as compared to last year’s quarter and as a result of generally increasing interest rates. See also the discussion of liquidity and capital resources below.
Taxes—The provision for income taxes from continuing operations was $2.3 million on pretax income of $6.1 million in the quarter ended November 30, 2005. The effective tax rate for the year was 38% in both years. The effective tax rate on discontinued operations was nearly 100%. For Federal income tax purposes, the Climax stock sale provided the purchaser with a step-up in basis of the underlying assets of Climax under Section 338 (h) (10) of the Internal Revenue Code. This treatment results in a significantly higher taxable gain to the Company than is reflected in the financial statements since the Company’s tax basis calculation is
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limited to the amount of the historic tax basis of Climax in its underlying assets. The total differential between book and tax gain is approximately $4.9 million resulting in approximately $1.7 million of current income tax. Deferred income taxes of approximately $0.8 million were provided for the tax-effect of the differential at the time of the Company’s purchase of Climax in 1998. An additional $0.9 million of income tax expense has been provided in the second quarter in the discontinued operations section of the income statement to reflect the additional tax obligation resulting from the Section 338 (h) (10) election.
Six Months Ended November 30, 2005 Compared To Six Months Ended November 30, 2004
The following sets forth the components of revenue and operating income from continuing operations for the six months ended November 30, 2005 and 2004 (in thousands):
Total operating income
Industrial Services Segment—Segment operating income was $14.0 million for the six months ended November 30, 2005, up 111% from the same period of the prior year. Segment operating income as a percent of revenue was 7%, up 3 percentage points from the prior year. Total industrial services revenues were $121 million in the current six month period, versus $78 million in the same period of the prior year. Approximately 13% of industrial services revenues in the current six month period are from foreign
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operations, primarily in Canada (8%) and the South America/Caribbean basin (5%). In the six months period ended November 30, 2005, only about 8% of industrial service revenues were foreign sourced. Of the $43.0 million in revenue growth, approximately $11.0 million is associated with the acquisition of Cooperheat and $32.0 is from organic growth.
Revenues and margins—Revenues for TMS increased $11.8 million or 29% over the six months ended November 2004. Nearly all TMS service lines contributed to this growth. On stream services (leak repair, hot tapping, and fugitive emissions monitoring) grew 18% over last year. Turnaround related services, (field machining, bolting and field valve repair) increased by over 55%.
TCM revenue growth of $31.2 million includes $11.0 million associated with the inclusion of the Cooperheat business for the full period in 2005, and $20.2 million of organic growth, or a 45% increase on a pro forma basis. The organic growth reflects the continuing rebound of the former Cooperheat business unit from its depressed revenue levels while operating in bankruptcy prior to its acquisition by Team as well as the strong market demand for its services.
The company believes that the growth in all of its industrial service offerings reflects strong market demand driven in part by very robust customer profit margins in several key segments combined with Team’s continued market share growth driven by outstanding service performance and ongoing customer strategies to consolidate service procurement with fewer, larger multi-service, multi-location service companies. In the second quarter, Hurricanes Katrina and Rita depressed overall revenues slightly due to the disruptions and the inability to do any work at several major facilities. However, offsetting increases in work related to storm damage repairs are expected over the next several quarters.
For the year-to-date period, gross margins for both TMS and TCM are relatively the same as last year. This reflects, however, a significant improvement in TCM margins in the second quarter compared to the first quarter of the current fiscal year and a slight decline in TMS margins versus the second quarter of last year.
Selling General, and Administrative Expenses (Industrial Services Segment)—With respect to segment selling, general and administrative expenses (“SG&A”), of the total increase of $6.9 million, $3.8 million is associated with the additional field operations of the TCM acquired businesses. The remainder of the increase in SG&A ($3.1 million) primarily reflects increases in costs to support the organic growth of the industrial services business segment. As a percentage of revenues, segment SG&A improved to 22% in the current year quarter from 25% in last year’s quarter.
Corporate—Total corporate costs were $5.2 million for the six month period ended November 30, 2005 versus $3.2 million in the same period last year. The increase of $2.0 million includes $0.9 million in costs incurred in the first quarter related to Sarbanes-Oxley Section 404 compliance (“SOX”) for the year ended May 31, 2005, as well as additional costs to support the acquired business. The 2004 year to date period included $0.2 million of a non-cash compensation charge associated with the vesting of performance based stock options covering 67,000 shares that were granted in 1998 to the Company’s Chief Executive Officer.
Interest—Total interest expense was $2.3 million in the first six months of fiscal 2006 as compared to $1.1 million in the same period last year, of which $0.5 million and $0.2 million, respectively, was allocated to discontinued operations. (see Note 2 to the Consolidated Condensed Financial Statements). This increase is directly associated with the additional borrowings to fund the acquisition of Cooperheat (August 2004), and reflects the growth in debt due to growth in working capital as compared to last year’s period and as a result of generally increasing interest rates. See also the discussion of liquidity and capital resources below.
Taxes—The provision for income taxes on income from continuing operations was $2.6 million on pretax income of $7.0 million for the first six months of fiscal 2006. The effective tax rate for the year to date period was 38%, the same as last year. See the discussion for the three month period above for an explanation of the effective tax rate associated with discontinued operations.
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Liquidity and Capital Resources
Financing for the Company’s operations is provided by an $85 million credit facility, consisting of a $60 million revolving loan and a $25 million term facility. The facility originated in August 2004 and provided the financing for the Cooperheat acquisition. The facility matures in August 2009. The term facility requires mandatory principal reductions of $3 million in 2005, $4 million in 2006 and $6 million in each of years 2007 through 2009. Borrowings on the facility are generally at LIBOR (which was approximately 4.4% at November 30, 2005) plus a margin which is variable depending upon the ratio of funded debt to EBITDA. (EBITDA is earnings before interest, taxes, depreciation and amortization).
On October 5, 2005, the Company amended the credit agreement (the “First Amendment”) with its banks to increase the allowable debt to EBITDA ratio at August 31, 2005 and thereafter. The amended agreement requires that the debt to EBITDA ratio be no greater than 3.75 to 1 at November 30, 2005. The First Amendment also provided that proceeds from a sale of the Climax business would be applied to reduce amounts outstanding under the revolving loan, rather than the term loan, as provided in the original credit agreement. The First Amendment further provided that the maximum debt to EBITDA ratio would be reduced to 3.0 to 1 immediately upon the disposition of Climax.
On November 15, 2005, the Company further amended the credit agreement (the “Second Amendment”) to waive the required reduction in the debt to EBITDA ratio to 3.0 to 1 for the quarter ended November 30, 2005 if the sale of Climax occurred during the quarter then ended. The Second Amendment also increased the revolving credit facility by $5 million to a maximum amount of $60 million.
Total EBITDA from continuing operations was $8.7 million in the second quarter and $11.8 million for the year-to-date period. On a trailing twelve month basis, EBITDA from continuing operations was $20.8 million. At November 30, 2005, the Company’s Debt to EBITDA ratio was less than 3.0 to 1 and the Company was in compliance with the amended covenants.
On November 30, 2005, the Company completed the sale of Climax for a cash consideration of approximately $14.5 million, subject to future adjustments, which are not expected to be material. Approximately $14 million of revolving debt was repaid from the proceeds.
The Company recognized a pre-tax gain on the sale of Climax of $1.5 million, which is net of costs and expenses associated with the transaction of approximately $0.9 million. For Federal income tax purposes, the stock sale provided the purchaser with a step-up in basis of the underlying assets of Climax under Section 338 (h) (10) of the Internal Revenue Code. This treatment results in a significantly higher tax gain to the Company than is reflected in the financial statements since the Company’s tax basis calculation is limited to the amount of the historic tax basis of Climax in its underlying assets. The total differential between book and tax gain is approximately $4.9 million. Deferred income taxes of approximately $0.8 million were provided for the tax-effect of the differential at the time of the Company’s purchase of Climax in 1998. An additional $0.9 million of income tax expense has been provided in the second quarter in the discontinued operations section of the income statement to reflect the additional tax obligation resulting from the Section 338 (h) (10) election. Taxes associated with the transaction (totaling approximately $2.2 million) will be paid in the third quarter of the current fiscal year.
For the six months ended November 30, 2005, we used $2.8 million of cash in our operating activities from continuing operations as a result of an increase in receivables of $9.4 million an increase in prepaids, including approximately $2 million for prepaid premiums associated with the annual June renewal of the Company’s property and casualty insurance. Financing for the insurance renewal is provided through short term insurance notes (bearing interest at 5.95%) that are repayable over nine months.
In the year-to-date period, the Company continued to experience a lengthening of the number of days sales outstanding in accounts receivable (“DSO”) to approximately 91 days from 82 days at May 31, 2005.
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A significant portion of the increase in our DSO is associated with accounts associated with major turnaround projects completed last year, including the customer dispute discussed in Part II, Item 1, Legal Proceedings.
The Company incurred approximately $3.4 million for capital expenditures in the six months ended November 30, 2005. Over the course of the fiscal year, we would expect the amount of capital expenditures to be generally equivalent to the amount of depreciation and amortization expense, which was $3.0 million in the six month period of 2005.
At November 30, 2005, the Company was contingently liable for $ 6.5 million in outstanding stand-by letters of credit and, at that date, approximately $ 21 million was available to borrow under the credit facility.
Critical Accounting Policies
Goodwill and Other Intangible Assets - Goodwill represents the excess of costs over fair value of assets of businesses acquired. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually in accordance with the provisions of FASB Statement No. 142, Goodwill and Other Intangible Assets. Intangible assets with estimated useful lives are amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with FASB Statement No. 144, Accounting for Impairment or Disposal of Long-Lived Assets.
For purposes of computing the annual impairment test, the Company’s reporting units are Team Cooperheat MQS (“TCM”) of the Industrial Services Segment. The Company completed the required annual impairment test for fiscal 2005 and determined that there was no impairment of goodwill as of May 31, 2005. The Company does not believe that any triggering events have occurred during the six months ended November 30, 2005 that would require a re-assessment of the recoverability of its goodwill balances. The impairment test for the current fiscal year will not be performed until the end of the fiscal year.
Revenue Recognition - The Company derives its revenues by providing a variety of industrial services including leak repair, hot tapping, emissions control services, field machining and inspection services. For all of these services, revenues are recognized when services are rendered. Because most of the Company’s projects are short-term in nature, revenue recognition does not involve a significant use of estimates, as would be the case if our services were longer term in nature. At the end of each reporting period there is an amount of earned but unbilled revenue that is accrued to properly match revenues with related costs. At November 30, 2005 and May 31, 2005, the amount of unbilled revenue included in receivables was $ 5.5 million and $ 3.0 million, respectively.
Deferred Income Taxes - The Company records deferred income tax assets and liabilities related to temporary differences between the book and tax bases of assets and liabilities. The Company computes its deferred tax balances by multiplying these temporary differences by the current tax rates. If deferred tax assets exceed deferred tax liabilities, the Company must estimate whether those net deferred asset amounts will be realized in the future. A valuation allowance is then provided for the net deferred tax asset amounts that are not likely to be realized. As of November 30, 2005 management believes that it is more likely than not that the Company will have sufficient future taxable income to allow it to realize the benefits of the net deferred tax assets. Our belief is based upon our track record of consistent earnings growth over the past five years and
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projections of future taxable income over the periods in which the deferred tax assets are deductible. Accordingly, no valuation allowance has been recorded. For interim reporting purposes, the Company computes an estimated annual effective tax rate and multiplies that rate times earnings before income tax to compute income tax expense for interim periods.
Loss Contingencies - The Company is involved in various lawsuits and claims encountered in the normal course of business. When such a matter arises and periodically thereafter, management consults with its legal counsel and evaluates the merits of the claim based on the facts available at that time. Currently, the Company is not involved with any significant legal matters, having settled two potentially significant matters in the second quarter. See Part II, Item 1, Legal Proceedings.
Critical Expense Estimates - Certain costs and expenses are subject to a significant degree of estimation whose outcome is not certain until the passage of time. Among these estimates are the provision for doubtful accounts as well as claims expense associated with workers compensation, automobile liability and group health insurance claims, for which the Company is self insured to certain stop-loss limits. For workers’ compensation and automobile liability claims, the self insured retention is $250,000 per case. For medical claims, the self insured retention is $175,000 per individual claimant determined on an annual basis. The Company estimates it liability with respect to self-insured retention amounts on the basis of claims information provided by insurance carriers and makes periodic adjustments to its accruals based upon analysis received from the carriers. The provision for doubtful accounts is based managements best estimate of the ultimate uncollectible accounts based upon its analysis of the agings of individual accounts and with reference to the Company’s historical experience.
Other Contractual Obligations and Commercial Commitments
The Company enters into operating leases related to facilities and transportation and other equipment. These operating leases are over terms ranging from one to five years.
The Company is occasionally required to post letters of credit generally issued by a bank as collateral under certain agreements. A letter of credit commits the issuer to remit specified amounts to the holder, if the holder demonstrates that the Company has failed to meet its obligations under the letter of credit. If this were to occur, the Company would be obligated to reimburse the issuer for any payments the issuer was required to remit to the holder of the letter of credit. To date, the Company has not had any claims made against a letter of credit that resulted in a payment made by the issuer or the Company to the holder. The Company believes that it is unlikely that it will have to fund claims made under letters of credit in the foreseeable future. At November 30, 2005, $6.5 million was outstanding under standby letters of credit to secure, generally, workers compensation and automobile liability insurance contracts.
In December 2004, the FASB issued SFAS No. 123 (revised 2004) “Share-Based Payment” (“SFAS 123(R)”). SFAS 123(R) addresses the accounting for transactions in which an enterprise exchanges its equity instruments for employee services. It also addresses transactions in which an enterprise incurs liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of those equity instruments in exchange for employee services. For public entities, the cost of employee services received in exchange for equity instruments, including employee stock options, is to be measured on the grant-date fair value of those instruments. That cost will be recognized as compensation expense over the service period, which would normally be the vesting period. The Company will be required to adopt the provisions of SFAS 123(R) in the first quarter of fiscal 2007. Management does not anticipate that adoption of this standard will have a material impact on the Company’s operating results.
In November 2004, FASB issued SFAS No. 151 “Inventory Costs” which amends the guidance in ARB No. 43, Chapter 4 “Inventory Pricing” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated “that under some circumstances, items such as idle facility expense, excessive spoilage, double freight and re-
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handling costs may be so abnormal as to require treatment as current period charges.” SFAS No. 151 requires that those items be recognized as current period charges regardless of whether they meet the criterion of “so abnormal.” In addition, SFAS No. 151 requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 shall be effective for inventory costs incurred during fiscal years beginning after June 15, 2005 which is effective with the Company’s first quarter of fiscal 2007. . Earlier application is permitted for inventory costs incurred during fiscal years beginning after the date SFAS No. 151 was issued. SFAS No. 151 shall be applied prospectively. The Company does not expect the adoption of SFAS No. 151 to have a material effect on its consolidated financial statements.
In May 2005, the FASB issued SFAS No 154, “Accounting Changes and Error Corrections – A replacement of APB Opinion No 20 and FASB Statement No. 30” (“SFAS 154”). SFAS 154 changes the requirement for the accounting for and reporting of a change in accounting principle. This statement applies to all voluntary changes in accounting principles and changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. The provisions in SFAS 154 are effective for accounting changes and correction of errors made in fiscal years beginning after December 15, 2005, which is effective with the Company’s first quarter of fiscal 2007. The Company intends to adopt the disclosure requirements upon the effective date of the pronouncement. Since this disclosure pronouncement only relates to requirements, the adoption will have no impact on the Company’s consolidated financial statements.
The Company has reviewed other new accounting standards not identified above and does not believe any other new standards will have a material impact on the Company’s financial position or operating results.
Disclosure Regarding Forward Looking Statements
Any forward-looking information contained herein is being provided in accordance with the provisions of the Private Securities Litigation Reform Act. Such information is subject to certain assumptions and beliefs based on current information known to the Company and is subject to factors that could result in actual results differing materially from those anticipated in any forward-looking statements contained herein. Such factors include domestic and international economic activity, interest rates, market conditions for the Company’s customers, regulatory changes and legal proceedings, and the Company’s successful implementation of its internal operating plans. Accordingly, there can be no assurance that any forward-looking statements contained herein will occur or those objectives will be achieved.
The Company holds certain floating-rate obligations. There were no material quantitative or qualitative changes during the first six months of fiscal 2005 in the Company’s market risk sensitive instruments.
The Company’s chief executive officer and its chief financial officer have evaluated the Company’s disclosure controls and procedures (as defined in Exchange Act rules 13a-15(e) and 15d-15(e)) as of November 30, 2005, and have concluded that such controls are effective.
There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect those controls subsequent to the date of their evaluation.
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PART II - OTHER INFORMATION
On October 19, 2005 the Company entered into an agreement settling the pending litigation styled Diamond Shamrock Refining Company, L.P. v. Puffer-Sweiven, Inc. et al in the 36th Judicial District Court of Live Oak County, Texas, Cause number L-05-0093-CV-A. The suit sought recovery for approximately $40 million in property damages from an explosion and fire originating at a valve near a leaking gasket that the Company’s personnel were attempting to seal. Additionally, indemnity coverage from the $1 million primary policy which was in dispute in an action styled Team Industrial Services, Inc. v. American Safety Indemnity Company et. al. in the 149th Judicial District Court of Brazoria County, Texas, Cause number 28,400 was settled in December 2005. The entire settlement of the Diamond Shamrock case is being funded by the Company’s insurance carriers.
In November 2004, the Company participated in a turnaround at a refinery facility of a major customer which resulted in a claim being made by that customer against the Company. The customer alleged that the Company’s work resulted in damage to a vessel flange that required further repairs that delayed the re-commencement of the refinery’s production. The customer submitted a demand for $1.8 million dollars in damages (which included an alleged $1.5 million of damages for lost production). On December 16, 2005, the parties executed a settlement agreement that included pricing discounts to the customer on future work totaling $300,000 and a revision to certain contract terms.
In August 2005, the Company was served in a lawsuit styled Paulette Barker, as named Executor for the Estate of Robert Barker, et. al. v. Emmett J. Lescroart, Michael Urban, Team, Inc. et. al., Case Number 355868-402 in the Probate Court #1, Harris County, Texas. Apparently, the dispute arises out of the sale by Mr. Barker to Mr. Lescroart of stock in Thermal Solutions, Inc. Subsequently, all of the outstanding stock of Thermal Solutions, Inc. was acquired by the Company in April of 2004 allegedly for a much higher price than Mr. Lescroart paid Mr. Barker in July of 2003. The plaintiff claims damages in excess of $1,000,000. The Company does not believe that it has any legal liability under the allegations of the suit and, further, believes it is protected under the terms of the Stock Purchase Agreement related to the acquisition. Mr. Lescroart is a member of the Board of Directors of the Company and was dismissed from the lawsuit for lack of personal jurisdiction in December 2005.
The Company and certain subsidiaries are involved in various other lawsuits and are subject to various claims and proceedings encountered in the normal conduct of business. In the opinion of management, any uninsured losses that might arise from these lawsuits and proceedings will not have a materially adverse effect on the Company’s consolidated financial statements.
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The 2005 Annual Meeting of Shareholders of the Company was held on September 29, 2005. At that meeting, Messrs. Philip J. Hawk and Louis B. Waters were elected to serve as Class I directors for a three-year term. The votes with respect to the election of each director were as follows:
NAME
FOR
WITHHELD
Philip J. Hawk
Louis B. Waters
The shareholders also elected Mr. Vincent D. Foster to serve as a Class II Director on the Company’s Board of Directors for a term expiring at the 2006 Annual Meeting of Shareholders. The votes with respect to his election were as follows:
AGAINST
ABSTAIN
Vincent D. Foster
The five directors continuing in office until the expiration of their respective terms are Messrs. E. Patrick Manuel, Sidney B. Williams, Emmett J. Lescroart, Jack M. Johnson, Jr., and E. Theodore Laborde .
The shareholders also approved the appointment of KPMG LLP as independent auditors for the fiscal year ending May 31, 2006 by the following vote:
8,724,075
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Exhibit
Number
Description
The Company filed four (4) reports on Form 8-K during the quarter ended November 30, 2005, as follows:
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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 thereto duly authorized.
TEAM, INC
(Registrant)
Date: January 9, 2006
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