Williams Industrial Services Group Inc. - Quarter Report: 2004 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 26, 2004

OR

For the transition period from              to             

Commission File Number: 001-16501

GLOBAL POWER EQUIPMENT GROUP INC.

(Exact name of registrant as specified in its charter)

6120 South Yale, Suite 1480, Tulsa, Oklahoma

(Address of principal executive offices)

74136

(Zip Code)

(918) 488-0828

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  x    No  ¨

The number of shares of the Registrant’s common stock, $.01 par value, outstanding at August 2, 2004 was 46,325,798.

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GLOBAL POWER EQUIPMENT GROUP INC.

FORM 10-Q

June 26, 2004

INDEX

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PART I. FINANCIAL INFORMATION

ITEM I. FINANCIAL STATEMENTS

GLOBAL POWER EQUIPMENT GROUP INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands, except share data)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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GLOBAL POWER EQUIPMENT GROUP INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(in thousands, except per share amounts)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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GLOBAL POWER EQUIPMENT GROUP INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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GLOBAL POWER EQUIPMENT GROUP INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. BUSINESS AND ORGANIZATION

Global Power Equipment Group Inc. and Subsidiaries (the Company or GPEG) designs, engineers and manufactures heat recovery and auxiliary power equipment. Our products include:

The Company’s corporate headquarters are located in Tulsa, Oklahoma, with operating facilities in Plymouth, Minnesota; Tulsa, Oklahoma; Auburn, Massachusetts; Clinton, South Carolina; Monterrey, Mexico; Toluca, Mexico; Shanghai, China; and Heerlen, Netherlands. The Clinton, South Carolina and Toluca, Mexico facilities will be closed during the third quarter of 2004.

2. INTERIM FINANCIAL STATEMENTS

The unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. The information furnished in the condensed consolidated financial statements, in the opinion of management, includes normal recurring adjustments and reflects all adjustments which are necessary for a fair presentation of such financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. Although the Company believes that the disclosures are adequate to make the information presented not misleading, these condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Form 10-K for the fiscal year ended December 27, 2003, filed with the Securities and Exchange Commission. The quarterly results are not necessarily indicative of the actual results that may occur for the entire fiscal year.

3. GOODWILL

There were no changes in the carrying amount of goodwill during the first six months of fiscal 2004. The Company will complete its annual impairment testing during the fourth quarter of fiscal year 2004 or earlier as necessary if circumstances warrant a possible impairment charge. The balances by operating segment as of June 26, 2004 and December 27, 2003 were as follows (in thousands):

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4. EARNINGS PER SHARE

Basic and diluted earnings per common share are calculated as follows (in thousands, except share and per share data):

5. DERIVATIVE FINANCIAL INSTRUMENTS

SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” establishes accounting and reporting standards requiring that certain derivative instruments be recorded on the balance sheet as either an asset or a liability measured at fair value. SFAS 133 requires that changes in a derivative’s fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Accounting for qualifying hedges allows a derivative’s gains and losses to be deferred in other comprehensive income until the transaction occurs (“cash flow hedge”) or to offset related results on the hedged item in the income statement (“fair value hedge”). Hedge accounting requires that a company formally document, designate and assess the effectiveness of transactions that receive hedge accounting treatment.

Periodically, the Company uses derivative financial instruments in the management of its foreign currency exchange and interest rate exposures. As of June 26, 2004, there were foreign currency forward exchange contracts outstanding with a notional amount of approximately $3.0 million with varying amounts due through December 2004. Currently, the Company recognizes changes in fair values of the forward agreements through earnings. The changes in the fair values of unrealized gains on the forward agreements of approximately $0.09 and $0.04 million for the three and six months ended June 26, 2004, respectively, are included in earnings through cost of sales. As of June 28, 2003, amounts outstanding under foreign currency forward exchange agreements were $5.2 million with varying amounts due through July 2003. The Company recorded unrealized gains on the forward agreements of approximately $0.01 and $0.05 million for the three and six months ended June 28, 2003, respectively.

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6. LITIGATION, COMMITMENTS AND CONTINGENCIES

In June 2003, Stone & Webster, Inc. and Stone & Webster Purchasing, Inc. (collectively, “S&W”) commenced a lawsuit in the U.S. District Court for the Southern District of Iowa Central Division, against Deltak, L.L.C. (“Deltak”), one of the Company’s subsidiaries. The lawsuit alleged Deltak committed breach of contract and warranty and made certain intentional misrepresentations in connection with a contract to provide two heat recovery steam generators for a project in which S&W was the general contractor. S&W alleged it incurred significant cost increases and delays on the project resulting from certain design, constructability and fabrication issues related to the heat recovery steam generators provided by Deltak and sought an unspecified amount of damages for costs. Deltak filed counterclaims against S&W seeking damages from S&W for breach of contract and unjust enrichment. On March 8, 2004, this lawsuit was settled for an amount that was less than the reserve the Company had accrued for this contingency in fiscal 2003, resulting in an increase to the first six months of 2004 pre-tax net income of $1.1 million. Under the confidential settlement agreement, all claims by the parties were mutually dismissed and the parties were mutually released from any and all damages.

The Company is involved in other legal actions which arise in the ordinary course of its business. Although the outcomes of any such legal actions cannot be predicted, in the opinion of management, the resolution of any currently pending or threatened actions will not have a material adverse effect upon the consolidated financial position or results of operations of the Company.

Estimated costs related to product warranty are accrued and included in cost of sales as revenue is recognized. Estimated costs are based upon past warranty claims and sales history. Warranty terms vary by contract but generally provide for a term of three years or less. We manage our exposure to warranty claims by having our field service and quality assurance personnel regularly monitor our projects and maintain ongoing and regular communications with the customer.

A reconciliation of the changes to our warranty accrual for the periods indicated is as follows (in thousands):

During most of the periods presented above, the Company had changes in previous accruals due to the lapse of warranty periods and lesser than expected settlements under warranty claims. The Company continues to review its warranty accrual policy in light of its changing business operations and settlement experience.

At June 26, 2004, the Company had a contingent liability for issued and outstanding stand-by letters of credit totaling $32.0 million that generally were issued to secure performance on customer contracts. Currently, there are no amounts drawn upon these letters of credit.

During the first quarter of fiscal 2004, the Company entered into two loan agreements with banks in China. The agreements allow for the Company to borrow $4.8 million at a rate of 5.31%. The agreements expire April 1, 2005. As of June 26, 2004, approximately $1.0 million has been borrowed under the loan agreements. The loans are collateralized by letters of credit issued under the Company’s amended and restated senior credit facility.

The Company’s amended and restated senior credit facility:

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The Company is currently in compliance with these covenants and restrictions.

Under a management agreement with Harvest Partners, Inc., the Company is contractually committed to annual payments of certain fees for financial advisory and strategic planning services to Harvest of $1.3 million per year. The terms of the management agreement provide for automatic renewals of additional one-year periods commencing each August unless terminated for cause or by Harvest. During any subsequent renewal period of the management agreement, the management fee will decrease to $750,000 per year if the affiliates of Harvest Partners, Inc. sell more than 50% of the shares of the Company’s common stock they owned at the time of the Company’s initial public offering on May 23, 2001. The management fee will be eliminated and the management agreement will terminate, if in any subsequent renewal period the affiliates of Harvest Partners, Inc. sell more than 66.6% of the shares of the Company’s common stock they owned on May 23, 2001.

7. SEGMENT INFORMATION

The “management approach” called for by SFAS 131, “Disclosures about Segments of an Enterprise and Related Information” has been used by GPEG management to present the segment information which follows. GPEG considered the way its management team makes operating decisions and assesses performance and considered which components of its enterprise have discrete financial information available. Management makes decisions using a product group focus and its analysis resulted in two operating segments, Heat Recovery Equipment and Auxiliary Power Equipment. The Company evaluates performance based on net income or loss not including certain items as noted below. Intersegment revenues and transactions were not significant. Corporate assets consist primarily of cash and deferred tax assets. Interest income has not been allocated as cash management activities are handled at a corporate level. In the first quarter of 2004, the Company changed the basis by which it allocates corporate general and administrative expenses to the operating segments. This new manner of allocating corporate expenses better reflects the use of corporate resources by the operating segments. Prior year amounts were reclassified to conform to the 2004 presentation.

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The following table presents information about segment income and assets (in thousands):

The following tables present information which reconciles segment information to consolidated totals (in thousands):

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The following table represents revenues by product group (in thousands):

The following table presents revenues by geographic region (in thousands):

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8. MAJOR CUSTOMERS

The Company has certain customers that represent more than 10 percent of consolidated revenues. The revenue for these customers, as well as corresponding accounts receivable, as a percentage of the consolidated revenues and accounts receivable balances, are as follows:

9. SUPPLEMENTAL CASH FLOW INFORMATION

Changes in current operating items were as follows (in thousands):

Supplemental cash flow disclosures are as follows (in thousands):

During the first six months of fiscal years 2004 and 2003, there was approximately $4.0 million and $0 million, respectively, of tax benefit related to stock options exercised that were reflected as an increase to paid-in capital.

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10. RECENT ACCOUNTING PRONOUNCEMENTS

In January 2003, the Financial Accounting Standards Board (FASB) issued FIN 46, “Consolidation of Variable Interest Entities.” This is an interpretation of ARB No. 51 “Consolidation of Financial Statements,” which addresses the consolidation by business enterprises of variable interest entities that either: (1) do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) the equity investors lack an essential characteristic of a controlling interest. In December 2003, the FASB issued a revision of FIN 46 (FIN 46R), which clarified certain complexities of FIN 46 and generally requires adoption of all special-purpose entities that qualify as variable interest entities no later than the end of the first reporting period ending after December 15, 2003 and to all non special-purpose entities that qualify as variable interest entities no later than the end of the first reporting period ending after March 15, 2004. At June 26, 2004, the Company did not have any entities that require disclosure or new consolidation as a result of adopting the provisions of FIN 46 or FIN 46R.

11. COMPREHENSIVE INCOME

The table below presents comprehensive income for all applicable periods (in thousands):

12. RESTRUCTURING

In October 2003, the Company announced a management restructuring plan pursuant to which certain employees were offered either one-time termination or retirement benefits. Certain employees that were offered the retirement incentive packages entered into consulting agreements with the Company subsequent to their retirement. The expense of the consulting agreements will be recognized as the services are provided over the term of the agreements. In addition, retiring employees were offered the right to amend their stock option agreements to extend the date such options remain exercisable from the original period of 90 days after termination of employment to a new period extending to one year after termination of employment. In some cases, this plan also provided for the acceleration of vesting for certain unvested stock options. As required by variable plan option accounting under APB Opinion No. 25, “Accounting for Stock Issued to Employees,” the Company will expense the intrinsic value of the options. The Company recorded charges of approximately $0.3 million during the second quarter and approximately $2.3 million during the first six months of fiscal year 2004 related to the restructuring plan in selling and administrative expenses.

Under the 2003 management restructuring plan, a retirement benefits agreement was entered into with the Company’s Chief Executive Officer (CEO), Larry Edwards, pursuant to which he determines his own future retirement date. At this time, the retirement date is unknown. Upon retirement, Mr. Edwards will receive a payment of approximately $1.9 million, which was expensed in 2003 and is included in other long-term liabilities as of June 26, 2004.

From the inception of the management restructuring plan through June 26, 2004, the Company has incurred costs of approximately $6.2 million related to the plan. The Company expects to incur approximately $4.5 million of restructuring charges in the future, including an estimate of $2.6 million for the expected consulting fees and variable stock option expense related to the CEO’s retirement benefits agreement.

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A reconciliation of the liability (included in other current liabilities) for the restructuring costs from December 27, 2003 to June 26, 2004 is as follows (in thousands):

The balance of $1.9 million in other long-term liabilities remained unchanged from December 27, 2003 to June 26, 2004.

Approximately $0.9 million and $1.4 million of the fiscal year 2004 restructuring costs were allocated to the Heat Recovery Equipment and Auxiliary Power Equipment segments, respectively.

13. STOCK-BASED COMPENSATION

Stock-based compensation is accounted for using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” No compensation expense is recorded for stock options when granted, as option prices have historically been set at the market value of the underlying stock at the date of grant.

SFAS 123 “Accounting for Stock-Based Compensation,” requires the measurement of the fair value of options to be included in the statement of operations or disclosed in the notes to the financial statements. The Company elected the disclosure-only alternative under SFAS 123.

Had compensation cost been determined consistent with SFAS 123, the Company’s pro forma net income would have been as follows (in thousands, except per share amounts):

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The paid-in capital deficit decreased from December 27, 2003 to June 26, 2004 primarily as a result of 1,117,868 stock options that were exercised during this period. A reconciliation of the changes in the account is as follows (in thousands):

14. SUBSEQUENT EVENT

On July 30, 2004, the Company purchased a 90 percent interest in Nanjing Boiler Works (NBW) from Nanjing Machinery & Electronics for approximately $10.1 million in cash. NBW manufactures heat recovery steam generating units for combined-cycle gas turbine power plants, as well as specialty boiler systems for worldwide customers of Deltak LLC based on Deltak’s design and engineering specifications. In addition, NBW designs and manufactures industrial and package boilers used by domestic customers in China for various applications where steam is required. NBW is located in Jiangsu province in eastern China. As of the purchase date, the Company changed NBW’s name to Deltak Power Equipment (China) Co., Ltd.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS

Overview

In addition to historical information, this Form 10-Q includes certain “forward-looking statements.” Forward-looking statements represent our beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside of our control. These forward-looking statements include, in particular, the statements about our plans, strategies and prospects. When used in this report, the words “expect,” “may,” “intend,” “plan,” “anticipate,” “believe,” “seek” and similar expressions, as well as statements regarding our focus for the future, are generally intended to identify forward-looking statements. Although we believe that our plans, intentions and expectations reflected in or suggested by these forward-looking statements are reasonable, these forward-looking statements rely on assumptions and are subject to risks and uncertainties that may prevent us from achieving our plans, intentions or expectations.

Information concerning some of the risks, uncertainties and other factors that could cause actual results to differ materially from those in, or implied by, the forward-looking statements we make in this Form 10-Q is set forth under “Risk Factors” in Item 1 of our Form 10-K for the fiscal year ended December 27, 2003, and in this section. All forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by the cautionary statements, risks and uncertainties found in the sections mentioned above. Accordingly, undue reliance should not be placed on these forward-looking statements, which speak only as of the date of this Form 10-Q. We undertake no obligation to update or revise the forward-looking statements.

We design, engineer and fabricate a comprehensive portfolio of heat recovery and auxiliary power equipment and provide related services. We conduct our business through two operating segments: our Heat Recovery Equipment segment and our Auxiliary Power Equipment segment. The Company’s corporate headquarters are located in Tulsa, Oklahoma, with operating facilities in Plymouth, Minnesota; Tulsa, Oklahoma; Auburn, Massachusetts; Clinton, South Carolina; Monterrey, Mexico; Toluca, Mexico; Shanghai, China and Heerlen, Netherlands. During fiscal year 2003, we focused our efforts on maintaining profitability despite the decrease in revenues. These efforts included closing one manufacturing plant, reducing debt and implementing a management restructuring plan to reduce staff and related costs and improve competitiveness. In addition, we strengthened our sales and operating initiatives in China and Southeast Asia allowing us to take advantage of the increasing need for additional power in that region. However, the demand for new power plants in the United States has decreased significantly, and we enter the remainder of fiscal year 2004 with uncertainty regarding when that demand may increase.

During the second quarter of 2003, we decided to permanently close our San Antonio, Mexico plant effective April 30, 2003. The decision was based primarily on a reduction in volume due to the downturn in new power plant construction within the U.S. The Auxiliary Power Equipment segment recorded approximately $170,000 in severance and other costs associated with the elimination of approximately 35 employees and the closing of the plant. During 2003, we have also scaled back operations at other locations in our efforts to continually seek to further our use of low-cost subcontractor fabrication as well as manage our costs due to the downturn in the U.S. market. Also in 2003, the Auxiliary Power Equipment and Heat Recovery Equipment segments further reduced their workforce by 201 and 41, respectively. The severance costs associated with these 2003 workforce reductions totaled approximately $390,000. All amounts have been paid.

In October 2003, we announced a management restructuring plan pursuant to which certain employees were offered either one-time termination or retirement benefits. Certain employees that were offered the retirement incentive packages entered into consulting agreements with us subsequent to their retirement. The expense of the consulting agreements will be recognized as the services are provided over the term of the agreements. In addition, retiring employees were offered the right to amend their stock option agreements to extend the date such options remain exercisable from the original period of 90 days after termination of employment to a new period extending to one year after termination of employment. In some cases, this plan also provided for the acceleration of vesting for certain unvested stock options. As required by variable plan option accounting under APB Opinion No. 25, “Accounting for Stock Issued to Employees,” we will expense the intrinsic value of the options.

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Under the 2003 management restructuring plan, a retirement benefits agreement was entered into with our Chief Executive Officer (CEO), Larry Edwards, pursuant to which he determines his own future retirement date. At this time, his retirement date is unknown. Upon retirement, Mr. Edwards will receive a payment of approximately $1.9 million, which was expensed in 2003 and included in other long-term liabilities as of June 26, 2004. This amount is included in the $3.9 million of restructuring costs recognized in fiscal year 2003. In addition, we agreed to pay Mr. Edwards approximately $812,000 in the future upon signing a release agreement on the retirement date. This amount will be expensed in the fiscal quarter in which he retires. On the retirement date, we plan to enter into a one-year consulting agreement with Mr. Edwards. The consulting fees, currently estimated at approximately $850,000, will be expensed as the services are rendered over the term of the agreement. This amount will change based on the actual salary and target bonus at the retirement date.

Under our current stock option plans, participants may exercise their vested options up to 90 days after their termination date. As part of his retirement benefits package, Mr. Edwards may execute an extension agreement, on the retirement date, whereby certain of his stock options become immediately fully vested. In addition, instead of the normal 90-day exercise period, Mr. Edwards would have one year from the retirement date to exercise his options. If this extension agreement were executed and these modifications were made to Mr. Edwards’ original stock option agreements, the Company could incur significant compensation expense in accordance with APB 25. The compensation expense would be measured on the retirement date, as the excess of the fair value of the stock over the exercise prices multiplied by the number of stock options outstanding. Assuming the number of options outstanding ($0.36/share options – 202,151 shares; $4.87/share options – 100,000 shares; $6.10/share options – 100,000 shares) and the closing stock price of $6.96 as of August 2, 2004, we estimate that this pre-tax charge would be approximately $1.8 million. This amount would vary based on the number of unexercised options and the stock price as of the retirement date.

We recorded charges of approximately $2.3 million during the first six months of fiscal year 2004 in selling and administrative expenses related to the restructuring plan.

Continuing our efforts to maximize profitability by shifting manufacturing capacity to even lower-cost sources, we announced in the second quarter of 2004 our plans to merge the operations of Consolidated Fabricators, Inc. and Braden Manufacturing, L.L.C. The merger occurred in June 2004. The costs associated with the merger will be incurred during the third and fourth quarters of fiscal 2004. The merger will result in the closing of our manufacturing facilities in Toluca, Mexico and Clinton, South Carolina. The production from these plants will be moved to other Company facilities or subcontractors. We expect to incur restructuring costs in the range of approximately $2.0 to $3.0 million to complete the merger. The Company estimates annual cost savings of at least $2.0 million.

The Company completed the purchase of a 90% interest in NBW on July 30, 2004. This acquisition is important to the Heat Recovery Equipment segment of the business from a strategic perspective. NBW owns both the license necessary to manufacture and sell boilers in China and a fully functioning, state-of-the-art manufacturing plant.

Results of Operations

The table below represents the operating results of the Company for the periods indicated (in thousands):