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GSE > SEC Filings for GSE > Form 10-K on 28-Mar-2013All Recent SEC Filings

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Form 10-K for GSE HOLDING, INC.


28-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

This discussion and analysis should be read together with Item 6, "Selected Financial Data" and our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. This discussion and analysis contain forward-looking statements that are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. Actual results could differ materially from those discussed in or implied by forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in "Forward-Looking Statements" and Item 1A, "Risk Factors."

Overview

We are the leading global provider by sales of highly engineered geosynthetic containment solutions for environmental protection and confinement applications. Our products are used in a wide range of infrastructure end markets such as mining, waste management, liquid containment (including water infrastructure, agriculture and aquaculture), coal ash containment and oil and gas. We are one of the few providers with the full suite of products required to deliver customized solutions for complex projects on a global basis, including geomembranes, drainage products, GCLs, nonwoven geotextiles and specialty products. We have a global infrastructure that includes seven manufacturing facilities located in the United States, Germany, Chile, Egypt and Thailand, 27 regional sales and/or marketing offices located in 19 countries and engineers and technical salespeople located on four continents. We generate the majority of our sales outside of North America, including high-growth emerging markets in Asia, Latin America, Africa and the Middle East. Our comprehensive product offering and global infrastructure, along with our extensive relationships with customers and end-users, provide us with access to high-growth markets worldwide and the flexibility to serve customers regardless of geographic location.

Net Sales

We derive our net sales from selling innovative and reliable geosynthetic solutions that have been customized from our broad product offering, including geomembranes, drainage products, GCLs, nonwoven geotextiles and specialty products. We focus primarily on the global mining, waste management and liquid containment end markets, and are developing new end markets such as coal ash containment and oil and gas. Our products are used in a variety of material containment and environmental protection applications by end-users in these industries, including some of the largest mining, waste management, power and other civil and industrial infrastructure companies in the world. In 2012, we served approximately 1,200 customers and no single customer generated more than 10% of our total net sales.

Depending on the size and complexity of the application, we may identify opportunities for new projects years before we ultimately deliver our products. During this time, the project owners typically conduct feasibility analyses and arrange funding for the project while our engineering and sales personnel work with the project's design engineers to advise on the technical details of the geosynthetic solution required for the project. Before construction commences, our customers may issue requests for proposals ("RFPs"), which establish certain specifications for the desired geosynthetic products, including design and performance criteria based on our advice. We respond to these RFPs by proposing product specifications for our geosynthetic solutions, providing details regarding production and anticipated delivery schedules and stipulating contractual terms such as product pricing. By leveraging our customer relationships, reputation for quality and innovation, full product breadth and engineering capabilities to work with end-users during the planning phase of these large and complex projects, our products are often specified for a project prior to the issuance of a RFP. This means that our customers often indicate in their RFPs that only GSE products may be used for a particular application, whether by identifying characteristics of our products that our competitors cannot manufacture or by expressly specifying our brand name. Similarly, in many instances our customers choose to work exclusively with us on a particular application, by-passing the RFP process altogether.

Our net sales from major projects depend, in part, on the level of capital expenditures in our principal end markets. The number of such projects we win in any particular year fluctuates, and is dependent on the number of projects available and our ability to bid successfully for such projects. Negotiations with our customers are complex and frequently involve a lengthy bidding and selection process, which is affected by a number of factors, such as competitive position (including the timing of our introduction to a project and our relationships to those involved in the project), market conditions, financing arrangements and required governmental approvals. We do not typically enter into long-term contracts with our customers; rather, we receive orders from our customers that contractually govern our participation in a project.

Pricing for our products is driven to a large extent by the costs of polyethylene resin and other raw materials. Changes in our raw material costs can affect the sales prices we charge our customers. We may increase our selling prices charged to our customers, when contractually able, if there are increases in our raw material costs. Conversely, if our raw material costs decline our selling prices we charge to our customers may be reduced.


Cost of Products

Cost of products is our primary operating expense, accounting for 83.7%, 84.8% and 87.2% of our net sales for the years ended December 31, 2012, 2011 and 2010, respectively. Cost of products includes primarily the direct cost of raw materials and labor used in the manufacture of our products as well as indirect costs such as labor, depreciation, insurance, supplies, tools, repairs and shipping and handling. Cost of products also includes all but a de minimis amount of procurement expenses incurred to purchase, receive, store and maintain our inventories. Our principal products are manufactured primarily from specially formulated high-grade polyethylene resins with chemical additives that enable the end product to better resist weathering, ultraviolet degradation and chemical exposure. HDPE is our primary raw material. We also use LLDPE, polypropylene and blow molding resin. Raw material costs represented 83.1%, 81.1% and 80.2% of our total cost of products for the years ended December 31, 2012, 2011 and 2010, illustrating the importance of effectively managing material costs to maintaining stable levels of profitability.

Selling, General and Administrative Expenses

Selling, general and administrative ("SG&A") expenses represent overhead costs associated with support functions such as finance, human resources, legal, information technology and sales and marketing costs. Primary drivers of SG&A expenses include personnel costs, severance costs and sales force commissions. SG&A expenses were 10.3%, 9.6% and 11.7% of net sales for the years ended December 31, 2012, 2011 and 2010, respectively, and each year was impacted by professional fees and restructuring costs.

Discontinued Operations

The discussion below of our results of operations excludes the impact discontinued operations for all periods presented. Discontinued operations were immaterial in 2012 and 2011.

Segment Data

We have organized our operations into five reporting segments: North America, Europe Africa, Asia Pacific, Latin America and Middle East. We generate a greater proportion of our gross profit, as compared to our net sales, in our North America segment, which consists of the United States, Canada and Mexico, because our product mix in this segment is focused on higher-margin products. We expect the percentage of total gross profit derived from outside North America to continue to increase in future periods as we continue to focus on selling these higher-value products in our other segments. We also expect the percentage of net sales derived from outside North America to increase in future periods as we continue to expand globally.

The following table presents our net sales, by segment for the periods presented, as well as gross profit and gross profit as a percentage of net sales from each segment:

                                 North        Europe         Asia        Latin       Middle
                                America       Africa       Pacific      America       East
                                            (in thousands, except percentages)
Year ended December 31, 2012
Net sales                      $ 185,893     $ 139,329     $ 97,233     $ 46,112     $ 8,077
Gross profit                      45,351        10,076       16,771        4,799         692
Gross margin                        24.4 %         7.2 %       17.2 %       10.4 %       8.6 %
Year ended December 31, 2011
Net sales                      $ 205,015     $ 131,258     $ 74,287     $ 44,402     $ 9,489
Gross profit                      44,848        10,123       10,261        4,647         628
Gross margin                        21.9 %         7.7 %       13.8 %       10.5 %       6.6 %
Year ended December 31, 2010
Net sales                      $ 142,956     $ 104,506     $ 49,370     $ 36,120     $ 9,831
Gross profit                      24,005        10,506        4,301        3,855       1,216
Gross margin                        16.8 %        10.1 %        8.7 %       10.7 %      12.4 %


The following table presents our net sales from each segment, as a percentage of total net sales:

                          Year Ended
                         December 31,
                 2012        2011        2010
North America      39.0 %      44.1 %      41.7 %
Europe Africa      29.2        28.3        30.5
Asia Pacific       20.4        16.0        14.4
Latin America       9.7         9.6        10.5
Middle East         1.7         2.0         2.9
Total             100.0 %     100.0 %     100.0 %

North America

North America net sales decreased $19.1 million, or 9.3%, during 2012 to $185.9 million from $205.0 million in 2011. Lower third party volume shipped due to increased production related to intersegment sales contributed $17.3 million and reduced selling prices contributed $10.9 million. These decreases were partially offset by changes in product mix of $9.1 million. North America intersegment sales increased $22.3 million during 2012 as a result of utilizing our plant sourcing decision model to manufacture our products at the most cost efficient locations. The increase in intersegment sales reduced the manufacturing capacity available for third party customers, which had a negative effect on 2012 net sales in North America. North America gross profit increased $0.6 million, or 1.1%, to $45.4 million during 2012 from $44.8 million in 2011 primarily due to changes in product mix which was partially offset by an increase in manufacturing costs and the decrease in volume shipped.

North America net sales increased $62.0 million, or 43.4%, during 2011 to $205.0 million from $143.0 million in 2010. Increases in sales prices contributed $36.4 million in additional sales and increased volume shipped contributed $25.6 million to the increase in net sales. North America net sales increased due to improved market share in high end products, higher volume requirements from existing large customers and increases in solid waste, mining and liquid containment markets. North America sales were also positively affected by increased sales of specialty products. North America gross profit increased $20.8 million, or 86.8%, during 2011 to $44.8 million from $24.0 million in 2010. North America gross profit increased $11.8 million due to increased sales prices, changes in product mix and the pursuit of higher-margin projects, and $9.0 million due to an increase in volumes shipped. During 2010, margins were lower due to the increase in resin prices and the lag in corresponding sales price increases which led to the implementation of the margin management tool in 2010.

Europe Africa

Europe Africa net sales increased $8.0 million, or 6.1%, during 2012 to $139.3 million from $131.3 million in 2011. Net sales increased $12.4 million due to higher volume shipped, $5.4 million due to increases in selling prices, and $3.8 million due to changes in product mix. Europe Africa net sales were negatively affected by approximately $13.6 million from changes in foreign currency exchange rates. Europe Africa gross profit was $10.1 million in each of 2012 and 2011. Gross profit increased $0.9 million due to the higher volume shipped and $1.1 million due to the favorable shift in product mix. Gross profit increases were offset by increased manufacturing costs of $0.9 million and unfavorable changes in foreign currency exchange rates of $1.1 million.

Europe Africa net sales increased $26.8 million, or 25.6%, during 2011 to $131.3 million from $104.5 million in 2010. Sales increased $13.6 million due to increases in sales prices and $3.9 million due to increases in volume shipped. These increases were primarily due to higher volume sold into Europe, primarily within the solid waste market. Europe Africa sales were also positively affected by approximately $9.3 million from changes in foreign currency exchange rates. Europe Africa gross profit decreased $0.4 million to $10.1 million in 2011 compared to $10.5 million in 2010 due to increased manufacturing costs, which were partially offset by increased sales prices and favorable changes in foreign currency exchange rates.

Asia Pacific

Asia Pacific net sales increased $22.9 million, or 30.9%, during 2012 to $97.2 million from $74.3 million in 2011. Higher volume shipped due to increased international demand contributed $17.3 million to additional net sales and changes in product mix contributed $6.5 million. These increases were partially offset by a decline in selling prices of $0.9 million. Asia Pacific net sales increased due to higher volumes sold into Australia, Thailand, Malaysia and China. Asia Pacific gross profit increased $6.5 million, or 63.4%, during 2012 to $16.8 million from $10.3 million in 2011. Gross profit increased $8.9 million due to changes in product mix and higher volume shipped, which were partially offset by increased manufacturing expenses of $2.4 million.


Asia Pacific net sales increased $24.9 million, or 50.5%, during 2011 to $74.3 million from $49.4 million in 2010. Increases in volumes shipped contributed $16.8 million to additional sales and increases in sales prices contributed $8.1 million. Asia Pacific sales increased due to higher volumes sold into China, Australia and India. Asia Pacific gross profit increased $6.0 million, or 138.6%, during 2011 to $10.3 million from $4.3 million in 2010. Gross profit increased $4.8 million due to an increase in volumes shipped and $1.2 million due to increased sales prices.

Latin America

Latin America net sales increased $1.7 million, or 3.9%, during 2012 to $46.1 million from $44.4 million in 2011. Increases in selling prices and changes in product mix contributed $2.7 million, which were partially offset by $1.0 million resulting from lower volume shipped. Latin America gross profit increased $0.2 million, or 3.3%, during 2012 to $4.8 million from $4.6 million in 2011. Gross profit increased primarily due to changes in product mix.

Latin America net sales increased $8.3 million, or 22.9%, during 2011 to $44.4 million from $36.1 million in 2010. Increases in volumes shipped contributed $4.7 million in additional net sales and increased sales prices increased net sales by $3.6 million. Latin America gross profit increased $0.7 million, or 20.5%, during 2011 to $4.6 million from $3.9 million in 2010. Gross profit increased $1.6 million, or 10.2%, due to increased sales prices and $1.3 million due to an increase in volumes shipped, which were partially offset by an increase in manufacturing costs.

Middle East

Middle East net sales decreased $1.4 million, or 14.9%, to $8.1 million during 2012 from $9.5 million in 2011. A decline in volume shipped and decreases in selling prices reduced net sales by $1.9 million. These decreases were partially offset by favorable changes in product mix of $0.7 million. Middle East gross profit increased $0.1 million to $0.7 million in 2012 from $0.6 million in 2011. Gross profit increased $0.7 million due to the changes in product mix, which was partially offset by an increase of $0.5 million in manufacturing costs and $0.1 million due to lower volume shipped.

Middle East sales decreased $0.3 million, or 3.4%, to $9.5 million during 2011 from $9.8 million in 2010. Decreases in volumes shipped and changes in foreign currency negatively affected sales by $1.4 million, which were partially offset by an increase in sales prices. Middle East gross profit decreased $0.6 million to $0.6 million in 2011 from $1.2 million in 2010. This decrease was due to a decline in volumes shipped and increased selling prices.

Recent Developments

On January 9, 2013, we held a groundbreaking ceremony for our new manufacturing facility in Suzhou, Jiangsu Province, China. The manufacturing facility is expected to add 44 million pounds of new capacity and be completed in late 2013, at a cost of approximately $15 million, the majority is expected to be spent in 2013. Once completed, the facility will have the ability to manufacture our entire line of geomembrane products and service the growing demand for landfill expansions, industrial waste containment, coal ash containment and oil and gas fracking in the region.

On February 4, 2013, we acquired all of the equity interests of SynTec, LLC, based in Baltimore, Maryland, for cash of approximately $10 million. SynTec is manufacturer of geosynthetic drainage and soil reinforcement products and provides us access to new technology for environmental and civil applications.


Key Drivers

The following are the key drivers of our business:

Timing of Projects. Our financial results are influenced by the timing of projects that are developed and constructed by the end-users of our products in our primary end markets, including mining, waste management and liquid containment.

Mining projects and associated capital expenditures are driven by global commodity supply and demand factors. Our products are used primarily in metal mining, including copper, silver, uranium and gold. Metal mining projects are typically characterized by long lead times and large capital investment by the owners of the projects. In addition, these projects are often located in remote geographies with limited infrastructure, such as power and roads, creating complex logistics management requirements and long supplier lead times.

In our waste management end market, landfill construction and expansion projects are driven by waste volume generation and the need for additional municipal solid waste disposal resources. In developed markets, landfill construction and expansion projects are influenced by economic factors, particularly retail sales and consumer spending, housing starts and commercial and infrastructure construction. In emerging markets, waste management projects are also driven primarily by increased per capita GDP, which is positively correlated with waste generation, as well as by increasing environmental awareness and regulation, as discussed further below.

Finally, projects in our liquid containment end markets, including water management infrastructure, agriculture and aquaculture and industrial wastewater treatment applications, are driven by investment in civil and industrial infrastructure globally. This global spending is influenced by increased urbanization, increased wealth and protein-rich diets in developing economies necessitating higher levels of food production, population growth and other secular and economic factors, in both developed and emerging markets.

Environmental Regulations. Our business is influenced by international levels of environmental regulation and mandated geosynthetics specifications, which vary across jurisdictions and by end market. Environmental regulations often require the use of geosynthetic products to contain materials and protect groundwater in various types of projects. In emerging markets, waste management and water infrastructure projects are driven by an ongoing increase in environmental awareness and regulation that has developed through the continued urbanization and increased affluence of these economies.

Although environmental regulations may not be as stringent or may not be enforced in emerging markets, we believe these regulations will continue to develop and to be enforced more diligently. In developed markets, existing regulations, which often specify our products, tend to be highly specific and stringently enforced. As a result, regulatory changes in developed markets tend to impact new end markets, such as coal ash containment in the United States.

Seasonality. Due to the significant amount of our projects in the northern hemisphere (North America and Europe), our operating results are impacted by seasonal weather patterns in these markets. Our sales in the first and fourth quarters of the calendar year have historically been lower than sales in the second and third quarters. This is primarily due to lower activity levels in our primary end markets during the winter months in the northern hemisphere. The impact of this seasonality is partially mitigated by our mining and liquid containment end markets, which are located predominantly in the southern hemisphere. As our mining end market becomes a greater source of our sales, we expect seasonality to be further mitigated.

Resin Cost Volatility. Resin-based material, derived from crude petroleum and natural gas, accounted for 83.1%, 81.1% and 80.2% of our cost of products for the years ended December 31, 2012, 2011 and 2010, respectively. Our ability to both manage the cost of our resin purchases as well as pass fluctuations in the cost of resin through to our customers is critical to our profitability. Fluctuations in the price of crude oil impact the cost of resin. In addition, planned and unplanned outages in facilities that produce polyethylene and its feedstock materials have historically impacted the cost of resin. In 2010, we implemented successful performance initiatives that focused on reducing the risk of volatility in resin costs on our profitability. We have developed policies, procedures, tools and organizational training procedures to enable better resin cost management and facilitate the efficient pass through of increases in our resin costs to our customers. These initiatives included diversifying our resin sources, hiring a polyethylene expert to lead procurement, implementing pricing tools that account for projected resin pricing, institutionalizing a bid approval process, creating a plant sourcing decision model, and running a large project tracking process. As a result of these policies, we were able to effectively manage the volatility in resin prices during 2012 and 2011, which minimized the effect of resin price volatility on our results of operations. While the significant majority of our products are sold under orders that include 30-day re-pricing provisions at our option, and while we have taken advantage of this option in the past, the policies, processes, tools and organizational training procedures described above allow us to limit the need to re-price projects already under contract. This, in turn, helps us better manage our relationships with our customers. We believe that managing the risks associated with volatility in resin costs is now among our critical and core competencies.


Results of Operations

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

                                                              Year Ended
                                                             December 31,               Period over
                                                          2012          2011           Period Change
                                                                   (in thousands)
Net sales                                               $ 476,644     $ 464,451     $ 12,193           3 %
Cost of products                                          398,955       393,944        5,011           1
Gross profit                                               77,689        70,507        7,182          10
Selling, general and administrative expenses               49,326        44,474        4,852          11
Public offering related costs                               9,655             -        9,655         100
Amortization of intangibles                                 1,182         1,379         (197 )        14
Operating income                                           17,526        24,654       (7,128 )        29
Other expenses (income):
Interest expense, net                                      16,797        20,081       (3,284 )        16
Foreign currency transaction gain                            (459 )        (568 )        109          19
Change in fair value of derivatives                             -            71          (71 )       100
Loss on extinguishment of debt                              1,555         2,016         (461 )        23
Other income, net                                          (2,269 )      (1,253 )     (1,016 )        81
Income from continuing operations before income taxes       1,902         4,307       (2,405 )        56
Income tax provision                                          356         3,490       (3,134 )        90
Income from continuing operations                       $   1,546     $     817     $    729          89 %

Net Sales

Consolidated net sales increased $12.2 million, or 2.6%, to $476.6 million for the year ended December 31, 2012 from $464.4 million for the year ended December 31, 2011. Consolidated net sales increased $12.1 million due to changes in product mix, $9.7 million due to increased volume, and $4.2 million due to higher selling prices. Consolidated nets sales were negatively affected by approximately $13.8 million from changes in foreign currency exchange rates, principally the Euro.

Cost of Products

Cost of products increased $5.0 million, or 1.3%, to $398.9 million for the year ended December 31, 2012 from $393.9 million for the year ended December 31, 2011. The increase in raw material costs contributed approximately 83%, or $4.2 million to the increase in cost of products. The increase in volume shipped and increased manufacturing costs, net of changes in foreign currency, contributed approximately 17%, or $0.8 million, to the increase.

Gross Profit

Consolidated gross profit for the year ended December 31, 2012 increased $7.2 million, or 10.2%, to $77.7 million compared to $70.5 million for the year ended December 31, 2011. Gross profit increased $9.4 million due to changes in product mix and $1.2 million due to increased volume, partially offset by an increase in manufacturing expenses of $2.2 million. Changes in foreign currency exchange rates, principally the Euro, also negatively affected gross profit by $1.2 million. Gross profit as a percentage of net sales was 16.3% for the year ended December 31, 2012, compared to 15.2% for year ended December 31, 2011.

Selling, General and Administrative Expenses

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