UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

OR

Commission file number 0-20328

AMTROL Inc.

1400 Division Road, West Warwick, RI 02893-1008

Registrant’s telephone number, including area code: (401) 884-6300

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 Exchange Act).           Yes [  ]   No [X]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: $.01 Par Value: 100 shares of Common stock as of November 5, 2004.

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AMTROL INC. AND SUBSIDIARIES

FORM 10-Q FOR THE QUARTER ENDED OCTOBER 2, 2004

INDEX

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AMTROL INC. AND SUBSIDIARIES

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

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AMTROL INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

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

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AMTROL INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Shareholders’ Equity

Nine Months Ended October 2, 2004

Nine Months Ended September 30, 2003

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

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AMTROL INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows
(Unaudited - in thousands)

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

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AMTROL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Basis of Presentation

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary to present fairly, in accordance with U.S. generally accepted accounting principles, the financial position, results of operations and cash flows of AMTROL Inc. and its subsidiaries (the “Company”) for the interim periods presented. Such adjustments consisted of only normal recurring items. The results of operations for the interim periods shown in this report are not necessarily indicative of results for any future interim period or for the entire year. These condensed consolidated financial statements do not include all disclosures associated with annual consolidated financial statements and accordingly should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K.

2. Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

3. Significant Accounting Policies

Revenue Recognition and Related Costs

In accordance with Staff Accounting Bulletin (“SAB”) No. 104, the Company recognizes revenue only when there is a valid contract or purchase order, which includes a fixed price; the goods have been delivered in accordance with the shipping terms; and there is an expectation that the collection of the revenue is reasonably assured.

The Company generally recognizes revenue upon shipment of its products to customers net of applicable provisions for discounts and allowances. Allowances for cash discounts and volume rebates, among others, are recorded as a reduction to revenue at the time of sale based upon the estimated future outcome. Cash discounts and volume rebates are based upon certain percentages and sales targets agreed to with the Company’s customers, which are typically earned by the customers over an annual period. The allowance for volume rebates is consistent with the provisions of EITF 00-22, “Accounting for ‘Points’ and Certain Other Time-Based or Volume-Based Sales Incentive Offers, and Offers for Free Products or Services to Be Delivered in the Future.” At October 2, 2004 and December 31, 2003, the Company had accrued $3.4 million and $3.9 million, respectively, for such unpaid volume allowances. These amounts are included in accrued expenses in the accompanying condensed consolidated balance sheets.

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Cash and Cash Equivalents

Cash and cash equivalents include cash on hand and short-term investments that are readily convertible into cash with an original maturity to the Company of three months or less.

The Company invests its excess cash in highly liquid short-term investments. The Company has established guidelines that maintain safety and liquidity and reviews these guidelines as economic conditions change. The Company has not experienced any losses on its cash equivalents.

Allowance for Doubtful Accounts

In circumstances where the Company is aware of a specific customer’s inability to meet its financial obligations, an allowance is established. The majority of accounts are individually evaluated on a regular basis and appropriate allowances are established as deemed appropriate. The remainder of the allowance is based upon historical trends and current market assessments.

Concentration of Credit Risk

The Company extends credit to almost all its customers on an uncollateralized basis. Concentration of credit and geographic risk with respect to accounts receivable is limited due to the large number of and general dispersion of accounts that constitute the Company’s customer base. The Company periodically performs credit evaluations of its customers. At October 2, 2004 and September 30, 2003, there were no customers accounting for greater than ten percent of the Company’s accounts receivable. The Company has not experienced significant credit losses on customers’ accounts.

Inventories

The Company’s inventories are stated at the lower of cost or net realizable value including material, labor and manufacturing overhead (see Note 6). The Company records provisions, as appropriate, to write-down obsolete and excess inventory to estimated net realizable value. The process for evaluating obsolete and excess inventory often requires the Company to make subjective judgments and estimates concerning future sales levels, quantities and prices at which such inventory will be able to be sold in the normal course of business. Accelerating the disposal process or incorrect estimates of future sales potential may cause the actual results to differ from the estimates at the time such inventory is disposed or sold. The Company believes that its procedures for estimating such amounts are reasonable and historically have not resulted in material adjustments in subsequent periods when the estimates are adjusted to the actual amounts.

Warranty

The Company extends various warranties covering most of its products ranging from a limited one-year warranty to a limited lifetime warranty against defects in materials and workmanship. The specific terms and conditions of the warranties depend on the type of product that is sold. The Company’s warranties are generally limited to the replacement of the defective parts or products at the Company’s option. The Company estimates the costs that may be incurred under its warranty program and records a liability at the time of sale. Factors that influence the Company’s warranty liability include the amount of production, manufactured cost of the product, historical warranty returns and anticipated returns based upon engineering and material

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improvements. The Company periodically assesses the adequacy of its warranty reserve through a detailed analysis and adjusts the reserve accordingly.

The following chart illustrates the changes in the Company’s warranty reserve:

Goodwill

Goodwill represents the excess of acquisition costs over the estimated fair value of the net assets acquired. The Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, which requires that amortization of goodwill cease and that the Company evaluate the recoverability of goodwill and other intangible assets annually, or more frequently if events or changes in circumstances, such as a decline in sales, earnings or cash flows, or material adverse changes in the business climate, indicate that the carrying value of an asset might be impaired. Goodwill is considered to be impaired when the net book value of a reporting unit exceeds its estimated fair value.

Fair values are established using a discounted cash flow methodology (specifically, the income approach). The determination of discounted cash flows is based on the Company’s strategic plans and long-range forecasts. The revenue growth rates included in the forecasts are the Company’s best estimates based on current and anticipated market conditions, and the profit margin assumptions are projected based on the current and anticipated cost structures.

Deferred Financing Costs

Deferred financing costs are stated at cost as a component of other assets and amortized over the life of the related debt using the effective interest method. Amortization of deferred financing costs is included in interest expense.

Foreign Currency Translation

Assets and liabilities of non-U.S. operations have been translated into United States dollars using the quarter-end rate of exchange. Shareholders’ equity has been converted using historical rates, and revenues and expenses at the average exchange rates prevailing during the three and nine month periods. The cumulative effect of the resulting translation was reflected as a separate component of shareholders’ equity.

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During the current quarter, the Company used forward contracts, generally three months in duration, to hedge its foreign currency exposures. The foreign currency exposures relate primarily to the Company’s operations in Portugal. A portion of revenues from the Company’s Portuguese operations were denominated in U.S. dollars and British Pounds so as the Euro changed, the corresponding value of these receivables also changed. At October 2, 2004, the Company’s Portuguese operations had forward contracts for the purchase of $1.1 million with maturity dates through December 2004. The fair value of these forward contracts was immaterial to the balance sheet of the Company.

Recent Accounting Pronouncements

In January 2003, the FASB issued FASB Interpretation 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (“Interpretation 46”). In December 2003, the FASB issued a revision to Interpretation 46 to make certain technical corrections and address certain implementation issues that had arisen. Interpretation 46, as revised, provides a new framework for identifying variable interest entities (“VIEs”) and determining when a company should include the assets, liabilities, noncontrolling interests and results of activities of a VIE in its consolidated financial statements. Interpretation 46 was effective immediately for VIEs created after January 31, 2003. The provisions of Interpretation 46, as revised, are required to be adopted by the Company in 2005. The adoption of this Interpretation is not expected to have a material impact on the Company’s overall financial position and results of operations.

4. Long-Term Debt

Revolving Credit and Term Loans

The Company is a party to two credit facilities: a $52.5 million ($42.5 million prior to the November 18, 2003 amendments discussed below) senior first-priority secured credit facility arranged by Foothill Capital Corporation (the “Foothill Facility”) and a $35.0 million ($25.0 million prior to the November 18, 2003 amendments discussed below) senior second-priority secured credit facility with affiliates of The Cypress Group L.L.C. (the “Cypress Facility”).

The Foothill Facility provides the Company (i) a term loan facility consisting of a (a) five-year Term A Loan maturing in December 2006, with an outstanding principal amount of $5.5 million at October 2, 2004, bearing interest at the Wells Fargo Reference Rate (approximates the prime rate) plus 0.75% (5.50%), and (b) a four-year Term B Loan maturing December 2005, with an outstanding principal amount of $19.7 million as of October 2, 2004, bearing interest at the Wells Fargo Reference Rate plus 3.5% and a paid-in-kind (“PIK”) component of 3.5% (11.75%) (collectively the “Term Loans”) and (ii) a five-year Revolving Credit Facility maturing December 2006, bearing interest at LIBOR plus 2.5% or the Wells Fargo Reference Rate plus 0.5% (5.25%), providing the lesser of (a) $30.0 million less the aggregate outstanding principal amount of the Term A Loan less letter of credit usage and (b) borrowing base less letter of credit usage. At October 2, 2004, total availability and aggregate borrowings under the Revolving Credit Facility were $13.1 million and $5.5 million, respectively.

On November 18, 2003, the Company amended its Foothill Facility by entering into the First Amendment and Waiver to Loan and Security Agreement (the “First Amendment”) and also amended its Cypress Facility by entering into the Second Amendment to Loan and Security Agreement (the “Second Amendment”), (collectively the “Amendments”). The First

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Amendment increased the Term B Loan by $15.0 million to $20.3 million and extended the maturity date of Term B Loan to December 26, 2005. Commitments under the Revolving Credit Facility and Term A Loan were reduced in the aggregate from $35.0 million to $30.0 million. The additional funds provided by the First Amendment will be used for capital investment programs, general working capital purposes and may also be used to purchase the Company’s Senior Subordinated Notes in an aggregate amount not to exceed $5.0 million. The First Amendment also revised certain covenants to be more consistent with the Company’s business plans. The amendments did not effect the maturity date (December 26, 2006) of the Revolving Credit Facility, Term A Loan and the Cypress Facility.

Upon execution of the First Amendment and Second Amendment in 2003, the Company was required per EITF 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments”, to record a loss of $0.5 million on extinguishment of debt for unamortized costs associated with the original Term B Loan and any bank related fees in relation to the recent Amendments.

The Cypress Facility consists of term loans totaling $35.0 million (the “Term C Loan”). The Term C Loan, with an outstanding principal amount of $44.3 million (includes PIK interest of $9.3 million) as of October 2, 2004, has a maturity date of December 26, 2006, and bears PIK interest fixed at 12% per annum paid quarterly, which at the lenders option can be paid in common stock of the Company. In connection with the Cypress Facility, AMTROL Holdings, Inc issued the lenders under the Cypress Facility 60,000 warrants to purchase approximately 5.2% of its common stock on a fully diluted basis. The 60,000 warrants, which have an exercise price of $.01 and are exercisable immediately, were valued at $3.4 million using the Black-Scholes model. This amount was recorded as a discount to the Term C Loan debt and included as a component of shareholders’ equity. The Company expects that the effective interest rate associated with the Term C Loan will be greater than 12% given the additional interest expense associated with the warrants.

The Foothill Facility and Cypress Facility contain certain affirmative and negative covenants and restrictions, such as maintaining a minimum amount of earnings before interest, taxes, depreciation and amortization (“EBITDA”) and Fixed Charges Ratio on a North America and Worldwide basis. As of October 2, 2004, the Company was in compliance with the various covenants of the Foothill Facility and Cypress Facility.

Senior Subordinated Notes

The Company has $97.8 million of Senior Subordinated Notes due November 2006 (the “Notes”), which are unsecured obligations of the Company and bear interest at a rate of 10.625% per annum payable semi-annually on June 30 and December 31.

The Notes are redeemable at the option of the Company on or after December 31, 2003, in whole or in part, at par. Upon a “Change of Control” (as defined in the Indenture), each Notes holder has the right to require the Company to repurchase such holder’s Notes at a purchase price of 101% of the principal amount plus accrued interest. The Indenture contains certain affirmative and negative covenants and restrictions. As of October 2, 2004, the Company was in compliance with the various covenants of the Notes.

During the quarter ended March 2003, the Company purchased a portion of the Notes with a face value of $2.6 million. The purchase was financed through the issuance of additional Term C debt of $1.1 million. The extinguishment resulted in a gain of $1.5 million that was included in

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Gain on extinguishment of debt on the Company’s Condensed Consolidated Statement of Operations. The Company and/or affiliates of the Company, including entities related to Cypress may continue, from time to time, to purchase the Notes previously issued by the Company in the open market or by other means.

5. Discontinued Operations

The Company, on February 27, 2004, completed the sale of the stock of AMTROL Holdings GmbH (“Holdings”) to DTT NOVA Beteiligungen GmbH & Co. KG (“DTT”) for approximately 300,000 Euros or $375,000 which was received during 2004. Holdings’ principal subsidiary is AMTROL Nova GmbH & Co. KG, a German-based manufacturer of indirect fired water heaters. DTT is a German-based company that operates as a manufacturer of water heaters.

Holdings’ results of operations were included within the Company’s Europe segment. The Company has treated the sale of Holdings as a discontinued operation in this quarterly report on Form 10-Q for the periods ended October 2, 2004 and September 30, 2003 and accordingly the results of operations of Holdings are excluded from continuing operations for all periods presented. Net Sales excluded from continuing operations for the periods ended October 2, 2004 and September 30, 2003 were $1.9 million and $8.3 million, respectively. In addition, the assets and liabilities of Holdings are reflected as assets and liabilities from discontinued operations in the accompanying December 31, 2003 balance sheet. There was no interest expense allocated to this discontinued operation.

6. Inventories

Inventories are stated at the lower of cost or market and were as follows (in thousands):

7. Accounting for Derivative Instruments and Hedging Activities

The Company had an interest rate swap contract and an interest rate cap (the “Contract”) that matured on June 30, 2004. The Company received the 90-day LIBOR rate and paid a fixed rate of 4.60%, unless LIBOR increased to 7.1%, for the period from January 1, 2001 through June 30, 2004. The Contract was designated as a cash flow hedge of variable future cash flows associated with the Foothill Agreement Term A Loan and Term B Loan debt.

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8. Provision for Income Taxes

The effective income tax rates used in the interim consolidated financial statements are estimates of the full year’s rates. Net deferred tax assets recognized on the Company’s balance sheet continue to require management’s evaluation as to their realization. Although realization is not assured, management believes it is more likely than not that the net deferred tax assets will be realized. The amount expected to be realized is based upon estimates derived from tax planning strategies which the Company believes are currently prudent and feasible. A valuation allowance has been provided for certain net operating loss carryforwards, as the realizability of those carryforwards is uncertain. Additions to the valuation allowance may be required in the event that estimates are changed.

9. Business Segment Information

The Company’s reportable segments are delineated geographically. In addition to the geographic delineation, the segments are managed separately because of their different product offerings, markets served and cost structures.

The Company’s North America segment operates manufacturing facilities in Rhode Island, Kentucky, Maryland and Ohio, and operates a distribution facility in Ontario, Canada. This segment manufactures and markets products used principally in flow control, storage, heating, and other treatment of fluids in the water system and HVAC markets. These products are marketed throughout the world but primarily in North America, Western Europe and Asia.

The Company’s European segment includes its facilities in Guimaraes, Portugal and Swarzedz, Poland. The Guimaraes facility manufactures returnable and non-returnable steel gas cylinders for storing cooking, heating and refrigerant gases that are marketed worldwide. The Swarzedz facility refurbishes returnable gas cylinders.

The primary criteria by which financial performance is evaluated and resources are allocated include revenues and EBITDA. The method of calculating EBITDA is consistent with the definition contained in the Foothill Agreement, the Cypress Agreement and the Indenture. Readers of financial statements frequently consider EBITDA a useful tool in evaluating a company’s performance. Therefore, the Company believes that inclusion of EBITDA is useful supplemental information. However, EBITDA is not a measure of true cash flow since it does not incorporate changes of other assets or liabilities that may generate or require cash. EBITDA is not a generally accepted accounting measure. The following is a summary of key financial data by segment:

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