Attached files

file filename
EX-32 - SECTION 906 CERTIFICATION OF PEO AND PFO - Edgen Murray II, L.P.dex32.htm
EX-10.7 - EMPLOYMENT AGREEMENT - Edgen Murray II, L.P.dex107.htm
EX-12.1 - COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - Edgen Murray II, L.P.dex121.htm
EX-31.1 - SECTION 302 CERTIFICATION OF PEO - Edgen Murray II, L.P.dex311.htm
EX-99.1 - SEPARATE FINANCIAL STATEMENTS - Edgen Murray II, L.P.dex991.htm
EX-31.2 - SECTION 302 CERTIFICATION OF PFO - Edgen Murray II, L.P.dex312.htm
EX-21.1 - LIST OF SUBSIDIARIES OF THE REGISTRANT - Edgen Murray II, L.P.dex211.htm
EX-10.5(A) - AMENDMENT TO AMENDED AND RESTATED EMPLOYMENT AGREEMENT - Edgen Murray II, L.P.dex105a.htm
Table of Contents
Index to Financial Statements

 

 

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

x ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE YEAR ENDED DECEMBER 31, 2010

OR

 

¨ TRANSITION UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number: 333-165928

 

 

EDGEN MURRAY II, L.P.

(Exact name of registrant as specified in its charter)

 

Delaware   20-8864225

(state of

incorporation)

 

(IRS Employer

I.D. Number)

18444 Highland Road

Baton Rouge, Louisiana 70809

(225) 756-9868

(Address and telephone number of registrant’s principal

executive offices and principal place of business)

Securities registered under Section 12(b) of the Exchange Act: None

Securities registered under Section 12(g) of the Exchange Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes  ¨    No  x

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 twelve 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 has submitted electronically and posted on its corporate Website, if any Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.

 

Large accelerated filer   ¨   Accelerated filer   ¨
Non-accelerated filer   x   Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of March 24, 2011, there were 209,493 common partnership units of the registrant outstanding, The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant is not applicable as no public market for such common equity exists.

 

 

DOCUMENTS INCORPORATED BY REFERENCE.

None.

 

 

 


Table of Contents
Index to Financial Statements

TABLE OF CONTENTS

 

PART I

  

ITEM 1

  

Business

     1   

ITEM 1A

  

Risk Factors

     8   

ITEM 1B

  

Unresolved Staff Comments

     21   

ITEM 2

  

Properties

     22   

ITEM 3

  

Legal Proceedings

     24   

PART II

     

ITEM 5

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     25   

ITEM 6

  

Selected Financial Data

     26   

ITEM 7

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     28   

ITEM 7A

  

Quantitative and Qualitative Disclosures About Market Risk

     47   

ITEM 8

  

Financial Statements and Supplementary Data

     50   

ITEM 9

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     90   

ITEM 9A

  

Controls and Procedures

     90   

ITEM 9B

  

Other Information

     90   

PART III

     

ITEM 10

  

Directors, Executive Officers and Corporate Governance

     91   

ITEM 11

  

Executive Compensation

     93   

ITEM 12

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     106   

ITEM 13

  

Certain Relationships and Related Transactions, and Director Independence

     108   

ITEM 14

  

Principal Accounting Fees and Services

     109   

PART IV

     

ITEM 15

  

Exhibits and Financial Statement Schedules

     110   

 

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CAUTIONARY STATEMENT REGARDING FORWARD–LOOKING STATEMENTS

Certain statements and information in this Form 10–K may constitute “forward–looking statements” within the meaning of the Private Securities Litigation Act of 1995. The words “believe,” “expect,” “anticipate,” “plan,” “intend,” “foresee,” “should,” “would,” “may,” “could,” “estimate” or other similar expressions are intended to identify forward–looking statements, which are generally not historical in nature. These forward–looking statements are based on our current expectations and beliefs concerning future developments and their potential effect on us. While management believes that these forward–looking statements are reasonable as and when made, there can be no assurance that future developments affecting us will be those that we anticipate. All comments concerning our expectations for future revenues and operating results are based on our forecasts for our existing operations and do not include the potential impact of any future acquisitions.

Our forward–looking statements involve significant risks and uncertainties (some of which are beyond our control) and assumptions that could cause actual results to differ materially from our historical experience and our present expectations or projections. Important factors that could cause actual results to differ materially from those in the forward–looking statements include, but are not limited to, those described in (1) Part I, Item 1A Risk Factors and elsewhere in this Form 10–K, (2) our reports and registration statements filed from time to time with the Securities and Exchange Commission (SEC) and (3) other announcements we make from time to time. Readers are cautioned not to place undue reliance on forward–looking statements, which speak only as of the date hereof. We undertake no obligation to publicly update or revise any forward–looking statements after the date they are made, whether as a result of new information, future events or otherwise.

 

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PART I

 

ITEM 1. BUSINESS.

General

Edgen Murray II, L.P. and its subsidiaries (“Edgen Murray”, “Company”, “we”, “us” and “our”) is a leading global industrial distributor of specialty steel products primarily to the oil and gas, power, petrochemical and civil construction markets. Our product catalog consists of pipes, plate and sections, including highly-engineered prime carbon or alloy steel pipe, pipe components, valves and high-grade structural sections and plate. These items are often designed to operate in severe conditions, including high pressure, load bearing, compression and extreme temperature environments, and to withstand the effects of corrosive or abrasive materials.

Our sales and distribution network enables us to efficiently procure and deliver our entire product offering worldwide. We stock and distribute inventory and support our customers through a global network of facilities located on five continents. This allows us to supply and service projects in remote and challenging locations, while also supporting the daily maintenance, repair and operation (“MRO”) requirements of installed facilities. The severe conditions in which many of our products operate often result in significant wear and tear on the products, which generally necessitates regular maintenance and replacement of the products. We employ experienced local market specialists and sales personnel, many of whom have technical backgrounds, training or relevant industry experience, in all of the regions in which we operate. To augment our extensive specialty product line, we offer our customers specialized product knowledge, technical consultation, global logistical support and project management and procurement services. These services include inventory management and just-in-time product delivery, which we believe allows our customers to reduce their inventory carrying costs.

Our customers include engineering, procurement and construction (“EPC”) firms, equipment fabricators, multi-national and national major integrated oil and natural gas companies, independent oil and natural gas companies, natural gas transmission and distribution companies, petrochemical companies, mining companies, oil sands developers, hydrocarbon, nuclear and renewable power generation companies, utilities, civil construction contractors and municipality and transportation authorities. For the year ended December 31, 2010, approximately 82% of our total revenue was attributable to customers that operate in or service the oil and natural gas industry.

We believe we are a critical link between our customers and product manufacturers (our vendors). Many of our customers rely on us to source products for them as they may not have the expertise, relationships, resources, volume or logistical capabilities to complete procurement independently or on a cost-effective basis. Additionally, we are able to complete orders in smaller quantities than many of our customers are readily able to purchase directly from manufacturers, benefiting both our customers and our vendors. We also provide support to our vendors through our sales, marketing and credit functions, with respect to the products we distribute.

History

On February 1, 2005, management and funds managed by Jefferies Capital Partners (“JCP”) purchased our business. We refer to this transaction as the “Buy-out Transaction”. On December 16, 2005, our business expanded through the acquisition of Murray International Metals Ltd. (“MIM Acquisition”) and its subsidiaries.

 

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On April 3, 2007, funds managed by JCP formed Edgen Murray II, L.P. (“EM II LP”), a Delaware limited partnership, to acquire the common shares of the operating subsidiaries of Edgen/Murray, L.P., the Company’s predecessor. Subsequently, on May 11, 2007, institutional investors and existing management invested in EM II LP which then acquired the common shares of Edgen Murray Corporation (“EMC”) and Pipe Acquisition Limited, the principal assets of Edgen/Murray, L.P. The formation of EM II LP, the acquisition of the assets of Edgen/Murray, L.P. and the related financing transactions are referred to as the “Recapitalization Transaction”.

Our business segments

We separate our business into two geographic markets—the Western Hemisphere and the Eastern Hemisphere. We are capable of offering our complete product line in both markets which enables us to effectively serve our customers worldwide.

Western Hemisphere. Our Western Hemisphere operations are headquartered in Houston, Texas and operate through a regional and branch network in the United States, Canada and South America. Thirteen of our Western Hemisphere locations stock inventory for distribution. For the year ended December 31, 2010, sales in our Western Hemisphere market comprised 63% of our total sales.

Eastern Hemisphere. Our Eastern Hemisphere operations are headquartered in Newbridge, Scotland and operate through a regional and branch network of locations in Europe, Asia/Pacific, and the Middle East. In addition, our Bahraini joint venture operates in Saudi Arabia through a service contract arrangement. We stock inventory at six locations throughout the Eastern Hemisphere. For the year ended December 31, 2010, sales in our Eastern Hemisphere market comprised 37% of our total sales.

See note 12 of the notes to our unaudited condensed consolidated financial statements included elsewhere in this Form 10-K for additional information regarding our sales and assets by geographical area.

Revenue sources

We do not manufacture any products. We are a distributor/reseller of our vendors’ manufactured products. Through our operating subsidiaries, we purchase specialty steel products from a number of vendors worldwide, but primarily from vendors located in Germany, Italy, Japan, South Korea and the United States. Our operating subsidiaries in the Western Hemisphere are primarily responsible for sales and fulfillment efforts for customers in the Western Hemisphere and our operating subsidiaries in the Eastern Hemisphere are primarily responsible for sales and fulfillment efforts for customers in the Eastern Hemisphere.

In anticipation of the aggregate future needs of our customers, we purchase specialty steel products in larger quantities that are efficient for our vendors to produce. We also purchase these products in smaller quantities in response to specific requests from our customers. In making purchasing decisions, we use general economic indicators, inquiries, orders and continuous interaction with our customers to help us determine customer usage patterns, expected delivery dates and the nature of active projects in the market. Our company-wide management information system assists us in evaluating historical usage, the inventory at each of our locations and other purchasing data.

Our vendors generally use third-party freight carriers to ship these products to our customers at our direction or to us. When we ship products to our customers from inventory on hand, we also predominantly use third-party freight carriers.

We generate substantially all of our revenues from the sale of our products to third parties. Through third party service providers, we also offer a wide range of cutting and finishing services for our products. Our fees for these services are incorporated into our sales price. Freight costs are generally included in our sales price as well.

 

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Products

We distribute specialty steel and alloy products for use primarily in specialized applications throughout the energy infrastructure markets. Our product catalog consists of pipes, plate and sections, including highly-engineered prime carbon or alloy steel pipe, pipe components, valves and high-grade structural sections and plate. These items are often designed to operate in severe conditions, including high pressure, load bearing, compression and extreme temperature environments, and to withstand the effects of corrosive or abrasive materials. Our products are primarily used for maintenance and repair projects, expansions of infrastructure and development projects as follows:

 

   

onshore and offshore exploration and gathering of oil and gas;

 

   

refining;

 

   

offshore platform construction;

 

   

mechanical construction;

 

   

hydrocarbon, nuclear, and renewable power generation;

 

   

petrochemical;

 

   

mining; and

 

   

certain civil construction applications.

Our primary products include:

Carbon and Alloy Steel Pipe. We offer a full range of seamless and welded carbon and alloy pipe used for high pressure, load bearing, compression, severe corrosion and extreme temperature resistance applications for oil and natural gas gathering and transmission, refining, hydrocarbon, nuclear and renewable power generation, petrochemical, mining and civil construction applications. Structural applications of our pipe offering include civil, offshore jackets, topsides, jack up drilling rig braces and onshore production facilities. Down-hole and other subsea applications include marine riser and conductor, booster line and annulus pipe.

Pipe components, fittings and flanges. We offer a complete line of carbon and alloy components, fittings and flanges used primarily to connect piping systems for high pressure, severe corrosion and extreme temperature resistance applications for oil and natural gas gathering and transmission, refining, hydrocarbon, nuclear and renewable power generation applications, petrochemical, process and mining.

Structural sections and plate. Products offered include universal beams, columns, channels, flats, angles, hollow sections and specialty rolled quenched and tempered plates in engineered lengths, widths and thicknesses. The primary market served is conventional and severe offshore and deep water drilling, production facilities and certain civil construction projects. Principal end uses include offshore jackets, topsides, jack up drilling rigs, onshore production assemblies and load bearing civil installations.

Valves. Our full line of ball, check, gate, globe, butterfly, needle and plug valves are used in piping systems to regulate flow and pressure of various gases and fluids. End markets served include production, gathering, transmission, refining and certain industrial applications. When required, we offer full actuation packages.

Customers

We market products to customers located around the world who are involved throughout the complete scope of the energy industry. Our customers are generally large, well capitalized companies who are recognized as leaders in their respective industries. Our customers include EPC firms, equipment fabricators, multi-national and major national integrated oil and natural gas companies, independent oil and natural gas companies, natural gas transmission and distribution companies, petrochemical companies, mining companies, oil sands developers, hydrocarbon, nuclear and renewable power generation companies, utilities, civil construction contractors and municipality and transportation authorities. For the year ended December 31, 2010, our top ten customers accounted for approximately 28% of our total sales.

Customer support

Complete procurement and project management services. We believe that our customers require us to supply a full range of products to meet the needs of their complex projects and applications. We are able to provide complete procurement services that we believe to be of significant value to our customers, particularly where the range of products required is beyond the scope of one or more distributors or manufacturers. We further believe that our customers appreciate the convenience of being able to place a single purchase order covering a full range of specialty products required for a project, rather than having to manage numerous providers.

We believe that we meet our customers’ requirements through the integration of our significant levels of stock with access to direct mill supply sources. Given our significant levels of stock, we can often fulfill many of our customers’ requirements immediately and expedite delivery. Our mill relationships allow us to efficiently source and deliver the products we do not have on hand. We believe that this full service approach maximizes material availability while retaining optimum project cost controls. We also offer a wide range of cutting and finishing services primarily through third parties.

 

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Maintenance and repair operations. Our business model allows us to meet the ongoing MRO needs of our clients’ installed facilities. Our large inventory of specialized steel products in strategic global locations can provide the immediate delivery of solutions that fit our customers’ requirements, which are often time-sensitive. We also maintain the ability to access inventories globally, allowing our offices to ship from any of our locations.

Logistics. Our customers’ requirements for delivery to various fabrication destinations and ultimate end-use locations are often complex and time-sensitive. We provide extensive project management support, coordinated shipping expertise and if required, just-in-time delivery of maintenance and repair components. Our regional and branch networks allow us to respond to our customers’ global logistical needs with local contacts and assistance and to fulfill both project and expedited shipping requirements.

Sales and marketing

Our sales force operates under a branch, market segment and product specialist model. Managers employ a mix of market and product specialist and internal and external sales representatives in their respective territories. The sales representatives are located at various branch locations and are responsible for order solicitation, account and relationship management and market development. Managers have responsibility for pricing, order placement and fulfillment, logistics, customer service, business development and marketing strategies. Managers report to geographic market executives who have responsibility for the management, implementation and execution of our sales and marketing strategy.

Geographical executives and their managers are assisted by warehousing and logistics personnel and by a product and inventory management team that is responsible for procurement, pricing, product forecasting, inventory control and vendor development.

Vendors

We have longstanding relationships with many vendors, which enables us to offer and distribute a considerable breadth of products. For the year ended December 31, 2010, approximately 39% of our purchases were from our top ten vendors. We believe focusing our purchasing power on certain vendors’ specialty product niches has resulted in favored status with many of our vendors in regard to lead times, discounts and payment terms. As we continue to strengthen our vendor relationships, we are able to devote increased resources to providing our customers with products that are of greater importance to their business and for which they have fewer substitutes. Although we concentrate our purchasing power on a select group of highly valued vendors, we have multiple sources for the products we distribute and are not dependent on any single vendor.

We are a volume purchaser of high-specialty steel products and provide significant value-added support as an intermediary between high-grade steel manufacturing vendors and end-users. There are a limited number of vendors with the capabilities to produce these steel products, and we believe that we have demonstrated to our vendors over time that we are a high quality, reliable and high-volume purchaser of their products. In addition, our significant participation in large long-term projects enables us to plan our purchases and provides our vendors with critical visibility to schedule their production. As a result, we have developed strong, longstanding relationships with an established network of steel manufacturing vendors.

Intellectual property

We have registered the EDGEN MURRAY mark in the United States, Mexico, Australia, the European Union, Norway, Singapore, Malta, Chile, Colombia, the Dominican Republic, Ecuador, Panama, Peru, Bahrain and Saudi Arabia. We have registered the EDGEN MURRAY mark with the World Intellectual Property Organization (WIPO). The International Registration claims protection of the EDGEN MURRAY mark in Azerbaijan, the European Union, Norway, Singapore, Switzerland, Cyprus, the Czech Republic, Iceland, Morocco and Russia. Protection has been granted by the local trademark offices in the European Union, Norway, Australia and Singapore (as noted above), and is pending in the remaining jurisdictions. We have pending applications in Argentina, Brazil, Canada, Malaysia, South Africa, Egypt, Nigeria, Kazakhstan, Venezuela, Puerto Rico, India and the UAE. We claim common law rights in the EDGEN MURRAY mark in those jurisdictions that recognize trademark rights based on use without registration. We also claim common law trademark rights to a number of other names and marks important to our business, including Edgen™, Bartow Steel™, Resource Pipe Co.™, SISCO™, Thomas Pipe™, PetroSteel™, Equipment Valve & Supply™, Pro Metals™ and Radnor Alloys™, although we have not applied for U.S. federal or international registration for them.

 

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We recognize the importance to our business of the various intellectual property rights, including trademarks, that we use. While we acknowledge that the statutory rights arising from a successful trademark registration generally gives greater certainty as to the ownership of the registered mark as well as making enforcement of the owner’s rights against third parties easier than if it had to rely on the enforcement of its unregistered rights in the mark, we nevertheless believe that adequate protection of the goodwill in the marks used by our business is afforded through the various unregistered rights that are acquired simply by use over a period of time in a number of the jurisdictions in which we operate. Where intellectual property rights used by our business are not owned by us, we have entered into licensing arrangements with the relevant owner.

Employees

As of December 31, 2010, our workforce consisted of 454 full-time employees, of whom 165 were sales personnel. We employed 261 people in the Western Hemisphere, and 163 employees in the Eastern Hemisphere and 30 employees in our corporate office. We are not a party to any collective bargaining agreements, and we consider our relations with our employees to be good.

Competition

Our products are sold in highly competitive markets. Companies in the markets in which we operate compete primarily on customer service, access to materials, price and ability to deliver products in a timely manner. Purchase decisions are also influenced by previous experience with a particular distributor and a distributor’s ability to supply the full range of pipes, pipe components, tubes, plate, valves and sections.

In our Western Hemisphere market, our primary competition comes from numerous smaller, privately-owned regional distributors and, in some cases, subsidiaries of large privately-owned and publicly held companies. Our major competitors in our U.K. (Europe/West Africa) segment are generally trading companies that are owned by large international steel producers. Although these competitors may have significantly greater resources than us, they do not maintain stocks of readily available products that compete with the range of products we offer. In our UAE (Middle East) segment, our principal competitors are locally owned distributors, except in the case of our specialty plate products where we again compete with trading companies owned by various international steel makers. Finally, our Singapore (Asia/Pacific) segment competes across our product lines with trading companies owned by various international steel makers and, to a lesser extent, with local Singapore based distributors.

We believe that none of our competitors offer the depth and breadth of specialty steel products that we offer in any particular market. Although we have competitors with respect to many of the specific products we offer in specific markets, who may be larger and have greater resources than we do, we believe that no competitor or small group of competitors is dominant in any of our markets. While we must be price competitive in all of our markets, we believe that our customers select our products based on local leadership, the product knowledge of our staff and our broad product offering of specialty products.

Information technology

We have an advanced information technology (“IT”) platform to help us manage our business. As a distributor, our primary operational focus is order management and our systems are designed to streamline the logistics involved with obtaining products from our vendors, tracking those products within our sizable inventory and delivering those products to our customers. This system uses bar coded tags and wireless handheld scanners to track the inventory in our major distribution facilities and allows our salespeople to quickly ascertain what products are available and where those products are located. The system allows for efficient pick and ship execution and is accessible from all of our locations worldwide.

In our Western Hemisphere segment, business functions including order management, procurement, inventory control, accounting and finance operate on a unified Oracle platform. Effective July 1, 2010, the Eastern Hemisphere shared the same accounting and financial system; however, the Eastern Hemisphere continues to operate under a separate ERP system for business functions including order management, procurement, and inventory control. A global financial consolidation package is also utilized to streamline the consolidation and financial reporting process.

 

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We believe the combined system is well-protected against service disruptions. All production servers utilize highly available components, minimizing single points of failure. The primary data center in Baton Rouge, Louisiana is further protected with redundant cooling, battery backup, generator power and carded access. Finally, a full disaster recovery site is leased in Dallas, Texas in the event the Baton Rouge systems are disrupted for an extended period of time.

Legal proceedings

We are from time to time a party to various claims and legal proceedings related to our business. It is not possible to predict the outcome of these claims and proceedings. However, there are no current material claims or legal proceedings pending against us that, in the opinion of our management, are likely to have a material adverse effect on our business, financial condition, results of operations or liquidity.

Environmental matters

Our operations are subject to various laws and regulations relating to environmental concerns. As with other companies engaged in like businesses, the nature of our operations exposes us to the risk of liabilities or claims with respect to environmental matters, including those relating to the disposal and release of hazardous substances. Primary U.S. environmental laws that our operations may be subject to include the U.S. federal Clean Water Act and comparable state laws, and regulations thereunder, which regulate the discharge of pollutants into regulated waters, including industrial wastewater discharges and storm water runoff; the U.S. federal Resource Conservation and Recovery Act and comparable state laws, and regulations thereunder, which regulate the management and disposal of solid and hazardous waste; and the U.S. federal Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”) and regulations thereunder, which imposes liability for the clean-up of hazardous substances that may have been released at properties currently or previously owned or operated by us or locations to which we have sent waste for disposal. Our operations are also governed by laws and regulations relating to workplace safety and worker health which, among other things, regulate employee exposure to hazardous chemicals in the workplace. In addition, our operations are subject to similar non-U.S. environmental, workplace safety and worker health laws. Failure to comply with these laws and regulations or newly adopted laws or regulations may trigger a variety of administrative, civil and criminal enforcement measures, including the assessment of monetary and other penalties, the imposition of remedial requirements and the issuance of orders enjoining future operations or imposing additional compliance requirements on such operations. Certain environmental laws, including CERCLA and similar state laws and regulations, impose strict, joint and several liability for costs required to clean up and restore sites where hazardous substances have been disposed or otherwise released. Moreover, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the release of hazardous substances, hydrocarbons or other waste products into the environment. Management believes that our operations are in substantial compliance with environmental laws and regulations applicable to us.

We have not made any material expenditures during the last four fiscal years in order to comply with environmental and health and safety laws or regulations. Based on our experience to date, we believe that the future cost of compliance with existing environmental laws and regulations will not have a material adverse effect on our business, consolidated financial condition, results of operations or liquidity. However, we cannot predict what environmental or health and safety legislation or regulations will be enacted in the future or how existing or future laws or regulations will be enforced, administered or interpreted, nor can we predict the amount of future expenditures that may be required in order to comply with current and future environmental or health and safety laws or regulations or to respond to any claims.

Cyclicality and seasonality

Some of our customers are in cyclical businesses, in particular customers in the oil and natural gas refining industries. See “Item 1A. Risk factors—Risks relating to our business—Volatility in the global energy infrastructure market, and in particular a significant decline in oil and natural gas prices and refining margins, has reduced, and could reduce in the future, the demand for our products, which could cause our sales and margins to decrease.”

 

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In addition, some of our customers are in seasonal businesses, especially those customers who purchase our products for use in new capital expenditure projects at refineries, oil and natural gas infrastructure and processing and power generation plants. As a consequence, our results of operations and working capital, including our accounts receivable, inventory and accounts payable, may fluctuate during the year. However, because of our geographic, product and customer diversity, our operations have not shown any material seasonal trends. In addition, our sales for MRO tend not to be seasonal, and help mitigate the overall effects of seasonality on our business. Sales in the months of November and December traditionally have been lower than in other months because of a reduced number of working days for shipments of our products and holiday closures for some of our customers. We cannot assure you that period-to-period fluctuations will not occur in the future. Results of any one or more quarters are, therefore, not necessarily indicative of annual results.

Working capital practices

Volatility in the specialty pipe, pipe components and high-grade structural steel industry and the price of high-grade steel tubes, valves, plate and sections used in the offshore oil and natural gas industry, from time to time, can result in significant fluctuations in cash flow supporting our working capital levels. Inventory and accounts receivable comprise a large percentage of our total assets and can vary significantly from quarter to quarter. At December 31, 2010 and 2009, inventory and accounts receivable represented approximately 50% and 47%, respectively, of total assets excluding cash. See “Item 7. Management’s discussion and analysis of financial condition and results of operations—Liquidity and capital resources.”

Backlog orders

Sales backlog was approximately $212 million at December 31, 2010 compared to sales backlog of approximately $144 million at December 31, 2009.

Available Information

The Company’s internet website address is www.edgenmurray.com. Information on the Company’s website is not incorporated by reference in this Annual Report on Form 10-K. The Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports filed by the Company with the U.S. Securities and Exchange Commission pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are accessible free of charge through the Company’s website as soon as reasonably practicable after the documents are filed with, or otherwise furnished to, the U. S. Securities and Exchange Commission.

The Company’s Code of Business Conduct and Ethics is available on the Company’s website. Copies of such documents will be sent to securityholders free of charge upon written request to the corporate secretary at the address shown on the cover page of this Form 10-K.

 

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ITEM 1A. RISK FACTORS.

The risks described below are not the only ones that we face. Additional risks not presently known to us may also impair our business operations. The actual occurrence of any of these risks could materially adversely affect our business, financial condition and results of operations.

Volatility in the global energy infrastructure market, and in particular a significant decline in oil and natural gas prices and refining margins, has reduced, and could reduce in the future, the demand for our products, which could cause our sales and margins to decrease.

Proceeds from the sale of products to the global energy infrastructure market constitute a significant portion of our sales. As a result, we depend upon the global energy infrastructure market, and in particular the oil and natural gas and refining industries, and upon the ability and willingness of industry participants to make capital expenditures to explore for, develop and produce, transport, process and refine oil and natural gas. The industry’s willingness to make these expenditures depends largely upon the availability of attractive drilling prospects, the prevailing view of future oil and natural gas prices and refinery margins and general economic conditions. As we experienced in 2009 and the first half of 2010, volatile oil and natural gas prices can lead to decreased capital expenditures by industry participants, which in turn affects the demand for our products. Many factors affect the supply of and demand for oil and natural gas and refined products, thereby affecting our sales and margins.

These factors include the following:

 

   

the level of U.S. and worldwide oil and natural gas production;

 

   

the level of U.S. and worldwide supplies of, and demand for, oil, natural gas and refined products;

 

   

the expected cost of delivery of oil, natural gas and refined products;

 

   

the availability of attractive oil and natural gas fields for production, which may be affected by governmental action or environmental policy and which may restrict exploration and development prospects;

 

   

U.S. and worldwide refinery overcapacity or undercapacity and utilization rates;

 

   

the amount of capital available for maintenance of existing oil, gas and refined products infrastructure;

 

   

changes in the cost or availability of transportation infrastructure;

 

   

levels of exploration activity;

 

   

national, governmental and other political requirements, including the ability of the Organization of the Petroleum Exporting Countries (“OPEC”) to set and maintain production levels and pricing;

 

   

the impact of political instability, terrorist activities or armed hostilities involving one or more oil and natural gas producing nations;

 

   

pricing and other actions taken by competitors that impact the market;

 

   

the failure by industry participants to implement planned capital projects successfully or to realize the benefits expected for those projects;

 

   

the cost of developing alternative energy sources;

 

   

U.S. and non-U.S. governmental regulations, especially environmental regulations (including mandated changes in fuel consumption and specifications), trade laws, commodities and derivatives trading regulations and tax policies;

 

   

natural disasters, including hurricanes, tsunamis, earthquakes and other weather-related events; and

 

   

the overall global economic environment.

 

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Oil and natural gas prices and processing and refining margins have been and are expected to remain volatile. This volatility may cause our customers to change their strategies and expenditure levels. We are experiencing, have experienced in the past and may experience in the future, significant fluctuations in our business, financial condition and results of operations, based on these changes. In particular, such continued volatility in the oil, natural gas and refined products margins and markets more generally could adversely affect our business, consolidated financial condition, results of operations and liquidity.

The prices we pay and charge for steel products, and the availability of steel products generally, may fluctuate due to a number of factors beyond our control, which could adversely affect the value of our inventory, business, financial condition, results of operations and liquidity.

We purchase large quantities of steel products from our vendors. The prices we pay our vendors for these products and the prices we charge our customers for these products change depending on many factors outside of our control, such as general global economic conditions, competition, consolidation of steel producers, cost and availability of raw materials (such as iron ore, coking coal and steel scrap) necessary to produce steel, production levels, labor costs, freight and shipping costs, natural disasters, political instability, import duties, tariffs and other trade restrictions, currency fluctuations and surcharges imposed by our vendors. If steel prices increase between the time we order steel products and the time of delivery of those products to us, our vendors may increase prices and impose surcharges on the ordered products. We seek to maintain our profit margins by attempting to increase the prices we charge for our products in response to increases in the prices we pay for them. However, demand for our products, the actions of our competitors, our contracts with our customers and other factors largely out of our control will influence whether, and to what extent, we can pass any such steel cost increases and surcharges on to our customers. If we are unable to pass on higher costs and surcharges to our customers, or if we are unable to do so in a timely manner, our business, financial condition, results of operations and liquidity could be materially adversely affected. Alternatively, if the price of steel decreases significantly, we may have to reduce the prices we charge for our products to remain competitive. This may require us to write-down the value of inventory on hand that we purchased prior to the steel price decreases, which could materially adversely affect our business, financial condition, results of operations and liquidity. For example, we had an inventory write-down of $22.5 million and $0.3 million for the years ended December 31, 2009 and 2010, respectively, related to selling prices falling below our average cost of inventory in some of the markets we serve, including the United States and Middle East. Although we did not have significant inventory write-downs during the year ended December 31, 2010, there are no assurances this will not occur in the future.

The availability of steel products that we purchase from our vendors also may change based on factors outside of our control, such as the factors noted above that may affect the pricing of our products. In addition, our business, financial condition, results of operations and liquidity could be materially affected if our supply of products is delayed or curtailed due to any of the above factors and unforeseen occurrences.

Our substantial indebtedness could prevent us and the guarantors from fulfilling our and their obligations under EMC’s outstanding senior secured notes (the “notes”).

We have a substantial amount of indebtedness. As a result of our substantial indebtedness, a significant portion of our cash flow is required to pay interest and principal, and we may not generate sufficient cash flow from operations, or have future borrowings available, to enable us to repay our indebtedness, including the notes, or to fund other liquidity needs. As of December 31, 2010, we had approximately $479.8 million of indebtedness (including capital leases of $18.5 million and net of discount of approximately $3.7 million) and the ability to borrow approximately $80.8 million under our senior secured revolving credit facility (the “ABL Facility”) (based on the value of our borrowing base on such date) and $11.1 million under our EM FZE local facility. Because borrowing availability under the ABL Facility depends, in part, on inventory and accounts receivable values that fluctuate from time to time and is subject to discretionary reserves and revaluation adjustments imposed by the administrative agent and other limitations, our borrowing availability at December 31, 2010 or any other point in time may not reflect our borrowing availability at any subsequent point in time.

Our substantial indebtedness could have important consequences to our noteholders. For example, it could:

 

   

make it more difficult for us and the guarantors to satisfy our and their obligations with respect to the notes and the note guarantees, such as the issuers’ obligation to purchase notes tendered as a result of a change in control event;

 

   

increase our vulnerability to general adverse economic and industry conditions, including rising interest rates;

 

   

restrict us from making strategic acquisitions or exploiting business opportunities;

 

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limit, along with the financial and other restrictive covenants under our indebtedness, our ability to obtain additional financing, dispose of assets or pay cash dividends;

 

   

require us to dedicate a substantial portion of our cash flow from operations to service our indebtedness, thereby reducing the availability of our cash flow to fund future working capital, capital expenditures and other general corporate requirements;

 

   

require us to sell assets used in our business;

 

   

limit our flexibility in planning for, or reacting to, changes in its business and the industry in which we operate;

 

   

increase our cost of borrowing; and

 

   

place us at a competitive disadvantage as compared to our competitors that have less debt.

If our business, financial condition, results of operations and liquidity deteriorate, our creditors may restrict our ability to obtain future financing and our suppliers could require prepayment or cash on delivery rather than extend credit to us. If our creditors restrict advances, our ability to generate cash flows from operations sufficient to service our short and long-term debt obligations will be further diminished. In addition, our ability to make payments on and refinance our debt and to fund our operations will depend on our ability to generate cash in the future.

To service our indebtedness, we will require a significant amount of cash. Our ability to pay interest and principal on our indebtedness and to satisfy our other debt obligations will depend upon our future operating performance and the availability of refinancing indebtedness, which will be affected by prevailing economic conditions and financial, business and other factors, many of which are beyond our control. Our future cash flow may be insufficient to meet our obligations and commitments. If we generate insufficient cash flow from operations in the future to service our indebtedness and to meet our other commitments, we will be required to adopt one or more alternatives, such as refinancing or restructuring our indebtedness, selling material assets or operations or seeking to raise additional debt or equity capital. These actions may not be effected on a timely basis or on satisfactory terms, or at all, and these actions may not enable us to continue to satisfy our capital requirements. In addition, our existing or future debt agreements may contain restrictive covenants prohibiting us from adopting any of these alternatives. Our failure to comply with these covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all of our indebtedness. In addition, an inability to service our indebtedness could lead to a default under the indenture governing the notes and under our ABL Facility and other agreements governing our other current or future indebtedness, which may result in an acceleration of our debt obligations.

For the year ended December 31, 2009 and 2010, our earnings were insufficient by $44.5 million and $121.7 million, respectively, to cover fixed charges. See “Exhibit 12.1 Computation of ratio of earnings to fixed charges.” We were able to cover this deficiency with cash on hand. See “Item 7. Management’s discussion and analysis of financial condition and results of operations—Liquidity and capital resources—Debt.”

We maintain an inventory of products for which we do not have firm customer orders, which could adversely affect our profit margins and results of operations if prices or sales volumes decline.

Because we maintain substantial inventories of specialty steel products for which we do not have firm customer orders, there is a risk that we will be unable to sell our existing inventory at the volumes and prices we expect. For example, the value of our inventory could decline if the prices we are able to charge our customers decline. In that case, we may experience reduced margins or losses as we dispose of higher-cost products at reduced market prices. For instance, during the fiscal year ended December 31, 2009, we incurred losses of $12.7 million due to strategic inventory liquidation (at prices below our cost) of non-core inventory related primarily to products for the North American natural gas market. Although we did not incur significant losses related to inventory liquidation during the year ended December 31, 2010, there are no assurances this will not occur in the future.

 

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As a distributor, our profitability, margins and cash flows can also be negatively affected if we are unable to sell our inventory in a timely manner. Although we stock inventory based on historical usage patterns and expected demand, market conditions and inventory mix may affect the demand for our inventoried products. If we are unable to sell our inventory in a timely manner, we may incur costs, such as maintenance, insurance and storage costs and property taxes that may reduce our profitability, and we may be required to write-down the value of our slow moving inventory.

Our business is sensitive to economic downturns and adverse credit market conditions, which could adversely affect our business, financial condition, results of operations and liquidity.

Aspects of our business, including demand for and availability of our products, are dependent on, among other things, the state of the global economy and adverse conditions in the global credit markets. Our business has been affected in the past and may be affected in the future by the following ways:

 

   

our customers may reduce or eliminate capital expenditures as a result of reduced demand from their customers;

 

   

our customers may not be able to obtain sufficient funding for their capital projects at a reasonable cost as a result of tightening credit markets, which may result in delayed or cancelled projects or maintenance expenditures;

 

   

our customers may not be able to pay us in a timely manner, or at all, as a result of declines in their cash flows or available credit;

 

   

we may experience supply shortages for certain products if our vendors reduce production as a result of reduced demand for their products;

 

   

we may experience tighter credit terms from our vendors, which could increase our working capital needs and potentially reduce our liquidity; and

 

   

the value of our inventory could decline if the sales prices we are able to charge our customers decline.

As a result of these and other effects, economic downturns such as the one we have recently experienced have adversely affected and could in the future adversely affect our business, financial condition, results of operations and liquidity. For example, sales have declined by approximately 19% for the year ended December 31, 2010 compared to the year ended December 31, 2009.

In addition, market disruptions, such as the recent global economic recession, could adversely affect the creditworthiness of lenders under our ABL Facility. Any reduced availability under our ABL Facility could require us to seek other forms of liquidity through financing in the future and the availability of such financing will depend on market conditions prevailing at that time.

We rely on our steel vendors to meet the required specifications for the steel we purchase from them, and we may have unreimbursed losses arising from our vendors’ failure to meet such specifications.

We rely on our vendors to provide mill certifications that attest to the specifications and physical and chemical properties of the steel products that we purchase from them for resale. We generally do not undertake independent testing of any such steel but rely on our customers or assigned third-party inspection services to notify us of any steel that does not conform to the specifications certified by the mill. We may be subject to customer claims and other damages if steel purchased from our vendors is deemed not to meet quality specifications. These damages could exceed any amounts that we are able to recover from our vendors or under our insurance policies.

Loss of key vendors or reduced product availability could decrease our sales volumes and overall profitability.

For the year ended December 31, 2010, our ten largest vendors accounted for approximately 39% of our total purchases and our single largest vendor accounted for approximately 8% of our total purchases. Consistent with industry practice, we do not have long-term contracts with most of our vendors. Therefore, most of our vendors have the ability to terminate their relationships with us at any time. The loss of any of these vendors could put us at a competitive disadvantage by decreasing the availability or increasing the prices, or both, of products we distribute, which in turn could result in a decrease in our sales volumes and overall profitability.

 

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Significant competition from a number of companies could reduce our market share and have an adverse effect on our selling prices, sales volumes and earnings.

We operate in a highly competitive industry and compete against a number of other market participants, some of which have significantly greater financial, technological and marketing resources than we do. We believe that our ability to compete successfully depends on having access to a broad range of high-performance specialty products, ability to deliver on a quick response basis or in our customers’ desired timeframe, competitive pricing and superior customer service and support. We may be unable to compete successfully with respect to these or other competitive factors. If we are unsuccessful, we could lose market share to our competitors. Moreover, our competitors’ actions could have an adverse effect on our selling prices and sales volume. To compete for customers, we may elect to lower selling prices or offer increased services at a higher cost to us, each of which could reduce our sales volumes, margins and earnings.

The development of alternatives to steel product distributors in the supply chain in the industries in which we operate could cause a decrease in our sales and results of operations and limit our ability to grow our business.

If our customers or manufacturers were to acquire or develop the capability to enable our customers to purchase products directly from our manufacturers in a competitive fashion, it would likely reduce our sales volume and overall profitability. Our vendors also could expand their own local sales forces and inventory stocking capabilities and sell more products directly to our customers. Likewise, customers could purchase from our vendors directly in situations where large orders are being placed and where inventory and logistics support planning are not necessary in connection with the delivery of the products. These and other actions that remove us from, or limit our role in, the distribution chain, could materially adversely affect our business, financial condition and results of operations.

Increases in customer, manufacturer and competitor inventory levels could reduce our sales and overall profitability.

Customer, manufacturer and distributor inventory levels of specialty steel pipe, pipe components, high-grade structural steel products and valves can change significantly from period to period. Increases in our customers’ inventory levels could cause customers to utilize existing inventory rather than purchase new products through us. Any such a reduction in purchases by our customers would likely reduce our sales volume and overall profitability.

During 2009 and the first half of 2010, the markets we serve saw increased inventory levels by other distributors, which caused an oversupply of some steel products and reduced the prices that we are able to charge for our products. Reduced prices, in turn, resulted in reduced margins on some items, adversely affecting our overall profitability. Although we believe inventory levels stabilized during the second half of 2010, there can be no assurances a similar oversupply of market inventory will not occur in the future.

These increased inventory levels and resulting price reductions on some items could continue. Further, after the inventories are reduced and prices rise, the same increased inventories could reoccur at any time. Manufacturer levels of inventory are currently lower than they were before the global recession. However, the levels of manufacturer inventory could increase at any time. Increased levels of manufacturer inventory could cause an oversupply of some steel products in the markets we serve and could reduce the prices that we are able to charge for our products. Reduced prices, in turn, would likely reduce our margins on some items and reduce our overall profitability.

 

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We rely on our information technology systems to manage numerous aspects of our business and customer and vendor relationships, and a disruption of these systems could adversely affect our business, financial condition and results of operations.

We depend on our information technology (“IT”) systems to manage numerous aspects of our business transactions and provide analytical information to management. Our IT systems allow us to efficiently purchase products from our vendors, ship products to our customers on a timely basis, maintain cost-effective operations and provide superior service to our customers. Our IT systems are an essential component of our business and growth strategies, and a disruption to our IT systems could significantly limit our ability to manage and operate our business efficiently. These systems are vulnerable to, among other things, damage and interruption from power loss, including as a result of natural disasters, computer system and network failures, loss of telecommunications services, operator negligence, loss of data, security breaches and computer viruses. Any such disruption could adversely affect our competitive position and thereby our business, financial condition and results of operations.

Loss of third-party transportation providers upon which we depend or conditions negatively affecting the transportation industry could increase our costs and disrupt our operations.

We depend primarily upon third-party transportation providers for delivery of products to our customers. Strikes, slowdowns, piracy, terrorism, shortages of transportation vessels, transportation disruptions or other adverse conditions in the transportation industry, including shortages of truck drivers, disruptions in rail service, closures of shipping routes due to war, insurrection, piracy or terrorism, unavailability of ports and port service for other reasons, increases in fuel prices and adverse weather conditions, could increase our costs and disrupt our operations and our ability to service our customers on a timely basis. We cannot predict whether or to what extent any of these factors would affect our costs or cause a disruption in our operations.

Our ten largest customers account for a substantial portion of our sales and profits, and the loss of these customers could result in materially decreased sales and profits.

Our ten largest customers accounted for approximately 28% of our total sales for the year ended December 31, 2010. We may lose a customer for any number of reasons, including as a result of a merger or acquisition, the selection of another provider of high-grade steel products, business failure or bankruptcy of the customer or dissatisfaction with our performance. Consistent with industry practice, we do not have long-term contracts with most of our major customers. Our customers with whom we do not have long-term contracts have the ability to terminate their relationships with us at any time. Moreover, to the extent we have long-term contracts with our major customers, these contracts generally may be discontinued with 30 days notice by either party, are not exclusive and do not require minimum levels of purchases. We cannot assure you that we will retain long-term relationships or secure renewals of short-term relationships with our major customers in the future.

We may need additional capital in the future and it may not be available on acceptable terms.

We may require additional capital in the future to do the following:

 

   

fund our operations;

 

   

finance investments in equipment and infrastructure needed to maintain and expand our distribution capabilities;

 

   

enhance and expand the range of products and services we offer;

 

   

respond to potential strategic opportunities, such as investments, acquisitions and expansion; and

 

   

service or refinance our indebtedness.

Additional financing may not be available on terms favorable to us, or at all. The terms of available financing may restrict our financial and operating flexibility. If adequate funds are not available on acceptable terms, we may be forced to reduce our operations or delay, limit or abandon expansion opportunities. Moreover, even if we are able to continue our operations, the failure to obtain additional financing could adversely affect our competitiveness.

Risks generally associated with acquisitions, including identifying and integrating future acquisitions, could adversely affect our growth strategy.

A key element of our growth strategy has been, and is expected to continue to be, the pursuit of acquisitions of other businesses that either expand or complement our global platform. However, we cannot assure you that we will be able to identify additional acquisitions or that we would realize any anticipated benefits from any such acquisitions. Integrating businesses involves a number of special risks, including the possibility that management may be distracted from regular business concerns by the need to integrate operations, unforeseen difficulties in integrating operations and systems, problems concerning assimilating and retaining the employees of the acquired business, accounting issues that arise in connection with the acquisition, challenges in retaining customers and potentially adverse short-term effects on operating results. Acquired businesses may require a greater amount of capital, infrastructure or other spending than we anticipate. In addition, we may incur debt to finance future acquisitions, which could increase our leverage. We cannot assure you that we will be successful in consummating future acquisitions on favorable terms, if at all. If we are unable to successfully complete and integrate strategic acquisitions in a timely manner, our growth strategy could be adversely impacted.

 

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War, other armed conflicts or terrorist attacks could materially adversely affect our business.

The continuing armed conflicts in the Middle East, tension between the global community and North Korea and Iran, as well as terrorist attacks have significantly increased political and economic instability in some of the geographic areas in which we operate and could also affect other areas in which we operate. Our operations in the Middle East could be adversely affected by developments in Iraq if armed hostilities, acts of terrorism or other unrest persist, as well as developments in Iran. Acts of terrorism and threats of armed conflict elsewhere in the Middle East and in or around various other geographic areas in which we operate, such as the Caspian Sea region, West Africa, Latin America and Southeast Asia, could also limit or disrupt the markets we serve and our operations. Further hostilities or additional acts of terrorism in these regions could result in the evacuation of personnel, cancellation of contracts or the loss of personnel or assets. Armed conflicts, terrorism and their effects on our operations or the markets we serve could materially adversely affect our business.

The moratorium on drilling offshore in the United States, as well as changes in and compliance with restrictions or regulations on offshore drilling in the U.S. Gulf of Mexico and in other areas around the world, has and may continue to adversely affect our business and operating results and reduce the need for our services in those areas.

While the moratorium on drilling offshore in the United States was lifted on October 12, 2010, there is a delay in resuming operations related to drilling offshore in the United States and there is no assurance that operations related to drilling offshore in the United States will reach the same levels that existed prior to the moratorium. Any delay in resuming these activities or the failure of these activities to reach levels that existed prior to the moratorium has and could continue to adversely impact our operating results as the demand for our goods declines. The April 2010 Deepwater Horizon accident in the Gulf of Mexico and its aftermath has resulted in new and proposed legislation and regulation in the United States of the offshore oil and gas industry, which may result in substantial increases in costs or delays in drilling or other operations in the Gulf of Mexico, oil and gas projects becoming potentially non-economic, and a corresponding reduced demand for our services. We cannot predict with any certainty the impact of the moratorium or the substance or effect of any new or additional regulations. If the United States or other countries where we operate enact stricter restrictions on offshore drilling or further regulate offshore drilling or contracting services operations, higher operating costs could result, which could, in turn, diminish demand for our products and services, thereby adversely affecting our business and operating results.

Disruptions in the political and economic conditions of the countries where we operate could adversely affect our business, financial condition and results of operations.

Our operations are subject to risks associated with the political and economic conditions of the countries in which we operate, such as:

 

   

foreign currency fluctuations and devaluations;

 

   

regional and local economic conditions;

 

   

restrictions on the repatriation of income;

 

   

restrictions on access to markets for periods of time;

 

   

political instability;

 

   

unfavorable government policies disrupting purchasing and distribution capabilities;

 

   

war and civil disturbances; and

 

   

terrorist attacks.

 

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Some of the international areas in which we operate are politically less stable than other areas. Current political unrest in North Africa and the Middle East may affect our operations in these areas as well as oil and gas markets generally.

With respect to our potential exposure to foreign currency fluctuations and devaluations, as of and for the year ended December 31, 2010, approximately 21% of our total assets and 20% of our sales, respectively, were denominated in U.K. pounds, our functional currency in the United Kingdom. As a result, a material decrease in the value of the U.K. pound relative to the U.S. dollar may have a negative impact on our sales, net income and cash flows. Each one percentage point change in the value of the U.K. pound relative to the U.S. dollar for the year ended December 31, 2010 would have impacted our sales by approximately $1.3 million. Any currency controls implemented by local monetary authorities in countries where we currently operate could adversely affect our business, financial condition and results of operations.

We are also subject to other risks associated with the political and economic conditions of the countries where we operate, including foreign monetary and tax policies, expropriation, nationalization and nullification or modification of contracts. In addition, our ability to compete in international markets may be adversely affected by foreign governmental regulations that favor or require the awarding of contracts to local contractors or by regulations requiring foreign contractors to employ citizens of, or purchase supplies from, a particular jurisdiction. Our subsidiaries also may face governmentally imposed restrictions from time to time on their ability to transfer funds to us.

Loss of key management or sales and customer service personnel could harm our business.

Our future success depends to a significant extent on the skills, experience and efforts of management, including our President and Chief Executive Officer, Mr. Daniel J. O’Leary. While we have not experienced problems in the past attracting and maintaining members of our management team, the loss of any or all of these individuals could materially adversely affect our business. We do not carry key-man life insurance on any member of management. We must continue to develop and retain a core group of individuals if we are to realize our goal of continued expansion and growth. We cannot assure you that we will be able to do so in the future. See “Item 10. Directors, Executive Officer and Corporate Governance–Directors and Executive Officers.”

Because of the specialized nature of our products and services, generally only highly qualified and trained sales and customer service personnel have the necessary skills to market our products and provide product support to our customers. These employees develop relationships with our customers that could be damaged if these employees are not retained. We face intense competition for the hiring of these professionals. Any failure on our part to hire, train and retain a sufficient number of qualified sales and customer service personnel could materially adversely affect our business. In addition, a significant increase in the wages paid by competing employers could result in a reduction of our skilled labor force, increases in the wage rates that we must pay or both. The actual occurrence of any of these events could appreciably increase our cost structure and, as a result, materially impair our growth potential.

We are subject to environmental laws and regulations relating to hazardous materials, substances and waste used in or resulting from our operations. Liabilities or claims with respect to environmental matters could materially adversely affect our business.

As with other companies engaged in like businesses, the nature of our operations exposes us to the risk of liabilities or claims with respect to environmental matters, including those relating to the disposal and release of hazardous substances. These liabilities or claims, if incurred, could be material. Environmental laws and regulations are comprehensive, complex and frequently changing, and may be subject to varying and conflicting interpretations. From time to time, we may be subject to administrative or judicial proceedings or investigations brought by private parties or government agencies with respect to environmental matters. Failure to comply with environmental laws and regulations may result in the assessment of administrative, civil and criminal penalties, imposition of cleanup and site restoration costs and liens and issuance of injunctions to limit or cease operations. In addition, claims for damages to persons or property may result from environmental and other related matters.

 

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We are subject to workplace safety and employee health laws and regulations that could subject us to significant liabilities and compliance expenditures.

Our operations are subject to laws and regulations governing workplace safety and employee health, including employee exposure to hazardous chemicals in the workplace. These laws and regulations are comprehensive, complex and frequently changing, and may be subject to varying and conflicting interpretations. From time to time, we may be subject to administrative or judicial proceedings or investigations brought by private parties or government agencies with respect to workplace safety and employee health matters.

We could be subject to personal injury, property damage, product liability, warranty and other claims, and environmental claims involving allegedly defective products that we distribute.

The products we distribute are often used in potentially hazardous applications that could result in death, personal injury, property damage, environmental damage, loss of production, punitive damages and consequential damages. Actual or claimed defects in the products we distribute may result in us being named as a defendant in lawsuits asserting potentially large claims, despite our not having manufactured the products alleged to have been defective. Furthermore, applicable law may render us liable for damages regardless of negligence or fault on our part. In particular, certain environmental laws provide for joint and several and strict liability for remediation of spills and releases of hazardous substances. Some of these risks may be reduced because we are a distributor of products produced by third-party manufacturers, and so, in certain circumstances we may have third-party warranty or other claims against the manufacturer of products alleged to have been defective. However, we may offer warranty terms that exceed those of the manufacturer or the manufacturer may be financially unable to cover the losses and damages caused by any defective products that it manufactured and we distributed. In addition, our insurance coverage may not be adequate to cover the underlying claims, as our insurance policies do not provide coverage for all liabilities (including liability for certain types of events involving pollution). Finally, the third party manufacturer may be in a jurisdiction where it is impossible to enforce our rights to obtain contribution.

We may not have adequate insurance for potential liabilities.

In the ordinary course of business, we may be subject to various product and non-product related claims, laws and administrative proceedings seeking damages or other remedies arising out of our commercial operations. We maintain insurance to cover our exposure for most claims and losses. However, our insurance coverage is subject to various exclusions, self-retentions and deductibles, may be inadequate or unavailable to protect us fully, and may be canceled or otherwise terminated. Furthermore, we face the following additional risks under our insurance coverage:

 

   

we may not be able to continue to obtain insurance coverage on commercially reasonable terms, or at all;

 

   

we may be faced with types of liabilities that are not covered under our insurance policies, such as damages from environmental contamination or terrorist attacks, and that exceed any amounts we may have reserved for such liabilities;

 

   

the amount of any liabilities that we may face may exceed our policy limits and any amounts we may have reserved for such liabilities; and

 

   

we may incur losses resulting from interruption of our business that may not be fully covered under our insurance policies.

Even a partially uninsured claim of significant size, if successful, could materially adversely affect our business, financial condition, results of operations and liquidity. However, even if we successfully defend ourselves against any such claim, we could be forced to spend a substantial amount of money in litigation expenses, our management could be required to spend valuable time in the defense against these claims and our reputation could suffer, any of which could harm our business.

We are controlled by parties whose interests may not be aligned with the interest of our noteholders.

Funds managed by JCP currently control EM II LP and the general partner of EM II LP. Accordingly, by virtue of the ownership interests of these funds and the terms of the limited partnership agreement of EM II LP, and the limited liability company agreement of the general partner, JCP has significant influence over our management, and the ability to elect the board of directors of the general partner of EM II LP and to determine the outcome of any other matter submitted for partner approval, including the power to determine the outcome of all business transactions, such as mergers, consolidations and the sale of all or substantially all of our assets. The interests of JCP may differ from the interest of our noteholders, and as such JCP may take actions that may not be in the interest of our noteholders. For example, if we encounter financial difficulties or are unable to pay our debts as they mature, the interests of JCP might conflict with the interest of our noteholders. In addition, JCP may have an interest in pursuing acquisitions, divestitures, financings or other transactions that, in its judgment, could enhance its equity investment, even though such transactions might involve risks to our noteholders. In addition, funds managed by JCP may invest in businesses that are related to or competitive with our business. For example, the oil country tubular goods business is related to, but not competitive with, our business. See “Item 13. Certain relationships and related person transactions.”

 

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Compliance with laws and regulations related to corporate governance and public disclosure will result in additional expenses.

Keeping abreast of, and in compliance with, laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002 and rules and regulations of the SEC thereunder, will require a significant amount of management attention and external resources. While we intend to invest all reasonably necessary resources to comply with current and future laws, regulations and standards, this investment will result in increased general and administrative expenses and a diversion of management time and attention from revenue generating activities to compliance activities.

Potential U.S. tax law changes could increase our U.S. tax expense on overseas earnings which could have a negative impact on our after tax income and cash flow.

President Obama’s Budget of the U.S. government for 2012 indicated that legislative proposals may be made to reform the deferral of U.S. taxes on non-U.S. earnings, potentially significantly changing the timing and extent of taxation on unrepatriated non-U.S earnings. These reforms include, among other items, a proposal to further limit foreign tax credits and a proposal to defer interest expense deductions allocable to non-U.S earnings until earnings are repatriated. The proposal to defer interest expense deductions could result in our inability to currently deduct interest expense, including interest expense incurred with respect to the notes. The proposal to defer tax deductions for interest expense allocable to unrepatriated non-U.S. earnings has been set out in various draft Congressional legislative proposals in recent years which were not enacted, and at this juncture it is unclear whether these proposed tax revisions will be enacted, or if enacted, what the scope of the revisions will be. However, depending on their content, such proposals could have a material adverse effect on our after-tax income and cash flow.

Due to the international nature of our business we could be adversely affected by violations of the U.S. Foreign Corrupt Practices Act, similar worldwide anti-bribery laws, and various international trade and export laws

The international nature of our business creates various domestic and local regulatory challenges. The U.S. Foreign Corrupt Practices Act (FCPA) and similar anti–bribery laws in other jurisdictions generally prohibit U.S. based companies and their intermediaries from making improper payments to non–U.S. officials for the purpose of obtaining or retaining business. Our policies mandate compliance with these anti–bribery laws. We operate in many parts of the world that experience corruption by government officials to some degree, and, in certain circumstances, compliance with anti–bribery laws may conflict with local customs and practices. Our global operations require us to import and export to and from a myriad of countries, which geographically stretches our compliance obligations. To help ensure compliance, our anti-bribery policy and training on a global basis provide our employees with procedures, guidelines and information about anti-bribery obligations and compliance. Further, we require our partners, subcontractors, agents and others who work for us or on our behalf that they are obligated to comply with anti-bribery laws. We also have procedures and controls in place designed to ensure internal and external compliance. However, such anti-bribery policy, training, internal controls and procedures will not always protect us from reckless or criminal acts committed by our employees or agents. If we are found to be in violation of the FCPA or other anti-bribery laws (either due to acts or inadvertence of our employees, or due to the acts or inadvertence of others), we could suffer from criminal or civil penalties or other sanctions, which could have a material adverse effect on our business.

 

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Actual results could differ from the estimates and assumptions that we use to prepare our financial statements.

To prepare financial statements in conformity with U.S. generally accepted accounting principles, our management is required to make estimates and assumptions, as of the date of the financial statements, that affect the reported values of assets and liabilities and revenues and expenses and disclosures of contingent assets and liabilities. Areas requiring significant estimates by our management include, among other things:

 

   

recoverability of inventory and application of lower of cost or market accounting;

 

   

provisions for uncollectible receivables and client claims and recoveries of costs from vendors and others;

 

   

provisions for income taxes and related valuation allowances;

 

   

recoverability of goodwill;

 

   

recoverability of other intangibles and related estimated lives;

 

   

valuation of assets acquired and liabilities assumed in connection with business combinations; and

 

   

accruals for estimated assets and liabilities, including litigation and insurance recoveries/reserves.

Our actual results could differ materially from our estimates. Changes in reported amounts, the effects of those changes and changes in estimate may be recorded in future periods.

Our internal controls over financial reporting may not be effective, which could have a significant and adverse effect on our business and reputation.

We are evaluating our internal controls over financial reporting in order to allow management to report on the design and operational effectiveness of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002, as amended, and rules and regulations of the SEC thereunder, which we refer to as “Section 404.” We are in the process of documenting and initiating tests of our internal control procedures in order to satisfy the requirements of Section 404, which requires annual management assessments of the effectiveness of our internal controls over financial reporting. During the course of our testing, we may identify deficiencies which we may not be able to remediate in time to meet the deadline imposed by the Sarbanes-Oxley Act for compliance with the requirements of Section 404. We are required to comply with the requirements of Section 404 for our fiscal year ending December 31, 2011. In addition, if we fail to achieve and maintain the adequacy of our internal controls over financial reporting, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404. We cannot be certain as to the timing of completion of our evaluation, testing and any remediation actions or the impact of the same on our operations. If we are not able to implement the requirements of Section 404 in a timely manner or with adequate compliance we may be subject to sanctions or investigation by regulatory authorities, such as the SEC. As a result, there could be a negative reaction in the financial markets due to a loss of confidence in the reliability of our financial statements. In addition, we may be required to incur costs in improving our internal control system and the hiring of additional personnel. Any such action could negatively affect our results of operations.

We may incur asset impairment charges for goodwill and other indefinite lived intangible assets, which would result in lower reported net income (or higher net losses).

Under accounting principles generally accepted in the United States, we are required to evaluate our goodwill and other indefinite lived intangible assets for impairment whenever a triggering event occurs that indicates the carrying value may not be recoverable. Goodwill is also required to be tested at least annually and we have selected January 1 as our annual testing date.

During 2010, we performed an interim goodwill impairment analysis that indicated the book value of goodwill for our Americas and UAE reporting units exceeded the estimated fair value. As a result, we recorded an impairment charge of $62.8 million, which is reflected in the statement of operations for the year ended December 31, 2010. At December 31, 2010, there was no goodwill balance remaining at the Americas and UAE reporting units after this impairment charge and $22.9 million of goodwill remained in our U.K. and Singapore reporting units. In connection with the performance of the interim goodwill impairment analysis, tradenames were also tested for impairment and no impairment was recorded as the fair value of the tradenames exceeds their carrying value at the review date. As of December 31, 2010, we had $11.4 million of tradenames on the consolidated balance sheet.

In assessing the recoverability of our goodwill and other indefinite lived intangible assets, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. Any significant changes to any of these assumptions or factors could have a material impact on the results of our goodwill impairment analysis. If goodwill is determined to be impaired for any of our reporting units now or in the future, a non-cash charge would be required. Any such charge would result in lower reported net income (or higher net losses).

 

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Changes in the payment terms we receive from our vendors could materially adversely affect our liquidity.

The payment terms we receive from our vendors are dependent on several factors, including our payment history with the vendor, the vendor’s credit granting policies, contractual provisions, our credit profile, industry conditions, our recent operating results, financial position and cash flows and the vendor’s ability to obtain credit insurance on amounts that we owe. Adverse changes in any of these factors, certain of which may not be wholly in our control, may induce our vendors to shorten the payment terms of their invoices, particularly given our high level of outstanding indebtedness. Given the large amounts and volume of our purchases from vendors, a change in payment terms may materially adversely affect our liquidity and our ability to make payments to our vendors, and consequently may materially adversely affect our business, financial condition and results of operations.

Some of our indebtedness is subject to floating interest rates, which would result in our interest expense increasing if interest rates rise.

Although none of our indebtedness was subject to floating interest rates as of December 31, 2010, we have in the past and may in the future have indebtedness subject to floating interest rates under our ABL Facility or otherwise. Accordingly, we may experience a negative impact on earnings as a result of interest rate fluctuation. The actual impact would depend on the amount of floating rate debt outstanding, which fluctuates from time to time. As of December 31, 2010, there were no cash borrowings outstanding under the ABL Facility. Changes in economic conditions could result in higher interest rates, thereby increasing our interest expense and reducing funds available for operations or other purposes. See “Item 7A. Quantitative and qualitative disclosures about market risk” and “Item 7. Management’s discussion and analysis of financial condition and results of operations—Liquidity and capital resources.”

Notwithstanding our current indebtedness levels and restrictive covenants in the agreements governing our indebtedness, we may still be able to incur substantial additional debt or make certain restricted payments, which could exacerbate the risks described above.

We may be able to incur additional debt in the future, including in connection with acquisitions or joint ventures. Although our ABL Facility and the indenture governing the notes contain restrictions on our ability to incur indebtedness, those restrictions are subject to a number of exceptions. In addition, if we are able to designate some of our restricted subsidiaries under the indenture governing the notes as unrestricted subsidiaries, those unrestricted subsidiaries would be permitted to borrow beyond the limitations specified in the indenture and engage in other activities in which restricted subsidiaries may not engage. We may also consider investments in joint ventures or acquisitions, which may increase our indebtedness. Moreover, although our ABL Facility and the indenture governing the notes contain restrictions on our ability to make restricted payments, including the declaration and payment of dividends, we are able to make such restricted payments under certain circumstances. Adding new debt to current debt levels or making otherwise restricted payments could intensify the related risks that we and our subsidiaries now face. See “Item 7. Management’s discussion and analysis of financial condition and results of operations—Liquidity and capital resources—Debt.”

Restrictive covenants in the indenture governing the notes, in our ABL Facility and in other agreements governing our other current or future indebtedness could restrict our operating flexibility.

The indenture governing the notes and our ABL Facility contain affirmative and negative covenants that limit our ability and the ability of our subsidiaries to take certain actions. These restrictions may limit our ability to operate our business and may prohibit or limit our ability to enhance our operations or take advantage of potential business opportunities as they arise. Our ABL Facility requires us, under certain circumstances, to maintain specified financial ratios and satisfy other financial conditions. Our ABL Facility and the indenture governing the notes restrict, among other things, the ability of us and certain of our subsidiaries to:

 

   

incur or guarantee additional debt and issue preferred stock;

 

   

pay dividends or make other distributions, repurchase capital stock or subordinated debt;

 

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make certain investments and loans;

 

   

create liens;

 

   

engage in sale and leaseback transactions;

 

   

make material changes in the nature or conduct of our business;

 

   

create restrictions on the payment of dividends and other amounts to us from subsidiaries;

 

   

enter into agreements restricting the ability of a subsidiary to make or repay loans to, transfer property to, or guarantee indebtedness of, us or any of our subsidiaries;

 

   

merge or consolidate with or into other companies;

 

   

make capital expenditures;

 

   

transfer or sell assets; and

 

   

engage in transactions with affiliates.

In addition, our ABL Facility contains other covenants that are typical for credit agreements of its size, type and tenor, such as requirements that we comply, under certain circumstances, with a fixed charge coverage ratio. Furthermore, if we or certain of our subsidiaries experience specific kinds of changes of control, our borrowings under our ABL Facility will become due and payable. The breach of any of these covenants by us or the failure by us to meet any of these ratios or conditions could result in a default under any or all of such indebtedness. If a default occurs under any such indebtedness, all of the outstanding obligations thereunder could become immediately due and payable, which could result in a default under our other outstanding indebtedness and could lead to an acceleration of obligations related to the notes and other outstanding indebtedness. Our ability to comply with the provisions of the indenture governing the notes, our ABL Facility and other debt agreements governing other indebtedness we may incur in the future can be affected by events beyond our control and, therefore, we may be unable to meet these ratios and conditions. See “Item 7. Management’s discussion and analysis of financial condition and results of operations—Liquidity and capital resources—Debt.”

Borrowing availability under our ABL Facility is subject to a borrowing base limitation that fluctuates from time to time and is subject to redetermination.

Our borrowing availability under our ABL Facility could decline if the value of our borrowing base (which is calculated based on a percentage of our eligible inventory and accounts receivable) declines, the administrative agent imposes reserves in its discretion, our borrowings under the ABL Facility increase or for other reasons. The value of our borrowing base could decline if the value of our eligible inventory or accounts receivable declines, due to economic or market conditions, working capital practices or otherwise. In addition, the agents under the ABL Facility are entitled to conduct borrowing base field audits and inventory appraisals periodically, which may result in a lower borrowing base valuation. If our borrowing availability is less than our outstanding borrowings under the ABL Facility, we would be required to repay borrowings and/ or cash collateralize letters of credit sufficient to eliminate the deficit. Furthermore, if our borrowing availability falls below certain thresholds, the minimum fixed coverage charge ratio covenant under our ABL Facility would be applicable and our ability to utilize our full borrowing availability would be limited by the requirement to maintain the fixed charge coverage ratio at or above 1.25 to 1.00 because any additional borrowings would increase cash interest expense and, all else being equal, decrease our fixed charge coverage ratio. As of the years ended December 31, 2009 and 2010, our ABL Facility fixed charge coverage ratio was below the required minimum fixed charge coverage ratio of 1.25 to 1.00. Although the ABL Facility fixed charge coverage ratio covenant was not applicable because our aggregate borrowing availability was above the applicable thresholds, there can be no assurance that our borrowing availability will not fall below one of the applicable thresholds in the future. Our failure to satisfy the ABL minimum fixed charge coverage ratio at a time when it is applicable would be an event of default under the ABL Facility, in which case either the administrative agent or the requisite lenders may accelerate the maturity of the ABL Facility and/or terminate the lending commitments thereunder and which could result in a default under and acceleration of our other indebtedness. Our operations are funded, in part, from borrowings under the ABL Facility. If we are unable to continue borrowing under the ABL Facility and if we cannot obtain alternate borrowing sources at commercially reasonable rates, or if we are required to repay debt under the ABL Facility or any other facility, we may not be able to continue our operations without substantial disruptions, or at all.

 

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The rating assigned to the notes may be lowered or withdrawn in the future, which may adversely affect the market price of the notes, increase our borrowing costs and reduce our access to capital.

Our debt currently has a non-investment grade rating. The rating that has been assigned to the notes addresses our ability to perform our obligations under the terms of the notes and credit risks in determining the likelihood that payments will be made when due under the notes. A rating is not a recommendation to buy, sell or hold securities and may be subject to revision, suspension, downgrade or withdrawal at any time. In addition, the credit ratings assigned to us and the notes are limited in scope, do not address all material risks relating to an investment in the notes and reflect only the view of each rating agency at the time the rating is issued. An explanation of the significance of such rating may be obtained from such rating agency. Credit rating agencies continually revise their ratings for companies that they follow. No assurances can be given that a rating will remain constant for any given period of time or that a rating will not be revised, suspended, downgraded or withdrawn entirely by the relevant rating agency if in its judgment circumstances in the future so warrant. We have no obligation to inform holders of the notes of any such revision, suspension, downgrade or withdrawal. Each agency’s rating should be evaluated independently of any other agency’s rating. Actual or anticipated changes, including any revisions, suspensions, downgrades or withdrawal, with respect to our credit ratings, including any announcement that our ratings are under further review for a downgrade, may affect the market value of the notes, increase our borrowing costs and reduce our access to capital.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS.

None.

 

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ITEM 2. PROPERTIES.

We currently own or lease facilities in eleven countries: Australia, Brazil, Canada, China, India, Indonesia, Singapore, United Arab Emirates, France, the United Kingdom and the United States. We have representative sales offices in each of these countries. Seventeen of our facilities stock inventory, including eleven in the United States, two in the United Kingdom, two in Canada, one in the United Arab Emirates, and one in Singapore. We also have stocking facilities at one of our customer’s sites in Baku, Azerbaijan and at a third party commercial storage site in Rotterdam, the Netherlands.

We use agents in Abu Dhabi, Brunei, China, India, Indonesia, New Zealand, South Korea, Malaysia, Singapore, Hong Kong and Vietnam, whose properties are neither owned nor leased by us. We have a branch office in Sharjah, United Arab Emirates. We lease residential premises as staff accommodations in the United Arab Emirates. We also have a Bahraini joint venture which operates in Saudi Arabia.

The following table provides a summary of our facilities:

Summary of leased and owned facilities

 

Location

   Building
(sq. ft.)
     Leased/
Owned
     Lease
Expiration
     Facility description  

Company Headquarters

           

Baton Rouge, Louisiana

     17,410         Leased         2013         Office   

Western Hemisphere

           

Houston, Texas

     15,788         Leased         2014         Office   

Baton Rouge, Louisiana

     6,725         Leased         2015         Office/Warehouse   

Broussard, Louisiana

     4,500         Leased         2012         Office/Warehouse   

Charlotte, North Carolina

     12,550         Leased         2011         Office/Warehouse/Yard   

Calgary, Alberta(1)

     425         Leased         2012         Office   

Edmonton, Alberta(1)

     22,400         Leased         2015         Office/Warehouse   

Edmonton, Alberta(1)

     NA         Leased         2015         Yard   

Henderson, Colorado

     2,500         Leased         2013         Office/Warehouse/Yard   

Houston, Texas

     51,000         Leased         2015         Office/Warehouse/Yard   

Houston, Texas(2)

     17,750         Leased         2012         Office/Warehouse/Yard   

Houston, Texas

     22,191         Leased         2013         Office/Warehouse   

Houston, Texas

     NA         Leased         2015         Yard   

Anaheim, California

     13,200         Leased         2013         Office/Warehouse   

 

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Location

   Building
(sq. ft.)
     Leased/
Owned
     Lease
Expiration
     Facility description  

Mulberry, Florida(3)

     1,800         Leased         2014         Office   

Odessa, Texas

     5,000         Leased         2012         Office/Warehouse/Yard   

Port Allen, Louisiana (4)

     9,500         Owned         N/A         Office/Warehouse/Yard   

St. Charles, Illinois

     22,000         Leased         2015         Office/Warehouse   

St. Louis, Missouri

     2,800         Leased         2012         Office/Yard   

Conshohocken, Pennsylvania

     4,175         Leased         2012         Office   

Canonsburg, Pennsylvania

     2,443         Leased         2015         Office   

Rio de Janeiro, Brazil(1)

     1,010         Leased         2012         Office   

Eastern Hemisphere(1)

           

Newbridge, Scotland

     210,000         Leased         2030         Office/Warehouse/Yard   

Darlington, England

     2,000         Owned         N/A         Office   

Kirknewton, Scotland

     NA         Owned         N/A         Yard   

London, England

     1,494         Leased         2014         Office   

Jakarta, Indonesia

     1,250         Leased         2011         Office   

Perth, Australia

     1,287         Leased         2012         Office   

Shanghai, China

     1,152         Leased         2011         Office   

Paris, France

     115         Leased         2011         Office   

Tuas, Singapore(5)

     167,594         Leased         2038         Office/Warehouse   

Tuas, Singapore (6)

     71,687         Leased         NA         Office/Warehouse   

Jebel Ali, Dubai, UAE

     22,041         Leased         2019         Office/Yard   

Haryana, India

     1,253         Leased         2013         Office   

 

(1) All non-U.S. facilities are owned or leased by non-guarantor subsidiaries.
(2) No operations at this time, as location is currently being subleased to a third party.
(3) This facility and yard was sold in December 2010; however, EMC has entered into a lease to support a small sales office.
(4) This property is subject to a line securing the notes.
(5) Represents a new distribution facility in Singapore which was completed in December 2010.
(6) Represents the old distribution facility in Singapore which was an asset held for sale at December 31, 2010. In January 2011, the distribution facility was sold for $6.2 million and a gain of approximately $1.0 million was recognized at the time of the sale.

 

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ITEM 3. LEGAL PROCEEDINGS.

There are no current material claims or legal proceedings pending against us that, in the opinion of our management, are likely to have a material adverse effect on our business, financial condition, results of operations or liquidity. However, we are from time to time a party to various claims and legal proceedings related to our business. It is not possible to predict the nature of the claims, the size of the claims, whether the claims as covered by our insurance, or the outcome of these claims and legal proceedings.

 

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Market Information

Our common partnership units are privately held and there is no established public trading market for our common partnership units. As of March 24, 2011, there were sixty-nine holders of record of our 209,493 outstanding common partnership units.

Dividend Policy

We have not declared or paid any cash dividends or distributions on our common partnership units during our two most recent fiscal years. Covenants within the agreements governing our ABL Facility and the notes restrict our ability to pay cash dividends and distributions on our common partnership units. Future declaration and payment of cash dividends and distributions, if any, on our common partnership units will be determined in light of factors deemed relevant by our general partner, including our earnings, operations, capital requirements and financial condition and restrictions in our financing agreements. See “Item 7. Management’s discussion and analysis of financial condition and results of operations–Debt.”

Securities Authorized For Issuance under Equity Compensation Plans

For information on securities authorized for issuance under equity compensation plans, see “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters.”

 

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ITEM 6. SELECTED FINANCIAL DATA.

The following table presents certain historical consolidated financial data and other data for each of the years ended December 31, 2006, 2007, 2008, 2009 and 2010. The information presented below has been derived from our audited consolidated financial statements and should be read in conjunction with our consolidated financial statements and related notes thereto included elsewhere in this Annual Report on Form 10-K.

The following tables set forth, for the periods and dates indicated, our selected historical consolidated financial information.

 

     Year ended December 31,  

(dollars in thousands)

   2006(1)     2007     2008     2009     2010  

Statement of operations:

          

Sales

   $ 686,937      $ 917,657      $ 1,265,615      $ 773,323      $ 627,713   

Operating expenses:

          

Cost of sales (exclusive of depreciation and amortization shown separately below)(2)

     548,744        748,722        997,940        672,595        536,807   

Selling, general and administrative expense(3)

     60,292        68,310        90,823        70,693        65,256   

Depreciation and amortization expense

     21,051        22,570        22,559        20,136        20,269   

Impairment of goodwill

     —          —          —          —          62,805  
                                        

Total operating expenses

     630,087        839,602        1,111,322        763,424        685,137   

Income from operations

     56,850        78,055        154,293        9,899        (57,424

Equity in earnings of unconsolidated entity

     —          —          —          —          1,029   

Other income (expense)(4)

     13,345        3,176        (902     1,447        190   

Loss on prepayment of debt

     —          (31,385     —          (7,523     —     

Interest expense, net

     (33,822     (48,301     (45,040     (47,085     (64,208
                                        

Income (loss) before income tax expense (benefit)

     36,373        1,545        108,351        (43,262     (120,413

Income tax expense (benefit)

     12,891        (1,370     35,124        (22,373     (22,125
                                        

Net income (loss)

     23,482        2,915        73,227        (20,889     (98,288

Preferred partnership unit interest and dividend requirement

     (4,349     (1,656     —          —          —     

Net loss attributable to non-controlling interest

     —          —          —          —          (14
                                        

Net (loss) income available to common partnership interest

   $ 19,133      $ 1,259      $ 73,227      $ (20,889   $ (98,302
                                        

 

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      As of December 31,  

(dollars in thousands)

   2006      2007     2008     2009     2010  

Balance sheet data:

           

Cash and cash equivalents

   $ 15,858       $ 48,457      $ 41,708      $ 65,733      $ 62,478   

Net property, plant and equipment

     41,116         43,530        42,703        43,342        49,287   

Total assets

     545,760         709,554        742,086        563,460        464,020   

Long-term debt and capital leases

     286,546         575,856        518,013        483,503        479,811   

Preferred partnership interest included in total partners’ capital(5)

     55,067         —          —          —          —     

Total partners’ capital (deficit)(6)

     98,174         (68,486     (36,539     (29,779     (131,262

 

(1) Our consolidated statement of operations for the year ended December 31, 2006 includes eleven months of consolidated operating results of the MIM Acquisition from February 1, 2006 to December 31, 2006 because such subsidiary’s January 31 fiscal year end was not changed to December 31 until September 30, 2006.
(2) Cost of sales (exclusive of depreciation and amortization) for the year ended December 31, 2009 includes an inventory write-down of $22.5 million related to selling prices falling below our average cost of inventory in some of the markets we serve, and losses of $12.7 million due to strategic inventory liquidation (at prices below our cost) of non-core inventory related to products primarily for the North American natural gas market.
(3) Selling, general and administrative expense includes $2.5 million in Recapitalization Transaction related expenses, and $2.0 million of compensation expense related to one-time equity grants for the year ended December 31, 2007. For the years ended December 31, 2007 and 2009, $3.7 million and $3.3 million in accumulated registration costs were expensed within selling, general and administrative expenses, respectively.
(4) Other income (expense) for the year ended December 31, 2006 includes a $13.2 million foreign exchange gain on U.S. dollar denominated debt held at our U.K. subsidiary with a functional currency of U.K. pounds.
(5) In connection with the Recapitalization Transaction and subsequent dissolution of Edgen/Murray, L.P., our predecessor holding company, the preferred partnership units were extinguished.
(6) Total partners’ capital/shareholders’ equity (deficit) as of December 31, 2007 and 2008 reflects reductions in partners’ capital in connection with the Recapitalization Transaction on May 11, 2007. Because the same principals at JCP controlled both Edgen/Murray, L.P. and EM II LP, the entities were considered to be under common control for financial reporting purposes. As a result, fair value purchase accounting has not been applied, which means that we have not recorded the fair value of the acquired assets and assumed liabilities, including goodwill and other intangibles, at the date of the Recapitalization Transaction. Instead, we have maintained the historical carryover basis of the acquired assets and assumed liabilities in accordance with ASC 805, and we have recorded the purchase by EM II LP of the interests held by the partners of Edgen/Murray, L.P. as a distribution in the statement of partners’ capital (deficit) and comprehensive income (loss). This has resulted in a negative balance for total partners’ capital/shareholders’ equity.

 

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with Part I of this Form 10-K as well as our consolidated financial statements and the related notes to the financial statements included elsewhere in this Annual Report on Form 10-K. The following discussion and analysis of our financial condition and results of operations contains forward looking statements within the meaning of the federal securities laws. See “Cautionary Statement Regarding Forward-Looking Statements” and Part I, Item 1A – Risk Factors for a discussion of the risks, assumptions and uncertainties affecting these statements.

Overview

General

We are a global industrial distributor of specialty steel products primarily to the oil and gas, power, petrochemical and civil construction markets. Our product catalog consists of pipes, plate and sections, including highly-engineered prime carbon or alloy steel pipe, pipe components, valves and high-grade structural sections and plate. These items are often designed to operate in severe conditions, including high pressure, load bearing, compression and extreme temperature environments and to withstand the effects of corrosive or abrasive materials. We stock and distribute inventory and support our customers through a global network of facilities located on five continents.

Principal Factors Affecting Our Business

Our business is cyclical and substantially dependent upon conditions in the energy industry and, in particular, capital expenditures by customers in the oil and natural gas exploration and production, gathering and transmission, crude oil refining and the energy processing and power generation industries. The level of customers’ expenditures generally depends on prevailing views of future oil, natural gas, refined products, electric power, petrochemicals, mined products and civil construction supply and demand, which are influenced by numerous factors, including, among others, changes in global economic conditions, changes in oil and natural gas prices, availability of adequate financing or commercially reasonable terms, increasing rates of oil and natural gas production in non-traditional geographies and investment in refining capacity.

In addition to demand driven factors, our business is also affected by changes in the cost of steel. Fluctuations in the costs of the products we supply are largely driven by changes in the condition of the general economy, changes in product inventories held by our customers, our vendors and other distributors and prevailing steel prices around the world. Demand for our products, the actions of our competitors and other factors largely out of our control will influence whether, and to what extent, we will be successful in improving our profit margins in the future.

Reportable segments

We manage our operations in two geographic markets—the Western Hemisphere and the Eastern Hemisphere. We have four reportable segments, which are determined primarily based upon the geographic locations of our operations. Our Western Hemisphere market comprises one of our reportable segments. Our Eastern Hemisphere market is segregated further to derive our reportable segments for that geographic market, which include the U.K. (Europe/West Africa), Singapore (Asia/Pacific), and UAE (Middle East). Our Western Hemisphere segment includes the operations of Brazil which does not meet the quantitative threshold for separate segment disclosure as of or for the year ended December 31, 2010. We include operating expenses of our non-trading entities, including EM II LP, EMGH Limited, Edgen Murray Cayman Corporation and Pipe Acquisition Limited, in General Company expenses.

Our Western Hemisphere operations are headquartered in Houston, Texas and operate through a regional and branch network of locations in the United States and Canada. Thirteen of our Western Hemisphere locations stock inventory for distribution.

 

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Our Eastern Hemisphere operations are headquartered in Newbridge, Scotland and operate through a regional and branch network of locations in Europe, Asia/Pacific, the Middle East and South America. Six locations in the Eastern Hemisphere stock inventory.

Effects of currency fluctuations

As of and for the years ended December 31, 2009 and 2010, approximately 16% and 21%, respectively, of our total assets and approximately 16% and 20%, respectively, of our sales were denominated in U.K. pounds, our functional currency in the United Kingdom. As a result, a material change in the value of the U.K. pound relative to the U.S. dollar could significantly impact our sales, cash flows and net income. The balance sheet amounts are translated into U.S. dollars at the exchange rate at the end of the month and the income statement amounts are translated at the average exchange rate for the period, in each case using the noon buying rate as quoted by the Federal Reserve Bank of New York.

From time to time, we also enter into purchase and sales commitments that are denominated in a currency other than the functional currency of one of our operating entities (primarily the Euro and US Dollar). Currency fluctuations can create volatility in earnings and cash flows from period to period. Our practices include entering into foreign currency forward exchange contracts in an effort to minimize foreign currency exposure related to forecasted purchases and sales of certain products. We do not use derivative financial instruments for speculative purposes.

Revenue sources

We do not manufacture any products. We are a distributor/reseller of our suppliers’ manufactured products. We often purchase these products in large quantities that are efficient for our suppliers to produce, and we subsequently resell these products in smaller quantities to meet our customers’ requirements.

We generate substantially all of our revenues, net of returns and allowances, from the sale of our products to third parties. We also generate a negligible component of our revenues from a range of cutting and finishing services that we coordinate for our customers upon request. Our fees for these services are incorporated into our sales price. Freight costs are generally included in our sales price as well. Our sales are reduced by sales discounts and incentives provided to our customers.

Pricing

Pricing for our products significantly impacts our results of operations. Generally, as pricing increases, so do our sales. Our pricing usually increases when the cost of our materials increases. If prices increase and we maintain the same gross profit percentage, we generate higher levels of gross profit dollars for the same operational efforts. Conversely, if pricing declines, we will typically generate lower levels of gross profit. Because changes in pricing do not necessarily lower our expense structure, the impact on our results of operations from changes in pricing may be greater than the effect of volume changes.

Principal costs and expenses

Our principal costs and expenses consist of the following: cost of sales (exclusive of depreciation and amortization), selling, general and administrative expenses, depreciation and amortization, impairment of goodwill and interest expense. Our most significant cost of sales consists primarily of the cost of our products at weighted average cost, plus inbound and outbound freight expense, outside processing expenses, physical inventory adjustments and inventory obsolescence charges, less earned incentives from vendors.

Our cost of sales is influenced significantly by the prices we pay our vendors to procure the products we distribute to our customers. Changes in these costs may result, for example, from increases or decreases in raw material costs, changes in our relationships with vendors or earned incentives from our vendors. Generally, we are able to pass cost increases on to our customers. However, during certain periods when there are excess inventories, discounting occurs and we are unable to realize full value for our products. Market conditions in the future may not permit us to fully pass through future cost increases or may force us to grant other concessions to customers. An inability to promptly pass through such increases and to compete with excess inventories may reduce our profitability. Our product costs are reduced by vendor discounts and purchase incentives. Payment for our products is typically due to our vendors within 30 to 60 days of delivery.

 

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Selling, general and administrative expenses include sales and administrative employee compensation and benefit costs, as well as travel expenses for sales representatives, information technology infrastructure and communication costs, office rent and supplies, professional services and other general Company expenses. Selling, general and administrative expenses also include costs for warehouse personnel and benefits, supplies, equipment maintenance and rental and contract storage and distribution expenses.

Depreciation and amortization consists of amortization of acquired intangible assets, including customer relationships and backlog, and the depreciation of property, plant and equipment including leasehold improvements, capitalized leases, and picking and lifting equipment.

Impairment of goodwill consists of the write-off of goodwill recorded in connection with historical acquisitions that is not amortized but rather tested for impairment annually or when events and circumstances occur that indicate the fair value of the asset is below its carrying value.

Interest expense includes interest incurred on our indebtedness and amortization of deferred financing costs associated with such indebtedness and original issue discount, if applicable.

Critical Accounting Policies

The preparation of financial statements, in conformity with accounting principles generally accepted in the United States, requires management to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, sales and expenses in our consolidated financial statements. We base our estimates on historical experience and assumptions that we believe are reasonable under the circumstances, the results of which form the basis for our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates under different circumstances or conditions. If actual amounts are ultimately different from these estimates, the revisions are included in our results of operations for the period in which the actual amounts become known.

We believe the following critical accounting policies and estimates affect our more significant judgments and estimates used in preparing our consolidated financial statements.

Revenue recognition

Revenue is recognized on product sales when the earnings process is complete, meaning the risks and rewards of ownership have transferred to the customer (typically upon title transfer), and collectability is reasonably assured. Revenue is recorded, net of discounts, customer incentives, value added tax and similar taxes as applicable in foreign jurisdictions. Rebates and discounts to customers are determined based on the achievement of certain agreed upon terms and conditions by the customer during each period. Shipping and handling costs related to product sales are also included in sales.

Intercompany eliminations and General Company expenses

We present our segment sales and income (loss) from operations on an arm’s-length basis, consistent with how we manage our operations and how our chief operating decision maker reviews our results. Sales and expenses attributable to intercompany transactions are included in the results of our reportable segments. Such amounts are eliminated (under the Eliminations caption) to reconcile our reportable segment amounts to consolidated amounts, as reported in our consolidated statement of operations. In addition to intercompany sales and expenses, we also separately report General Company expenses, which include unallocated expenses that are not directly attributable to business unit performance.

 

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Accounts receivable

We maintain an allowance for doubtful accounts to reflect our estimate of uncollectible accounts receivable. Concentration of credit risk with respect to accounts receivable is within several sectors of the oil and natural gas industry and is dispersed over a large number of customers worldwide. We perform ongoing credit evaluations of customers and set credit limits based upon reviews of customers’ current credit information and payment histories. We monitor customer payments and maintain a provision for estimated uncollectible accounts based on historical experience and specific customer collection issues that we have identified. Estimation of such losses requires adjusting historical loss experience for current economic conditions and judgments about the probable effects of economic conditions on certain customers. The rate of future credit losses may not be similar to past experience.

We record the effect of any necessary adjustments prior to the publication of our consolidated financial statements. We consider all available information when assessing the adequacy of the allowance for doubtful accounts. Adjustments made with respect to the allowance for doubtful accounts often relate to improved information not previously known to us. Uncertainties with respect to the allowance for doubtful accounts are inherent in the preparation of financial statements.

Inventories

We state our inventories at the lower of cost or market (net realizable value). We account for our inventories using the weighted average cost method of accounting. Cost includes all costs incurred in bringing the product to its present location and condition, based on purchase cost on a weighted average cost basis. Inventory is written off for obsolete, slow moving or defective items where appropriate. We regularly review our inventory on hand and update our allowances based on historical and current sales trends. Changes in product demand and our customer base may affect the value of inventory on hand and may require higher inventory allowances. Uncertainties with respect to the inventory valuation are inherent in the preparation of financial statements. For example, during the years ended December 31, 2009 and 2010, we incurred inventory write-downs of $22.5 million and $0.3 million, respectively, related to selling prices falling below inventory cost.

Goodwill and other intangible assets

Goodwill represents the excess of the amount we paid to acquire a company over the estimated fair value of tangible assets and identifiable intangible assets acquired, less liabilities assumed. At December 31, 2009 and 2010, the goodwill and other identifiable intangible assets with indefinite lives balances were $95.0 million and $34.3 million, respectively, representing 16.9% and 7.4% of total assets, respectively.

We account for goodwill under the provisions of Intangibles—Goodwill and Other, ASC Topic 350. Under these rules we test goodwill and other intangible assets with indefinite lives for impairment annually or at any other time when impairment indicators exist. In assessing the recoverability of our goodwill and other indefinite lived intangible assets, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. We estimate future cash flows at the reporting unit level. If these estimates or their related assumptions change in the future, we may be required to record impairment charges not previously recorded for these assets.

In connection with the preparation of our financial information for the second quarter of 2010, we noted that results of operations for the first half of 2010 continued to remain below the original budget assumptions and operating forecasts for some of our reporting units. We began a process to reforecast our budget assumptions and operating forecasts for the remainder of 2010 and the first quarter of 2011. While we have experienced an increase in sales inquiries and new order bookings since March 2010, the current energy market and overall economic conditions have adversely affected our customer’s commitments and time frames for making capital and maintenance expenditures compared to our original assumptions and forecasts. The continued slow global economic recovery in addition to uncertainty surrounding energy demand and commodity pricing resulted in revised budget assumptions and operating forecasts with a slower future earnings recovery than was previously forecasted. We believe that the revised operating forecasts constituted an interim impairment indicator. Accordingly, we performed an interim goodwill impairment analysis at June 30, 2010 using a methodology consistent with our annual impairment test. The methodology uses a combined discounted cash flow valuation and comparable company market value approach to determine the fair value of our reporting units.

This second quarter 2010 interim analysis indicated that our Americas and UAE reporting units failed Step 1 of the impairment test because the book value of each reporting unit exceeded its estimated fair value. We performed Step 2 of the goodwill impairment analysis for these reporting units. The process included among other things a determination of the implied fair value of each reporting unit’s goodwill by assigning the fair value of the reporting unit determined in Step 1 to all of the assets and liabilities of the reporting unit (including any recognized and unrecognized intangible assets) as if the reporting unit had been acquired in a business combination; to complete the process, we then compared the implied fair value of goodwill to the carrying amount of goodwill to determine if goodwill was impaired. The goodwill impairment charge was estimated at $62.8 million consisting of $55.8 million in the Americas reporting unit and $7.0 million in the UAE reporting unit, and was reflected in our statement of operations for the second quarter 2010. The goodwill impairment charge recognized during the second quarter of 2010 was finalized during the third quarter of 2010 and the amount of the impairment did not differ from the initial estimate. The goodwill impairment charge did not impact our liquidity position, debt covenants or cash flows.

 

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At December 31, 2010, our $22.9 million goodwill balance is related to our U.K. and Singapore reporting units which is included within General Company for segment reporting purposes. As of January 1, 2011, we performed our annual goodwill impairment test, which requires comparison of our estimated fair value to our book value including goodwill. The annual goodwill impairment test supported that the fair value of our U.K. and Singapore reporting units exceeded the carrying value by at least 30% and that the goodwill on our consolidated balance sheet at that date was not impaired.

In connection with our January 1, 2011 annual goodwill impairment test, we performed a sensitivity analysis on the projected results for our U.K. and Singapore reporting units. For this analysis, we assumed that revenue attributable to goodwill for each individual reporting unit decreased an additional 20% from our projections while all other factors remained constant, and no impairment was identified. Additionally, we assumed an increase in the relevant discount rate of 100 basis points while all other factors remain constant, and no impairment was identified.

We will continue to monitor all events and circumstances that would potentially affect the fair value of our U.K. and Singapore reporting units. Events or circumstances which could indicate a potential impairment include, but are not limited to: further declines and volatility in oil and natural gas demand and prices, possible regulatory limitations on drilling and production activity, and further deterioration of the ability of our customers to obtain appropriate financing for energy infrastructure projects.

In connection with performing the goodwill impairment analysis as of June 30, 2010 and as of January 1, 2011, tradenames were also tested; the fair value of the tradenames exceeded their carrying value. As a result, no impairment was identified during 2010.

Long-lived assets

We assess the impairment of long-lived assets, including property, plant and equipment and finite-lived other identifiable intangible assets such as customer relationships, when events or changes in circumstances indicate that the carrying value of the assets or the asset group may not be recoverable. The asset impairment review assesses the fair value of the assets based on the future cash flows the assets are expected to generate. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset plus net proceeds expected from the disposition of the asset (if any) are less than the related asset’s carrying amount. Impairment losses are measured as the amount by which the carrying amounts of the assets exceed their fair values. Estimates of future cash flows are judgments based on our experience and knowledge of our operations and the industries in which we operate. We also estimate the useful lives of other finite-lived intangible assets based on estimates of the economic benefit expected to be received from the acquired assets which could differ from actual results. These estimates can be significantly affected by future changes in market conditions, the capital spending decisions of our customers and inflation. For example, a one year reduction in the useful lives of customer relationship intangible assets, our largest long-lived asset which is amortized over approximately seven years, would have reduced operating income and net income by $2.0 million and $1.4 million, respectively, for the year ended December 31, 2010.

In connection with the preparation of financial information in the second quarter 2010 and our conclusion that the revised operating forecasts constitute an interim impairment indicator, we tested our long-lived assets, including customer relationships and noncompetition agreements, for impairment and the fair value of the assets exceeded their carrying amounts. No impairment of these long-lived assets was identified in 2010.

At December 31, 2009 and 2010, our long-lived assets were $88.9 million and $78.6 million, respectively, representing 15.8% and 16.9%, respectively, of total assets.

 

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Equity-based compensation

We have equity-based compensation plans for certain of our executive officers, directors and employees. We account for these plans in accordance with Compensation—Stock Compensation, ASC Topic 718 (“ASC 718”). ASC 718 requires all forms of share-based payments to employees, including options, to be recognized as compensation expense. The compensation expense is measured as the fair value of the award at grant date. No amounts were paid by the holders to obtain the restricted common units we have issued to date. ASC 718 also requires compensation cost to be recognized over the requisite service period for all awards granted subsequent to adoption.

For restricted units granted in July 2010, the $312.26 fair value of a restricted common limited partnership unit was based on a valuation methodology which uses a combined discounted cash flow valuation and comparable company market value approach which is divided by the total outstanding common limited partnership units to determine the fair value of a common limited partnership unit at the grant date.

For unit options granted in July 2010 and December 2010, the fair value of unit options was calculated as $69.26 per unit option using the Black-Scholes pricing model with an exercise price of $1,000 per unit, a risk-free interest rate of 1.87%, an expected volatility of 50.0% and an expected term of 6.5 years.

Because no historical data was available, we calculated the expected term for employee unit options using the simplified method in accordance with the SEC’s Staff Accounting Bulletin No. 110. The risk-free interest rate was based on a traded zero-coupon U.S. Treasury bond with a term substantially equal to the option’s expected term at the grant date. The expected volatility used to value unit options was based on an average of historical volatility of companies in industries in which we operate and for which management believes is comparable.

Income tax expense estimates and policies

As part of the income tax provision process of preparing our consolidated financial statements, we are required to estimate our income taxes. This process involves estimating our current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. We then assess the likelihood that our deferred tax assets will be recovered from future taxable income, and to the extent we believe the recovery is not likely, we establish a valuation allowance. Further, to the extent that we establish a valuation allowance or increase this allowance in a financial accounting period, we include a tax provision, or reduce our tax benefit in our consolidated statement of operations. We use our judgment to determine the provision or benefit for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets.

At December 31, 2010, a valuation allowance of $11.5 million was recorded against deferred tax assets and state net operating loss carryforwards (“NOL’s”) because we believe it is more likely than not that the future benefits will not be realized in subsequent periods. The estimated future U.S. taxable income will limit the ability of the Company to recover the net deferred tax assets and also limit the ability to utilize the state NOL’s during the respective state carryforward periods. Additionally, statutory restrictions in the states in which the Company has incurred a NOL limit the ability to recover the loss via a carryback claim. The state NOL’s are set to expire beginning in 2021 through 2030.

There are various factors that may cause our tax assumptions to change in the near term, and we may have to record a valuation allowance against our remaining or future deferred tax assets. We cannot predict whether future tax laws or regulations, including at the foreign, U.S. federal, state or local level, might be passed that could have a material effect on our results of operations. We assess the impact of significant changes to tax laws and regulations on a regular basis and update the assumptions and estimates used to prepare our financial statements when new legislation and regulations are enacted.

In accordance with the provisions of Income Taxes, ASC Topic 740, (“ASC 740”), we had unrecognized tax benefits of $1.0 million at December 31, 2010. There were no unrecognized tax benefits at December 31, 2009.

Derivative Financial Instruments

We enter into transactions involving various derivative instruments to hedge interest rates and foreign currency denominated sales, purchases, assets and liabilities. These derivative contracts are entered into with financial institutions. We do not use derivative instruments for trading purposes, and we have procedures in place to monitor and control their use.

 

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The Company accounts for certain derivative financial instruments in accordance with Derivatives and Hedging, ASC Topic 815, (“ASC 815”). ASC 815 requires that all derivative instruments be recorded on the consolidated balance sheet at fair value.

Interest rate risk. Prior to the extinguishment of our first and second lien term loans on December 23, 2009, we concluded that the interest rate swaps and collar we entered into qualified as cash flow hedges under the provisions of ASC 815. The swaps and collar were considered substantially effective, with ineffectiveness, if any, charged to the consolidated statements of operations in the period assessed as ineffective. Gains and losses related to the interest rate swaps, net of related tax effects were reported as a component of accumulated other comprehensive income (loss), and upon the repayment of the term loans, the underlying hedge exposure ceased to exist and deferred losses of $7.5 million were recognized as interest expense in the statement of operations for the year ended December 31, 2009. Net settlements occurred quarterly concurrent with interest payments made on the underlying debt. Under the interest rate swap contracts the settlements are the net difference between the fixed rates payable and the floating rates receivable during the quarter. Prior to the extinguishment of the term loans, the settlements were recognized as a component of interest expense in the consolidated statement of operations. Subsequent to the extinguishment of the term loans, the settlements were recognized as a component of other income (expense) in the statement of operations. At December 31, 2010, there were no interest rate derivatives outstanding.

Currency exchange rate risk. We also hedge against foreign currency exchange rate risk, on a case by case basis, using a series of forward contracts to protect against the exchange risk inherent in our transactions denominated in foreign currencies. The majority of the forward contracts are economic hedges, but from time to time we have forward contracts that meet the designation of a cash flow hedge as defined by ASC 815. For transactions designated as foreign currency cash flow hedges, the effective portion of the change in the fair value (arising from the change in the spot rates from period to period) is deferred in “Other comprehensive income (loss)” in the consolidated statement of partners’ capital (deficit) and comprehensive income (loss). These amounts are subsequently recognized in cost of sales in the consolidated statements of operations in the same period when the underlying transaction impacts the consolidated statements of operations. This recognition generally will occur over periods of less than one year. The ineffective portion of the change in fair value (arising from the change in the value of the forward points or a mismatch in terms) is recognized in the period incurred and are recognized in selling, general and administrative expenses in the consolidated statements of operations.

Equity in earnings of unconsolidated entity. On August 19, 2010, EM II LP’s subsidiary, EMC, invested $10.0 million in exchange for 14.5% of the common equity of Bourland & Leverich Holding Company LLC (“B&L”), a distributor of oil country tubular goods. The B&L investment is accounted for using the equity method of accounting in accordance with ASC 323, Investments—Equity Method and Joint Ventures. Equity method investments are included in Investment in Unconsolidated Entity on the consolidated balance sheets. Earnings from this investment are recorded in Equity in earnings of unconsolidated entity in the consolidated statements of operations. At December 31, 2010, the investment in B&L was $10.8 million. Income from the investment in B&L for the year ended December 31, 2010 was $1.0 million for the period from the initial investment on August 19, 2010 through December 31, 2010.

Related person transactions

From time to time, we engage in transactions with our affiliates, including JCP. These transactions include, among others, equity and debt financing transactions. For more information about these transactions see “Item 13. Certain relationships and related transactions, and director independence.”

Results of Operations

Overview

2010 was one of the most difficult operating environments in our history. The unstable financial markets of 2009 continued to create uncertainty around credit availability for our customers and as a result, through much of 2010 capital expenditures continued to be reduced and/or deferred. Also, lower customer operating levels because of reduced demand as a result of the worldwide economic recession curtailed maintenance and repair expenditures. The reduction in demand depressed steel prices; gross profit margins were also negatively affected as competitors slashed prices to reduce inventories and to seek any business opportunities that were available.

 

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The operating conditions noted above adversely affected our 2010 financial results, particularly in the first half of the year; after a slow start our financial results were characterized by improving sales inquiries and new order bookings, but with significant volume fluctuations from month to month. We also experienced a product demand and sales mix shift from our higher margin products, including alloy pipe and pipe components and large diameter high yield carbon pipe generally associated with midstream energy infrastructure projects, to lower margin products, including smaller diameter carbon pipes, particularly in North America. We believe this shift has, to a large extent, been driven by an increase in drilling and production activity related to shale natural gas.

Year ended December 31, 2009 compared to the year ended December 31, 2010

The following table compares sales and income (loss) from operations for the year ended December 31, 2009 and 2010. The period-to-period comparisons of financial results are not necessarily indicative of future results. We define “NM” as not meaningful for increases or decreases greater than 200%.

 

     Year ended December 31,  

(millions, except percentages)

   2009     2010     % Change  

Sales

      

Western Hemisphere

   $ 508.0      $ 397.9        (21.7 )% 

Eastern Hemisphere

      

•  U.K. (Europe/West Africa)

     133.3        129.6        (2.8 )% 

•  Singapore (Asia/Pacific)

     120.7        76.5        (36.6 )% 

•  UAE (Middle East)

     37.0        31.3        (15.4 )% 
                  

Total Eastern Hemisphere

     291.0        237.4        (18.4 )% 

Eliminations

     (25.7     (7.6  
                  

Total

   $ 773.3      $ 627.7        (18.8 )% 
                  

Income (loss) from operations

      

Western Hemisphere

   $ 2.9      $ (56.9     NM   

Eastern Hemisphere

      

•  U.K. (Europe/West Africa)

     19.1        18.0        (5.8 )% 

•  Singapore (Asia/Pacific)

     12.7        5.3        (58.3 )% 

•  UAE (Middle East)

     (6.3     (1.4     77.8
                  

Total Eastern Hemisphere

     25.5        21.9        (14.1 )% 

General Company

     (18.5     (22.4     21.1
                  

Total

   $ 9.9      $ (57.4     NM   
                  

Income (loss) from operations as a % of sales

      

Western Hemisphere

     0.6     (14.3 )%   

Eastern Hemisphere

      

•  U.K. (Europe/West Africa)

     14.3     13.9  

•  Singapore (Asia/Pacific)

     10.5     6.9  

•  UAE (Middle East)

     (17.0 )%      (4.5 )%   

Total Eastern Hemisphere

     8.8     9.2  

Total

     1.3     (9.2 )%   

Sales

For the year ended December 31, 2010, our consolidated sales decreased $145.6 million, or 18.8%, to $627.7 million compared to the year ended December 31, 2009. The decrease in sales reflects the effects of the global economic downturn and the associated spending cuts by our customers in all segments of the energy industry—upstream, midstream and downstream— which impacted our results during the last two quarters of 2009 and throughout 2010. Because of our customers focus on preserving cash during an uncertain economic recovery, both new project expenditures and routine maintenance and repair expenditures were negatively affected. Lower demand also negatively affected selling prices. Sales for the year ended December 31, 2009 also reflect a strong order backlog at December 31, 2008 of approximately $339 million which drove sales volumes, higher gross profits and margins into the first half of 2009. As a result of improving market conditions, sales backlog was approximately $212 million at December 31, 2010 compared to sales backlog of approximately $144 million at December 31, 2009.

 

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For the year ended December 31, 2010, sales in our Western Hemisphere market decreased $110.1 million, or 21.7%, to $397.9 million compared to the year ended December 31, 2009. The decrease in Western Hemisphere sales was primarily the result of lower demand from our customers in the downstream petrochemical market and from the absence of large natural gas transportation projects. Additionally, our sales mix shifted from higher margin products, including alloy pipe and pipe components and large diameter carbon pipe products associated with infrastructure projects, to smaller diameter pipe, valve and fitting products which generally have lower selling prices and margins.

For the year ended December 31, 2010, sales in our Eastern Hemisphere market decreased $53.6 million, or 18.4%, to $237.4 million compared to the year ended December 31, 2009. This decrease is primarily the result of a decline in offshore oil and natural gas structure construction in our Singapore segment. We also experienced a significant drop in selling prices across all of our Eastern Hemisphere segments as market inventories and short mill lead times created a competitive pricing environment.

For the year ended December 31, 2009 and 2010, 77% and 82%, respectively, of our consolidated sales were from oil and natural gas industry customers, and our top ten customers represented 26% and 28%, respectively, of our consolidated sales in each of the periods. No single customer represented more than 10% of consolidated sales for the years ended December 31, 2009 and 2010.

Income (loss) from operations

For the year ended December 31, 2010, our consolidated income from operations decreased $67.3 million to an operating loss of $57.4 million compared to operating income of $9.9 million for the year ended December 31, 2009. The decrease in operating income was primarily the result of a goodwill impairment charge of $62.8 million, before taxes, and to a lesser extent, reduced sales volumes and lower sales prices as described above. Gross margins for the year ended December 31, 2009 were adversely impacted by a sharp decline in product prices which resulted in significant inventory valuation write-downs during the period. Selling, general and administrative expenses for the year ended December 31, 2009 included $3.2 million of initial public offering expenses written off in the period. No similar charge occurred for the year ended December 31, 2010.

For the year ended December 31, 2010, income from operations for our Western Hemisphere market decreased $59.8 million to an operating loss of $56.9 million compared to the year ended December 31, 2009. This decrease in operating income was primarily the result of a goodwill impairment charge of $55.8 million, before taxes, and to a lesser extent, lower sales volume and prices.

For the year ended December 31, 2010, income from operations for our Eastern Hemisphere market decreased $3.6 million, or 14.1%, to $21.9 million compared to the year ended December 31, 2009. This decrease in income from operations was primarily the result of lower selling prices across all Eastern Hemisphere markets, partially offset by improving market conditions in our Middle East segment where sharp declines in inventory prices led to significant valuation write-downs during 2009.

For the year ended December 31, 2010, operating loss for General Company increased $3.9 million, or 21.1%, to $22.4 million compared to the year ended December 31, 2009. For the year ended December 31, 2010, General Company expenses includes a $7.0 million goodwill impairment charge related to the UAE reporting unit; goodwill and other intangibles are allocated to the Eastern Hemisphere reporting units for goodwill impairment testing purposes based on their relative fair values at December 16, 2005, the acquisition date. For the year ended December 31, 2009, General Company expenses include the expensing of accumulated initial public offering costs of $3.2 million. General Company expenses normally consist of amortization expenses related to acquired and identified intangible assets and corporate overhead expenses were consistent for both periods.

 

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Equity in earnings of unconsolidated entity

On August 19, 2010, EM II LP’s subsidiary, EMC, invested $10,000 in exchange for 14.5% of the common equity in B&L. The B&L investment is accounted for using the equity method of accounting in accordance with ASC 323, Investments—Equity Method and Joint Ventures. Income from the B&L investment for the period August 19, 2010 through December 31, 2010 was $1.0 million and is included in equity in earnings of unconsolidated entity on the consolidated statement of operations.

Interest expense, net

Interest expense, net, for the year ended December 31, 2010 increased $17.1 million, or 36.3%, to $64.2 million compared to the year ended December 31, 2009. The overall increase in interest expense, net, for the year ended December 31, 2010 was primarily the result of higher period interest rates on our $465 million 12.25% EMC senior secured notes issued on December 23, 2009 compared to interest rates on the $500 million term loans outstanding during the year ended December 31, 2009.

Income tax expense (benefit)

Income tax benefit was $22.1 million for the year ended December 31, 2010, compared to income tax benefit of $22.4 million for the year ended December 31, 2009. The income tax benefit for the year ended December 31, 2010 reflects the pre-tax loss from operations at the Company’s estimated annual effective tax rate which is the result of operating losses and higher statutory income tax rates in our Western Hemisphere market offset by taxable income and lower statutory income tax rates in our Eastern Hemisphere market. In addition, for the year ended December 31, 2010, the estimated annual effective tax rate and income tax benefit reflect the impact of a goodwill impairment charge of $62.8 million for which $29.9 million was related to non-deductible goodwill and $9.0 million related to recording a valuation allowance against certain deferred tax assets.

At December 31, 2010, a valuation allowance of $11.5 million was recorded against deferred tax assets and state net operating loss carryforwards as we believe it is more likely than not that the future income tax benefits will not be realized in subsequent periods. The estimated future U.S. taxable income will limit the ability of the Company to recover the net deferred tax assets and also limit the ability to utilize the state NOLs during the respective state carryforward periods. Additionally, statutory restrictions in the states in which the Company has incurred a NOL limit the ability to recover the loss via a carryback claim. The state NOLs are set to expire beginning in 2021 through 2030.

Year ended December 31, 2008 compared to the year ended December 31, 2009

The following tables compare sales and income (loss) from operations for the years ended December 31, 2008 and 2009. The period-to-period comparisons of financial results are not necessarily indicative of future results.

 

     Year ended December 31,  

(millions, except percentages)

   2008     2009     % Change  

Sales

      

Western Hemisphere

   $ 859.4      $ 508.0        (40.9 )% 

Eastern Hemisphere

      

•  U.K. (Europe/West Africa)

     167.1        133.3        (20.2 )% 

•  Singapore (Asia/Pacific)

     158.4        120.7        (23.8 )% 

•  UAE (Middle East)

     117.6        37.0        (68.5 )% 
                  

Total Eastern Hemisphere

     443.1        291.0        (34.3 )% 

Eliminations

     (36.9     (25.7  
                  

Total

   $ 1,265.6      $ 773.3        (38.9 )% 
                  

Income (loss) from operations

      

Western Hemisphere

   $ 115.3      $ 2.9        (97.5 )% 

Eastern Hemisphere

      

•  U.K. (Europe/West Africa)

     27.8        19.1        (31.3 )% 

•  Singapore (Asia/Pacific)

     21.8        12.7        (41.7 )% 

•  UAE (Middle East)

     6.9        (6.3     (191.3 )% 
                  

Total Eastern Hemisphere

     56.5        25.5        (54.9 )% 

General Company

     (17.5     (18.5     5.7
                  

Total

   $ 154.3      $ 9.9        (93.6 )% 

Income from operations as a % of sales

      

Western Hemisphere

     13.4     0.6  

Eastern Hemisphere

      

•  U.K. (Europe/West Africa)

     16.6     14.3  

•  Singapore (Asia/Pacific)

     13.8     10.5  

•  UAE (Middle East)

     5.9     (17.0 )%   

Total Eastern Hemisphere

     12.8     8.8  

Total

     12.2     1.3  

 

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Sales

For the year ended December 31, 2009, our consolidated sales decreased 38.9% to $773.3 million from our record sales of $1,265.6 million for the year ended December 31, 2008. The decrease in sales reflects the overall economic slowdown and our customers’ reluctance to commit to capital expenditures because of uncertainties surrounding future oil and natural gas demand and prices. In addition to lower volumes, sales prices were also negatively impacted by excessive market and producer price reductions, particularly on commodity steel and natural gas transmission products.

For the year ended December 31, 2009, sales in our Western Hemisphere market decreased $351.4 million, or 40.9%, to $508.0 million compared to the year ended December 31, 2008. The decrease in Western Hemisphere sales was primarily the result of reduced sales volume and lower selling prices to customers in the upstream oil and natural gas, and natural gas transmission business and, to a lesser extent, a decline in MRO business.

For the year ended December 31, 2009, sales in our Eastern Hemisphere market decreased $152.1 million, or 34.3%, to $291.0 million compared to the year ended December 31, 2008. This decrease is primarily the result of postponements and cancellation of offshore oil and natural gas structure construction, and a severe drop in general construction demand in the Middle East. In addition, total Eastern Hemisphere sales were adversely affected by unfavorable foreign exchange rate movements between the U.S. dollar and the U.K. pound which resulted in a 16% decline in the U.S. dollar value of United Kingdom sales.

For the years ended December 31, 2008 and 2009, 61% and 77%, respectively, of our consolidated sales were from oil and natural gas industry customers and our top ten customers represented 26% of our consolidated sales in each of the respective periods. No single customer represented more than 10% of consolidated sales for the years December 31, 2008 and 2009.

Income (loss) from operations

For the year ended December 31, 2009, our consolidated income from operations decreased $144.4 million, or 93.6%, to $9.9 million compared to the year ended December 31, 2008. The decrease was primarily the result of reduced sales volume and lower gross profit and margins, partially offset by a decrease in selling, general and administrative expenses. During the first half of the year ended December 31, 2009, we sold high cost inventory into a declining price market that significantly reduced our gross margins. Our year ended December 31, 2009 gross profit and margins also include inventory valuation write-downs of approximately $22.5 million; these write-downs occurred primarily in our Western Hemisphere segment in the first nine months of 2009. In the fourth quarter of 2009 we began to see inventory market values stabilize. Additionally, for the year ended December 31, 2009, losses of approximately $12.7 million were incurred due to certain strategic inventory liquidation sales at prices below our cost of certain products. For the year ended December 31, 2009, selling, general and administrative expenses were $20.1 million, or 22.0% lower compared to the year ended December 31, 2008. Included in selling, general and administrative expenses for the year ended December 31, 2009 are $3.3 million of initial public offering expenses. The reduction in selling, general and administrative expense reflects our highly variable cost structure with about 54% of our expenses personnel-related. For the year ended December 31, 2009, we reduced our workforce by approximately 80 employees or 15%. Further, throughout our workforce, employees have a significant portion of compensation tied to profitability. Because of lower profitability levels in 2009, our compensation expense has declined.

 

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For the year ended December 31, 2009, income from operations for our Western Hemisphere market decreased $112.4 million, or 97.5%, to an operating income of $2.9 million compared to the year ended December 31, 2008. This decrease in income from operations was primarily the result of lower sales volume, inventory valuation adjustments and strategic inventory liquidation sales as described above, partially offset by a reduction in selling, general and administrative expenses.

For the year ended December 31, 2009, income from operations for our Eastern Hemisphere market decreased $31.0 million, or 54.9%, to $25.5 million compared to the year ended December 31, 2008. This decrease in income from operations was primarily the result of lower sales volume, particularly in the Middle East market, and, to a lesser extent, lower gross margins. The decrease in gross profit was partially offset by a reduction in selling, general and administrative expenses. For the year ended December 31, 2009, selling, general and administrative expenses in our Eastern Hemisphere segments decreased $9.5 million, or 32.2%, compared to the year ended December 31, 2008.

For the year ended December 31, 2009, operating loss for General Company increased $1.0 million, or 5.7%, to $18.5 million compared to the year ended December 31, 2008. General Company expenses primarily consist of amortization expenses related to MIM Acquisition identified intangible assets. For the year ended December 31, 2009, operating loss for General Company also includes the expensing of accumulated initial public offering costs of $3.3 million.

Other income (expense)

Other income (expense) for the year ended December 31, 2009 of $1.4 million was primarily attributable to unrealized currency exchange gains of $1.0 million on cash balances denominated in foreign currencies. This compares to $0.9 million of other expense for the year ended December 31, 2008.

Loss on prepayment of debt

Loss on prepayment of debt of $7.5 million for the year ended December 31, 2009 was the result of the write-off of deferred financing costs as a result of the repayment of our first and second lien term loans on December 23, 2009.

Interest expense, net

Interest expense, net for the year ended December 31, 2009 increased $2.0 million, or 4.5%, to $47.1 million compared to the year ended December 31, 2008. The increase in interest expense, net was primarily the result of a $7.5 million deferred loss recognized on interest rate derivatives for which the underlying hedge no longer exists as a result of the repayment of our first and second lien term loans on December 23, 2009. The overall increase in interest expense, net was offset by lower period interest rates and reduced borrowings under our ABL Facility.

Income tax expense (benefit)

Income tax benefit was $22.4 million for the year ended December 31, 2009, compared to income tax expense of $35.1 million for the year ended December 31, 2008. The income tax benefit for the year ended December 31, 2009 reflects the pre-tax loss from operations and includes the reversal of prior year tax provisions established with respect to foreign earnings repatriation to the United Kingdom. In 2009, the United Kingdom changed its income tax laws and exempted foreign earnings repatriation from U.K. taxation. The income tax expense for the year ended December 31, 2008 reflects the taxable income generated from operations at an effective tax rate of approximately 32.4%.

 

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Liquidity and capital resources

We finance our operations principally through cash flows generated from operations and from borrowings under our ABL Facility. Our principal liquidity requirements are to meet debt service requirements, finance our capital expenditures and provide adequate working capital. In addition, we may need capital to fund strategic business acquisitions or investments. Our primary source of acquisition funds has historically been the issuance of debt securities, preferred and common equity and cash flows from operations.

Our ability to make payments on and to refinance our indebtedness and to fund planned capital expenditures will depend on our ability to generate cash in the future, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Additionally, provisions of our ABL Facility and the indenture governing the notes, as well as the laws of the jurisdictions in which our companies are organized, restrict or will restrict our ability to pay dividends or make certain other restricted payments.

At December 31, 2009 and 2010, our total indebtedness, including capital leases, was $483.5 million and $479.8 million, respectively. At December 31, 2009 and 2010, there were no borrowings outstanding under our ABL facility and EM FZE local credit facility. During the year ended December 31, 2010 our maximum utilization under the ABL facility was $33.6 million. At December 31, 2010, we had approximately $80.8 million available for borrowings under our ABL Facility, net of reserves, and net of $22.1 million of outstanding letters of credit and guarantees. However, our borrowing availability at December 31, 2010 or any other point in time may not reflect our borrowing availability at any subsequent point in time because borrowing availability depends, in part, on inventory and accounts receivable values that fluctuate and is subject to discretionary reserves and revaluation adjustments imposed by the administrative agent and other limitations. In addition, during periods of low borrowing availability when our ABL fixed charge coverage ratio applies, our ability to utilize our full borrowing availability is limited by the requirement to maintain the ABL fixed charge coverage ratio at or above 1.25 to 1.00 because any additional borrowings would increase cash interest expense and, all else being equal, decrease our ABL fixed charge coverage ratio. See “Item 7. Management’s discussion and analysis of financial condition and results of operations – Debt”. At December 31, 2010, our ABL fixed charge coverage ratio was below 1.25 to 1.00. At December 31, 2010, there was approximately $11.1 available for borrowing under our EM FZE local credit facility, net of $0.9 million of outstanding letters of credit and guarantees. At December 31, 2009 and 2010, cash and cash equivalents was $65.7 million and $62.5 million, respectively.

As of December 31, 2010, we believe our cash flows from operations, available cash and available borrowings under our ABL Facility will be adequate to meet our liquidity needs for at least the next twelve months. We cannot assure you, however, that if our business declines we would be able to generate sufficient cash flows from operations or that future borrowings will be available to us under our ABL Facility in an amount sufficient to enable us to service our indebtedness or to fund our other liquidity needs. If we are unable to generate sufficient cash flow from operations in the future to service our indebtedness and to meet our other commitments and liquidity needs, we will be required to adopt one or more alternatives, such as refinancing or restructuring our indebtedness, selling material assets or operations or raising additional debt or equity capital. We cannot assure you that any of these actions could be affected on a timely basis or on satisfactory terms, if at all, or that these actions would enable us to continue to satisfy our capital requirements. In addition, our existing or future debt agreements, including the ABL Facility and the indenture governing the notes, may contain provisions prohibiting us from adopting any of these alternatives. Our failure to comply with these provisions could result in an event of default which, if not cured or waived, could result in the acceleration of all of our debt.

Statement of cash flow data

 

     Year ended December 31,  

(dollars in millions)

   2008     2009     2010  

Cash flows provided by (used in) activities:

      

Operating

   $ 53.8      $ 91.9      $ 30.2   

Investing

     (12.3     (8.0     (26.8

Financing

     (42.4     (59.9     (5.6

 

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Year ended December 31, 2009 compared to year ended December 31, 2010

Operating activities. Net cash inflows from operating activities were $30.2 million for the year ended December 31, 2010 compared to net cash inflows of $91.9 million for the year ended December 31, 2009. The decrease in cash flows from operations was primarily the result of an increase in net loss partially offset by non-cash operating expenses and reduced working capital requirements. The $62.8 million goodwill impairment charge recorded in the second quarter of 2010 did not impact our liquidity position, debt covenants or cash flows.

Investing activities. Net cash outflows from investing activities were $26.8 million for the year ended December 31, 2010 compared to net cash outflows of $8.0 million for the year ended December 31, 2009. Cash outflows from investing activities of $26.8 million for the year ended December 31, 2010 includes the $10.0 million investment in B&L, $14.0 million of capital primarily related to the expansion of our Singapore and Middle East warehouse facilities, and a $4.0 million earn-out payment made to the former owners of PetroSteel International L.P. and PetroSteel International LLC (“PetroSteel”) as required by the purchase agreement. Cash outflows of $8.0 million for the year ended December 31, 2009 include a $4.0 million earn-out payment to the former owners of PetroSteel and $2.0 million of capital expenditures for routine improvement of warehouse facilities and machinery and equipment.

Financing activities. Net cash outflows from financing activities were $5.6 million during the year ended December 31, 2010 compared to net cash outflows of $59.9 million for the year ended December 31, 2009. Cash outflows from financing activities of $5.6 million for the year ended December 31, 2010 include payments associated with capital leases and with a $4.0 million note payable to the former owners of PetroSteel. Cash outflows from financing activities of $59.9 million for the year ended December 31, 2009 include $498.2 million of payments associated with the ABL Facility and the term loans, $9.0 million of repayments of managed cash overdrafts and short-term loans, $13.3 million of deferred financing costs, and $460.6 million of proceeds from the issuance of the notes.

Year ended December 31, 2008 compared to year ended December 31, 2009

Operating activities. Net cash inflows from operating activities were $91.9 million for the year ended December 31, 2009 compared to net cash inflows of $53.8 million for the year ended December 31, 2008. The increase in cash flows from operations was primarily the result of a decrease in net cash required for working capital, partially offset by lower net income. Historically, lower sales results in cash collection in the short term as our working capital requirements shrink.

Investing activities. Net cash outflows from investing activities were $8.0 million for the year ended December 31, 2009 compared to net cash outflows of $12.3 million for the year December 31, 2008. Cash outflows from investing activities of $8.0 million for the year ended December 31, 2009 include a $4.0 million earn-out payment to the former owners of PetroSteel and $2.0 million of capital expenditures for routine improvement of warehouse facilities and machinery and equipment. Cash outflows of $12.3 million for the year ended December 31, 2008 include capital expenditures of $8.4 million and a $4.0 million earn-out payment to the former owners of PetroSteel.

Financing activities. Net cash outflows from financing activities were $59.9 million during the year ended December 31, 2009 compared to net cash outflows of $42.4 million for the year ended December 31, 2008. Cash outflows from financing activities of $59.9 million for the year ended December 31, 2009 include $498.2 million of payments associated with the ABL Facility and the term loans, $9.0 million repayments of managed cash overdrafts and short-term loans, $13.3 million of transaction costs, and $460.8 million of proceeds from the issuance of the notes. Cash outflows from financing activities for the year ended December 31, 2008 include net principal payments associated with the ABL Facility, the first and second lien term loans, and to a lesser extent, managed cash overdrafts and short-term loans.

Debt

ABL Facility. On May 11, 2007, we entered into the ABL Facility with JPMorgan Chase Bank, N.A. and the other financial institutions party thereto. The ABL Facility is a $175.0 million global credit facility, of which:

 

   

EMC may utilize up to $165.0 million ($25.0 million of which can only be used for letters of credit) less any amounts utilized under the sub-limits of EM Canada and EM Europe;

 

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EM Europe may utilize up to $50.0 million;

 

   

EM Canada may utilize up to $7.5 million; and

 

   

EM Singapore may utilize up to $10.0 million.

Actual borrowing availability for each subsidiary fluctuates from time to time because it is subject to a borrowing base limitation that is calculated based on a percentage of eligible trade accounts receivable and inventories and is subject to discretionary reserves and revaluation adjustments imposed by the administrative agent and other limitations. As a result, our borrowing availability at any one point in time may not reflect our borrowing availability at any subsequent point in time. Subject to sublimits, the subsidiaries may utilize the ABL Facility for borrowings as well as for the issuance of bank guarantees and letters of credit as defined by the ABL Facility.

Revolving borrowings under our ABL Facility bear interest at variable rates of Alternate Base Rate, Adjusted LIBOR, Banker’s Acceptance Rate, U.K. Base Rate, Canadian Prime Rate, or Singapore Base Rate, in each case plus a percentage spread that varies from 0.50% to 2.50% based on the type of borrowing and our average borrowing availability.

The ABL Facility is guaranteed by EM II LP. Additionally, each of the EM Canada sub-facility, the EM Europe sub-facility and the EM Singapore sub-facility is guaranteed by EM Cayman, EMGH, Pipe Acquisition Ltd, EM Europe, EM Canada and EM Singapore. The ABL Facility is secured by a first priority security interest in all of the working capital assets, including trade accounts receivable and inventories, of the borrowers and of the guarantors under the ABL Facility.

Pursuant to the terms of an intercreditor agreement, the security interest in the working capital collateral that secures the notes and related guarantees described below is contractually subordinated to the liens securing the ABL Facility and related guarantees.

As of December 31, 2009, there was no outstanding balance for cash borrowings under the ABL Facility. Outstanding letters of credit totaled $19.7 million, which consisted of letters of credit outstanding for EMC, EM Europe and EM Singapore of $12.9 million, $1.6 million and $5.2 million, respectively. EMC’s outstanding letter of credit balance includes a letter of credit issued in the amount of $5.0 million that supports the local credit facility of EM FZE.

As of December 31, 2010, there was no outstanding balance for cash borrowings under the ABL Facility. Outstanding letters of credit totaled $22.1 million, which consisted of letters of credit outstanding for EMC, EM Europe and EM Singapore of $18.5 million, $0.5 million, and $3.1 million, respectively. EMC’s outstanding letter of credit balance includes a $12.0 million letter of credit issued to support the local credit facility of EM FZE. Total remaining borrowing availability, net of reserves, under the ABL Facility at December 31, 2010 and 2009 was $80.8 million and $93.9 million, respectively, based on the value of our borrowing base at that date.

The ABL Facility contains a minimum fixed charge coverage ratio covenant of not less than 1.25 to 1.00 that applies if our aggregate borrowing availability is reduced below $25.0 million, or the sum of EMC and EM Canada availability is less than $15.0 million until the date that both aggregate availability is greater than $30.0 million and the sum of EMC and EM Canada availability is greater than $20.0 million for a consecutive ninety day period, and no default or event of default exists or has existed during the period. The ABL fixed charge coverage ratio is a ratio of our earnings before interest, depreciation and amortization, and income taxes, subject to certain adjustments and minus capital expenditures and cash taxes, to the sum of our cash interest expense, scheduled principal payments, cash management fees, dividends and distributions and cash earnout or similar payments, all as more specifically defined in our ABL Facility. It is calculated as of the end of each of our fiscal quarters for the period of the previous four fiscal quarters. As of the years ended December 31, 2009 and 2010, our ABL Facility fixed charge coverage ratio was below 1.25 to 1.00. Although the ABL Facility fixed charge coverage ratio covenant was not applicable because our aggregate borrowing availability was above the applicable thresholds, there can be no assurance that our borrowing availability will not fall below one of the applicable thresholds in the future. Our borrowing availability could decline if the value of our borrowing base (which is calculated based on a percentage of our eligible inventory and accounts receivable) declines, the administrative agent imposes reserves in its discretion, our borrowings under the ABL Facility increase or for other reasons. In addition, the agents under the ABL Facility are entitled to conduct borrowing base field audits and inventory appraisals periodically, which may result in a lower borrowing base valuation. Our failure to comply with the ABL minimum fixed charge coverage ratio at a time when it is applicable would be an event of default under the ABL Facility, which could result in a default under and acceleration of our other indebtedness.

 

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We believe that the inclusion of the ABL fixed charge coverage ratio calculation provides useful information to investors about our compliance with the minimum fixed charge coverage ratio covenant in our ABL Facility. The ABL fixed charge coverage ratio is not intended to represent a ratio of our fixed charges to cash provided by operating activities as defined by generally accepted accounting principles and should not be used as an alternative to cash flow as a measure of liquidity. Because not all companies use identical calculations, this fixed charge coverage ratio presentation may not be comparable to other similarly titled measures of other companies.

The ABL Facility also contains other affirmative and negative covenants, including, among others, limitations on:

 

   

the incurrence of additional indebtedness and liens;

 

   

the payment of dividends and distributions;

 

   

the making of investments, loans and advances;

 

   

transactions with affiliates; and

 

   

mergers and the sale of assets.

Under the ABL Facility, our first-tier operating companies, EMC and EM Europe, may pay dividends and make distributions to EM II LP, directly or indirectly, to the extent EM II LP uses such dividends or distributions to (1) repurchase its equity interests from present and former directors, officers and employees (subject to a $2.0 million cap), (2) pay management fees to JCP and (3) pay its corporate overhead and operating expenses. EMC and EM Europe may also pay dividends and make distributions to EM II LP, directly or indirectly, so long as no default has occurred which is continuing and the availability of EMC and the availability of EM Europe, respectively, is not less than $15.0 million. EM II LP may pay dividends from the amounts received from its subsidiaries so long as no default has occurred which is continuing and aggregate availability is at least $40.0 million.

The ABL Facility permits us to allocate cash flow and resources freely among (1) the parent entities of EMC and EM Europe, (2) EMC and its U.S. subsidiaries, (3) the Canadian loan parties, (4) the U.K. loan parties, (5) the Singapore loan parties, (6) the UAE loan parties and (7) subject to various availability thresholds and caps, among all loan parties and otherwise by any loan party in or to any other person.

Events of default under the ABL Facility include, but are not limited to, a default in the payment of any principal, interest or fees due under the ABL Facility; a breach of representations, warranties or covenants; a default or acceleration in the payment of any material indebtedness; events of bankruptcy, insolvency or the like; becoming subject to certain judgments or pension liabilities; a change in control; and the invalidity of the related guarantees, security interests or agreements. If an event of default shall occur and be continuing under the ABL Facility, either the administrative agent or the requisite lenders may accelerate the maturity of the ABL Facility and/or terminate the lending commitments thereunder. The covenants, events of default and acceleration rights described above are subject to important exceptions and qualifications, which are described in the ABL Facility.

EM FZE Local Facility. EM FZE has a credit facility with local lenders in Dubai under which it has the ability to borrow up to the lesser of $15.0 million or the amount it has secured by a letter of credit. At December 31, 2010 and 2009, respectively, EM FZE had the ability to borrow up to $12.0 million and $5.0 million because the facility was secured by a letter of credit in the amount of $12.0 million and $5.0 million issued under our ABL Facility. At December 31, 2010, borrowings on the local facility bear interest at the prevailing London Interbank Offered Rate plus a margin of 2.0%. EM FZE may utilize the local facility for borrowings, foreign exchange, letters of credit, bank guarantees and other permitted indebtedness. This facility is primarily used to support the trade activity of EM FZE. At December 31, 2010 and 2009, there was approximately $0.9 million and $0.7 million, respectively, in letters of credit and bank guarantees issued under the local credit facility. Availability under the local credit facility was $11.1 million and $4.3 million at December 31, 2010 and 2009, respectively. As of December 31, 2009 and 2010, there were no cash borrowings under the local facility.

Note Payable to Sellers of PetroSteel. In connection with the PetroSteel acquisition, EMC issued a three-year, $4.0 million subordinated note to the sellers of PetroSteel, with principal and interest due May 2010. The note accrues interest at a rate of 8% per annum compounded annually. In May 2010, the note payable to the sellers of PetroSteel, including accrued interest of $1.0 million was paid in full.

 

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Senior Secured Notes. We have outstanding $465.0 million aggregate principal amount of 12.25% Secured Senior Notes due 2015 that were issued by EMC on December 23, 2009 (the “notes”). Total cash interest payments required under the notes is approximately $57.0 million on an annual basis. The indenture governing the notes contains various covenants that limit our discretion in the operation of our business. It, among other things, limits our ability and the ability of our subsidiaries to incur additional indebtedness, issue shares of preferred stock, incur liens and enter into certain transactions with affiliates. It also places restrictions on our ability to pay dividends or make certain other restricted payments.

EM II LP and each of its future U.S. subsidiaries that (1) is directly or indirectly 80% owned by EM II LP, (2) guarantees the indebtedness of EMC or any of the guarantors and (3) is not directly or indirectly owned by any non-U.S. subsidiary fully and unconditionally guarantee the notes on a joint and several basis. The notes and the note guarantees are secured by first-priority liens, subject to permitted liens, in the issuer’s and the guarantors’ principal U.S. assets (other than cash and cash equivalents, inventory, accounts receivable, deposit and securities accounts, other personal property relating to such inventory, accounts receivable, deposit and securities accounts and all proceeds therefrom pledged by the issuer and the guarantors, in each case now owned or hereafter acquired, all of which constitute collateral for our ABL Facility on a first-priority basis, and other than excluded assets), including material real property, fixtures and equipment, intellectual property and capital stock of EM II LP’s restricted subsidiaries (which, in the case of non-U.S. subsidiaries, is limited to 65% of the voting stock of each first-tier non-U.S. subsidiary). The notes and guarantees are also secured by second-priority liens, subject to permitted liens, in the issuer’s and the guarantors’ assets securing the ABL Facility on a first-priority basis (other than excluded assets).

All of the subsidiaries that constitute the reportable segments of our Eastern Hemisphere market, and one of the subsidiaries that constitutes our Western Hemisphere reportable segment (EM Canada), are non-U.S. subsidiaries and, therefore, do not guarantee the notes. The notes and the guarantees are structurally subordinated to all existing and future indebtedness, including under our ABL Facility and the guarantees thereof and trade payables, of our non-guarantor subsidiaries. EM II LP and each of its future U.S. subsidiaries that (1) is directly or indirectly 80% owned by EM II LP, (2) guarantees the indebtedness of the issuer or any of the guarantors and (3) is not directly or indirectly owned by any non-U.S. subsidiary, will fully and unconditionally guarantee the notes on a joint and several basis. Currently, there are no subsidiary guarantors.

Newbridge, Scotland facility lease. In connection with the Company’s acquisition of Murray International Metals Ltd. on December 16, 2005, EM Europe sold land, an office building and two warehouses at its Newbridge location for $23.0 million, less fees of approximately $0.3 million. Concurrent with the sale, EM Europe entered into an agreement to lease back all of the sold property for an initial lease term of 25 years. Under the lease agreement, the initial term will be extended for two further terms of ten years each unless cancelled by EM Europe. The lease is being accounted for as a capital lease because the net present value of the future minimum lease payments exceed 90% of the fair value of the leased asset. The lease requires an annual rental payment which is subject to adjustment based on the U.K. consumer price index on the fifth anniversary of the inception of the lease and every two years thereafter, and payment of customary operating and repair expenses. Pipe Acquisition Limited entered into a guarantee in respect of the obligations of EM Europe under the lease.

In December 2010, the annual rental payments were increased to £1.4 million, or $2.1 million (at December 31, 2010 exchange rates) based on the U.K. consumer price index. Annual rental payments were £1.2 million, or $1.9 million at December 31, 2009. As a result, the capitalized lease asset and related capital lease liability were increased by £1.0 million, or $1.6 million (at December 31, 2010 exchange rates).

Recent accounting pronouncements

New accounting standards—From time to time, new accounting pronouncements are issued by the FASB which are adopted by us as of the specified effective date.

Revenue Recognition, ASC Topic 605: Multiple Deliverable Revenue Arrangements – A Consensus of the FASB Emerging Issues Task Force. In October 2009, the FASB issued guidance on whether multiple deliverables exist, how the deliverables should be separated and how the consideration should be allocated to one or more units of accounting. This update establishes a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific objective evidence, if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific or third-party evidence is available. We will be required to apply this guidance prospectively for revenue arrangements entered into or materially modified after January 1, 2011; however, earlier application is permitted. We do not expect the adoption of this new guidance to have a material impact on our financial position or results of operations.

 

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In December 2010, the FASB issued Business Combinations, ASU Topic 805: Disclosure of Supplementary Pro Forma Information forBusiness Combinations—A consensus of the FASB Emerging Issues Task Force. This update provides clarification requiring public companies that have completed material acquisitions to disclose the revenue and earnings of the combined business as if the acquisition took place at the beginning of the comparable prior annual reporting period, and also expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. We will be required to apply this guidance prospectively for business combinations for which the acquisition date is on or after January 1, 2011. We do not expect the adoption of this new guidance to have a material impact on our financial position or results of operations.

Off-balance sheet arrangements

In the normal course of business, we are a party to certain off-balance sheet arrangements. These arrangements include guarantees and financial instruments with off-balance sheet risk, such as bank letters of credit. No liabilities related to these arrangements are reflected in our consolidated balance sheet, and we do not expect any material adverse effects on our financial condition, results of operations or cash flows to result from these off-balance sheet arrangements.

As of December 31, 2010 and 2009, we had $23.0 million and $20.4 million of letters of credit outstanding, respectively. As of December 31, 2010 and 2009, we had issued payment guarantees with a maximum aggregate potential obligation for future payments (undiscounted) of $16.9 million and $39.8 million, respectively, to third parties to secure payment performance by certain Edgen Murray entities. The outstanding aggregate value of guaranteed commitments at December 31, 2010 and 2009, were $14.9 million and $31.0 million, respectively, for which no commitment extended beyond one year.

Commitments and contractual obligations

Our contractual obligations and commitments principally include obligations associated with our outstanding indebtedness and future minimum operating lease obligations as set forth in the following tables as of December 31, 2010. The information presented in the table below reflects management’s estimates of the contractual maturities of our obligations. These maturities may differ significantly from the actual maturities of these obligations.

 

     Payments due by period ending December 31,  

(dollars in millions)

   2011      2012
and 2013
     2014
and 2015
     2016
and
thereafter
     Total  

Contractual obligations—

              

Senior secured notes(1)

   $ 56.7       $ 113.9       $ 550.4       $ —         $ 721.0   

Capital lease(2)

     2.1         4.3         4.3         31.8         42.5   

Operating lease obligations

     3.3         5.0         2.0         0.1         10.4   

Derivative instruments—

              

Foreign currency exchange contracts(3)

     27.7         —           —           —           27.7   

Purchase commitments(4)

     197.5         —           —           —           197.5   
                                            

Total

   $ 287.3       $ 123.2       $ 556.7       $ 31.9       $ 999.1   
                                            
(1) Includes $465.0 million of aggregate principal amount of senior secured notes. This also includes current interest payment obligations on the notes of $57.0 million per annum. The notes were issued at a price of 99.059% of their face value, resulting in approximately $460.6 million of gross proceeds. The discount of approximately $4.4 million will be amortized and included in interest expense until the notes mature.

 

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(2) Includes interest obligations of 9.84%, the implicit interest rate, under our Newbridge, Scotland facility capital lease at 9.84%, the implicit interest rate. In December 2010, the annual rental payments were increased by $0.3 million based on the U.K. consumer index and are subject to further adjustment every two years until the lease term expires.
(3) Represents the notional value of foreign currency contracts to purchase and sell foreign currencies at specified forward rates in connection with our foreign currency hedging policy.
(4) Includes purchase commitments for stock inventory and inventory for existing orders from our customers. We enter into purchase commitments on as-needed basis, typically daily, but these commitments generally do not extend beyond one year.

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

In the normal course of operations, we are exposed to market risks arising from adverse changes in interest rates and foreign exchange rates. Market risk is defined for these purposes as the potential change in the fair value of financial assets or liabilities resulting from an adverse movement in interest rates or foreign exchange rates.

Management is responsible for raising financing for operations, together with associated liquidity management, and the management of foreign exchange and interest rate risk. Our treasury operations are conducted under the oversight of management, who receive regular updates of treasury activity. Financial instruments are entered into for risk management purposes only. Our policy on foreign exchange rate hedging requires that only known, firm commitments are hedged and that no trading in financial instruments is undertaken.

Our principal risks are exposures to changes in interest rates and currency exchange rates. These risks are closely monitored and evaluated by management. Following evaluation of those positions, we selectively enter into derivative financial instruments to manage exposures related to currency exchange rate changes and changes in interest rates.

Interest rate risk

We are exposed to interest rate risk related to changes in interest rates on our variable rate debt. At December 31, 2009 and 2010, our variable rate debt consisted of our ABL Facility and our EM FZE local credit facility, and there were no cash borrowings outstanding.

Prior to the issuance of the notes on December 23, 2009, to mitigate the interest rate risk related to a portion of our variable rate debt on our first and second lien term loans, we entered into three interest rate swap agreements which terminated on August 13, 2009. Under these agreements, we paid fixed interest rates for varying periods and received floating interest rate payments. These interest rate swaps were based on the 3-month LIBOR. The interest rate swaps had notional values of $175.0 million, $100.0 million and $75.0 million with fixed interest rates of 5.15%, 4.88% and 5.19%, respectively.

At December 31, 2010, there were no interest rate derivatives outstanding.

Interest rate sensitivity

The table below provides information about our derivative financial instruments and other financial instruments that are sensitive to changes in interest rates, including interest rate swaps and debt obligations. For debt obligations, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. For interest rate swaps, the table presents notional amounts and weighted average interest rates by expected (contractual) maturity dates. Notional amounts are used to calculate the contractual payments to be exchanged under the contract. Weighted average variable rates are based on implied forward rates in the yield curve at the reporting date. The information is presented in U.S. dollar equivalents, which is our reporting currency. The instrument’s actual cash flows are denominated in U.S. dollars.

 

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(dollars in thousands,

except percentages)

   Expected maturity date  
   2011      2012      2013      2014      2015      Thereafter      Total      Fair value  

Long term debt

                       

Fixed rate

   $        —         $        —         $        —         $        —         $ 465,000       $        —         $ 465,000       $ 406,875   

Average interest rate

     —           —           —           —           12.25         —           —           —     

Variable Rate

   $ —         $ —         $ —         $ —         $ —         $ —         $ —         $ —     

Average interest rate

     —           —           —           —           —           —           —           —     

Foreign Currency Exchange Rate Risk

Foreign currency risk

We assess currency exchange exposure on certain monetary assets and liabilities and enter into derivative financial instruments as we believe is necessary to manage this risk. During the normal course of business, we are exposed to foreign currency risk. This risk can create volatility in earnings and cash flows from year to year.

In our business, we may enter into purchase and sales commitments that are denominated in a foreign currency. Our practices include entering into foreign currency forward exchange contracts to minimize foreign currency exposure related to forecasted purchases and sales of certain inventories. We use derivative financial instruments to reduce exposure to foreign currency movements on foreign currency purchases and sales. We do not use derivative financial instruments for speculative purposes.

The fair value of these foreign currency forward derivative contracts was a liability of $0.2 million and an asset of $0.2 million at December 31, 2009 and 2010, respectively. At December 31, 2009 and 2010, the total notional amount of outstanding currency exchange contracts was $10.1 million and $27.7 million, respectively.

Exchange rate sensitivity

The table below provides information about our derivative financial instruments, other financial instruments, and firmly committed sales and purchase transactions by functional currency and presents such information in U.S. dollar equivalents. The table summarizes information on instruments and transactions that are sensitive to foreign currency exchange rates, including foreign currency forward exchange agreements, and firmly committed U.S. dollars, U.K. pounds, UAE dirhams, Euro, Singapore dollars and Australian dollars sales and purchase transactions. For firmly committed sales and purchase transactions, sales and purchase amounts are presented by the expected transaction date, which are not expected to exceed one year. For foreign currency forward exchange agreements, the table presents the notional amounts and weighted average exchange rates by expected contractual maturity dates. These notional amounts generally are used to calculate the contractual payments to be exchanged under the contract.

 

     Expected maturity date               

December 31, 2010 (in dollars, except

exchange rates)

   2011     2012      2013      2014      2015      Thereafter      Total     Fair value  

On balance sheet financial instruments

                     

U.S. dollars functional currency—PTE

                     

Asset

     15,189        —           —           —           —           —           15,189        15,189   

Liability

     (14,529     —           —           —           —           —           (14,529     (14,529

U.S. dollars functional currency—Western Hemisphere

                     

Asset

     —          —           —           —           —           —           —          —     

Liability

     (88,367     —           —           —           —           —           (88,367     (88,367

U.K. pounds functional currency

                     

Asset

     275,839        —           —           —           —           —           275,839        275,839   

Liability

     (104,637     —           —           —           —           —           (104,637     (104,637

U.S. dollars functional currency—UAE

                     

Asset

     92,464        —           —           —           —           —           92,464        92,464   

Liability

     —          —           —           —           —           —           —          —     

Anticipated transactions and related derivatives

                     

U.S. dollars functional currency

                     

Firmly committed transactions:

                     

Sales

     319,032        —           —           —           —           —           319,032        —     

Purchase orders

     (10,950,648     —           —           —           —           —           (10,950,648     —     

Forward exchange agreements:

                     

(Receive $/Pay Euro)—by currency

     (240,307     —           —           —           —           —           (240,307     —     

Contract amount ($)

     319,032        —           —           —           —           —           319,032        (387

Average contractual exchange rate

     1.33        —           —           —           —           —           1.33        —     

Pay $/Receive Euro—by currency

     8,123,854        —           —           —           —           —           8,123,854        —     

Contract Amount ($)

     (10,835,026     —           —           —           —           —           (10,835,026     4,710   

Average contractual exchange rate

     1.33        —           —           —           —           —           1.33        —     

(Pay $/receive S$)—by currency

     149,244        —           —           —           —           —           149,244        —     

Contract amount ($)

     (115,622     —           —           —           —           —           (115,622     434   

Average contractual exchange rate

     1.29        —           —           —           —           —           1.29        —     

 

 

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December 31, 2010 (in dollars,

except exchange rates)

   Expected maturity date               
     2011     2012      2013      2014      2015      Thereafter      Total     Fair value  

On balance sheet financial instruments

                     

U.K. pounds functional currency

                     

Firmly committed transactions:

                     

Sales

     3,475,958        —           —           —           —           —           3,475,958        —     

Purchase orders

     (7,149,710     —           —           —           —           —           (7,149,710     —     

Forward exchange agreements:

                     

(Receive £/pay Euro)—by currency

     (1,602,013     —           —           —           —           —           (1,602,013     —     

Contract amount (£)

     1,364,437        —           —           —           —           —           1,364,437        (25,311

Average contractual exchange rate

     1.17        —           —           —           —           —           1.17        —     

(Pay £/receive Euro)—by currency

     5,678,195        —           —           —           —           —           5,678,195        —     

Contract amount (£)

     (4,862,039     —           —           —           —           —           (4,862,039     48,548   

Average contractual exchange rate

     1.17        —           —           —           —           —           1.17        —     

(Receive £/pay $)—by currency

     (3,211,769     —           —           —           —           —           (3,211,769     —     

Contract amount (£)

     2,111,521        —           —           —           —           —           2,111,521        64,761   

Average contractual exchange rate

     1.52        —           —           —           —           —           1.52        —     

(Receive $/pay £)—by currency

     3,633,282        —           —           —           —           —           3,633,282        —     

Contract amount (£)

     (2,287,671     —           —           —           —           —           (2,287,671     83,295   

Average contractual exchange rate

     1.59        —           —           —           —           —           1.59        —     

As of and for the year ended December 31, 2009 and 2010, approximately 16% and 20% of our sales, respectively, and 16% and 21% of our total assets, respectively, were denominated in U.K. pounds, our functional currency in the United Kingdom. As a result, a material decrease in the value of the U.K. pound relative to the U.S. dollar may negatively impact our sales, cash flows and net income.

Credit risk

We believe our credit risk on short-term loans and derivative financial instruments is limited because the counterparties are generally banks with high credit ratings assigned by international credit-rating agencies. We have no significant concentration of credit risk with a specific counterparty because exposure is spread over a number of counterparties.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Edgen Murray II, L.P.—Audited Consolidated Financial Statements

 

Report of Independent Registered Public Accounting Firm

   51

Consolidated Balance Sheets at December 31, 2010 and 2009

   52

Consolidated Statements of Operations for the years ended December 31, 2010, 2009 and 2008

   54

Consolidated Statements of Partner’s (Deficit) Capital and Comprehensive Income (Loss) for the years ended December 31, 2010, 2009 and 2008

   55

Consolidated Statements of Cash Flows for the years ended December 31, 2010, 2009 and 2008

   57

Notes to Consolidated Financial Statements

   59

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Partners of Edgen Murrary II, L.P.

Baton Rouge, Louisiana

We have audited the accompanying consolidated balance sheets of Edgen Murrary II, L.P. and subsidiaries (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of operations, partners’ (deficit) capital and comprehensive income (loss) and cash flows for each of the three years in the period ended December 31, 2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Edgen Murray II, L.P. and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.

/s/ Deloitte & Touche LLP

New Orleans, Louisiana

March 24, 2011

 

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Edgen Murray II, L.P. and subsidiaries

Consolidated balance sheets

At December 31, 2010 and 2009

(In thousands)

 

      2010      2009  

ASSETS

     

CURRENT ASSETS:

     

Cash and cash equivalents

   $ 62,478       $ 65,733   

Accounts receivable—net of allowance for doubtful accounts of $1,725 and $2,628, respectively

     104,831         108,006   

Inventory

     128,482         155,555   

Income tax receivable

     19,595         21,840   

Prepaid expenses and other current assets

     6,039         10,189   

Deferred tax asset—net

     35         2,833   

Asset held for sale

     5,224         —     
                 

Total current assets

     326,684         364,156   
                 

PROPERTY, PLANT, AND EQUIPMENT—Net

     49,287         43,342   

GOODWILL

     22,912         83,280   

OTHER INTANGIBLE ASSETS

     40,766         57,286   

OTHER ASSETS

     812         190   

DEFERRED TAX ASSET—Net

     38         20   

DEFERRED FINANCING COSTS

     12,678         15,186   

INVESTMENT IN UNCONSOLIDATED ENTITY

     10,843         —     
                 

TOTAL

   $ 464,020       $ 563,460   
                 

(Continued)

 

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Edgen Murray II, L.P. and subsidiaries

Consolidated balance sheets

At December 31, 2010 and 2009

(In thousands)

 

     2010     2009  

LIABILITIES AND PARTNERS’ DEFICIT

    

CURRENT LIABILITIES:

    

Managed cash overdrafts and short-term loans

   $ 2      $ 2   

Accounts payable

     68, 812        64,332   

Accrued expenses and other current liabilities

     10,140        20,875   

Income tax payable

     2,046        2,275   

Deferred revenue

     2,304        6,091   

Accrued interest payable

     26,340        2,617   

Deferred tax liability—net

     38        —     

Current portion of capital lease

     318        303   

Current portion of long-term debt

     —          4,916   
                

Total current liabilities

     110,000        101,411   
                

DEFERRED TAX LIABILITY—Net

     5,470        13,045   

OTHER LONG-TERM LIABILITIES

     319        499   

CAPITAL LEASE

     18,201        17,646   

LONG-TERM DEBT

     461,292        460,638   
                

Total liabilities

     595,282        593,239   
                

COMMITMENTS AND CONTINGENCIES

    

PARTNERS’ DEFICIT:

    

General partner

     1        1   

Limited partners

     (131,305     (29,780

Non-controlling interest

     42        —     
                

Total partners’ deficit

     (131,262     (29,779
                

TOTAL

   $ 464,020      $ 563,460   
                

(Concluded) See notes to consolidated financial statements.

 

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Edgen Murray II, L.P. and subsidiaries

Consolidated statements of operations

For the years ended December 31, 2010, 2009, and 2008

(In thousands)

 

     2010     2009     2008  

SALES

   $ 627,713      $ 773,323      $ 1,265,615   

OPERATING EXPENSES:

      

Cost of sales (exclusive of depreciation and amortization shown separately below)

     536,807        672,595        997,940   

Selling, general, and administrative expense

     65,256        70,693        90,823   

Depreciation and amortization expense

     20,269        20,136        22,559   

Impairment of goodwill

     62,805        —          —     
                        

Total operating expenses

     685,137        763,424        1,111,322   
                        

(LOSS) INCOME FROM OPERATIONS

     (57,424     9,899        154,293   

OTHER INCOME (EXPENSE):

      

Equity in earnings of unconsolidated entity

     1,029        —          —     

Other income (expense)—net

     190        1,447        (902

Loss on prepayment of debt

     —          (7,523     —     

Interest expense—net

     (64,208     (47,085     (45,040
                        

(LOSS) INCOME BEFORE INCOME TAX (BENEFIT) EXPENSE

     (120,413     (43,262     108,351   

INCOME TAX (BENEFIT) EXPENSE

     (22,125     (22,373     35,124   
                        

NET (LOSS) INCOME

     (98,288     (20,889     73,227   

NET LOSS ATTRIBUTABLE TO NON-CONTROLLING INTEREST

     (14     —          —     
                        

NET (LOSS) INCOME AVAILABLE TO COMMON PARTNERSHIP INTERESTS

   $ (98,302   $ (20,889   $ 73,227   
                        

See notes to consolidated financial statements.

 

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Edgen Murray II, L.P. and subsidiaries

Consolidated statements of partners’ (deficit) capital and comprehensive income (loss)

For the years ended December 31, 2010, 2009, and 2008

(In thousands, except unit data)

 

     Number of units                                 
     Common
general
partnership
interests
     Common
limited
partnership
interests
    Common
partnership
interests
    Accumulated
other
comprehensive
income (loss)
    Total     Non-controlling
interest
     Total  

BALANCE—January 1, 2008

     1         209,827      $ (64,899   $ (3,587   $ (68,486   $ —         $ (68,486

Net income

     —           —          73,227          73,227        —           73,227   

Other comprehensive income—

                

Unrealized losses on foreign currency exchange contracts—net of tax

     —           —          —          (1,947     (1,947     —           (1,947

Unrealized losses on interest rate derivatives—net of tax

     —           —          —          (4,197     (4,197     —           (4,197

Foreign translation adjustments

     —           —          —          (37,322     (37,322     —           (37,322
                      

Comprehensive income

     —           —          —          —          29,761        —        

Forfeiture of non-vested restricted units

     —           (29     —          —            —        

Amortization of restricted common units

     —           —          1,176        —          1,176        —           1,176   

Amortization of unit options

     —           —          1,010        —          1,010        —           1,010   
                                                          

BALANCE—December 31, 2008

     1         209,798      $ 10,514      $ (47,053   $ (36,539   $ —         $ (36,539

Net loss

     —           —          (20,889     —          (20,889     —           (20,889

Other comprehensive income—

                

Unrealized gains on foreign currency exchange contracts—net of tax

     —           —          —          1,474        1,474        —           1,474   

Unrealized gains on interest rate derivatives—net of tax

     —           —          —          10,589        10,589        —           10,589   

Foreign translation adjustments

     —           —          —          13,521        13,521        —           13,521   
                      

Comprehensive income

     —           —          —          —          4,695        

Forfeiture of non-vested restricted units

     —           (200     —          —          —          —           —     

Amortization of restricted common units

     —           —          1,061        —          1,061        —           1,061   

Amortization of unit options

     —           —          1,004        —          1,004        —           1,004   
                                                          

BALANCE—December 31, 2009

     1         209,598      $ (8,310   $ (21,469   $ (29,779   $ —         $ (29,779
                                                          
                   (Continued ) 

 

55


Table of Contents
Index to Financial Statements
     Number of units                                
     Common
general
partnership
interests
     Common
limited
partnership
interests
    Common
partnership
interests
    Accumulated
other
comprehensive
income (loss)
    Total     Non-controlling
interest
    Total  

Net loss

     —           —          (98,288     —          (98,288     (14     (98,302

Other comprehensive loss—

               

Foreign translation adjustments

     —           —          —          (4,062     (4,062     —          (4,062
                     

Comprehensive loss

     —           —          —          —          (101,350    

Contributions to non-controlling interest

     —           —          —          —          —          56        56   

Forfeiture of non-vested restricted units

     —           (355     —          —          —          —          —     

Issuance of restricted common units

     —           250        —          —          —          —          —     

Amortization of restricted common units

     —           —          493        —          493          493   

Amortization of unit options

     —           —          332        —          332        —          332   
                                                         

BALANCE—December 31, 2010

     1         209,493      $ (105,773   $ (25,531   $ (131,304   $ 42      $ (131,262
                                                         

See notes to consolidated financial statements.

 

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Table of Contents
Index to Financial Statements

Edgen Murray II, L.P. and subsidiaries

Consolidated statements of cash flows

For the years ended December 31, 2010, 2009, and 2008

(In thousands)

 

     2010     2009     2008  

CASH FLOWS FROM OPERATING ACTIVITIES:

      

Net (loss) income

   $ (98,288   $ (20,889   $ 73,227   

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

      

Depreciation and amortization

     20,269        20,136        22,559   

Amortization of deferred financing costs

     3,684        2,372        2,507   

Impairment of goodwill

     62,805        —          —     

Equity in earnings of unconsolidated entity

     (1,029     —          —     

Accretion of discount on long-term debt

     654        14        —     

Noncash accrual of interest on note payable

     —          363        343   

Loss on prepayment of debt

     —          7,523        —     

Unit-based compensation expense

     825        2,065        2,186   

Provision for doubtful accounts

     126        1,632        1,951   

Provision for inventory allowances and writedowns

     2,515        24,175        —     

Deferred income tax benefit

     (5,022     (9,470     (1,353

Loss on foreign currency transactions

     1,559        853        2,810   

Loss (gain) on derivative instruments

     —          7,264        (256

Gain on sale of property, plant, and equipment

     (357     (22     (91

Changes in assets and liabilities:

      

Decrease (increase) in accounts receivable

     1,977        98,245        (36,983

Decrease (increase) in inventory

     23,399        104,239        (66,357

Decrease (increase) in income tax receivable

     2,187        (21,225     4,948   

Decrease (increase) in prepaid expenses and other current assets

     3,493        7,010        (12,700

Increase (decrease) in accounts payable

     2,965        (92,224     24,106   

Increase (decrease) in accrued expenses and other current liabilities and deferred revenue

     7,038        (12,023     12,563   

Increase (decrease) in income tax payable

     380        (27,199     24,071   

Decrease Increase (decrease) in other

     1,029        (969     303   
                        

Net cash provided by operating activities

     30,209        91,870        53,834   
                        

CASH FLOWS FROM INVESTING ACTIVITIES:

      

Investment in unconsolidated entity

     (10,000     —          —     

Purchase of PetroSteel business—net of cash acquired

     (4,000     (4,000     (4,000

Purchases of property, plant, and equipment

     (13,999     (4,140     (8,440

Proceeds from the sale of property, plant, and equipment

     1,170        176        119   
                        

Net cash used in investing activities

     (26,829     (7,964     (12,321
                        

(Continued)

 

57


Table of Contents
Index to Financial Statements

Edgen Murray II, L.P. and subsidiaries

Consolidated statements of cash flows

For the years ended December 31, 2010, 2009, and 2008

(In thousands)

 

     2010     2009     2008  

CASH FLOWS FROM FINANCING ACTIVITIES:

      

Proceeds from issuance of long-term debt

   $ —        $ 460,624      $ —     

Deferred financing costs and financing advisory fees paid

     (1,209     (13,311     (449

Principal payments on notes payable and long-term debt, including prepayment fees

     (4,315     (493,916     (4,547

Proceeds from Asset Based Loan (“ABL”) Facility

     12,760        187,732        308,893   

Payments to ABL Facility

     (12,760     (192,025     (355,340

(Decrease) increase in managed cash overdraft and short-term loans

     (56     (8,976     9,081   
                        

Net cash used in financing activities

     (5,580     (59,872     (42,362

EFFECT OF FOREIGN CURRENCY EXCHANGE RATE ON CASH

     (1,055     (9     (5,900
                        

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS

     (3,255     24,025        (6,749

CASH AND CASH EQUIVALENTS—Beginning of year

     65,733        41,708        48,457   
                        

CASH AND CASH EQUIVALENTS—End of year

   $ 62,478      $ 65,733      $ 41,708   
                        

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION—Cash paid and received for:

      

Interest

   $ 35,795      $ 36,665      $ 42,640   
                        

Income taxes

   $ 2,085      $ 36,891      $ 11,853   
                        

Income tax refunds

   $ 21,975      $ 1,367      $ 4,951   
                        

NONCASH INVESTING AND FINANCING ACTIVITIES:

      

Purchases of property, plant and equipment included in accounts payable

   $ 2,109      $ 754      $ 1,280   
                        

Issuance of Edgen Murray II, L.P. restricted common units

   $ 78      $ —        $ —     
                        

Distributions from unconsolidated entity

   $ 186      $ —        $ —     
                        

(Concluded) See notes to consolidated financial statements.

 

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Table of Contents
Index to Financial Statements

Edgen Murray II, L.P. and subsidiaries

Notes to consolidated financial statements

(In thousands, except per unit data and number of units)

1. Organization and summary of significant accounting policies

Description of Operations—Edgen Murray II, L.P. (“EM II LP”), through its subsidiaries, has operations in North and South America, the United Kingdom (“U.K.”), Singapore and the United Arab Emirates (“UAE”), and sales or representative offices in Australia, Brazil, China, India, Indonesia, and France. The Company is headquartered in Baton Rouge, Louisiana. References to the “Company” include EM II LP and its subsidiaries.

The Company is a global industrial distributor of specialty steel products primarily to the oil and gas, power, petrochemical and civil construction markets. The Company’s product catalog consists of pipes, plate and sections, including highly-engineered prime carbon or alloy steel pipe, pipe components, valves and high-grade structural sections and plate. These items are often designed to operate in severe conditions, including high pressure, load bearing, compression and extreme temperature environments, and to withstand the effects of corrosive or abrasive materials. The Company’s customers include engineering, procurement and construction firms, equipment fabricators, multi-national and national major integrated oil and natural gas companies, independent oil and natural gas companies, natural gas transmission and distribution companies, petrochemical companies, mining companies, oil sands developers, hydrocarbon, nuclear and renewable power generation companies, utilities, civil construction contractors and municipality and transportation authorities.

Organization—EM II LP is a Delaware limited partnership formed on April 3, 2007, by Jefferies Capital Partners IV L.P., Jefferies Employee Partners IV LLC, and JCP Partners IV LLC (collectively, “Fund IV”), to acquire the common shares of the operating subsidiaries of Edgen/Murray, L.P., the Company’s predecessor, which was formed by ING Furman Selz Investors III, LP, ING Barings U.S. Leveraged Equity Plan LLC, ING Barings Global Leveraged Equity Plan Ltd. (collectively “Fund III”) and certain members of Edgen Murray Corporation (“EMC”) management. On May 11, 2007; institutional investors and existing management invested in EM II LP which then acquired the common shares of EMC and Pipe Acquisition Limited (“PAL”), the principal assets of Edgen/Murray, L.P. The formation of EM II LP, the acquisition of the assets of Edgen/Murray, L.P. and the related financing transactions are referred to as the “Recapitalization Transaction”. Jefferies Capital Partners (“JCP”) has controlled EM II LP and its predecessor, Edgen/Murray LP since the acquisition of Edgen Corporation on February 1, 2005.

Significant accounting policies:

Basis of presentation—The consolidated financial statements and notes are presented in accordance with accounting principles generally accepted in the United States of America (“generally accepted accounting principles” or “GAAP”) in accordance with the Financial Accounting Standards Board’s (“FASB”), Generally Accepted Accounting Principles Topic, Accounting Standards Codification (“ASC”) 105. The consolidated financial statements include the accounts of EM II LP and its wholly owned subsidiaries. The Company’s subsidiary, EM FZE, has a 70% ownership in a Bahraini joint venture which operates in Saudi Arabia and which is consolidated; the remaining 30% ownership is presented as a non-controlling interest in the consolidated financial statements.

At the Recapitalization Transaction date, Edgen/Murray, L.P. and EM II LP were controlled by general partners that were controlled by the same principals of JCP. In addition, funds managed by JCP owned approximately 75% of Edgen/Murray, L.P. prior to the Recapitalization Transaction and approximately 38% of EM II LP after the Recapitalization Transaction. Because EM II LP and Edgen/Murray, L.P. were controlled by the same principals of JCP, the acquisition of the principal assets of Edgen/Murray, L.P. by EM II LP has been accounted for as a transaction among entities under common control. Accordingly, fair value purchase accounting has not been applied and the fair value of acquired assets and liabilities, including goodwill and other intangibles, has not been recorded at the date of the Recapitalization Transaction. Instead, the historical carryover basis of the acquired assets and liabilities has been maintained and the purchase of the partners’ interests by EM II LP was recorded as a distribution in the statements of partners’ (deficit) capital and comprehensive income (loss) in 2007. All intercompany transactions have been eliminated in consolidation.

Use of estimates—The preparation of the Company’s consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, 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 reporting period. Actual results could differ from those estimates. Estimates and assumptions are primarily made in relation to the valuation of accounts receivable, inventory, and derivative financial instruments, the recoverability of goodwill and other intangible assets, and in establishing a valuation allowance, if any, on deferred tax assets.

 

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Table of Contents
Index to Financial Statements

Cash equivalents—The Company considers all highly liquid investments with an original maturity of three months or less at the time of purchase to be cash equivalents.

Accounts receivable—Customer accounts receivable is shown net of allowance for doubtful accounts and reflects the Company’s estimate of the uncollectible accounts receivable based on the aging of specific customer receivable accounts.

Inventory—Inventory consists primarily of prime carbon steel pipe and plate, alloy grade pipe, fittings and flanges, structural sections, and specialized valves. Inventory is stated at the lower of cost or market (net realizable value). Cost is determined by the average-cost method. Cost includes all costs incurred in bringing the product to its present location and condition. Net realizable value is based on estimated normal selling price less further costs expected to be incurred to completion and disposal. Inventory is reduced for obsolete, slow-moving or defective items. As a result of deteriorated market conditions in its industry, the Company reduced the carrying value of its inventory to its net realizable value resulting in a charge of $248 and $22,464, respectively, to cost of sales (excluding depreciation and amortization) in the statement of operations for the years ended December 31, 2010 and 2009.

Property, plant, and equipment—Property, plant, and equipment are recorded at cost. Depreciation of property, plant, and equipment is determined for financial reporting purposes by using the straight-line method over the estimated useful lives of the individual assets. Useful lives range from one to 10 years for leasehold improvements, two to 10 years for equipment and computers, and 10 to 50 years for buildings and land improvements. Work in process (“WIP”) represents costs associated with property, plant, and equipment that have not been placed into service; therefore, no depreciation is recorded on WIP until the assets are placed into service. For income tax purposes, accelerated methods of depreciation are used. Ordinary maintenance and repairs which do not extend the physical or economic lives of the plant or equipment are charged to expense as incurred.

Asset held for sale—Assets held for sale are recorded at the lower of their net carrying value less costs to sell or fair market value. As of December 31, 2010, the Company had moved its Singapore operations into its new facility and the former facility was available for sale with a firm commitment to sell the facility in January 2011. The asset was sold in January 2011 for $6,329 and the Company recognized a gain of $980 subsequent to December 31, 2010. During 2010, the Company also sold a facility in Florida for $1,020 and a gain of $75 was recognized and is included within the consolidated statements of operations for the year ended December 31, 2010.

Capitalized software costs—Capitalized costs associated with computer software developed or obtained for internal use includes external consultant costs and internal payroll and payroll-related costs for employees directly involved in the application development stage of computer software development.

Leases—The Company enters into both finance and operating lease agreements. Fixed assets held under lease agreements, which confer rights and obligations similar to those attached to owned assets, are capitalized as fixed assets, and are depreciated over their economic lives. Future finance lease obligations are recorded as liabilities, while the interest element is charged to the statements of operations over the period of the related finance lease obligation. Rentals under operating leases are charged to the statements of operations on a straight-line basis over the lease term, even if the payments are not made on such a basis.

Goodwill and other intangible assets—Goodwill represents the purchase price the Company paid to acquire a company in excess of the estimated fair value of tangible assets and identifiable intangible assets acquired minus the fair market value of liabilities assumed. Other identifiable intangible assets include customer relationships, tradenames, noncompetition agreements, and trademarks. Other identifiable intangible assets with finite useful lives are amortized to expense over the estimated useful life of the asset. Customer relationships, and noncompetition agreements are amortized on a straight-line basis over their estimated useful lives: 7 years for customer relationships, and 1 to 6 years for noncompetition agreements. Identifiable intangible assets with an indefinite useful life, including goodwill, tradenames, and trademarks, are evaluated annually for impairment and more frequently if circumstances dictate, by comparing the carrying amounts to the fair value of the individual assets.

At December 31, 2010, the Company’s goodwill balance is attributable to its U.K. and Singapore reporting units which is included within General Company for segment reporting purposes. As of January 1, 2011, the Company performed its annual goodwill impairment test, which requires comparison of the estimated fair value to the book value including goodwill. The annual goodwill impairment test supported that the fair value of the U.K. and Singapore reporting units exceeded the carrying value by at least 30% and that the goodwill on the Company’s consolidated balance sheet at that date was not impaired.

In connection with the preparation of financial information and management’s conclusion that the revised operating forecasts constituted an interim impairment indicator, the Company performed an interim goodwill impairment analysis at June 30, 2010 using a methodology consistent with its annual impairment test. As a result of the impairment analysis, a goodwill impairment charge of $62,805 was recorded and is included in the consolidated statement of operations for the year ended December 31, 2010. The goodwill impairment recorded at June 30, 2010 was considered to be a triggering event for further impairment analysis related to the Company’s tradename intangible asset. No impairment of the tradenames was recorded as the fair value of the assets exceeded their carrying amounts at June 30, 2010 and for the remainder of 2010 (see Notes 4 and 14).

 

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Index to Financial Statements

Impairment of long-lived assets—The Company assesses the impairment of long-lived assets, including property, plant, and equipment and long-lived intangible assets associated with noncompetition agreements and customer relationships, when events or changes in circumstances indicate that the carrying value of the assets or the asset group may not be recoverable. The asset impairment review assesses the fair value of the assets based on the future cash flows the assets are expected to generate. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset, plus net proceeds expected from the disposition of the asset (if any) are less than such asset’s carrying amount. Impairment losses are measured as the amount by which the carrying amounts of the assets exceed their fair values.

In connection with the preparation of financial information in the second quarter 2010 and management’s conclusion that the revised operating forecasts constituted an interim impairment indicator, the Company tested for impairment its long-lived assets, including customer relationships and noncompetition agreements, and no impairment was recorded as the fair value of the assets exceeded their carrying amounts at June 30, 2010. No impairment of these long-lived assets was identified for the remainder of 2010 or in 2009.

Deferred financing costs—Deferred financing costs are charged to operations as additional interest expense over the life of the underlying indebtedness using the effective interest method. Deferred financing costs charged to the statements of operations as interest during the years ended December 31, 2010, 2009, and 2008, were $3,684, $2,372 and $2,507, respectively. On December 23, 2009, the Company expensed $7,523 of deferred financing costs associated with the prepayment of debt; the expense is recorded within the loss on prepayment of debt in the consolidated statement of operations for the year ended December 31, 2009 (see Note 6).

Income taxes—Under Income Taxes Topic, ASC 740, deferred income taxes are recognized for the future tax consequences of differences between the tax bases of assets and liabilities and their financial reporting amounts based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount that is more likely than not to be realized. The Company considers future taxable income and ongoing tax planning strategies in assessing the need for a valuation allowance. The Company’s uncertain tax positions requiring recognition in these consolidated financial statements are disclosed in Note 10.

Revenue recognition—Revenue is recognized on product sales when the earnings process is complete, meaning the risks and rewards of ownership have transferred to the customer (typically upon title transfer), and collectability is reasonably assured. Revenue is recorded, net of discounts, rebates, value-added tax and similar taxes as applicable in foreign jurisdictions. Rebates and discounts to customers are determined based on the achievement of certain agreed-upon terms and conditions by the customer during each period. Shipping and handling costs related to product sales are also included in sales.

Equity-based compensation—The Company has equity-based compensation plans for certain employees and directors and accounts for these plans under Stock Compensation Topic, ASC 718 (“ASC 718”). ASC 718 requires all forms of share-based payments to employees, including options, to be recognized as compensation expense. The compensation expense is the fair value of the awards at the measurement date. Further, ASC 718 requires compensation cost to be recognized over the requisite service period for all awards granted subsequent to adoption.

Employee benefit plans—The Company has two primary plans which provide benefits to employees based in the United States (“U.S. Benefit Plan”) and the United Kingdom (the “U.K. Benefit Plan”). The U.K. Benefit Plan is a “money purchase” plan, and benefits at retirement are dependent upon the level of contributions paid, the investment return achieved, the charges deducted from the fund, and the cost of buying a pension at retirement. Both the U.S. and U.K. Employee Benefit Plans work on a defined contribution basis, whereby both the employee and the employer contribute a percentage of the employee’s salary each month, depending on the level and length of service of the employee. Contributions by the Company are discretionary. The Company also maintains certain smaller defined contribution plans for employees of other countries, and records the required contributions to the plans during the year. See Note 17 for further detail on these employee benefit plans.

Foreign currency—The Company’s non-U.S. subsidiaries maintain their accounting records in their respective functional currencies. All assets and liabilities in foreign currencies are translated into the relevant measurement currency for each entity/division at the rate of exchange at the consolidated balance sheet date. Transactions in foreign currencies are translated into the relevant measurement currency at the average rate of exchange during the period. The cumulative effect of exchange rate movements is included in a separate component of the consolidated statements of partners’ (deficit) capital and comprehensive income (loss) in accordance with Foreign Currency Matters Topic, ASC 830 and Comprehensive Income Topic, ASC 220.

Foreign currency exchange transaction gains or losses are charged to earnings in the period the transactions are settled. Foreign currency transaction losses of $1,559, $853 and $2,810 are included in the consolidated statements of operations for the years ended December 31, 2010, 2009, and 2008, respectively.

 

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Index to Financial Statements

Derivative financial instruments—The Company has entered into transactions involving various derivative instruments to hedge interest rates and foreign currency denominated sales, purchases, assets, and liabilities. These derivative contracts are entered into with various financial institutions. The Company does not use derivative instruments for trading purposes and has procedures in place to monitor and control their use.

The Company accounts for certain derivative financial instruments in accordance with Derivatives and Hedging Topic, ASC 815 (“ASC 815”). ASC 815 requires that all derivative instruments be recorded on the consolidated balance sheet at fair value. The accounting for changes in the fair value (i.e. gains or losses) of a derivative instrument is dependent upon whether the derivative has been designated and qualifies as part of a hedging relationship and, further, on the type of hedging relationship. For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss, if any, on the derivative instrument, as well as the offsetting gain or loss on the hedged item attributable to the hedged risk, is recognized in the results of operations. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of accumulated other comprehensive income (loss) and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Any ineffective portion of the gain or loss on the derivative instrument for a cash flow hedge is recorded in the results of operations immediately. For derivative instruments not designated as hedging instruments, the gain or loss is recognized in the results of operations immediately. See Notes 15 and 16 for a discussion of the use of derivative instruments, management of credit risk inherent in derivative instruments and fair value information. Other comprehensive income (loss)—ASC 220 establishes standards for reporting and displaying comprehensive income and its components in the consolidated financial statements. Comprehensive income (loss) includes net earnings and accumulated other comprehensive income (loss). The change in accumulated other comprehensive income (loss) for all periods presented resulted from foreign currency translation adjustments and changes in the fair value of interest rate derivatives and foreign currency exchange contracts.

Fair values of financial instruments—The carrying value of cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities approximate their fair value due to the short maturity of those instruments. The fair value of long-term debt is based on estimated market quotes or recent trades. The fair value of derivatives is based on the estimated amount the Company would receive or pay if the transaction was terminated, taking into consideration prevailing exchange rates and interest rates, in a transaction between market participants.

Investment in Unconsolidated Entity—The Company’s investment in Bourland and Leverich Holding Company LLC (“B&L”), a distributor of oil country tubular goods, is accounted for under the equity method in accordance with ASC 323, Investments—Equity Method and Joint Ventures, which requires the use of the equity method of accounting unless the investor’s interest is “so minor” that the investor may have virtually no influence over operating and financial policies. Given that the Company’s investment in B&L represents 14.5% of the common equity of a limited liability company, the Company’s investment is considered to be more than minor and is therefore subject to the equity method of accounting.

The Company’s investment in B&L is included in “Investment in unconsolidated entity” on the consolidated balance sheet at December 31, 2010. Earnings on this investment are recorded in “Equity in earnings of the unconsolidated entity” in the consolidated statements of operations. Any intra-entity profit or loss has been eliminated for the year ended December 31, 2010.

At December 31, 2010, the investment in unconsolidated entity was $10,843. Income from the investment in unconsolidated entity for the period August 19, 2010 through December 31, 2010 was $1,029.

New accounting standards—From time to time, new accounting pronouncements are issued by the FASB which are adopted by the Company as of the specified effective date.

Revenue Recognition, ASC Topic 605: Multiple Deliverable Revenue Arrangements – A Consensus of the FASB Emerging Issues Task Force. In October 2009, the FASB issued guidance on whether multiple deliverables exist, how the deliverables should be separated and how the consideration should be allocated to one or more units of accounting. This update establishes a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific objective evidence, if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific or third-party evidence is available. The Company will be required to apply this guidance prospectively for revenue arrangements entered into or materially modified after January 1, 2011; however, earlier application is permitted. The Company does not expect the adoption of this new guidance to have a material impact on our financial position or results of operations.

 

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2. Property, plant, and equipment

Property, plant, and equipment at December 31, 2010 and 2009, consisted of the following:

 

     2010     2009  

Land and land improvements

   $ 11,191      $ 13,351   

Building

     35,429        27,419   

Equipment and computers

     28,639        28,197   

Leasehold improvements

     4,631        4,809   

Work in progress

     90        220   
                
     79,980        73,996   

Less accumulated depreciation

     (30,693     (30,654
                

Property, plant, and equipment—net

   $ 49,287      $ 43,342   
                

Substantially all of the Company’s U.S. property, plant, and equipment serves as collateral for the Company’s long-term debt (see Note 6). Depreciation expense for the years ended December 31, 2010, 2009, and 2008 was $4,907, $4,690, and $4,304, respectively.

3. Intangible assets

Intangible assets at December 31, 2010 and 2009 consisted of the following:

 

     Gross carrying value      Accumulated
amortization
     Net carrying value  
     2010      2009      2010      2009      2010      2009  

Customer relationships

   $ 81,941       $ 83,938       $ 61,198       $ 50,645       $ 20,743       $ 33,293   

Non-competition agreements

     22,011         22,011         13,409         9,734         8,602         12,277   

Sales backlog

     9,580         9,748         9,580         9,748         —           —     

Tradenames

     11,407         11,702         —           —           11,407         11,702   

Trademarks

     14         14         —           —           14         14   
                                                     
   $ 124,953       $ 127,413       $ 84,187       $ 70,127       $ 40,766       $ 57,286   
                                                     

The gross carrying values and accumulated amortization of intangible assets recorded in the local currency of our non-U.S. subsidiaries fluctuates from period to period due to changes in foreign currency exchange rates.

The fair value of customer relationships and noncompetition agreements has been derived using an income/excess earnings valuation method, which is based on the assumption that earnings are generated by all of the assets held by the company, both tangible and intangible. The income/excess earnings method estimates the fair value of an intangible asset by discounting its future cash flows and applying charges for contributory assets. Certain estimates and assumptions were used to derive the customer relationship intangible, including future earnings projections, discount rates, and customer attrition rates. In determining the fair value for noncompetition agreements, the Company considers future earnings projections, discount rates, and estimates of potential losses resulting from competition, the enforceability of the terms and the likelihood of competition in the absence of the agreement. The useful lives for customer relationships have been estimated based on historical experience.

The fair value of tradenames has been derived using a relief from royalty valuation method which assumes that the owner of intellectual property is “relieved” from paying a royalty for the use of that asset. The royalty rate attributable to the intellectual property represents the cost savings that are available through ownership of the asset by the avoidance of paying royalties to license the use of the intellectual property from another owner. Accordingly, earnings forecasts of income reflect an estimate of a fair royalty that a licensee would pay, on a percentage of revenue basis, to obtain a license to utilize the intellectual property. Estimates and assumptions used in deriving the fair value of tradenames include future earnings projections, discount rates, and market royalty rates identified on similar recent transactions.

 

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Customer relationships and noncompetition agreements are subject to amortization while tradenames have indefinite lives and are not subject to amortization. The gross carrying value of intangible assets decreased approximately $2,459 in 2010 and increased approximately $6,384 in 2009 due to the effect of foreign currency translation. Amortization expense was $15,362, $15,446, and $18,255 for the years ended December 31, 2010, 2009, and 2008.

The following table presents scheduled amortization expense for the next five years:

 

2011

   $ 15,580   

2012

     11,625   

2013

     1,808   

2014

     332   

2015

     —     

The weighted-average remaining amortization period for customer relationships was two years and three years at December 31, 2010 and 2009, respectively. The weighted-average remaining amortization period for noncompetition agreements was two years and three years at December 31, 2010 and 2009, respectively. Sales backlog was fully amortized at December 31, 2010 and 2009.

4. Goodwill

Under IntangiblesGoodwill and Other, ASC Topic 350, an impairment test is required to be performed upon adoption and at least annually thereafter. Material amounts of recorded goodwill attributable to each of the Company’s reporting units are tested for impairment during the first quarter of each year, or whenever events indicate impairment may have occurred, by comparing the fair value of each reporting unit to its carrying value. Fair value is determined using discounted cash flows, and guideline company multiples. Significant estimates used in the methodologies include estimates of future cash flows, future short-term and long-term growth rates, weighted-average cost of capital and guideline company multiples for each of the reportable units.

At December 31, 2010, the Company’s goodwill balance is attributable to its U.K. and Singapore reporting units which is included within General Company for segment reporting purposes. As of January 1, 2011, the Company performed its annual goodwill impairment test, which requires comparison of the estimated fair value to the book value including goodwill. The annual goodwill impairment test supported that the fair value of the U.K. and Singapore reporting units exceeded the carrying value by at least 30% and that the goodwill on the Company’s consolidated balance sheet at that date was not impaired.

In connection with the preparation of financial information for the second quarter of 2010, the Company noted that for some of its reporting units results of operations for the first half of 2010 continued to remain below the original budget assumptions and operating forecasts. The Company began a process to reforecast budget assumptions and operating forecasts for the remainder of 2010 and the first quarter of 2011. Although sales inquiries and new order bookings have increased since March 2010, by the end of the second quarter the energy market and overall economic conditions adversely affected customers’ commitments and time frames for making capital and maintenance expenditures compared to the original assumptions and forecasts. The continued slow global economic recovery, in addition to uncertainty surrounding energy demand and commodity pricing, resulted in revised budget assumptions and operating forecasts with a slower future earnings recovery than was previously forecasted. The Company’s revised operating forecasts constituted an interim impairment indicator. Accordingly, the Company performed an interim goodwill impairment analysis at June 30, 2010 using a methodology consistent with its annual impairment test. The methodology uses a combined discounted cash flow valuation and comparable company market value approach to determine the fair value of our reporting units.

This second quarter 2010 interim goodwill impairment analysis indicated that the Company’s Americas and UAE reporting units failed Step 1 of the goodwill impairment test because the book value of the reporting units exceeded the estimated fair value. The Company performed Step 2 of the goodwill impairment analysis for the Americas and UAE reporting units. The process included among other things a determination of the implied fair value of the Americas and UAE reporting units goodwill by assigning the fair value of the reporting units determined in Step 1 to all of the assets and liabilities of the Americas and UAE reporting units (including any recognized and unrecognized intangible assets) as if the Americas and UAE reporting units had been acquired in a business combination; to complete the process, the Company then compared the implied fair value of goodwill to the carrying amount of goodwill to determine if goodwill was impaired. Based on a preliminary Step 2 goodwill impairment analysis, the impairment charge was estimated to be $62,805 and was reflected in the statement of operations in the second quarter of 2010. The goodwill impairment charge recognized during the second quarter of 2010 was finalized during the third quarter of 2010, and the amount of the impairment did not differ from the initial estimate. At December 31, 2010, the Americas and UAE reporting units had no remaining goodwill balance after this impairment charge (see Note 14).

 

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The following table reflects changes to goodwill during the years ended December 31, 2010 and 2009:

 

Balance—January 1, 2009

   $ 75,936   

PetroSteel earn-out adjustment

     4,000   

Foreign currency translation

     3,344   
        

Balance—December 31, 2009

     83,280   

PetroSteel earn-out adjustment

     4,000   

Goodwill impairment

     (62,805

Foreign currency translation

     (1,563
        

Balance—December 31, 2010

   $ 22,912   
        

At December 31, 2010, goodwill excluding any impairment charges was $85,717.

As a result of earn-out provisions in the Company’s purchase agreement to acquire the business of Petro Steel International, L.P. and Petro Steel International, LLC (collectively, “PetroSteel”), in May 2010 the Company paid a final purchase price adjustment of $4,000. See Note 14 for a description of goodwill and other intangible assets by reportable segment.

5. Investment in unconsolidated entity

On August 19, 2010, EM II LP’s subsidiary, EMC, invested $10,000 in exchange for 14.5% of the common equity in B&L, a distributor of oil country tubular goods. The B&L investment is accounted for using the equity method of accounting in accordance with ASC 323, Investments—Equity Method and Joint Ventures.

Equity method investments are included in “investment in unconsolidated entity” on the consolidated balance sheets. Earnings on this investment are recorded in Equity in earnings of unconsolidated entity within the consolidated statements of operations. At December 31, 2010, the investment in B&L was $10,843. Income from the investment in B&L for the pe