HAYNES INTERNATIONAL INC - Quarter Report: 2008 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

(Mark One)

 

x	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the quarterly period ended June 30, 2008
or
o	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the transition period from                     to

 

Commission File Number: 001-33288

 

HAYNES INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

 

(765) 456-6000

(Registrant’s telephone number, including area code)

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filler” and “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 

 

Large accelerated filer o

Accelerated filer o

Non-accelerated filer x (Do not check if a smaller reporting company)

Smaller reporting company o

 

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

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.  Yes x  No o

 

As of August 1, 2008, the registrant had 11,953,766 shares of Common Stock, $.001 par value, outstanding.

 

 

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HAYNES INTERNATIONAL, INC. and SUBSIDIARIES QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

 

			Page
PART I	FINANCIAL INFORMATION
Item 1.	Unaudited Condensed Financial Statements
	Haynes International, Inc. and Subsidiaries:
	Unaudited Consolidated Balance Sheets as of September 30, 2007 and June 30, 2008		1
	Unaudited Consolidated Statements of Operations for the Three and Nine Months Ended June 30, 2007 and 2008		2
	Unaudited Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended June 30, 2007 and 2008		3
	Unaudited Consolidated Statements of Cash Flows for the Nine Months Ended June 30, 2007 and 2008		4
	Notes to Consolidated Financial Statements		5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		13
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		29
Item 4.	Controls and Procedures		30
PART II	OTHER INFORMATION
Item 6.	Exhibits		31
	Signatures		32
	Index to Exhibits		33

 

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PART I      FINANCIAL INFORMATION

Item 1.     Unaudited Condensed Financial Statements

 

HAYNES INTERNATIONAL, INC. and SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands, except share and per share data)

 

		September 30, 2007			June 30, 2008
ASSETS
Current assets:
Cash and cash equivalents		$	5,717		$	9,857
Restricted cash - current portion		110			110
Accounts receivable, less allowance for doubtful accounts of $1,339 and $1,481, respectively		106,414			95,557
Inventories, net		286,302			321,946
Income taxes receivable		1,760			2,060
Deferred income taxes		10,801			10,039
Other current assets		1,457			3,368
Total current assets		412,561			442,937
Property, plant and equipment (at cost)		117,181			133,404
Accumulated depreciation		(19,321		)	(26,194		)
Net property, plant and equipment		97,860			107,210
Deferred income taxes - long term portion		22,738			19,358
Prepayments and deferred charges, net		3,702			2,864
Restricted cash - long term portion		330			220
Goodwill		41,252			43,737
Other intangible assets		8,526			8,202
Total assets		$	586,969		$	624,528
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued expenses		$	60,443		$	71,139
Accrued pension and postretirement benefits		14,647			20,518
Revolving credit facilities		35,549			22,347
Deferred revenue - current portion		2,500			2,500
Current maturities of long-term obligations		110			110
Total current liabilities		113,249			116,614
Long-term obligations (less current portion)		3,074			3,123
Deferred revenue (less current portion)		45,329			43,454
Non-current income taxes payable		—			2,591
Accrued pension and postretirement benefits		108,940			85,959
Total liabilities		270,592			251,741
Stockholders’ equity:
Common stock, $0.001 par value (40,000,000 shares authorized, 11,807,237 and 11,953,766 issued and outstanding at September 30, 2007 and June 30, 2008, respectively)		12			12
Preferred stock, $0.001 par value (20,000,000 shares authorized, 0 shares issued and outstanding)		—			—
Additional paid-in capital		218,504			224,501
Accumulated earnings		93,880			139,523
Accumulated other comprehensive income		3,981			8,751
Total stockholders’ equity		316,377			372,787
Total liabilities and stockholders’ equity		$	586,969		$	624,528

 

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

 

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HAYNES INTERNATIONAL, INC. and SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except share and per share data)

 

		Three Months Ended							Nine Months Ended
		June 30,							June 30,
		2007			2008				2007			2008
Net revenues		$	141,087		$	166,340			$	398,886		$	476,188
Cost of sales		104,148			126,223				287,993			365,946
Gross profit		36,939			40,117				110,893			110,242
Selling, general and administrative expense		10,871			11,007				29,152			31,059
Research and technical expense		747			819				2,225			2,566
Operating income		25,321			28,291				79,516			76,617
Interest expense, net		263			22				3,338			802
Income before income taxes		25,058			28,269				76,178			75,815
Provision for income taxes		7,317			10,705				27,849			29,345
Net income		$	17,741		$		17,564		$	48,329		$		46,470
Net income per share:
Basic		$	1.52		$	1.47			$	4.55		$	3.91
Diluted		$	1.49		$	1.46			$	4.40		$	3.87
Weighted average shares outstanding:
Basic		11,650,000			11,921,541				10,616,484			11,882,929
Diluted		11,913,310			12,045,253				10,981,509			12,013,792

 

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

 

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HAYNES INTERNATIONAL, INC. and SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(in thousands)

 

		Three Months Ended June 30						Nine Months Ended  June 30
		2007			2008			2007			2008
Net income		$	17,741		$	17,564		$	48,329		$	46,470
Other comprehensive income, net of tax:
Pension curtailment		—			—			—			2,701
Foreign currency translation adjustment		589			(207		)	2,276			2,069
Comprehensive income		$	18,330		$	17,357		$	50,605		$	51,240

 

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

 

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HAYNES INTERNATIONAL, INC. and SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

 

			Nine Months Ended  June 30,
			2007			2008
Cash flows from operating activities:
Net income			$	48,329		$	46,470
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			5,474			6,561
Amortization			843			824
Stock compensation expense			2,359			1,216
Excess tax benefit from option exercises			(7,888		)	(2,842		)
Deferred revenue			50,000			—
Deferred revenue - portion recognized			(1,546		)	(1,875		)
Deferred income taxes			2,775			1,767
Loss on disposal of property			51			223
Change in assets and liabilities:
Accounts receivable			(4,412		)	11,587
Inventories			(102,540		)	(33,595		)
Other assets			(2,695		)	(934		)
Accounts payable and accrued expenses			33,693			8,953
Income taxes			1,727			4,715
Accrued pension and postretirement benefits			(3,242		)	(12,578		)
Net cash provided by operating activities			22,473			30,492
Cash flows from investing activities:
Additions to property, plant and equipment			(11,132		)	(15,041		)
Asian distribution expansion and acquisition			—			(3,000		)
Change in restricted cash			110			110
Net cash used in investing activities			(11,022		)	(17,931		)
Cash flows from financing activities:
Net decrease in revolving credit facility			(99,032		)	(13,202		)
Proceeds from equity offering, net			72,753			—
Proceeds from exercise of stock options			6,083			1,939
Excess tax benefit from option exercises			7,888			2,842
Payments on long-term obligations			(123		)	(139		)
Net cash used in financing activities			(12,431		)	(8,560		)
Effect of exchange rates on cash			224			139
Increase (decrease) in cash and cash equivalents			(756		)	4,140
Cash and cash equivalents, beginning of period			6,182			5,717
Cash and cash equivalents, end of period			$	5,426		$	9,857
Supplemental disclosures of cash flow information:
Cash paid during period for:	Interest (net of capitalized interest)		$	3,198		$	972
	Income taxes		$	23,818		$	23,414

 

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

 

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HAYNES INTERNATIONAL, INC. and SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(in thousands, except share and per share data)

 

Note 1.          Basis of Presentation

 

Interim Financial Statements

 

The accompanying unaudited interim condensed consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and such principles are applied on a basis consistent with information reflected in our Form 10-K for the year ended September 30, 2007 filed with the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations promulgated by the SEC. In the opinion of management, the interim financial information includes all adjustments and accruals, consisting only of normal recurring adjustments, which are necessary for a fair presentation of results for the respective interim periods. The results of operations for the three and nine months ended June 30, 2008 are not necessarily indicative of the results to be expected for the full fiscal year ending September 30, 2008 or any interim period.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of Haynes International, Inc. and its wholly-owned subsidiaries (collectively, the “Company”). All significant intercompany transactions and balances are eliminated.

 

Equity Offering

 

On March 23, 2007, the Company completed an equity offering, which resulted in the issuance of 1,200,000 shares of its common stock at a price of $65.00 per share. The net proceeds to the Company after underwriting discounts, commissions and offering expenses were $72,753. As a part of the offering, certain employees and directors exercised 450,000 stock options and the payment of the exercise price for those stock options resulted in an additional $6,083 in proceeds to the Company. These combined resulted in a total of 1,650,000 shares issued.

 

Note 2.          New Accounting Pronouncements

 

In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 addresses the noncomparability in reporting tax assets and liabilities resulting from a lack of specific guidance in SFAS No. 109, Accounting for Income Taxes, on the uncertainty in income taxes recognized in an enterprise’s financial statements.  Specifically, FIN 48 prescribes (a) a consistent recognition threshold and (b) a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides related guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The impact of the adoption of FIN 48 on October 1, 2007, was to decrease accumulated earnings by $827, increase goodwill by $675, increase deferred tax assets by $3,316, and increase non-current income taxes payable by $4,818. In conjunction with the adoption of FIN 48, we have classified uncertain tax positions as non-current income tax liabilities unless they are expected to be paid within 12 months of the balance sheet date. Income tax-related interest expense is reported as a component of income tax expense and the related liability is included in non-current income taxes payable. As of October 1, 2007, we recorded a liability of approximately $200 for the payment of interest.

 

As of October 1, 2007, we were open to examination in the U.S. Federal tax jurisdiction for various years from 1994 to 2007, in the U.K. for the years 2001-2007, in Switzerland for the years 2002-2007, and in France for the years 2004-2007.  We are also open to examination in various state and local jurisdictions for various tax years, none of which were individually material.  In April 2008, an audit in the U.S. Federal tax jurisdiction was

 

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concluded, with no material change to our results of operations. As of June 30, 2008 we were open to examination in the U.S. Federal tax jurisdiction for only 2007.

 

As of October 1, 2007, the total amount of unrecognized tax benefits was $4,818, of which $827 would affect the effective tax rate, if recognized. The amount of unrecognized tax benefits as of June 30, 2008 was $2,591, of which $883 would affect the effective tax rate, if recognized.

 

The amount of unrecognized tax benefits changed in the three months ended June 30, 2008 due to international tax positions being effectively settled and as a result of tax positions taken on the Company’s September 30, 2007 tax returns. As a result of these events, the unrecognized tax benefits decreased by $4,480 along with a decrease to deferred tax assets of $3,167, a decrease of goodwill of $675, and a decrease to income tax provision of $638.

 

In September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurement (“SFAS 157”). SFAS 157 addresses standardizing the measurement of fair value for companies who are required to use a fair value measure for recognition or disclosure purposes. The FASB defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”   The statement is effective for fiscal years beginning after November 15, 2007 and for interim periods within those fiscal years. The Company is required to adopt SFAS 157 beginning on October 1, 2008. The Company is currently evaluating the impact, if any, of SFAS 157 on its financial position, results of operations and cash flows.

 

In February 2007, the FASB issued FASB Statement No. 159, Establishing the Fair Value Option for Financial Assets and Liabilities (“SFAS 159”), to permit all entities to elect to measure eligible financial instruments at fair value. SFAS 159 applies to fiscal years beginning after November 15, 2007, with early adoption permitted for an entity that has also elected to apply the provisions of SFAS 157, Fair Value Measurements. An entity is prohibited from retrospectively applying SFAS 159, unless it chooses early adoption. The Company is currently evaluating the impact, if any, of SFAS 159 on its financial position, results of operations and cash flows.

 

In December 2007, the FASB issued FASB Statement No. 141 (revised 2007), Business Combinations (“FAS 141(R)”).  FAS 141(R) requires that the fair value of the purchase price of an acquisition including the issuance of equity securities be determined on the acquisition date; requires that all assets, liabilities, noncontrolling interests, contingent consideration, contingencies, and in-process research and development costs of an acquired business be recorded at fair value at the acquisition date; requires that acquisition costs generally be expensed as incurred; requires that restructuring costs generally be expensed in periods subsequent to the acquisition date; and requires that changes in deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period impact income tax expense. FAS 141(R) also expands disclosures related to business combinations. FAS 141(R) will be applied prospectively to business combinations occurring after the beginning of the Company’s fiscal year 2010, except that business combinations consummated prior to the effective date must apply FAS 141(R) income tax requirements immediately upon adoption. The Company is currently evaluating the impact of FAS 141(R) on its financial position, results of operations and cash flows.

 

In December 2007, the FASB issued FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51 (“FAS 160”). FAS 160 requires that noncontrolling interests be reported as a separate component of equity, that net income attributable to the parent and to the noncontrolling interest be separately identified in the consolidated statement of operations, that changes in a parent’s ownership interest be accounted for as equity transactions, and that, when a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary and the gain or loss on the deconsolidation of the subsidiary be measured at fair value. FAS 160 will be applied prospectively, except for presentation and disclosure requirements which will be applied retrospectively, as of the beginning of the Company’s fiscal year 2010. The Company does not currently have noncontrolling interests, and therefore the adoption of FAS 160 is not expected to have an impact on the Company’s financial position, results of operations or cash flows.

 

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Note 3.          Inventories

 

The following is a summary of the major classes of inventories:

 

		September 30, 2007			June 30, 2008
Raw Materials		$	16,218		$	21,599
Work-in-process		162,266			171,659
Finished Goods		106,419			127,612
Other, net		1,399			1,076
		$	286,302		$	321,946

 

Note 4.          Income Taxes

 

Income tax expense for the three and nine months ended June 30, 2007 and 2008, differed from the U.S. federal statutory rate of 35% primarily due to state income taxes and differing tax rates on foreign earnings. The effective tax rate for the third quarter of fiscal 2008 was 37.9% compared to 29.2% in the same period of fiscal 2007. The low effective rate last year in the third quarter of fiscal 2007 was a result of the filing of amended tax returns during the quarter to claim favorable items from extraterritorial income exclusion and foreign tax credits, which approximated $2,889.

 

Note 5.          Pension and Post-retirement Benefits

 

Components of net periodic pension and post-retirement benefit cost for the three and nine months ended June 30, are as follows:

 

		Three Months Ended June 30,												Nine Months Ended June 30,
		Pension Benefits						Other Benefits						Pension Benefits						Other Benefits
		2007			2008			2007			2008			2007			2008			2007			2008
Service cost		$	1,044		$	708		$	361		$	361		$	3,161		$	2,123		$	1,083		$	1,083
Interest cost		2,430			2,684			1,115			1,115			7,361			8,056			3,345			3,345
Expected return		(2,590		)	(2,852		)	—			—			(7,844		)	(8,554		)	—			—
Amortizations		—			202			(1,032		)	(1,032		)	—			606			(3,096		)	(3,096		)
Curtailment gain		—			—			—			—			—			(3,659		)	—			—
Net periodic benefit cost (benefit)		$	844		$	742		$	444		$	444		$	2,678		$	(1,428	)	$	1,332		$	1,332

 

The Company contributed $6,512 to the Company sponsored domestic pension plans, $3,035 to its other post-retirement benefit plans and $921 to the U.K. pension plan for the nine months ended June 30, 2008. The Company presently expects future contributions of $1,950 to its domestic pension plans, $1,565 to its other post-retirement benefit plans and $306 to the U.K. pension plans for the remainder of fiscal 2008. The Pension Protection Act of 2006 requires funding over a seven year period to achieve 100% funded status.

 

On October 2, 2007, the U.S. pension plan was amended effective December 31, 2007 to freeze benefit accruals for all non-union employees in the U.S. and effective January 1, 2008, the pension multiplier used to calculate the employee’s monthly benefit was increased from 1.4% to 1.6%. In addition, the Company will make enhanced matching contributions to its 401K plan equal to 60% of the non-union and union plan participant’s salary deferrals, up to 6% of compensation. The Company estimates the redesign of the pension plan, including previous actions to close the plan to new non-union and union employees and the adjustment of the multiplier for non-union and union plan participants, will reduce funding requirements by $23,000 over the next six years. The offsetting estimated incremental cost of the enhanced 401K match is $2,300 over the same six year period. As a result of freezing the benefit accruals for all non-union employees in the U.S. in the first quarter of fiscal 2008, we recognized a reduction of the projected benefit obligation of $8,191, an increase to other comprehensive income (before tax) of $4,532 and a curtailment gain (before tax) of $3,659. The impact of the multiplier increase will be charged to pension expense over the estimated remaining lives of the participants.

 

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Note 6. Environmental and Legal

 

The Company is regularly involved in litigation, both as a plaintiff and as a defendant, relating to its business and operations, including environmental and intellectual property matters. Future expenditures for environmental, intellectual property and other legal matters cannot be determined with any degree of certainty; however, based on the facts presently known, management does not believe that such costs will have a material effect on the Company’s financial position, results of operations or cash flows.

 

The Company believes that any and all claims arising out of conduct or activities that occurred prior to March 29, 2004 are subject to dismissal. On March 29, 2004, the Company and certain of its subsidiaries and affiliates filed voluntary petitions for relief under Chapter 11 of Title 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of Indiana (the “Bankruptcy Court”). On August 16, 2004, the Bankruptcy Court entered its Findings of Fact, Conclusions of Law, and Order Under 11 U.S.C. 1129(a) and (b) and Fed. R. Bankr. P. 3020 Confirming the First Amended Joint Plan of Reorganization of Haynes International, Inc. and its Affiliated Debtors and Debtors-in-Possession as Further Modified (the “Confirmation Order”). The Confirmation Order and related Chapter 11 Plan, among other things, provide for the release and discharge of prepetition claims and causes of action. The Confirmation Order further provides for an injunction against the commencement of any actions with respect to claims held prior to the Effective Date of the Plan. The Effective Date occurred on August 31, 2004. When appropriate, the Company pursues the dismissal of lawsuits premised upon claims or causes of action discharged in the Confirmation Order and related Chapter 11 Plan. The success of this strategy is dependent upon a number of factors, including the respective court’s interpretation of the Confirmation Order and the unique circumstances of each case.

 

The Company is currently, and has in the past, been subject to claims involving personal injuries allegedly relating to its products. For example, the Company is presently involved in two actions involving welding rod-related injuries, both of which were filed in California state court against numerous manufacturers, including the Company, in May 2006 and February 2007, respectively, alleging that the welding-related products of the defendant manufacturers harmed the users of such products through the inhalation of welding fumes containing manganese. The Company believes that it has defenses to these allegations and, that if the Company were found liable, the cases would not have a material effect on its financial position, results of operations or liquidity. In addition to these cases, the Company has in the past been named a defendant in several other lawsuits with similar facts, and has since been voluntarily dismissed from all of these lawsuits on the basis of the release and discharge of claims contained in the Confirmation Order. While the Company contests such lawsuits vigorously, and may have applicable insurance, there are several risks and uncertainties that may affect its liability for claims relating to exposure to welding fumes and manganese. For instance, in recent cases, at least two courts (in cases not involving the Company) have refused to dismiss claims relating to inhalation of welding fumes containing manganese based upon a bankruptcy discharge order. Although the Company believes the facts of these cases are distinguishable from the facts of its cases, there can be no assurance that any or all claims against the Company will be dismissed based upon the Confirmation Order, particularly claims premised, in part or in full, upon actual or alleged exposure on or after the date of the Confirmation Order. It is also possible that the Company will be named in additional suits alleging welding-rod injuries. Should such litigation occur, it is possible that the aggregate claims for damages, if the Company is found liable, could have a material adverse effect on its financial condition, results of operations or liquidity.

 

The Company has received permits from the Indiana Department of Environmental Management, or IDEM, to close and to provide post-closure monitoring and care for certain areas at the Kokomo facility previously used for the storage and disposal of wastes, some of which are classified as hazardous under applicable regulations. Closure certification was received in fiscal 1988 for the South Landfill at the Kokomo facility and post-closure monitoring and care is ongoing there. Closure certification was received in fiscal 1999 for the North Landfill at the Kokomo facility and post-closure monitoring and care are permitted and ongoing there. In addition, at the request of IDEM, the Company has initiated an investigation of three additional areas at the Kokomo facility. The Company has also received permits from the North Carolina Department of Environment and Natural Resources, or NCDENR to close and provide post-closure monitoring and care for the hazardous waste lagoon at its Mountain Home, North Carolina facility. The lagoon area has been closed and is currently undergoing post-closure monitoring and care. The Company is required to monitor groundwater and to continue post-closure maintenance

 

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of the former disposal areas at each site. As a result, the Company is aware of elevated levels of certain contaminants in the groundwater and additional corrective actions by the Company could be required. In addition, groundwater monitoring has begun and is ongoing on two additional solid waste management units. The Company is unable to estimate the costs of these or any further corrective action at either site, if required. Accordingly, the Company provides no assurance that the costs of any future corrective action at these or any other current former sites would not have a material effect on the Company’s financial condition, results of operations or liquidity. Additionally, it is possible that the Company could be required to undertake other corrective action commitments for any other solid waste management unit existing or determined to exist at its facilities. As a condition of the post-closure permits, the Company must provide and maintain assurances to IDEM and NCDENR of the Company’s capability to satisfy post-closure groundwater monitoring and care requirements, including possible future corrective action as necessary. The Company provides these required assurances through a statutory financial assurance test as provided by Indiana and North Carolina law.

 

As of June 30, 2008 and September 30, 2007, the Company has accrued $1,519 for post-closure monitoring and maintenance activities. In accordance with Statement of Position 96-1, Environmental Remediation Liabilities, accruals for these costs are calculated by estimating the cost to monitor and maintain each post-closure site and multiplying that amount by the number of years remaining in the 30 year post-closure monitoring period. At each fiscal year-end, or earlier if necessary, the Company evaluates the accuracy of the estimates for these monitoring and maintenance costs for the upcoming fiscal year. The accrual was based upon the undiscounted amount of the obligation of $2,377 which was then discounted using an appropriate discount rate. The cost associated with closing the sites has been incurred in financial periods prior to those presented, with the remaining cost to be incurred in future periods related solely to post-closure monitoring and maintenance. Based on historical experience, the Company estimates that the cost of post-closure monitoring and maintenance will approximate $126 per year over the remaining obligation period.

 

Note 7.  Deferred Revenue

 

On November 17, 2006, the Company entered into a twenty-year agreement to provide conversion services to Titanium Metals Corporation (“TIMET”) for up to ten million pounds (with an option for TIMET to request an additional ten million pounds) of titanium metal annually at prices established by the terms of the agreement. TIMET paid the Company a $50.0 million up-front fee and will also pay the Company for its processing services during the term of the agreement (20 years) at prices established by the terms of the agreement. The cash received of $50.0 million is being recognized in income on a straight-line basis over the 20-year term of the agreement. The portion not recognized in income will be shown as deferred revenue on the consolidated balance sheet. The Company used the proceeds, net of expenses, of the $50 million up-front fee paid by TIMET to reduce the balance of its U.S. revolving credit facility. Revenue of $1,546 and $1,875 has been recognized related to this agreement, during the nine months ended June 30, 2007 and 2008, respectively. Taxes will be paid on the up-front fee primarily in the first quarter of fiscal 2009.

 

Note 8.  Intangible Assets and Goodwill

 

Goodwill was created as a result of the Company’s reorganization pursuant to Chapter 11 of the U.S. Bankruptcy Code and fresh start accounting. The Company adopted FASB Statement No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). Pursuant to SFAS 142, goodwill is not amortized and the value of goodwill is reviewed at least annually for impairment. If the carrying value exceeds the fair value, impairment of goodwill may exist resulting in a charge to earnings to the extent of goodwill impairment. Goodwill was also created in June 2008 related to the acquisition of assets and related agreements entered into with HW Limited and its affiliated companies in Hong Kong and China, including the acquisition of office equipment and non-compete agreements. The asset acquisition and related agreements increased fixed assets by $15, increased non-compete agreements by $500 and increased goodwill by $2,485.

 

The Company also has patents, trademarks and other intangibles. As the patents have a finite life, they are amortized over lives ranging from two to fourteen years. As the trademarks have an indefinite life, the Company tests them for impairment at least annually. If the carrying value exceeds the fair value (determined by calculating a fair value based upon a discounted cash flow of an assumed royalty rate), impairment of the trademark may exist resulting in a charge to earnings to the extent of impairment. The Company has non-compete agreements with lives

 

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of two to seven years. Amortization of the patents, non-competes and other intangibles was $843, and $824 for the nine months ended June 30, 2007 and 2008, respectively.

 

Goodwill and trademarks were tested for impairment on August 31, 2007 with no impairment recognized because the fair values exceeded the carrying values. Goodwill increased $2,485 during the nine months ended June 30, 2008 due to the acquisition of assets described above.

 

The following represents a summary of intangible assets and goodwill at September 30, 2007 and June 30, 2008:

 

September 30, 2007		Gross Amount			Accumulated Amortization			Carrying Amount
Goodwill		$	41,252		$	—		$	41,252
Patents		8,667			(4,712		)	3,955
Trademarks		3,800			—			3,800
Non-compete		840			(266		)	574
Other		465			(268		)	197
		$	55,024		$	(5,246	)	$	49,778

 

June 30, 2008		Gross Amount			Accumulated Amortization			Carrying Amount
Goodwill		$	43,737		$	—		$	43,737
Patents		8,667			(5,288		)	3,379
Trademarks		3,800			—			3,800
Non-compete		1,340			(418		)	922
Other		465			(364		)	101
		$	58,009		$	(6,070	)	$	51,939

 

Estimate of Aggregate Amortization Expense:
Year Ended September 30,
2008 (remainder of fiscal year)		$	294
2009		816
2010		376
2011		363
2012		288

 

Note 9.   Net Income Per Share

 

Basic and diluted net income per share were computed as follows:

 

		Three Months Ended						Nine Months Ended
		June 30,						June 30,
(in thousands except share and per share data)		2007			2008			2007			2008
Numerator:
Net Income		$	17,741		$	17,564		$	48,329		$	46,470
Denominator:
Weighted average shares outstanding - Basic		11,650,000			11,921,541			10,616,484			11,882,929
Effect of dilutive stock options		263,310			123,712			365,025			130,863
Weighted average shares outstanding - Diluted		11,913,310			12,045,253			10,981,509			12,013,792
Basic net income per share		$	1.52		$	1.47		$	4.55		$	3.91
Diluted net income per share		$	1.49		$	1.46		$	4.40		$	3.87
Number of shares excluded as their effect would be anti-dilutive		126,000			256,000			84,000			214,333

 

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Weighted average shares outstanding increased due to the equity offering in the second quarter of fiscal 2007 and the exercise of stock options. Anti-dilutive shares with respect to outstanding stock options have been excluded from the computation of diluted net income per share.

 

Note 10.  Stock-Based Compensation

 

The Company has two stock option plans that authorize the granting of non-qualified stock options to certain key employees and non-employee directors for the purchase of a maximum of 1,500,000 shares of the Company’s common stock. The original option plan was adopted in August 2004 pursuant to the plan of reorganization and provides for the grant of options to purchase up to 1,000,000 shares of the Company’s common stock. In January 2007, the Company’s Board of Directors adopted a second option plan that provides for options to purchase up to 500,000 shares of the Company’s common stock. Each plan provides for the adjustment of the maximum number of shares for which options may be granted in the event of a stock split, extraordinary dividend or distribution or similar recapitalization event. Unless the Compensation Committee determines otherwise, options granted under the option plans are exercisable for a period of ten years from the date of grant and vest 33 1/3% per year over three years from the grant date.

 

The fair value of the option grants was estimated as of the date of the grant pursuant FASB Statement No. 123 (R), Share-Based Payment, a replacement of SFAS No. 123, Accounting For Stock-Based Compensation, and rescission of APB Opinion No. 25, Accounting for Stock Issued to Employees (“SFAS 123(R)”), using the Black-Scholes option pricing model with the following assumptions:

 

Grant Date		Fair Value			Dividend Yield		Risk-free Interest Rate		Expected Volatility		Expected Life
March 30, 2007		$	19.06		0	%	4.54	%	30.00	%	3 years
September 1, 2007		$	21.42		0	%	4.16	%	30.00	%	3 years
March 31, 2008		$	16.41		0	%	1.88	%	42.00	%	3 years

 

On March 31, 2008, the Company granted 130,000 options at an exercise price of $54.00, the fair market value of the Company’s common stock on the day prior to the date of the grant. During the first quarter of fiscal 2008, 98,073 options were exercised which generated $1,255 cash to the Company and increased the shares of common stock outstanding by 98,073 shares. During the second quarter of fiscal 2008, 4,100 options were exercised which generated $52 cash to the Company and increased the shares of common stock outstanding by 4,100 shares.  During the third quarter of fiscal 2008, 44,356 options were exercised which generated $631 cash to the company and increased shares of common stock outstanding by 44,356.

 

The stock-based employee compensation expense for the three and nine months ended June 30, 2008 was $515 ($307 net of tax or $0.03 per fully diluted share) and $1,216 ($725 net of tax or $0.06 per fully diluted share), respectively, leaving remaining unrecognized compensation expense at June 30, 2008 of $3,676 to be recognized over a weighted average period vesting of 1.74 years. The stock-based employee compensation expense for the three and nine months ended June 30, 2007 was $933 ($556 net of tax or $0.05 per fully diluted share) and $2,359 ($1,404 net of tax or $0.13 per fully diluted share), respectively.

 

The following table summarizes the activity under the stock option plans for the nine months ended June 30, 2008:

 

		Number of Shares		Weighted Average Exercise Price			Weighted Average Remaining Contractual Life		Aggregate Intrinsic Value
Outstanding at September 30, 2007		503,763		$	30.52
Granted		130,000		54.00
Forfeited		(5,000	)	72.93
Exercised		(146,529	)	12.33
Outstanding at June 30, 2008		482,234		$	39.35		8.00 Years		$	9,653,037
Vested or expected to vest		482,234		$	41.66		8.00 Years		$	9,653,037
Exercisable at June 30, 2008		228,223		$	25.25		6.79 Years		$	7,371,471

 

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		Outstanding							Exercisable
Grant Date		Number of Shares		Exercise Price Per Share			Remaining Contractual Life in Years		Number of Shares		Exercise Price Per Share
August 31, 2004		157,899		$	12.80		6.17		157,899		$	12.80
May 5, 2005		8,334		19.00			6.83		8,334		19.00
August 15, 2005		11,667		20.25			7.17		—		20.25
October 1, 2005		5,000		25.50			7.25		—		25.50
February 21, 2006		33,334		29.25			7.67		16,666		29.25
March 31, 2006		10,000		31.00			7.75		5,000		31.00
March 30, 2007		121,000		72.93			8.75		40,324		72.93
September 1, 2007		5,000		83.53			9.17		—		83.53
March 31, 2008		130,000		54.00			9.75		—		54.00
		482,234							228,223

 

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Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

References to years or portions of years in Management’s Discussion and Analysis of Financial Condition and Results of Operations refer to the Company’s fiscal years ended September 30, unless otherwise indicated.

 

This discussion contains statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  Those statements appear in a number of places in this discussion and may include, but are not limited to, statements regarding the intent, belief or current expectations of the Company or its management with respect to, but are not limited to (i) the Company’s strategic plans; (ii) any significant change in customer demand for its products or in demand for its customers’ products; (iii) the Company’s dependence on production levels at its Kokomo facility and its ability to make capital improvements at that facility, including the effects of planned equipment downtime; (iv) rapid increases in the cost of nickel, energy and other raw materials; (v) the Company’s ability to continue to develop new commercially viable applications and products; (vi) the Company’s ability to recruit and retain key employees; (vii) the Company’s ability to comply, and the costs of compliance, with applicable environmental laws and regulations; (viii) economic and market risks associated with foreign operations and U.S. and world economic and political conditions; and (ix) increased competition in the Company’s markets from the Company’s competitors who produce both high-performance alloys and stainless steel. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties.  Actual results may differ materially from those in the forward-looking statements as a result of various factors, many of which are beyond the control of the Company.

 

The Company has based these forward-looking statements on its current expectations and projections about future events.  Although the Company believes that the assumptions on which the forward-looking statements contained herein are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based upon those assumptions also could be incorrect.  Risks and uncertainties, some of which are discussed in Item 1A. of Part 1 to the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2007, and in Part II, Item 1A of the Company’s Form 10-Q for the fiscal quarter ended March 31, 2008 may affect the accuracy of forward-looking statements.

 

The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

Overview

 

Business: Haynes International, Inc. (“Haynes” or “the Company”) is one of the world’s largest producers of high-performance nickel- and cobalt-based alloys in sheet, coil and plate forms. The Company is focused on developing, manufacturing, marketing and distributing technologically advanced, high-performance alloys, which are used primarily in the aerospace, chemical processing and land-based gas turbine industries. The global specialty alloy market consists of three primary sectors: stainless steel, general purpose nickel alloys and high-performance nickel- and cobalt-based alloys. Except for its stainless wire products, the Company competes exclusively in the high-performance nickel- and cobalt-based alloy sector, which includes high temperature resistant alloys, or HTA products, and corrosion resistant alloys, or CRA products. The Company believes it is one of four principal producers of high-performance alloys in sheet, coil and plate forms. The Company also produces its products as seamless and welded tubulars, and in bar, billet and wire forms.

 

The Company has manufacturing facilities in Kokomo, Indiana; Arcadia, Louisiana; and Mountain Home, North Carolina. The Kokomo facility specializes in flat products, the Arcadia facility specializes in tubular products and the Mountain Home facility specializes in high-performance alloy wire products. The Company sells its products primarily through its direct sales organization, which includes 11 service and/or sales centers in the United States, Europe, Asia and India. All of these centers are Company-operated.

 

Key Events: As the Company previously announced on April 4, 2008, Francis Petro informed the Board of his intention to retire as the Company’s President and Chief Executive Officer at the end of his existing employment agreement on September 30, 2008 and to continue to serve as a member of the Board of Directors. The Board then

 

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retained Spencer Stuart, an executive search firm, to conduct a national search for a new Chief Executive Officer. Mr. Petro continues to assist the Corporate Governance Committee in the search for his successor.

 

On June 2, 2008 the Company announced the expansion of its relationship with HW Limited and its affiliated companies in Hong Kong and China for sales of Haynes products throughout Asia. Under the terms of the new long-term consulting agreement and the related acquisition of assets, which became effective on June 1, Haynes’ sales and marketing presence in Asia will be greatly expanded. The sales force of HW Limited’s Chinese affiliate will be integrated into the Haynes operations in China expanding Haynes’ direct sales organization by eight people, which Haynes believes will lead to a more effective organization. In addition to overseeing this expanded organization, HW Limited’s principal, Helen Wang will promote Haynes’ products and services to customers in select markets in Asia, including China, Taiwan, South Korea, Singapore, Thailand, Laos, Malaysia, Vietnam, Indonesia, Cambodia, Philippines, Australia, and New Zealand. This consulting arrangement is one component of the Company’s continued campaign to grow its market presence in China and the rest of Asia. The asset acquisition and related agreements increased fixed assets $15, increased non-compete agreement by $500 and increased goodwill by $2,485.

 

The installation of the equipment for the upgrade of the second annealing line was completed on schedule in the third quarter of fiscal 2008. Throughout July, start-up and certification activities have been taking place and intermediate material has been successfully processed on the upgraded equipment. It is expected that the final survey of the equipment will be completed in early August 2008.  This completes the process of debottlenecking the sheet finishing operations and will enable the Company to take full advantage of previous capital improvements which improve operating performance in the form of increased capacity, reduced operating cost and improved working capital management.

 

Market Conditions:  Generally, demand in the Company’s markets remains strong and the Company saw improving results in both net revenue and gross profit margin as a percentage of net revenue in the third quarter of fiscal 2008. Management believes that the improving results were positively driven by several strategies. First, with demand in all markets strong and capacity limited, the Company carefully considers which types of projects to pursue in a given market to ensure the best margins are obtained. The Company’s focus is growing capacity, while continuing to sell the highest volumes into the applications which provide the highest margins. This can be seen particularly in the chemical processing and flue-gas desulphurization markets which can appear weak in certain quarters not always as a reflection of demand in the market, but as a result of the Company’s strategy to seek out higher-volume, higher-margin forms and alloys for project business which can be cyclical. In addition, the Company has continued to diversify its market base, expanding the industries served in the “Other Markets” category and also diversifying geographically, focusing on its presence in China and the rest of Asia. Finally, the Company looks to expand volumes through its capital upgrades. All of these strategies are intended to optimize returns and strengthen financial results.

 

Aerospace demand continues to be robust, as illustrated by the Company’s high level of sales in this market to date in fiscal 2008.  Haynes is well positioned to continue meeting current levels of demand and the anticipated increased level of demand in the latter part of fiscal 2009.  Projects supporting this growth include the completion of upgrades to the Company’s cold rolling mill in fiscal 2007 and both annealing lines in fiscal 2008 (which increased flat product finishing capacity by five million pounds), the installation of a new pilger mill at the Arcadia facility, also in fiscal 2008 (which increased capacity of seamless tubing), and continued expansion of the value-added operations in our service centers. The Company’s level of order entry and backlog also indicates that demand in the aerospace market continues to be strong.

 

While pounds shipped in the land-based gas turbine market in the third quarter of fiscal 2008 were down slightly from the previous quarter, order entry and backlog continue to be strong and the Company does not believe demand in this market has materially slowed. Management expects demand in the land-based gas turbine market to continue to be favorable, subject to world economic conditions, due to higher activity in power generation, oil and gas production, and alternative power systems application. Land-based gas turbines are favored in electric generating facilities due to low capital cost at installation, flexibility in use of alternative fuels and fewer SO2 emissions than the traditional fossil fuel-fired facilities.

 

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Although sales to the chemical processing industry were strong in the third quarter of fiscal 2008, the Company has seen some erosion in order entry in this market.  Although some cyclicality as a result of project business is expected in this market from quarter to quarter, historically the chemical processing industry slows as a result of an overall economic slowdown as seen in recent quarters.  It remains to be seen whether the slower rate of order entry is the result of a temporary dip in project business or a longer-term trend resulting from the economic environment.

 

The Company also continues its efforts to expand volumes sold into the industries which make up the “Other Markets” category. The industries in this category continue to seek to upgrade overall quality, improve product performance through increased efficiency, prolong product life, and lower long-term costs. Companies in these industries are looking to achieve these goals through the use of “Advanced Materials” which supports the increased use of high performance alloys in an expanding number of applications and industries. Due to non-repeating flue gas desulphurization projects, volume was lower in the third quarter of fiscal 2008, but overall management continues to see strength in the markets in this category.

 

Competition and Gross Profit: Beginning at the end of the second quarter and continuing through the fourth quarter of fiscal 2007, the Company experienced a trend of increasing revenues and average selling price per pound, while gross profit as a percentage of net revenues declined. During the first quarter of fiscal 2008, net revenue and average selling price per pound began to decline along with further erosion in gross profit as a percentage of net revenues. Compared to the first quarter of fiscal 2008, net revenue increased in the second quarter, but average selling price per pound and gross profit as a percentage of net revenue continued to decline.  The decline in gross profit as a percentage of net revenue from the first quarter to the second quarter should be analyzed in light of the fact that the first quarter of fiscal 2008 included a one-time benefit of $3.7 million related to the pension curtailment gain.  Adjusting for this gain, the gross profit as a percent of net revenue improved in the second quarter when compared to the first quarter. Although gross profit in the third quarter of fiscal 2008 is lower than the same period in fiscal 2007, it showed improvement over the second quarter of fiscal 2008.  We believe this continued quarter to quarter improvement shows a trend of increasing net revenue and improving gross profit as a percentage of net revenue, even as the average selling price declined as compared to the previous quarter.

 

The largest contributing factor to gross profits which are lower as a percentage of revenue compared to the same periods in fiscal 2007 is increased price competition. Starting in the third quarter of fiscal 2007, the Company experienced increasing competition from competitors who produce both stainless steel and high-performance alloys.  Due to a slowing stainless steel market, management believes these competitors increased their production levels and sales activity in high-performance alloys to keep capacity in their mills as full as possible, while offering very competitive prices and delivery times.  As a result of this competition, the Company’s ability to raise prices on certain products was limited in the five most recent fiscal quarters.  Historically, the Company experienced similar price competition in the 1990’s and in the early 2000’s, when demand in the stainless market weakened.

 

This competition should soften as the stainless market improves, however, American Metals Market reported in April 2008 that uncertainty as to the strengthening of the stainless market continues to exist. This could indicate that the recovery in the stainless market may take longer than anticipated or that the stainless market may continue to deteriorate.  We believe, however, that we continue to improve our ability to respond to the competition as a result of our increased emphasis on service centers, our value-added services and our improving cost structure which has resulted from our capital expenditure program.  We also believe that with the completion of the upgrade to the second annealing line, the Company’s delivery-times and reliability will improve starting in the fourth fiscal quarter.

 

Capital Spending:  Beginning in fiscal 2006, the Company began making significant investments in order to increase capacity in its sheet finishing operations, including upgrades to its cold rolling mill and one of two annealing lines, which were completed in fiscal 2007.  The first phase of upgrades to the second annealing line was completed in the second quarter of fiscal 2008, and the second phase of these upgrades was completed in the third quarter of fiscal 2008, with final testing and survey of the equipment in the fourth quarter. These upgrades to the sheet finishing operations have increased the production capacity for high-performance alloys in sheet form from 9.0 million pounds per year to 14.0 million pounds per year. The Company’s objective is to produce and sell 23.5 million pounds of high-performance alloys by no later than fiscal 2010 and possibly as early as fiscal 2009. With the completion of the upgrades to sheet finishing capacity and along with other capital upgrades since fiscal 2005, management is in the process of evaluating the positive impact of all these upgrades on total high-performance alloy

 

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capacity across all product forms.   It is believed that the upgrades may allow the Company to produce high-performance alloy volume in excess of the original estimate of 23.5 million pounds. In addition, management believes that completion of these upgrades will have a positive impact on gross profit as a percentage of net revenue, which has been negatively impacted by production downtime as a result of planned equipment upgrades.

 

Quarterly Market Information

 

Set forth below is selected data relating to the Company’s backlog, the 30-day average nickel price per pound as reported by the London Metals Exchange, as well as a breakdown of net revenues, shipments and average selling prices to the markets served by the Company for the periods shown. These data should be read in conjunction with the consolidated financial statements and related notes thereto and the remainder of the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Form 10-Q.

 

		Quarter Ended
		December 31, 2006			March 31, 2007			June 30,  2007			September 30, 2007			December 31, 2007			March 31, 2008			June 30, 2008
Backlog(1)
Dollars (in thousands)		$	206,859		$	237,589		$	258,867		$	236,256		$	247,775		$	254,470		$	252,598
Pounds (in thousands)		7,575			8,454			8,551			7,397			8,274			8,706			8,335
Average selling price per pound		$	27.31		$	28.10		$	30.27		$	31.94		$	29.95		$	29.23		$	30.30
Average nickel price per pound
London Metals Exchange (2)		$	15.68		$	21.01		$	18.92		$	13.40		$	12.11		$	14.16		$	10.23

 

⁽¹⁾     The Company defines backlog to include firm commitments from customers for delivery of product at established prices. Approximately 30% of the orders in the backlog at any given time include prices that are subject to adjustment based on changes in raw material costs. Historically, approximately 75% of the backlog orders have shipped within six months and approximately 90% have shipped within 12 months. The backlog information does not reflect that portion of the business conducted at service and sales centers on a spot or “just-in-time” basis.

 

⁽²⁾     Represents the average price for a cash buyer as reported by the London Metals Exchange for the 30 days ending on the last day of the period presented.

 

		Quarter Ended
		December 31, 2006			March 31, 2007			June 30, 2007			September 30, 2007			December 31, 2007			March 31, 2008			June 30, 2008
Net revenues (in thousands)
Aerospace		$	43,827		$	48,232		$	55,317		$	63,796		$	59,442		$	63,472		$	62,857
Chemical processing		38,778			37,701			31,495			39,986			40,805			37,404			49,165
Land-based gas turbines		20,076			27,993			26,812			28,120			25,505			33,506			31,004
Other markets		15,671			20,352			24,598			25,638			18,887			26,085			18,811
Total product revenue		118,352			134,278			138,222			157,540			144,639			160,467			161,837
Other revenue(1)		2,111			3,058			2,865			3,410			1,438			3,304			4,503
Net revenues		$	120,463		$	137,336		$	141,087		$	160,950		$	146,077		$	163,771		$	166,340
Pounds by markets (in thousands)
Aerospace		1,780			1,701			1,973			2,206			2,154			2,190			2,319
Chemical processing		1,479			1,322			1,082			1,238			1,312			1,287			1,649
Land-based gas turbines		1,144			1,382			1,256			1,311			1,060			1,742			1,519
Other markets(2)		1,053			1,320			1,538			923			681			861			732
Total shipments		5,456			5,725			5,849			5,678			5,207			6,080			6,219
Average selling price per pound
Aerospace		$	24.62		$	28.36		$	28.04		$	28.92		$	27.60		$	28.98		$	27.11
Chemical processing		26.22			28.52			29.11			32.30			31.10			29.06			29.82
Land-based gas turbines		17.55			20.26			21.35			21.45			24.06			19.23			20.41
Other markets		14.88			15.42			15.99			27.78			27.73			30.30			25.70
Total product (excluding other revenue)		21.69			23.45			23.63			27.75			27.78			26.39			26.03
Total average selling price (including other revenue)		22.08			23.99			24.12			28.35			28.05			26.94			26.75

 

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