HAYNES INTERNATIONAL INC - Quarter Report: 2011 December (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

(Mark One)

 

 

For the quarterly period ended December 31, 2011

 

or

 

 

For the transition period from                     to                   

 

Commission File Number:  001-33288

 

HAYNES INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code (765) 456-6000

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

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 has submitted electronically and posted on its corporate Website, if any, every 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  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.

 

 

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

 

As of February 1, 2012, the registrant had 12,286,596 shares of Common Stock, $.001 par value, outstanding.

 

 

Table of Contents

 

HAYNES INTERNATIONAL, INC. and SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

 

		Page
PART I	FINANCIAL INFORMATION
Item 1.	Unaudited Condensed Consolidated Financial Statements
	Haynes International, Inc. and Subsidiaries:
	Unaudited Consolidated Balance Sheets as of September 30, 2011 and December 31, 2011	1
	Unaudited Consolidated Statements of Operations for the Three Months Ended December 31, 2010 and 2011	2
	Unaudited Consolidated Statements of Comprehensive Income (Loss) for the Three Months Ended December 31, 2010 and 2011	3
	Unaudited Consolidated Statements of Cash Flows for the Three Months Ended December 31, 2010 and 2011	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	21
Item 4.	Controls and Procedures	22
PART II	OTHER INFORMATION
Item 6.	Exhibits	23
	Signatures	24
	Index to Exhibits	25

 

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PART 1        FINANCIAL INFORMATION

 

Item 1.     Financial Statements

HAYNES INTERNATIONAL, INC. and SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands, except share and per share data)

 

		September 30, 2011			December 31, 2011
ASSETS
Current assets:
Cash and cash equivalents		$	60,062		$	54,363
Accounts receivable, less allowance for doubtful accounts of $1,129 and $1,125 respectively		87,680			78,652
Inventories		250,051			269,316
Income taxes receivable		2,573			178
Deferred income taxes		9,341			10,028
Other current assets		1,728			2,861
Total current assets		411,435			415,398
Property, plant and equipment, net		110,678			114,437
Deferred income taxes—long term portion		65,113			63,594
Prepayments and deferred charges		2,903			2,463
Intangible assets, net		6,440			6,328
Total assets		$	596,569		$	602,220
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	49,086		$	46,672
Accrued expenses		19,698			22,739
Revolving credit facility		—			—
Accrued pension and postretirement benefits		21,390			21,930
Deferred revenue—current portion		2,500			2,500
Current maturities of long-term obligations		—			—
Total current liabilities		92,674			93,841
Long-term obligations (less current portion)		1,348			1,348
Deferred revenue (less current portion)		35,329			34,704
Non-current income taxes payable		323			323
Accrued pension and postretirement benefits		194,042			192,188
Total liabilities		323,716			322,404
Commitments and contingencies (Note 6)		—			—
Stockholders’ equity:
Common stock, $0.001 par value (40,000,000 shares authorized, 12,204,179 and 12,286,596 shares issued and outstanding at September 30, 2011 and December 31, 2011, respectively)		12			12
Preferred stock, $0.001 par value (20,000,000 shares authorized, 0 shares issued and outstanding)		—			—
Additional paid-in capital		231,842			233,739
Accumulated earnings		124,047			129,799
Accumulated other comprehensive loss		(83,048		)	(83,734		)
Total stockholders’ equity		272,853			279,816
Total liabilities and stockholders’ equity		$	596,569		$	602,220

 

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 December 31,
		2010			2011
Net revenues		$	106,351		$	128,851
Cost of sales		88,482			105,360
Gross profit		17,869			23,491
Selling, general and administrative expense		9,120			9,816
Research and technical expense		753			765
Operating income		7,996			12,910
Interest income		(80		)	(62		)
Interest expense		29			26
Income before income taxes		8,047			12,946
Provision for income taxes		2,791			4,503
Net income		$	5,256		$	8,443
Net income per share:
Basic		$	0.44		$	0.69
Diluted		$	0.43		$	0.68
Dividend declared per common share		$	0.20		$	0.22

 

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 (LOSS)

(Unaudited)

(in thousands)

 

		Three Months Ended December 31
		2010			2011
Net income		$	5,256		$	8,443
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment		206			(686		)
Comprehensive income		$	5,462		$	7,757

 

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)

 

		Three Months Ended December 31,
		2010			2011
Cash flows from operating activities:
Net income		$	5,256		$	8,443
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation		2,766			2,982
Amortization		137			112
Stock compensation expense		380			460
Excess tax benefit from option exercises		(5		)	(616		)
Deferred revenue		(625		)	(625		)
Deferred income taxes		2,089			638
Loss on disposal of property		10			10
Change in assets and liabilities:
Accounts receivable		4,659			8,653
Inventories		(12,262		)	(19,612		)
Other assets		(425		)	(713		)
Accounts payable and accrued expenses		(698		)	1,497
Income taxes		69			3,183
Accrued pension and postretirement benefits		(1,727		)	(1,315		)
Net cash provided by (used in) operating activities		(376		)	3,097
Cash flows from investing activities:
Additions to property, plant and equipment		(3,403		)	(7,350		)
Change in restricted cash		110			—
Net cash used in investing activities		(3,293		)	(7,350		)
Cash flows from financing activities:
Dividends paid		(2,436		)	(2,691		)
Proceeds from exercise of stock options		19			821
Excess tax benefit from option exercises		5			616
Changes in long-term obligations		(109		)	—
Net cash used in financing activities		(2,521		)	(1,254		)
Effect of exchange rates on cash		53			(192		)
Decrease in cash and cash equivalents		(6,137		)	(5,699		)
Cash and cash equivalents, beginning of period		63,968			60,062
Cash and cash equivalents, end of period		$	57,831		$	54,363
Supplemental disclosures of cash flow information:
Cash paid during period for:
Interest (net of capitalized interest)		$	2		$	9
Income taxes paid (net of refunds)		$	602		$	693
Capital expenditures incurred but not yet paid		$	470		$	1,027

 

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 condensed interim 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, 2011 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 related to interim financial statements. 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 months ended December 31, 2011 are not necessarily indicative of the results to be expected for the full fiscal year ending September 30, 2012 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.

 

Note 2.          New Accounting Pronouncements

 

No new accounting pronouncements applicable to the Company were issued in the first quarter of fiscal 2012.

 

Note 3.          Inventories

 

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

 

		September 30, 2011			December 31, 2011
Raw Materials		$	22,430		$	31,740
Work-in-process		136,227			129,504
Finished Goods		90,386			107,033
Other		1,008			1,039
		$	250,051		$	269,316

 

Note 4.          Income Taxes

 

Income tax expense for the three months ended December 31, 2010 and 2011, 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 three months ended December 31, 2011 was 34.8% compared to 34.7% in the same period of fiscal 2011.

 

Note 5.          Pension and Post-retirement Benefits

 

Components of net periodic pension and post-retirement benefit cost for the three months ended December 31, 2010 and 2011 are as follows:

 

		Three Months Ended December 31,
		Pension Benefits						Other Benefits
		2010			2011			2010			2011
Service cost		$	903		$	1,000		$	66		$	73
Interest cost		3,174			2,676			1,172			1,145
Expected return		(3,405		)	(2,666		)	—			—
Amortizations		1,831			2,449			(770		)	(748		)
Net periodic benefit cost		$	2,503		$	3,459		$	468		$	470

 

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The Company contributed $3,840 to Company sponsored domestic pension plans, $1,143 to its other post-retirement benefit plans and $237 to the U.K. pension plan for the three months ended December 31, 2011.  The Company presently expects future contributions of $12,060 to its domestic pension plans, $3,857 to its other post-retirement benefit plans and $698 to the U.K. pension plan for the remainder of fiscal 2012.

 

Note 6. Legal, Environmental and Other Contingencies

 

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 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, 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 to be found liable, the cases would not have a material effect on its financial position, 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, IN 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 fiscal 2007, IDEM issued a single post-closure permit applicable to both the North and South Landfills, which contains monitoring and post-closure care requirements. In addition, IDEM required that a Resource Conservation and Recovery Act, or RCRA, Facility Investigation, or RFI, be conducted in order to further evaluate one area of concern and one solid waste management unit. The RFI commenced in fiscal 2008 and is ongoing.

 

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 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 action by the Company could be required.

 

As of September 30, 2011 and December 31, 2011, the Company has accrued $1,469 for post-closure monitoring and maintenance activities. 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 referred to above. 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 $1,766 which was then discounted using an appropriate discount rate.

 

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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 of titanium metal annually. TIMET paid the Company a $50,000 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.  TIMET may exercise an option to have ten million additional pounds of titanium converted annually, provided that it offers to loan up to $12,000 to the Company for certain capital expenditures which may be required to expand capacity.  In addition to the volume commitment, the Company has granted TIMET a security interest in its four-high steckel rolling mill, along with rights of access if the Company enters into bankruptcy or defaults on any financing arrangements.  The Company has agreed not to manufacture titanium products (other than cold reduced titanium tubing).  The Company has also agreed not to provide titanium conversion services to any entity other than TIMET for the term of the Conversion Services Agreement.  The agreement contains certain default provisions which could result in contract termination and damages, including the Company being required to return the unearned portion of the upfront fee.  The cash received of $50,000 is recognized in income on a straight-line basis over the 20-year term of the agreement. The portion of the upfront fee not recognized in income is shown as deferred revenue on the consolidated balance sheet.

 

Note 8.    Intangible Assets

 

The Company has patents, trademarks and other intangibles. As the patents have a definite 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 the impairment. The Company has non-compete agreements with lives of 5 to 7 years. Amortization of the patents, non-competes and other intangibles was $137 and $112 for the three months ended December 31, 2010 and 2011, respectively.

 

The following represents a summary of intangible assets at September 30, 2011 and December 31, 2011:

 

September 30, 2011		Gross Amount			Accumulated Amortization			Carrying Amount
Patents		$	8,667		$	(6,612	)	$	2,055
Trademarks		3,800			—			3,800
Non-compete		1,090			(820		)	270
Other		646			(331		)	315
		$	14,203		$	(7,763	)	$	6,440

 

December 31, 2011		Gross Amount			Accumulated Amortization			Carrying Amount
Patents		$	8,667		$	(6,682	)	$	1,985
Trademarks		3,800			—			3,800
Non-compete		1,090			(846		)	244
Other		330			(31		)	299
		$	13,887		$	(7,559	)	$	6,328

 

Estimate of Aggregate Amortization Expense: Year Ended September 30,
2012 (remainder of fiscal year)		311
2013		416
2014		416
2015		394
2016		330

 

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Note 9.   Net Income Per Share

 

The Company accounts for earnings per share using the two-class method. The two-class method is an earnings allocation that determines net income per share for each class of common stock and participating securities according to participation rights in undistributed earnings. Non-vested restricted stock awards that include non-forfeitable rights to dividends are considered participating securities. Per share amounts are computed by dividing net income attributable to common shareholders by the weighted average shares outstanding during each period. Basic earnings per share is computed by dividing net income available to common stockholders for the period by the weighted average number of common shares outstanding for the period. The computation of diluted earnings per share is similar to basic earnings per share, except the denominator is increased to include the number of additional common shares that would have been outstanding if the potentially dilutive common shares had been issued.

 

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

 

		Three Months Ended December 31,
(in thousands, except share and per share data)		2010			2011
Numerator:
Net income		$	5,256		$	8,443
Less amount allocable to participating securities		—			(108		)
Net income available for basic shareholders		5,256			8,335
Adjustment for dilutive potential common shares		—			1
Net income available for diluted common shares		$	5,256		$	8,336
Denominator:
Weighted average shares - Basic		12,049,976			12,095,599
Adjustment for dilutive potential common shares		147,786			84,402
Weighted average shares - Diluted		12,197,762			12,180,001
Basic net income per share		$	0.44		$	0.69
Diluted net income per share		$	0.43		$	0.68
Number of stock option shares excluded as their effect would be anti-dilutive		214,960			80,380

 

Anti-dilutive shares with respect to outstanding stock options have been properly excluded from the computation of diluted net income per share.

 

Note 10.  Stock-Based Compensation

 

Restricted Stock Plan

 

On February 23, 2009, the Company adopted a restricted stock plan that reserved 400,000 shares of common stock for issuance.  Grants of restricted stock are rights to acquire shares of the Company’s common stock, which vest in accordance with the terms and conditions established by the Compensation Committee.  The Compensation Committee may set restrictions on certain grants based on the achievement of specific performance goals and vesting of grants to participants will also be time-based.

 

Restricted stock grants are subject to forfeiture if employment or service terminates prior to the end of the vesting period or if the performance goal is not met, if applicable.  The Company will assess, on an ongoing basis, the probability of whether the performance criteria will be achieved. The Company will recognize compensation expense over the performance period if it is deemed probable that the goal will be achieved. The fair value of the Company’s restricted stock is determined based upon the closing price of the Company’s common stock on the grant date. The plan provides for the adjustment of the number of shares covered by an outstanding grant and the maximum number of shares of restricted stock that may be granted under the plan in the event of a stock split, extraordinary dividend or distribution or similar recapitalization event.  Outstanding shares of restricted stock are entitled to receive dividends on shares of common stock.

 

On November 25, 2011 and December 8, 2011, the Company granted 27,600 and 3,000 shares respectively, of

 

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restricted stock to certain key employees and non-employee directors. The shares of restricted stock granted to employees will vest on the third anniversary of their grant date, provided that (a) the recipient is still an employee with the Company and (b) the Company has met a three year net income performance goal if applicable. The shares of restricted stock granted to directors will vest on the earlier of (a) the third anniversary of the date of grant or (b) the failure of such non-employee director to be re-elected at an annual meeting of the stockholders of the Company as a result of such non-employee director being excluded from the nominations for any reason other than cause. The fair value of the grants were $55.88 and $58.64, respectively, the closing price of the Company’s common stock on the day of the grant.

 

The following table summarizes the activity under the restricted stock plan for the three months ended December 31, 2011:

 

		Number of Shares		Weighted Average Fair Value At Grant Date
Unvested at September 30, 2011		126,000		$	29.86
Granted		30,600		$	56.15
Forfeited / Canceled		—
Vested		—
Unvested at December 31, 2011		156,600		$	35.00
Expected to vest		131,000		$	38.35

 

Compensation expense related to restricted stock for the three months ended December 31, 2010 and 2011 was $179 and $323, respectively. The remaining unrecognized compensation expense at December 31, 2011 was $3,131 to be recognized over a weighted average period of 2.25 years. Compensation expense is not being recorded on the March 31, 2009 grant of 25,600 shares granted to employees as the performance goal was not achieved and the shares will be forfeited on March 31, 2012.

 

Stock Option Plans

 

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 option grants was estimated as of the date of the grant. The Company has elected to use the Black-Scholes option pricing model, which incorporates various assumptions including volatility, expected life, risk-free interest rates, expected forfeitures and dividend yields. The volatility is based on historical volatility of the Company’s common stock over the most recent period commensurate with the estimated expected term of the stock option granted. The Company uses historical volatility because management believes such volatility is representative of prospective trends. The expected term of an award is based on historical exercise data. The risk-free interest rate assumption is based upon observed interest rates appropriate for the expected term of the awards. The expected forfeiture rate is based upon historical experience. The dividend yield assumption is based on the Company’s history and expectation regarding dividend payouts at the time of the grant.  Valuation of future grants under the Black-Scholes model will include a dividend yield. The following assumptions were used for grants in the first quarter of fiscal 2012:

 

Grant Date		Fair Value			Dividend Yield		Risk-free Interest Rate		Expected Volatility		Expected Life
November 25, 2011		$	23.91		1.58	%	0.40	%	69	%	3 years

 

On November 25, 2011, the Company granted 23,200 options at an exercise price of $55.88, the fair market value of the

 

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Company’s common stock the day of the grant. During the first quarter of fiscal 2012, options exercised were 51,817 options and 0 options were forfeited/canceled.

 

The stock-based employee compensation expense for stock options for the three months ended December 31, 2010 and 2011 was $201 and $137, respectively.  The remaining unrecognized compensation expense at December 31, 2011 was $1,025, to be recognized over a weighted average vesting period of 1.45 years.

 

The following table summarizes the activity under the stock option plans for the three months ended December 31, 2011:

 

		Number of Shares		Aggregate Intrinsic Value (000s)			Weighted Average Exercise Prices			Weighted Average Remaining Contractual Life
Outstanding at September 30, 2011		373,187					$	38.53
Granted		23,200					$	55.88
Exercised		(51,817	)				$	15.85
Canceled		—
Outstanding at December 31, 2011		344,570		$	5,080		$	43.11		6.30 yrs.
Vested or expected to vest		329,675		$	5,080		$	43.11		6.30 yrs.
Exercisable at December 31, 2011		264,465		$	3,752		$	44.54		5.61 yrs.

 

Grant Date		Exercise Price Per Share			Remaining Contractual Life in Years		Outstanding Number of Shares		Exercisable Number of Shares
August 31, 2004		$	12.80		2.67		47,569		47,569
March 31, 2006		31.00			4.25		10,000		10,000
March 30, 2007		72.93			5.25		59,500		59,500
March 31, 2008		54.00			6.25		81,000		81,000
October 1, 2008		46.83			6.75		20,000		20,000
March 31, 2009		17.82			7.25		42,401		26,102
January 8, 2010		34.00			8.00		35,000		11,664
November 24, 2010		40.26			8.92		25,900		8,630
November 25, 2011		55.88			9.92		23,200		—
							344,570		264,465

 

Note 11.    Dividend

 

In the first quarter of fiscal 2012, the Company declared and paid a quarterly cash dividend. The dividend of $0.22 per outstanding share of the Company’s common stock was paid December 15, 2011 to stockholders of record at the close of business on December 1, 2011.  The dividend cash pay-out was $2,691 for the quarter based on the number of shares outstanding.

 

On February 2, 2012, the Company announced that the Board of Directors declared a regular quarterly cash dividend of $0.22 per outstanding share of the Company’s common stock.  The dividend is payable March 15, 2012 to stockholders of record at the close of business on March 1, 2012.

 

Note 12.  Fair Value Measurements

 

The Company applies the fair value approach as established in ASC 820, Fair Value Measurement.  This guidance establishes a framework for measuring fair value, clarifies the definition of fair value within that framework and expands disclosures about the use of fair value measurements.  Fair value is defined 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. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability.

 

This guidance specifies a hierarchy of valuation techniques based upon whether the inputs to those valuation techniques reflect assumptions that other market participants would use based upon market data obtained from

 

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independent sources (observable inputs) or reflect the Company’s own assumptions of market participant valuation (unobservable inputs). Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy prioritizes the use of inputs used in valuation techniques into the following three levels:

 

·		Level 1 — Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities;
·		Level 2 — Quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets and liabilities in active markets or financial instruments for which significant inputs are observable, either directly or indirectly; and
·		Level 3 — Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

 

When available, the Company uses unadjusted quoted market prices to measure fair value and classifies such items within Level 1. If quoted market prices are not available, fair value is based upon internally-developed models that use, where possible, current market-based or independently-sourced market parameters such as interest rates and currency rates. Items valued using internally-generated models are classified according to the lowest level input or value driver that is significant to the valuation. If quoted market prices are not available, the valuation model used depends on the specific asset or liability being valued. A portion of the Company’s pension plan assets are in a common collective trust that is considered within level 2.  To determine the fair value of these assets, the Company uses the quoted market prices of the underlying assets of the common collective trust.

 

The following table represents the Company’s fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2011 and December 31, 2011:

 

		September 30, 2011
		Fair Value Measurements at Reporting Date Using:
		Level 1			Level 2			Level 3			Total
Assets:
Cash and money market funds		$	60,062		$	—		$	—		$	60,062
U.S. pension plan assets:
Mutual fund		17,607			—			—			17,607
Common /collective funds
Bonds		—			57,883			—			57,883
Short-term money market		—			2,418			—			2,418
U.S. common stock		—			51,753			—			51,753
International equity		—			6,062			—			6,062
Total U.S pension plan assets		17,607			118,116			—			135,723
U.K. pension plan assets		13,208			—			—			13,208
Total pension plan assets		30,815			118,116			—			148,931
Total fair value		$	90,877		$	118,116		$	—		$	208,993

 

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		December 31, 2011
		Fair Value Measurements at Reporting Date Using:
		Level 1			Level 2			Level 3			Total
Assets:
Cash and money market funds		$	54,363		$	—		$	—		$	54,363
U.S. pension plan assets:
Mutual fund		19,861			—			—			19,861
Common /collective funds
Bonds		—			57,970			—			57,970
Short-term money market		—			3,237			—			3,237
U.S. common stock		—			58,882			—			58,882
International equity		—			6,385			—			6,385
Total U.S pension plan assets		19,861			126,474			—			146,335
U.K. pension plan assets		13,990			—			—			13,990
Total pension plan assets		33,851			126,474			—			160,325
Total fair value		$	88,214		$	126,474		$	—		$	214,688

 

The Company had no Level 3 assets as of September 30, 2011 or December 31, 2011.

 

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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 Quarterly Report on Form 10-Q (this “Form 10-Q”) contains statements that constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact, including statements regarding industry prospects and future results of operations or financial position, made in this Form 10-Q are forward-looking.    In many cases, you can identify forward-looking statements by terminology, such as “may”, “should”, “expects”, “intends”, “plans”, “anticipates”, “believes”, “estimates”, “predicts”, “potential” or “continue” or the negative of such terms and other comparable terminology. The forward-looking information may include, among other information, statements concerning the Company’s outlook for fiscal year 2012 and beyond, overall volume and pricing trends, cost reduction strategies and their anticipated results, capital expenditures and dividends.  There may also be other statements of expectations, beliefs, future plans and strategies, anticipated events or trends, and similar expressions concerning matters that are not historical facts.  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 Company’s control.

 

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. As a result, the forward-looking statements based upon those assumptions also could be incorrect.  Risks and uncertainties 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.

 

Business Overview

 

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 sold 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. The Company competes primarily 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 slab, 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 wire products.  The Company distributes its products primarily through its direct sales organization, which includes 11 service and/or sales centers in the United States, Europe and Asia.  All of these centers are company-operated.

 

Significant Event

 

Capital Spending

 

The Company has begun increasing the amount of capital spending from traditional levels in order to enhance its capabilities both to increase capacity commensurate with the expansion of the markets the Company services and also to improve customer service in the form of accelerated deliveries and expanded value-added products and services. In the first quarter of fiscal 2012, the Company spent $7.4 million on capital projects, which is consistent with the $27.1 million of capital spending the Company previously forecasted for fiscal 2012. This spending included the continuation of work on the four-high Steckel rolling mill, the upgrade of the vacuum melt furnace processing systems and instrumentation, upgrades to the research and technology laboratory equipment and the upgrade of the information technology system.

 

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These projects are expected to improve quality, enhance working capital management, reduce costs and increase capacity.

 

Dividends Paid and Declared

 

In the first quarter of fiscal 2012, the Company declared and paid a regular quarterly cash dividend of $0.22 per outstanding share of the Company’s common stock. The dividend was paid December 15, 2011 to stockholders of record at the close of business on December 1, 2011.  The dividend cash pay-out was approximately $2.7 million for the quarter based on the number of shares outstanding, and equal to approximately $10.8 million on an annualized basis.

 

On February 2, 2012, the Company announced that the Board of Directors declared a regular quarterly cash dividend of $0.22 per outstanding share of the Company’s common stock.  The dividend is payable March 15, 2012 to stockholders of record at the close of business on March 1, 2012.

 

Gross Profit Margin Performance

 

In the first quarter of each fiscal year, the Company’s gross margin percentage is typically lower than the preceding quarter due to lower absorption of fixed manufacturing cost as production decreases due to planned equipment down-time for major capital upgrades and maintenance projects and the Company’s observance of seasonal holidays. For the first quarter of fiscal 2012, gross margin, and to a lesser extent net income, were lower than anticipated due to an increase in the  number and length of planned and unplanned equipment outages. However, as noted in the “Quarterly Performance” section, the shortfall in net income versus expectations was primarily due to a delay in shipping finished product to customers. The impact on gross margin percentage of the reduced production days in the first fiscal quarter of 2012 for these planned and unplanned outages was not significantly different from what is usually expected for the first quarter.

 

		Comparison by Quarter of Gross Profit Margin and Gross Profit Margin Percentage for Fiscal 2011 and 2012
		Quarter Ended
(dollars in thousands)		December 31, 2010			March 31, 2011			June 30, 2011			September 30, 2011			December 31, 2011
Net Revenues		$	106,351		$	139,114		$	143,122		$	154,309		$	128,851
Gross Profit Margin		$	17,869		$	20,593		$	25,321		$	29,997		$	23,491
Gross Profit Margin %		16.8		%	14.8		%	17.7		%	19.4		%	18.2		%

 

Gross profit margins and gross profit margin percentages  improved in the first quarter of fiscal 2012 compared to the first quarter of fiscal 2011 due to a combination of rising volume, a shift to a higher-margin product mix, reduced cost structure and an improving market environment.  Also, between the fourth quarter of fiscal 2011 and the first quarter of fiscal 2012, service center transactional business volumes and prices have improved, particularly in the aerospace market, due to the end of inventory destocking by the Company’s customers in early fiscal 2011 and an increase in commercial aircraft build rates.

 

Backlog

 

Order entry activity started slowing in the fourth quarter of fiscal 2011 and continued to slow through the first quarter of fiscal 2012, contributing to the decrease in backlog at December 31, 2011 as compared to September 30, 2011.  Backlog was $261.8 million at December 31, 2011, a decrease of approximately 4.2% from $273.4 million at September 30, 2011.  This decrease is the result of a 5.4% decrease in backlog pounds, which was partially offset by a 1.3% increase in backlog average selling price.

 

The slowdown in order entry in the first quarter of fiscal 2012 only moderately impacted the quarter and was the result of the uncertain economic conditions during our first fiscal quarter associated with slowing growth in the U.S. and China and concern regarding a possible recession in Europe. However, the backlog continues to reflect a significant amount of higher value alloys and forms compared to previous quarters, which resulted in the continued increase in backlog average selling price.

 

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Quarterly Performance

 

Fiscal 2011 net revenues, volume and net income improved from quarter to quarter through the year and concluded in the fourth quarter of fiscal 2011 with a strong performance with revenue, volume and net income increasing from the first quarter of fiscal 2011 by 45.1%, 51.4% and 114.2%, respectively. For the first quarter of fiscal 2012 net revenues decreased by $25.5 million from the fourth quarter of fiscal 2011 to the first quarter of fiscal 2012, while volume declined by 1.5 million pounds and net income decreased by $2.8 million during this period. Although a decline was anticipated in each of these categories from the fourth quarter to the first quarter, each category declined more than anticipated. The decline in earnings, as compared to the previously provided guidance, for the first quarter of fiscal 2012 from the fourth quarter of fiscal 2011 was more than expected due to lower than anticipated volume of pounds shipped. The volume of pounds shipped for the quarter was reduced from anticipated levels due to the number of planned and unplanned capital and maintenance projects that occurred during the quarter and the longer duration of the resulting equipment outages that was experienced compared to expectations. The down time resulting from these projects, in conjunction with the normal occurrence of holidays and vacations, reduced the days available to finish and ship the product as planned. The Company expanded the scope and duration of its planned outages during the quarter versus prior comparable periods in order to enable the Company to enhance its equipment and processes to meet anticipated growth in the Company’s markets.  This expanded duration of planned outages, together with an increase in unplanned outages, resulted in unanticipated delays in completion of production. The delay in production in turn prevented the Company from finishing and shipping a portion of the production completed in the quarter, thereby leading to the shortfall in net income versus expectations.

 

Outlook

 

Guidance

 

Net income for the second quarter of fiscal 2012 is currently expected to equal or slightly exceed the net income of the fourth quarter of fiscal 2011 as the Company’s original forecast for net income for the second quarter remains on target and is expected to be enhanced by a realization of net income from shipment of most, if not all, of the product that was produced but not shipped in the first quarter.  The additional net income to be realized in the second quarter is based on the difference between the guidance previously provided for net income in the first quarter versus the actual net income for the first quarter of fiscal 2012.

 

Management continues to expect net income for fiscal 2012 to exceed net income of fiscal 2011. However, due to the continued competitive environment and the current uncertainty of the economic environment, particularly in Europe, the amount of any improvement from fiscal 2011 to fiscal 2012 continues to be uncertain.

 

Working Capital

 

Controllable working capital, which includes accounts receivable, inventory, accounts payable and accrued expenses, increased from the fourth quarter of fiscal 2011 to the first quarter of fiscal 2012 from $268.9 million to $278.6 million. This increase of $9.7 million or 3.6% in controllable working capital resulted from DSO’s (days sales outstanding) increasing from the end of the fourth quarter of fiscal 2011. Although working capital as a percentage of net revenues has increased from the end of fiscal 2011, it is anticipated that the favorable trends started in fiscal 2011will continue during fiscal 2012. This includes an improvement in DSO’s and declining inventory from December 31, 2011 through the balance of the year.

 

Competition and Pricing

 

Beginning in the fourth quarter of fiscal 2011 and continuing through the first quarter of fiscal 2012, the global economic environment experienced a number of unfavorable events which included the slowing of growth in China, a reduction in the growth rate in the U.S. plus the possibility of a recession in Europe. This significant global economic uncertainty impacted the Company in the form of reduced order entry activity, as compared to the second and third quarters of fiscal 2011, which reduced the backlog as of the end of the first quarter of 2012. In addition, fluctuating raw material costs through both quarters created  a moderate amount of both downward pressure on product pricing and postponement by customers in placing orders. Management considers these unfavorable events during these quarters short-term disruptions and anticipates long-term growth for the Company.

 

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Although the Company’s pricing continued to improve through the first quarter of fiscal 2012, the Company continues to experience price competition in the marketplace, particularly in mill-direct project business, from competitors that have the ability to produce both high-performance alloys and stainless steel flat products. This competition continues to require the Company to aggressively price project business orders in these markets, which has unfavorably impacted the Company’s gross profit margin and net income.  However, it appears that the stainless market is beginning to improve and may gain strength over the balance of the calendar year which should provide some relief to the competitive pricing environment.

 

As previously noted, current selling prices continue to be impacted by both the competitive environment and the volatility of raw material prices in the market place, which is expected to continue to put downward pressure on prices. If market conditions improve, pricing competition in the high-performance alloy industry may begin to ease in future quarters.  The Company continues to respond to this competition by increasing emphasis on service centers, offering value-added services, improving its cost structure and focusing on delivery times and reliability, in order to support rising average selling prices.

 

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 Quarterly Report on Form 10-Q.

 

		Quarter Ended
		December 31, 2010			March 31, 2011			June 30, 2011			September 30, 2011			December 31, 2011
Backlog (1)
Dollars (in thousands)		$	166,990		$	241,661		$	288,597		$	273,375		$	261,811
Pounds (in thousands)		6,911			9,648			10,356			9,037			8,547
Average selling price per pound		$	24.16		$	25.05		$	27.87		$	30.25		$	30.63
Average nickel price per pound
London Metals Exchange(2)		$	10.94		$	12.16		$	10.14		$	9.25		$	8.23

 

(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 figures do 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, 2010			March  31, 2011			June  30, 2011			September 30, 2011			December 31, 2011
Net revenues (in thousands)
Aerospace		$	44,537		$	48,953		$	53,594		$	56,477		$	52,726
Chemical processing		20,591			37,238			46,065			46,079			29,688
Land-based gas turbines		21,541			27,724			21,067			27,892			30,104
Other markets		15,217			21,985			19,248			20,217			12,721
Total product revenue		101,886			135,900			139,974			150,665			125,239
Other revenue		4,465			3,214			3,148			3,644			3,612
Net revenues		$	106,351		$	139,114		$	143,122		$	154,309		$	128,851
Shipments by markets (in thousands of pounds)
Aerospace		1,688			2,008			2,152			2,272			1,970
Chemical processing		914			1,846			2,185			2,020			1,121
Land-based gas turbines		1,199			1,664			1,093			1,590			1,585
Other markets		610			855			738			796			456
Total shipments		4,411			6,373			6,168			6,678			5,132

 

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