HAYNES INTERNATIONAL INC - Quarter Report: 2012 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, 2012

 

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)

 

 

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

 

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.

 

Large accelerated filer o		Accelerated filer x
Non-accelerated filer o		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

 

As of August 1, 2012, the registrant had 12,286,790 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 Consolidated Financial Statements
	Haynes International, Inc. and Subsidiaries:
	Unaudited Consolidated Balance Sheets as of September 30, 2011 and June 30, 2012	1
	Unaudited Consolidated Statements of Operations for the Three and Nine Months Ended June 30, 2011 and 2012	2
	Unaudited Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended June 30, 2011 and 2012	3
	Unaudited Consolidated Statements of Cash Flows for the Nine Months Ended June 30, 2011 and 2012	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	24
Item 4.	Controls and Procedures	25
PART II	OTHER INFORMATION
Item 6.	Exhibits	26
	Signatures	27
	Index to Exhibits	28

 

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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			June 30, 2012
ASSETS
Current assets:
Cash and cash equivalents		$	60,062		$	51,346
Accounts receivable, less allowance for doubtful accounts of $1,129 and $1,359 respectively		87,680			81,267
Inventories		250,051			291,425
Income taxes receivable		2,573			122
Deferred income taxes		9,341			10,034
Other current assets		1,728			2,198
Total current assets		411,435			436,392
Property, plant and equipment, net		110,678			117,137
Deferred income taxes—long-term portion		65,113			61,894
Prepayments and deferred charges		2,903			1,810
Intangible assets, net		6,440			6,121
Total assets		$	596,569		$	623,354
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	49,086		$	52,198
Accrued expenses		19,698			16,432
Revolving credit facility		—			—
Accrued pension and postretirement benefits		21,390			24,360
Deferred revenue—current portion		2,500			2,500
Current maturities of long-term obligations		—			—
Total current liabilities		92,674			95,490
Long-term obligations (less current portion)		1,348			1,348
Deferred revenue (less current portion)		35,329			33,454
Non-current income taxes payable		323			323
Accrued pension and postretirement benefits		194,042			186,971
Total liabilities		323,716			317,586
Commitments and contingencies (Note 6)		—			—
Stockholders’ equity:
Common stock, $0.001 par value (40,000,000 shares authorized, 12,204,179 and 12,286,790 shares issued and outstanding at September 30, 2011 and June 30, 2012, 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			236,183
Accumulated earnings		124,047			153,272
Accumulated other comprehensive loss		(83,048		)	(83,699		)
Total stockholders’ equity		272,853			305,768
Total liabilities and stockholders’ equity		$	596,569		$	623,354

 

The accompanying notes are an integral part of these interim 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,
		2011			2012			2011			2012
Net revenues		$	143,122		$	141,574		$	388,587		$	429,307
Cost of sales		117,801			109,185			324,804			338,892
Gross profit		25,321			32,389			63,783			90,415
Selling, general and administrative expense		10,710			10,382			29,988			30,885
Research and technical expense		733			835			2,348			2,414
Operating income		13,878			21,172			31,447			57,116
Interest income		(89		)	(57		)	(190		)	(152		)
Interest expense		37			19			96			69
Income before income taxes		13,930			21,210			31,541			57,199
Provision for income taxes		5,533			7,478			11,672			19,873
Net income		$	8,397		$	13,732		$	19,869		$	37,326
Net income per share:
Basic		$	0.70		$	1.12		$	1.65		$	3.05
Diluted		$	0.69		$	1.11		$	1.63		$	3.03
Dividend declared per common share		$	0.20		$	0.22		$	0.60		$	0.66

 

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

 

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HAYNES INTERNATIONAL, INC. and SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

(in thousands)

 

		Three Months Ended June 30,						Nine Months Ended June 30,
		2011			2012			2011			2012
Net income		$	8,397		$	13,732		$	19,869		$	37,326
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment		1,159			(1,589		)	2,811			(651		)
Comprehensive income		$	9,556		$	12,143		$	22,680		$	36,675

 

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

 

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HAYNES INTERNATIONAL, INC. and SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

 

		Nine Months Ended June 30,
		2011			2012
Cash flows from operating activities:
Net income		$	19,869		$	37,326
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		8,383			9,366
Amortization		409			319
Stock compensation expense		1,350			1,559
Excess tax benefit from option exercises		(144		)	(1,147		)
Deferred revenue		(1,875		)	(1,875		)
Deferred income taxes		5,176			2,057
Loss on disposal of property		48			167
Change in assets and liabilities:
Accounts receivable		(23,622		)	5,975
Inventories		(26,247		)	(41,436		)
Other assets		(205		)	595
Accounts payable and accrued expenses		24,726			1,123
Income taxes		1,075			4,031
Accrued pension and postretirement benefits		(4,907		)	(4,096		)
Net cash provided by operating activities		4,036			13,964
Cash flows from investing activities:
Additions to property, plant and equipment		(9,795		)	(17,134		)
Change in restricted cash		110			—
Net cash used in investing activities		(9,685		)	(17,134		)
Cash flows from financing activities:
Dividends paid		(7,317		)	(8,101		)
Proceeds from exercise of stock options		706			1,635
Excess tax benefit from option exercises		144			1,147
Changes in long-term obligations		(109		)	—
Net cash used in financing activities		(6,576		)	(5,319		)
Effect of exchange rates on cash		296			(227		)
Decrease in cash and cash equivalents		(11,929		)	(8,716		)
Cash and cash equivalents, beginning of period		63,968			60,062
Cash and cash equivalents, end of period		$	52,039		$	51,346
Supplemental disclosures of cash flow information:
Cash paid during period for:
Interest (net of capitalized interest)		$	13		$	20
Income taxes (net of refunds)		$	5,325		$	13,801
Capital expenditures incurred but not yet paid		$	1,498		$	513

 

The accompanying notes are an integral part of these interim 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 were prepared in conformity with accounting principles generally accepted in the United States of America, and such principles were applied on a basis consistent with information reflected in the Company’s Annual Report on Form 10-K for the fiscal 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 or nine months ended June 30, 2012 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

 

In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-05, Presentation of Comprehensive Income.  The objective of this update is to facilitate convergence of U.S. GAAP and IFRS.  This update revises the manner in which entities present comprehensive income in their financial statements.  Entities have the option to present total comprehensive income, the components of net income, and the components of other comprehensive income as either a single, continuous statement of comprehensive income or as two separate but consecutive statements.  The amendments of this update do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.

 

The amendments in this update are to be applied retrospectively for all periods presented in the financial statements and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  The adoption of this guidance will not have a significant impact on the Company’s consolidated financial statements.

 

Note 3.   Inventories

 

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

 

		September 30, 2011			June 30, 2012
Raw Materials		$	22,430		$	31,668
Work-in-process		136,227			157,531
Finished Goods		90,386			101,106
Other		1,008			1,120
		$	250,051		$	291,425

 

Note 4.   Income Taxes

 

Income tax expense for the three and nine months ended June 30, 2011 and 2012 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

 

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tax rate for the three months ended June 30, 2012 was 35.3% compared to 39.7% in the same period of fiscal 2011. The effective tax rate for the nine months ended June 30, 2012 was 34.7% compared to 37.0% 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 and nine months ended June 30, 2011 and 2012, respectively, were as follows:

 

		Three Months Ended June 30,												Nine Months Ended June 30,
		Pension Benefits						Other Benefits						Pension Benefits						Other Benefits
		2011			2012			2011			2012			2011			2012			2011			2012
Service cost		$	902		$	1,000		$	67		$	72		$	2,709		$	3,001		$	199		$	218
Interest cost		2,824			2,567			1,172			1,146			8,546			8,115			3,516			3,436
Expected return		(2,989		)	(2,537		)	—			—			(9,056		)	(8,102		)	—			—
Amortizations		1,768			2,436			(771		)	(749		)	5,303			7,359			(2,312		)	(2,243		)
Net periodic benefit cost		$	2,505		$	3,466		$	468		$	469		$	7,502		$	10,373		$	1,403		$	1,411

 

The Company contributed $11,880 to Company-sponsored domestic pension plans, $3,221 to its other post-retirement benefit plans and $712 to the U.K. pension plan for the nine months ended June 30, 2012.  The Company presently expects future contributions of $4,020 to its domestic pension plans, $1,779 to its other post-retirement benefit plans and $223 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, Indiana 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, and an application for permit renewal has been timely filed. 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

 

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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 June 30, 2012, 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 applicable 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 $1,766, which was then discounted using an appropriate discount rate.

 

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 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 five to seven years. Amortization of the patents, non-competes and other intangibles was $409 and $319 for the nine months ended June 30, 2011 and 2012, respectively.

 

The following represents a summary of intangible assets at September 30, 2011 and June 30, 2012:

 

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

 

June 30, 2012		Gross Amount			Accumulated Amortization			Carrying Amount
Patents		$	8,667		$	(6,821	)	$	1,846
Trademarks		3,800			—			3,800
Non-compete		1,090			(882		)	208
Other		330			(63		)	267
		$	13,887		$	(7,766	)	$	6,121

 

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Estimate of Aggregate Amortization Expense: Year Ended September 30,
2012 (remainder of fiscal year)		104
2013		416
2014		416
2015		394
2016		330

 

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 stockholders 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 June 30,						Nine Months Ended June 30,
(in thousands, except share and per share data)		2011			2012			2011			2012
Numerator:
Net income		$	8,397		$	13,732		$	19,869		$	37,326
Less amount allocable to participating securities		—			(123		)	—			(335		)
Net income available for basic stockholders		8,397			13,609			19,869			36,991
Adjustment for dilutive potential common shares		—			1			—			2
Net income available for diluted common shares		$	8,397		$	13,610		$	19,869		$	36,993
Denominator:
Weighted average shares - Basic		12,077,102			12,175,935			12,063,975			12,137,237
Adjustment for dilutive potential common shares		153,334			64,600			155,901			74,588
Weighted average shares - Diluted		12,230,436			12,240,535			12,219,876			12,211,825
Basic net income per share		$	0.70		$	1.12		$	1.65		$	3.05
Diluted net income per share		$	0.69		$	1.11		$	1.63		$	3.03
Number of stock option shares excluded as their effect would be anti-dilutive		163,660			80,380			153,760			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.  Shares of restricted stock 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 may 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

 

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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. Holders of outstanding shares of restricted stock are entitled to receive dividends on, and to vote, shares of restricted stock.

 

On November 25, 2011 and December 8, 2011, the Company granted 27,600 and 3,000 shares, respectively, of 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 non-employee 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 nine months ended June 30, 2012:

 

		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		(25,600	)	$	17.82
Vested		(21,000	)	$	17.82
Unvested at June 30, 2012		110,000		$	42.27
Expected to vest		110,000		$	42.27

 

Compensation expense related to restricted stock for the three months ended June 30, 2011 and 2012 was $280 and $387, respectively, and for the nine months ended June 30, 2011 and 2012 was $739 and $1,129, respectively. The remaining unrecognized compensation expense at June 30, 2012 was $2,325, which is to be recognized over a weighted average period of  1.67 years. During the second quarter of fiscal 2012, 25,600 shares of restricted stock granted to employees on March 31, 2009 were forfeited because the performance goal was not achieved.

 

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 expectations 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 fiscal 2012:

 

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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 options to purchase up to 23,200 shares of common stock at an exercise price of $55.88, the fair market value of the Company’s common stock at the close of business on the day of the grant. During the first nine months of fiscal 2012, 77,611 options were exercised and no options were forfeited/canceled.

 

The stock-based employee compensation expense for stock options for the three months ended June 30, 2011 and 2012 was $150 and $130, respectively, and for the nine months ended June 30, 2011 and 2012 was $611 and $431, respectively.  The remaining unrecognized compensation expense at June 30, 2012 was $730, to be recognized over a weighted average vesting period of 1.41 years.

 

The following table summarizes the activity under the stock option plans for the nine months ended June 30, 2012:

 

		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		(77,611	)				$	21.05
Canceled		—
Outstanding at June 30, 2012		318,776		$	3,844		$	44.05		5.74 yrs.
Vested or expected to vest		303,731		$	3,844		$	44.05		5.74 yrs.
Exercisable at June 30, 2012		263,890		$	3,371		$	43.97		5.15 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		2.17		47,569		47,569
March 31, 2006		31.00			3.75		10,000		10,000
March 30, 2007		72.93			4.75		59,500		59,500
March 31, 2008		54.00			5.75		73,000		73,000
October 1, 2008		46.83			6.25		20,000		20,000
March 31, 2009		17.82			6.75		28,339		25,589
January 8, 2010		34.00			7.50		31,801		20,135
November 24, 2010		40.26			8.42		25,367		8,097
November 25, 2011		55.88			9.42		23,200		—
							318,776		263,890

 

Note 11.    Dividend

 

In the third 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 June 15, 2012 to stockholders of record at the close of business on June 1, 2012.  The dividend cash pay-out was $2,703 for the quarter based on the number of shares outstanding.

 

On August 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 September 17, 2012 to stockholders of record at the close of business on September 4, 2012.

 

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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 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 to be 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 June 30, 2012:

 

		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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		June 30, 2012
		Fair Value Measurements at Reporting Date Using:
		Level 1			Level 2			Level 3			Total
Assets:
Cash and money market funds		$	51,346		$	—		$	—		$	51,346
U.S. pension plan assets:
Mutual fund		21,023			—			—			21,023
Common /collective funds
Bonds		—			60,584			—			60,584
Short-term money market		—			5,365			—			5,365
U.S. common stock		—			64,455			—			64,455
International equity		—			6,665			—			6,665
Total U.S pension plan assets.		21,023			137,069			—			158,092
U.K. pension plan assets		14,770			—			—			14,770
Total pension plan assets		35,793			137,069			—			172,862
Total fair value		$	87,139		$	137,069		$	—		$	224,208

 

The Company had no Level 3 assets as of September 30, 2011 or June 30, 2012.

 

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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, each as amended. All statements other than statements of historical fact, including statements regarding market and 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, including, without limitation those risk factors set forth in Item 1A of the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2011. 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 12 service and/or sales centers in the United States, Europe and Asia.  All of these centers are Company-operated.

 

Capital Spending

 

The Company has begun increasing the amount of capital spending from traditional levels in order to enhance its capabilities to both increase capacity commensurate with the anticipated expansion over the long term 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 third quarter of fiscal 2012, the Company announced plans to invest approximately $61.0 million at two of its U.S. facilities. The Company plans to invest approximately $37.0 million to expand by an estimated 60% the specialty titanium and high-performance nickel alloy tubular production capacity of its Arcadia, Louisiana facility. In addition, the Company plans to invest approximately $24.0 million to expand by an estimated 20% its capacity to produce specialty high-performance alloy flat products at the Company’s Kokomo, Indiana facility. The Company has commenced initial planning and design and expects to

 

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complete both projects within the next two years, with benefits from the tubular project expected to emerge in twelve to fifteen months and benefits from the Kokomo project expected to emerge in nine to twelve months. These capital investments in Arcadia and Kokomo are expected to improve the Company’s ability to service its customers’ increasing demand for specialty products and also continue to improve product quality, improve operating efficiencies and enhance working capital management for all of the Company’s products produced at these locations.

 

In the third quarter of fiscal 2012, the Company spent $4.4 million on capital projects, which brings capital spending to $17.1 million for the first three quarters of fiscal 2012. For the fourth quarter of fiscal 2012 spending is estimated at $12.7 million, approximately $5.0 million of which is for projects already in-process including the four-high Steckel rolling mill, cold rolling finishing mill and an upgrade of the information technology system. The balance of the estimated spending of $7.7 million is divided between the Arcadia tubular project at approximately $5.0 million and the Kokomo plate project at approximately $2.7 million. This will bring spending for capital projects by the Company in fiscal 2012 to an estimated $29.8 million.

 

Dividends Paid and Declared

 

In the third 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 June 15, 2012 to stockholders of record at the close of business on June 1, 2012.  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 August 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 September 17, 2012 to stockholders of record at the close of business on September 4, 2012.

 

Gross Profit Margin Performance

 

Gross profit margins and gross profit margin percentages improved in each of the first three quarters of fiscal 2012 compared to the first three quarters of fiscal 2011 due to a combination of increased volume and pricing, a shift to a higher-margin product mix, reduced cost structure and an improved market environment in fiscal 2012.  Service center transactional business volumes and prices have improved in the first nine months of fiscal 2012 compared to the first nine months of fiscal 2011, particularly in the aerospace market, due to increasing projected commercial aircraft build rate. Contributing directly to the increased volumes and reduced cost structure noted above has been the capital spending over the last five years.

 

The following table shows net revenues, gross profit margin and gross profit margin percentage for each quarter in fiscal 2011 and for the first three quarters of fiscal 2012.

 

		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			March 31, 2012			June 30, 2012
Net Revenues		$	106,351		$	139,114		$	143,122		$	154,309		$	128,851		$	158,882		$	141,574
Gross Profit Margin		$	17,869		$	20,593		$	25,321		$	29,997		$	23,491		$	34,535		$	32,389
Gross Profit Margin %		16.8		%	14.8		%	17.7		%	19.4		%	18.2		%	21.7		%	22.9		%

 

When comparing the trend of gross profit margin and gross profit margin percentage from the first quarter of fiscal 2012 through the third quarter, both the gross profit margin and gross profit margin percentage increased consistent with the themes stated in the previous paragraph. Gross profit margin from the first quarter to the third quarter of fiscal 2012 increased by $8.9 million, and the gross profit margin percentage was 4.7% higher in the third quarter of fiscal 2012 compared to the first quarter.

 

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Backlog

 

Backlog dollars and backlog pounds declined during the third quarter of fiscal 2012 by $23.1 million and 0.9 million pounds, respectively. Backlog was $241.2 million at June 30, 2012, a decrease of approximately 8.7% from $264.2 million at March 31, 2012.  This decrease is the result of a 10.2% decrease in backlog pounds, which was partially offset by a 1.6% increase in backlog average selling price for the quarter.

 

On a year-to-date basis, the backlog has declined by $32.2 million or 11.8% primarily due to a 1.1 million pound reduction in backlog pounds.  The reduction in the backlog during the first three quarters of the fiscal year resulted from reduced order entry activity, as compared to sales, in the first and third quarters. While the level of transactional business in all markets has increased slightly compared to prior quarters, the Company has not received the typical number of large, project-based orders in fiscal 2012, which has resulted in a lower backlog level. Management believes that the reduced level of project-based orders resulted from customers exercising caution in making purchases for project business due to the current uncertain economic conditions associated with slow economic growth in the U.S. and China and the effect of the recession in Europe. Order entry and sales activity in the aerospace and land-based gas turbine markets has been steady, while order entry in the chemical processing and other markets categories has been negatively affected by the decline in project-related orders. Accordingly, the backlogs for the aerospace and land-based gas turbine markets are slightly lower than at the beginning of the fiscal year, and the majority of the decline in backlog, for the quarter and fiscal year, is attributable to the chemical processing and other markets categories. The strength of the order entry activity in the aerospace and land-based gas turbine markets is further illustrated by the quarterly shipment information presented in the Quarterly Market Information below. Based on the pounds shipped to these markets through the end of the third quarter, the Company’s shipments to these markets could equal or exceed the previous high-water mark set in fiscal 2008.  The backlog continues to include a significant amount of higher value alloys and forms compared to previous quarters in all market segments, with the backlog sustaining an average selling price of approximately $30.00 per pound over the last four fiscal quarters. The current backlog and order entry rate is expected to support the forecasted performance for the fourth quarter of fiscal 2012.

 

Quarter-Over-Quarter Performance

 

Net income for the third quarter of fiscal 2012, was $1.4 million lower than net income for the second quarter of fiscal 2012 due primarily to the fact that shipments in the second quarter included approximately 0.4 million pounds that were produced but not shipped in the first quarter. These carryover shipments increased second quarter net revenues by approximately $10.0 million and increased second quarter net income by approximately $1.1 million. Excluding the effect of the carryover net income from the second fiscal quarter makes the net incomes between the second and third fiscal quarters similar in amount. Also, due to the improved product mix and operating efficiencies, the gross margin percentage increased by 1.2% to 22.9% in the third quarter of fiscal 2012 as compared to the second quarter.

 

Outlook

 

Guidance

 

Net income for the fourth quarter of fiscal 2012 is expected to approximate net income of the third quarter of fiscal 2012.  Net income may exceed this level if improvement occurs in transactional business during the fourth quarter.

 

Working Capital

 

Controllable working capital, which includes accounts receivable, inventory, accounts payable and accrued expenses, increased from $297.3 million to $304.2 million from the end of the second quarter of fiscal 2012 to the end of the third quarter of fiscal 2012. This increase of $6.9 million, or 2.3%, in controllable working capital resulted from a lower accounts receivable balance, an increase in inventory and a flat accounts payable balance between periods. The accounts receivable balance decreased due to the reduced level of sales in the third quarter of fiscal 2012 compared to the previous quarter. The higher inventory level was a result of both the inventory required for project business scheduled to ship in the fourth quarter and melting of material in the third fiscal quarter to offset maintenance outages of melting equipment scheduled for the fourth fiscal quarter. Commensurate with net controllable working capital increasing from quarter to quarter, working capital as a percentage of sales also increased in the third quarter of fiscal 2012, when compared to the second quarter, due to the reduced level of sales in the third quarter compared to the second quarter of fiscal 2012. It is anticipated that controllable working capital will decline through year-end, that inventory turns will improve and that working capital as a percentage of sales

 

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will improve, resulting in an increase in the cash balance at the end of the fiscal year as compared to the end of the third quarter.

 

Competition, Pricing and Profitability

 

Beginning in the latter part of fiscal 2011 and continuing through the third quarter of fiscal 2012, the global economic environment experienced a number of unfavorable events which included slowing global growth, the recession in Europe and a forecast of continued slow global growth. The economic uncertainty created by these events impacted the Company in the form of reduced project-based order activity in the first and third fiscal quarters. In addition, this reduced level of global economic activity has contributed to an increased level of competition which continues to require the Company to aggressively price new business, which unfavorably impacts the Company’s gross profit margin and net income.  There continues to be significant uncertainty as to when any recovery may start or how robust any recovery may be.

 

The competitive environment in the marketplace, particularly as it applies to chemical processing and our other market category, is expected to continue to put downward pressure on prices, which could unfavorably impact profitability. 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 the unpredictable economic environment and the competition it creates by increasing its emphasis on service centers which offer value-added services, continuing to focus on moving to a more profitable product mix, improving its cost structure and focusing on delivery times and reliability, in order to maintain and improve gross profit margins and net income.

 

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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			March 31, 2012			June 30, 2012
Backlog (1)
Dollars (in thousands)		$	166,990		$	241,661		$	288,597		$	273,375		$	261,811		$	264,245		$	241,151
Pounds (in thousands)		6,911			9,648			10,356			9,037			8,547			8,853			7,951
Average selling price per pound		$	24.16		$	25.05		$	27.87		$	30.25		$	30.63		$	29.85		$	30.33
Average nickel price per pound
London Metals Exchange(2)		$	10.94		$	12.16		$	10.14		$	9.25		$	8.23		$	8.49		$	7.50

 

(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			March 31, 2012			June 30, 2012
Net revenues (in thousands)
Aerospace		$	44,537		$	48,953		$	53,594		$	56,477		$	52,726		$	61,901		$	55,908
Chemical processing		20,591			37,238			46,065			46,079			29,688			37,833			32,565
Land-based gas turbines		21,541			27,724			21,067			27,892			30,104			32,167			27,971
Other markets		15,217			21,985			19,248			20,217			12,721			23,082			21,280
Total product revenue		101,886			135,900			139,974			150,665			125,239			154,983			137,724
Other revenue		4,465			3,214			3,148			3,644			3,612			3,899			3,850
Net revenues		$	106,351		$	139,114		$	143,122		$	154,309		$	128,851		$	158,882		$	141,574
Shipments by markets (in thousands of pounds)
Aerospace		1,688			2,008			2,152			2,272			1,970			2,421			2,175
Chemical processing		914			1,846			2,185			2,020			1,121			1,500			1,304
Land-based gas turbines		1,199			1,664			1,093			1,590			1,585			1,771			1,559
Other markets		610			855			738			796			456			782			673
Total shipments		4,411			6,373			6,168			6,678			5,132			6,474			5,711
Average selling price per pound
Aerospace		$	26.38		$	24.38		$	24.90		$	24.86		$	26.76		$	25.57		$	25.70
Chemical processing		22.53			20.17			21.08			22.81			26.48			25.22			24.97
Land-based gas turbines		17.97			16.66			19.27			17.54			18.99			18.16			17.94
Other markets		24.95			25.71			26.08			25.40			27.90			29.52			31.62
Total product (excluding other revenue)		23.10			21.32			22.69			22.56			24.40			23.94			24.12
Total average selling price (including other revenue)		24.11			21.83			23.20			23.11			25.11			24.54			24.79

 

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