Item 2.
Managements Discussion and Analysis of Financial Condition and Results of Operations
Background
and General
Carpenter is engaged in the manufacturing, fabrication, and distribution of specialty metals and engineered products. We
have three reportable business segments: Premium Alloys Operations, Advanced Metals Operations, and Engineered Products Operations, which are discussed later below. As part of our overall business strategy, we expect to continue to seek and consider
opportunities related to strategic divestitures, acquisitions, and joint collaboration propositions.
Our discussions below in this
Item 2 are based upon the more detailed discussions about our business, operations and financial condition included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2007, under Item 8 thereof. Our discussions here
focus on our results during or as of the first quarter of fiscal 2008 (the three-month period ended September 30, 2007) and the comparable period of fiscal 2007 (the three-month period ended September 30, 2006), and, to the extent
applicable, on material changes from information discussed in that Form 10-K or other important intervening developments or information since that time that have not previously been reported. These discussions should be read in conjunction with that
Form 10-K for detailed background information.
Impact of Raw Material Surcharges and Product Mix
Increases in the cost of raw materials have impacted our operations over the past few years. We, and others in our industry, generally have been able
to pass these cost increases through to our customers using surcharges which are structured to recover high raw material costs. In the last several years, as raw material prices have escalated, surcharges have become an increasingly significant
component of our net sales. This has impacted our net sales numbers and had a dilutive effect on our gross margin and operating margin percentages as described later in this discussion. Generally, the formula used to calculate the surcharge is
based on prices quoted on the London Metal Exchange (LME) for the previous month for the respective raw materials, which essentially creates a lag between the raw materials price change on the LME and our corresponding surcharges on
sales. Except for the usually modest effect of the lag, the surcharge mechanism protects our net income on such sales, but generally does not increase our net income because surcharge revenues essentially offset an equivalent amount in our cost of
sales.
We produce hundreds of grades of materials, with a wide range of pricing and profit levels depending on the grade. In addition, our
product mix within a period is subject to the fluctuating order patterns of our customers as well as decisions we may make to participate in certain lower margin business in order to utilize available capacity. While we expect to see positive
contribution from a more favorable product mix in our margin performance over time, the impact by period may fluctuate, and period-to-period comparisons may vary.
Comparison of Quarters Ended September 30, 2007 and 2006
For the fiscal quarter ended September 30, 2007, we
reported net income of $57.7 million or $2.24 per diluted share. This was a 13 percent increase from net income for the same period a year ago. Our results reflected a richer product mix, growth in the energy market, and a continued focus on margin
enhancement.
17
Net Sales
Net sales for the three months ended September 30, 2007 were $475.0 million, which was a 17 percent increase over the same period a year ago. Adjusted for surcharge revenue, sales increased 3 percent. A 27 percent increase in pounds
shipped by the Companys Premium Alloys Operations segment, which benefited from strong demand in the energy market, contributed to the increase. Total volume declined by 9 percent during the current quarter due primarily to a reduction in the
shipment of lower priced stainless material.
Our sales are to customers across a diversified list of end-use markets. The table below
includes comparative information for the Companys estimated sales by end-use markets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
$
Increase
|
|
%
Increase
|
|
($ in millions)
|
|
2007
|
|
2006
|
|
|
Aerospace
|
|
$
|
174.4
|
|
$
|
160.1
|
|
$
|
14.3
|
|
9
|
%
|
Industrial
|
|
|
109.3
|
|
|
96.1
|
|
|
13.2
|
|
14
|
|
Automotive
|
|
|
59.4
|
|
|
49.9
|
|
|
9.5
|
|
19
|
|
Energy
|
|
|
56.3
|
|
|
29.0
|
|
|
27.3
|
|
94
|
|
Consumer
|
|
|
43.4
|
|
|
41.7
|
|
|
1.7
|
|
4
|
|
Medical
|
|
|
32.2
|
|
|
27.7
|
|
|
4.5
|
|
16
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net sales
|
|
$
|
475.0
|
|
$
|
404.5
|
|
$
|
70.5
|
|
17
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table includes estimated comparative information for the Companys estimated
sales by end-use markets excluding surcharge revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
$
Increase/
(decrease)
|
|
|
%
Increase/
(decrease)
|
|
($ in millions)
|
|
2007
|
|
2006
|
|
|
Aerospace
|
|
$
|
127.1
|
|
$
|
135.2
|
|
$
|
(8.1
|
)
|
|
(6
|
)%
|
Industrial
|
|
|
70.4
|
|
|
72.7
|
|
|
(2.3
|
)
|
|
(3
|
)
|
Automotive
|
|
|
39.5
|
|
|
38.2
|
|
|
1.3
|
|
|
3
|
|
Energy
|
|
|
44.3
|
|
|
23.4
|
|
|
20.9
|
|
|
89
|
|
Consumer
|
|
|
28.6
|
|
|
30.6
|
|
|
(2.0
|
)
|
|
(7
|
)
|
Medical
|
|
|
27.6
|
|
|
26.4
|
|
|
1.2
|
|
|
5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net sales excluding surcharge revenues
|
|
$
|
337.5
|
|
$
|
326.5
|
|
$
|
11.0
|
|
|
3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In terms of end-use markets, sales to the aerospace market increased 9 percent from the first
quarter a year ago to $174.4 million. Excluding surcharge revenue, sales declined approximately 6 percent from the record first quarter a year ago. Increased sales of nickel-based alloys used in jet engine components was more than offset by planned
inventory adjustments at certain key customers and by a decline in shipments to a customer who is now procuring some of its aerospace needs internally from a recently acquired subsidiary.
Industrial market sales increased 14 percent from the first quarter a year ago to $109.3 million. Adjusted for surcharge revenue, sales decreased
approximately 3 percent. During the quarter ended September 30, 2007, the Company benefited from increased sales of higher value materials used in capital equipment and in the manufacture of valves and fittings. This increase was more than
offset by reduced shipments of lower value materials sold through distributors.
18
Automotive and truck market sales grew 19 percent from the first quarter a year ago to $59.4 million.
Excluding surcharge revenue, sales increased 3 percent from a year ago. The increase primarily reflected demand for higher value materials to support technology changes in engine and exhaust systems. This increase was partially offset by a reduction
in pounds shipped due to lower automotive production levels and a decision not to participate in certain marginally profitable business.
Sales to the energy market of $56.3 million reflected a 94 percent increase from the first quarter of fiscal 2007. Excluding surcharge revenue, sales increased 89 percent from a year ago. Within the energy market, sales to the power
generation sector, excluding surcharge revenue, surged 140 percent to $22 million, due to increased demand for industrial gas turbines, particularly from the Middle East. Sales to the oil and gas sector, excluding surcharge revenue, increased 56
percent from the first quarter a year ago to $22 million. The Companys broad product portfolio of high strength corrosion resistant materials has allowed it to gain strong acceptance among customers. Growth with key customers and strong
international demand helped drive the increase in energy sales.
Sales to the consumer market increased 4 percent to $43.4 million from a
year ago. Adjusted for surcharge revenue, sales decreased 7 percent. Lower shipments of materials used in the housing sector more than offset increased sales to the sporting goods and electronics sectors.
Sales to the medical market increased 16 percent to $32.2 million from a year ago. Adjusted for surcharge revenue, sales increased 5 percent. The
increase reflected a pick-up in demand relative to last years comparatively low shipment levels.
Geographically, sales outside the
United States increased 28 percent from a year ago to $157.4 million. International sales represented 33 percent of total sales for the first quarter of fiscal 2008 compared to 30 percent for the prior year period, primarily reflecting increased
sales to the Companys energy, industrial and medical markets.
The table below includes comparative information for the
Companys sales by major product class:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended
September 30,
|
|
$
Increase /
(Decrease)
|
|
|
%
Increase /
(Decrease)
|
|
($ in millions)
|
|
2007
|
|
2006
|
|
|
Special alloys
|
|
$
|
252.3
|
|
$
|
169.0
|
|
$
|
83.3
|
|
|
49
|
%
|
Stainless steels
|
|
|
136.6
|
|
|
144.0
|
|
|
(7.4
|
)
|
|
(5
|
)
|
Titanium products
|
|
|
42.5
|
|
|
48.0
|
|
|
(5.5
|
)
|
|
(11
|
)
|
Ceramics and other materials
|
|
|
28.2
|
|
|
30.4
|
|
|
(2.2
|
)
|
|
(7
|
)
|
Tools and other steels
|
|
|
15.4
|
|
|
13.1
|
|
|
2.3
|
|
|
18
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net sales
|
|
$
|
475.0
|
|
$
|
404.5
|
|
$
|
70.5
|
|
|
17
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
19
The table below includes comparative information for the Companys sales by major product class
excluding surcharge revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended
September 30,
|
|
$
Increase /
(Decrease)
|
|
|
%
Increase /
(Decrease)
|
|
($ in millions)
|
|
2007
|
|
2006
|
|
|
Special alloys
|
|
$
|
143.2
|
|
$
|
123.6
|
|
$
|
19.6
|
|
|
16
|
%
|
Stainless steels
|
|
|
109.1
|
|
|
111.9
|
|
|
(2.8
|
)
|
|
(3
|
)
|
Titanium products
|
|
|
42.5
|
|
|
48.0
|
|
|
(5.5
|
)
|
|
(11
|
)
|
Ceramics and other materials
|
|
|
28.1
|
|
|
30.4
|
|
|
(2.3
|
)
|
|
(8
|
)
|
Tools and other steels
|
|
|
14.6
|
|
|
12.6
|
|
|
2.0
|
|
|
16
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net sales excluding surcharge revenues
|
|
$
|
337.5
|
|
$
|
326.5
|
|
$
|
11.0
|
|
|
3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales of special alloys products increased 49 percent from a year ago to $252.3 million. Adjusted
for surcharge revenues, sales increased 16 percent. The sales increase principally reflected the growth that we have experienced in our energy end-use market as a result of increased oil exploration activity, coupled with more demanding material
requirements that has fueled strong growth for our portfolio of special alloy products, particularly in Europe and Asia. In addition, strong demand for our non-magnetic drill collars helped drive the increase.
Sales of stainless steels decreased 5 percent from a year ago to $136.6 million. Excluding surcharge revenues, sales decreased 3 percent. The decrease
resulted primarily from reduced shipments of lower value materials sold through distributors.
Sales of titanium products decreased 11
percent from a year ago to $42.5 million. The decrease is primarily a result of reduced shipments of titanium coil used to make fasteners for the aerospace industry compared to the record shipments in the first quarter a year ago. The reduced
shipments in the current year reflected a combination of lean inventory initiatives in the European supply chain and a rebalancing of inventory levels at several domestic fastener manufacturers.
Gross Profit
Our gross profit in the first quarter
increased 17 percent to $121.4 million, or 25.6 percent of net sales, from $103.9 million, or 25.7 percent of net sales, in the same quarter a year ago. The higher gross profit reflected the increased sales of higher value materials, pricing, cost
containment and the lag effect in the Companys surcharge mechanism.
20
Our surcharge mechanism is structured to recover high raw material costs, although generally with a one
month lag effect. While the surcharge protects the absolute gross profit dollars, it does have a dilutive effect on gross margin as a percent of sales. The following represents a summary of the dilutive impact of the surcharges on gross margin for
the three months ended September 30:
|
|
|
|
|
|
|
|
|
(in millions)
|
|
2007
|
|
|
2006
|
|
Net sales
|
|
$
|
475.0
|
|
|
$
|
404.5
|
|
Less: surcharge revenues
|
|
|
(137.5
|
)
|
|
|
(78.0
|
)
|
|
|
|
|
|
|
|
|
|
Net sales excluding surcharges
|
|
$
|
337.5
|
|
|
$
|
326.5
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
$
|
121.4
|
|
|
$
|
103.9
|
|
|
|
|
|
|
|
|
|
|
Gross margin
|
|
|
25.6
|
%
|
|
|
25.7
|
%
|
|
|
|
|
|
|
|
|
|
Gross margin excluding dilutive effect of surcharges
|
|
|
36.0
|
%
|
|
|
31.8
|
%
|
|
|
|
|
|
|
|
|
|
We estimate that the lag effect of the surcharge mechanism, which results from calculating the
surcharge amount for each month based on the previous months raw material prices, positively impacted gross margin by approximately 115 basis points during the quarter ended September 30, 2007, and negatively impacted gross margin by
approximately 140 basis points during the prior years quarter.
Gross profit in the three months ended September 30, 2007 was
negatively impacted as a result of $4.6 million reserve we recorded with respect to the duty drawback claims discussed below.
After
considering the dilutive effect of surcharges and the duty drawback reserve, the underlying improvement in gross profit and gross margin was largely driven by a richer product mix and the Companys continued focus on cost.
Selling and Administrative Expenses
Selling and
administrative expenses of $35.7 million were 7.5 percent of net sales compared to $30.8 million or 7.6 percent of net sales in the same quarter a year ago. The increase primarily related to higher variable compensation accruals as well as the
investments we made in filling key positions and other initiatives to support our growth goals.
Interest Expense
Interest expense for the quarter was $5.6 million, compared with $5.8 million in the same quarter in the prior year.
Other income
Other income for the recent first
quarter was $6.4 million compared with $5.9 million in the first quarter a year ago. The increase is primarily due to increased interest income from higher balances of investments in marketable securities.
Income taxes
Our tax provision in the recent first
quarter was $28.8 million, or 33.3 percent of pre-tax income, versus $22.0 million, or 30.1 percent, in the same quarter a year ago. The tax provision for the quarter ended September 30, 2006 was favorably impacted by $4.0 million related to
the reversal of certain deferred tax valuation allowances.
21
Business Segment Results:
Advanced Metals Operations Segment
The Advanced Metals Operations (AMO) segment includes
the manufacturing and distribution of high temperature and high strength metal alloys, stainless steels, and titanium in the form of small bars and rods, wire, narrow strip and powder. Products in this segment typically go through more finishing
operations, such as rolling, turning, grinding, drawing, and atomization, than products in our Premium Alloys Operations segment. Also, sales in the AMO segment are spread across many end-use markets, including the aerospace, industrial, consumer,
automotive, and medical industries. AMO products are sold under the Carpenter, Dynamet, and Talley brand names.
Net sales for the quarter
ended September 30, 2007 for the AMO segment were $322.3 million, compared to $290.3 million in the same quarter a year ago. Excluding surcharge revenues, net sales decreased 2 percent from a year ago. The decrease reflected the impact of the
slowdown in the automotive and truck market as well as decreases in shipment volumes to the consumer market and overall reductions in lower value materials sold through distributors. These decreases were offset in part by price increases and
improvements to the overall product mix as the largest volume decreases related to lower value material.
Operating income for the AMO
segment was $48.9 million or 15 percent of net sales (22 percent of net sales excluding surcharge revenues) in the recent first quarter, compared to $40.7 million or 14 percent of net sales (18 percent of net sales excluding surcharge revenues) in
the same quarter a year ago. The increase in operating income reflected a richer product mix and a continued focus on cost.
Premium Alloys Operations
Segment
The Premium Alloys Operations (PAO) segment includes the manufacturing and distribution of high temperature and
high strength metal alloys and stainless steels in the form of ingots, billets, large bars and hollows. Also, the PAO segment includes conversion processing of metal for other specialty metals companies. A significant portion of PAO sales are to
customers in the aerospace and energy industries. Much of PAO sales are to forging companies that further shape, mill, and finish the metals into more specific dimensions. All such sales are made under the Carpenter brand name.
Net sales for the quarter ended September 30, 2007 for the PAO segment were $129.3 million, compared to $86.9 million in the same quarter a year
ago. Excluding surcharge revenues, net sales increased 30 percent from a year ago. The increase was largely driven by the growth with key customers and strong international demand in the energy market.
Operating income for the PAO segment was $36.5 million or 28 percent of net sales (41 percent of net sales excluding surcharge revenues) in the recent
first quarter, compared to $31.2 million or 36 percent of net sales (46 percent of net sales excluding surcharge revenues) in the same quarter a year ago. The decrease in operating income as a percentage of net sales reflected a less favorable
product mix, as a significant amount of the sales increase in the current quarter consisted of the lower value stainless material, as well as increases in costs related to future growth initiatives.
22
Engineered Products Operations Segment
The Engineered Products Operations (EPO) segment is essentially unchanged from our previous reporting. EPO involves the manufacture and sale
of structural ceramic products, ceramic cores for the investment casting industry and custom shaped bar. Sales of EPO products are made under the Certech, Carpenter Advanced Ceramics and Rathbone brand names.
Net sales for the EPO segment decreased 4 percent to $27.0 million from $28.0 million a year ago. The decrease was primarily a result of lower volume
during the first quarter of fiscal 2008.
Operating income for the EPO segment decreased to $3.4 million in the recent first quarter from
$5.4 million in the same quarter a year ago. The decrease reflected the reduction in volume as well as increases in current year investments in future growth initiatives.
Liquidity and Financial Condition:
We believe that our cash, cash equivalents and marketable
securities of approximately $538 million as of September 30, 2007, together with cash generated from operations and available borrowing capacity under our credit facilities, will be sufficient to fund our operating activities, planned capital
expenditures, share repurchases, and other obligations for the foreseeable future.
During the three months ended September 30, 2007,
our free cash flow, as defined on page 24, was $24.1 million as compared to $50.8 million for the same period a year ago. This reduction reflected the decrease in cash provided from operating activities and the increases in capital expenditures
during the first quarter of fiscal 2008.
Cash provided from operating activities was $48.9 million for the recent quarter. For the same
period last year, cash provided from operating activities was $64.0 million. This overall decrease reflected an increase in earnings for the period that was more than offset by the Companys investment in working capital.
Capital expenditures for plant, equipment and software were $18.4 million for the current first quarter versus $7.3 million for the same period a year
ago. The Company plans to invest in excess of $150 million in capital expenditures in fiscal 2008 including $75 million associated with the expansion of our premium melt facilities and $14 million associated with upgrades to our hot rolling
facilities.
Dividends were $7.6 million this year compared to $6.1 million last year. The Companys Board of Directors declared a
quarterly cash dividend of $0.30 per share of common stock which was paid on September 7, 2007 to stockholders of record on September 4, 2007.
During the quarter ended September 30, 2007, we used $157.7 million to purchase 1,341,579 shares of our common stock pursuant to the terms of a share repurchase program authorized by the Companys Board of
Directors. The share repurchase program authorizes the purchase, under certain conditions, up to $250 million of the Companys common stock. As of September 30, 2007, $63.4 million remains available for future purchases according to the
terms of the share repurchase program.
23
Non-GAAP Selected Financial Measures:
The following provides additional information regarding certain non-GAAP financial measures. Our definitions and calculations of these items may not
necessarily be the same as those used by other companies.
Net Sales Excluding Surcharges
This quarterly report includes discussions of net sales as adjusted to exclude the impact of raw material surcharges, which represents a financial measure
that has not been determined in accordance with U.S. GAAP. The Company provided this additional financial measure because management believes removing the impact of raw material surcharges from net sales provides a more consistent basis for
comparing results of operations from period to period. See page 21 for a reconciliation of net sales excluding surcharges to net sales as determined in accordance with U.S. GAAP.
Free Cash Flow
The following provides a reconciliation of free cash flow, as used in this
quarterly report, to its most directly comparable U.S. GAAP financial measures:
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended
September 30,
|
|
(in millions)
|
|
2007
|
|
|
2006
|
|
Net cash provided from operating activities
|
|
$
|
48.9
|
|
|
$
|
64.0
|
|
Purchases of property, equipment and software
|
|
|
(18.4
|
)
|
|
|
(7.3
|
)
|
Proceeds from disposals of property and equipment
|
|
|
1.2
|
|
|
|
0.2
|
|
Dividends paid
|
|
|
(7.6
|
)
|
|
|
(6.1
|
)
|
|
|
|
|
|
|
|
|
|
Free cash flow
|
|
$
|
24.1
|
|
|
$
|
50.8
|
|
|
|
|
|
|
|
|
|
|
Management believes that the presentation of free cash flow provides useful information to
investors regarding our financial condition because it is a measure of cash generated which management evaluates for alternative uses. It is managements current intention to use excess cash to fund investments in capital equipment, acquisition
opportunities, treasury stock purchases, dividend growth, the repayment of long-term debt if economically feasible, or for other general corporate purposes.
Contingencies:
Environmental
We are subject to various federal, state, local and foreign environmental laws and regulations relating to pollution, protection of public health and the environment, natural resource damages and occupational safety
and health. Although compliance with these laws and regulations may affect our costs of operations, compliance costs to date have not been material on an annual or periodic basis. We have environmental remediation liabilities at some of our owned
operating facilities and have been designated as a potentially responsible party (PRP) with respect to certain third-party Superfund waste disposal sites and other third party owned sites. Additionally, we have been notified that we may
be a PRP with respect to other Superfund sites as to which no proceedings have been instituted against us. Neither the exact amount of remediation costs nor the final method of their allocation among all designated PRPs at these Superfund sites has
been determined. The liability for future environmental remediation costs is evaluated by management on a quarterly basis. We accrue amounts for environmental remediation costs that represent our best estimate of the probable and reasonably
estimable costs related to environmental remediation. There were no additional amounts accrued during the three months ended September 30, 2007 or 2006. The liability recorded for environmental remediation costs at
24
Superfund sites, at other third party-owned sites and at Carpenter-owned current or former operating facilities remaining at September 30, 2007 was $5.3
million. The estimated range at September 30, 2007 of the reasonably possible future costs of remediation at Superfund sites, at other third party-owned sites and at Carpenter-owned current or former operating facilities is between $5.3 million
and $9.7 million.
Estimates of the amount and timing of future costs of environmental remediation requirements are inherently imprecise
because of the continuing evolution of environmental laws and regulatory requirements, the availability and application of technology, the identification of currently unknown remediation sites and the allocation of costs among the PRPs. Based upon
information currently available, such future costs are not expected to have a material effect on our financial position, results of operations or cash flows over the long-term. However, such costs could be material to our financial position, results
of operations or cash flows in a particular future quarter or year.
Duty Drawback
Historically, the Company has participated in a program offered by U.S. Customs and Border Protection (U.S. Customs) known as duty drawback.
Under the program, the Company claimed a refund of import duties on items manufactured and exported to customers in foreign countries. Certain vendors of the Company prepared certificates authorizing the Company to claim duty drawback refunds
against imported goods purportedly shipped by the vendor to the Company. Because of the complexity of the program, the Company engaged a licensed U.S. customs broker specializing in duty drawback claims. The customs broker was responsible for
performing the administration of the process which included maintaining and collecting various forms of supporting evidence for each claim including collecting appropriate certificates from vendors, as well as preparing and submitting the refund
claims.
The Company received notice from U.S. Customs that the Company was under investigation related to claims previously filed by
the customs broker on the Companys behalf. The investigation alleged certain discrepancies and a lack of supporting documentation for the claims that had been filed by the broker. The Company initiated an internal review of the claims filed
with U.S. Customs to determine the extent of claims that may have inadequate supporting documentation. The Company has also suspended the filing of any new duty drawback claims until the investigation can be concluded. The Company intends to
cooperate fully with U.S. Customs investigation of this matter.
As of the date of this filing, the Companys internal
review is not complete due to the extensive amount of documentation which must be compiled and reviewed. Based on the initial results of the review to date, the Company has recorded a charge of $4.6 million to Cost of Sales. This charge was
determined in accordance with Statements of Financial Accounting Standards No. 5, Accounting for Contingencies
,
and represents the Companys current best estimate of probable loss.
During the period the Companys customs broker was filing claims on the Companys behalf, July 2003 through December 2006, the Company applied
for and received refund claims totaling $6.9 million. While the ultimate outcome of the U.S. Customs investigation and the Companys internal review is not yet known, based on current facts we believe there is minimal risk of additional
loss.
Other
We are also
defending various claims and legal actions, and are subject to contingencies that are common to our operations including those pertaining to product claims, commercial disputes, employment actions, employee benefits, compliance with domestic and
foreign laws, personal injury claims and tax issues. We provide for costs relating to these matters when a loss is probable and the amount is reasonably estimable. The effect of the outcome of these matters on our future results of operations and
liquidity cannot be predicted because any such effect depends on future results of operations and the amount and timing (both as to recording future charges to operations and cash expenditures) of the resolution of such matters. While it is not
feasible to determine the outcome of these
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matters, management believes that any total ultimate liability will not have a material effect on our financial position, results of operations or cash
flows. However, such costs could be material to our financial position, results of operations or cash flows in a particular future quarter or year.
Critical Accounting Policies and Estimates:
Inventories are stated at the lower of cost or market. The cost of
inventories is primarily determined using the Last-In, First-Out (LIFO) method, although we also use the First-In, First-Out (FIFO) and average cost methods. Costs include direct materials, direct labor and applicable
manufacturing overhead, and other direct costs. Under the LIFO inventory valuation method, changes in the cost of raw materials and production activities are recognized in cost of sales in the current period even though these materials and other
costs may have been incurred at significantly different values due to the length of time of our production cycle. The prices for many of the raw materials we use have been volatile. Since we value most of our inventory utilizing the LIFO inventory
costing methodology, rapid changes in raw material costs have an impact on our operating results. In a period of rising prices, cost of sales expense recognized under LIFO is generally higher than the cash costs incurred to acquire the inventory
sold. Conversely, in a period of declining raw material prices, cost of sales recognized under LIFO is generally lower than cash costs incurred to acquire the inventory sold. For example, during the first quarter of the current fiscal year, the
effect of the decrease in raw material costs on our LIFO inventory valuation method resulted in a decrease of cost of sales of $14.5 million.
Since the LIFO inventory valuation methodology is designed for annual determination, interim estimates of the annual LIFO valuation are required. We recognize the effects of the LIFO inventory valuation method on an interim basis by
estimating the expected annual LIFO cost based on cost increases to date. These projections of annual LIFO inventory valuation reserve changes are updated quarterly and are evaluated based upon material, labor and overhead costs.
Other Critical Accounting Policies and Estimates
A summary of other significant accounting policies is discussed in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations and in Note 1, Summary of Significant Accounting Policies, of Notes
to Consolidated Financial Statements included in Part II, Item 8 of our Annual Report on Form 10-K for the year ended June 30, 2007.
Recent Accounting Pronouncements:
During the quarter ended September 30, 2007, as required, the Company adopted
FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 prescribes recognition and measurement standards for a tax position taken or expected to be taken in a tax return. The evaluation of
a tax position in accordance with FIN 48 is a two step process. The first step is the determination of whether a tax position should be recognized in the financial statements. Under FIN 48, a tax position taken or expected to be taken in a tax
return is to be recognized only if the Company determines that it is more-likely-than-not that the tax position will be sustained upon examination by the tax authorities based upon the technical merits of the position. In step two, for those tax
positions which should be recognized, the measurement of a tax position is determined as being the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. FIN 48 was effective as of the beginning of the
Companys 2008 fiscal year, with adoption treated as a cumulative-effect type reduction to beginning retained earnings of $1.8 million. Upon adoption of FIN 48, the Company made an accounting policy election to classify interest and penalties
on estimated liabilities for uncertain tax positions as components of the provision for income taxes.
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Outlook:
We see opportunity to further improve our performance through an enhanced focus on operational excellence. We expect the energy market to remain favorable. We are confident about the outlook for our aerospace business
in the second half of our fiscal year in which we expect aerospace sales will more closely reflect the increase in growth rate of commercial jet deliveries projected for 2008.
We expect that cash flows from operations will approach $300 million and anticipate that free cash flow will be approximately $100 million in fiscal
2008.
Forward-Looking Statements
This Form 10-Q contains various forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements, which represent our current
expectations concerning various future events, include statements concerning future revenues and continued growth in various market segments. These forward-looking statements are subject to known and unknown risks and uncertainties that could cause
actual results to differ from those projected, anticipated or implied. The most significant of these uncertainties are described in our annual report on Form 10-K for the year ended June 30, 2007, and the exhibits attached to that filing. They
include but are not limited to: 1) the cyclical nature of the specialty materials business and certain end-use markets, including aerospace, industrial, automotive, consumer, medical and energy, or other influences on our business such as new
competitors, the consolidation of customers and suppliers or the transfer of manufacturing capacity from the United States to foreign countries; 2) our ability to achieve cost savings, productivity improvements or process changes; 3) our
ability to recoup increases in the costs of energy and raw materials or other factors; 4) domestic and foreign excess manufacturing capacity for certain products; 5) fluctuations in currency exchange rates; 6) the degree of success of
government trade actions; 7) the valuation of the assets and liabilities in our pension trusts and changes to regulations related to pension plan funding requirements; 8) possible labor disputes or work stoppages; 9) the potential that our
customers may substitute alternate materials or adopt different manufacturing practices that replace or limit the suitability of our products; 10) the ability to successfully implement acquisition and disposition strategies; 11) the ability to
retain key personnel; and 12) the risk of loss associated with our concentration of manufacturing facilities located in Reading, Pennsylvania. Any of these factors could have an adverse and/or fluctuating effect on our results of operations. The
forward-looking statements in this document are intended to be subject to the safe harbor protection provided by Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We
undertake no obligation to update or revise any forward-looking statements.
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