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 December 31, 2003. |
| | | |
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 33-32617
HAYNES INTERNATIONAL, INC.
(Exact name of the registrant as specified in its charter)
| Delaware | 06-1185400 |
| (State or other jurisdiction of incorporation or organization) |
(IRS Employer Identification No.) |
| 1020 West Park Avenue, Kokomo, Indiana | 46904-9013 |
| (Address of principle executive offices) |
(Zip Code) |
| (765) 456-6000 | |
| (Registrant's telephone number, including area code) | |
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes No
X
As of February 16, 2004, the registrant had 100 shares of Common Stock, $.01 par value, outstanding.
Page 1 of 23
HAYNES INTERNATIONAL, INC.
TABLE OF CONTENTS
|
Page | ||
| PART I |
FINANCIAL INFORMATION | |
| Item 1. | Financial Statements: | |
|
Consolidated Condensed Balance Sheets as of September 30, 2003 (restated) and December 31, 2003 |
3 | |
|
Consolidated Condensed Statements of Operations for the Three Months ended December 31, 2002 (restated) and 2003 |
4 | |
|
Consolidated Condensed Statements of Comprehensive Income for the Three Months ended December 31, 2002 (restated) and 2003 |
5 | |
|
Consolidated Condensed Statements of Cash Flows for the Three Months ended December 31, 2002 (restated) and 2003 |
6 | |
| Notes to Consolidated Condensed Financial Statements | 7 | |
| Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations |
9 |
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
16 |
| Item 4. | Controls and Procedures |
17 |
| PART II |
OTHER INFORMATION | |
| Item 6. | Exhibits and Reports on Form 8-K |
17 |
| Signatures |
18 | |
| Index to Exhbits |
23 |
Page 2 of 23
PART 1 FINANCIAL INFORMATION
Item 1. Financial Statements
HAYNES INTERNATIONAL, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(dollars in thousands, except share amounts)
| September 30, 2003 Restated (Note 3) |
December 31, 2003 (Unaudited) | |||||||
|---|---|---|---|---|---|---|---|---|
| ASSETS | ||||||||
| Current assets: | ||||||||
| Cash and cash equivalents | $ | 4,791 | $ | 3,297 | ||||
| Accounts and notes receivable, less allowance for | ||||||||
| doubtful accounts of $974 and $932, respectively | 35,267 | 35,158 | ||||||
| Inventories | 85,809 | 94,210 | ||||||
| Refundable income taxes | 563 | 639 | ||||||
| Total current assets | 126,430 | 133,304 | ||||||
| Property, plant and equipment (at cost) | 131,406 | 133,255 | ||||||
| Accumulated depreciation | (91,177 | ) | (93,232 | ) | ||||
| Net property, plant and equipment | 40,229 | 40,023 | ||||||
| Prepayments and deferred charges, net | 13,456 | 13,723 | ||||||
| Total assets | $ | 180,115 | $ | 187,050 | ||||
| LIABILITIES AND CAPITAL DEFICIENCY | ||||||||
| Current liabilities: | ||||||||
| Senior notes | $ | 139,555 | $ | 139,673 | ||||
| Revolving credit | 56,815 | 61,358 | ||||||
| Accounts payable and accrued expenses | 23,179 | 27,667 | ||||||
| Accrued postretirement benefits | 4,400 | 4,400 | ||||||
| Note payable | 2,382 | 2,323 | ||||||
| Total current liabilities | 226,331 | 235,421 | ||||||
| Deferred foreign income taxes | 1,020 | 774 | ||||||
| Long-term debt | 2,255 | 2,028 | ||||||
| Accrued pension and postretirement benefits | 123,367 | 123,659 | ||||||
| Total liabilities | 352,973 | 361,882 | ||||||
| Capital deficiency: | ||||||||
| Common stock, $.01 par value (100 shares authorized, | ||||||||
| issued and outstanding) | ||||||||
| Additional paid-in capital | 51,381 | 51,381 | ||||||
| Accumulated deficit | (222,232 | ) | (226,570 | ) | ||||
| Accumulated other comprehensive income (loss) | (2,007 | ) | 357 | |||||
| Total capital deficiency | (172,858 | ) | (174,832 | ) | ||||
| Total liabilities and capital deficiency | $ | 180,115 | $ | 187,050 | ||||
The accompanying notes are an integral part of these financial statements.
Page 3 of 23
HAYNES INTERNATIONAL, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
(dollars in thousands)
| Three Months Ended December 31, |
|||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2002 Restated (Note 3) |
2003 (Unaudited) | ||||||||||
| Net revenues | $ | 42,922 | $ | 46,561 | |||||||
| Cost of sales | 35,667 | 39,195 | |||||||||
| Selling and administrative | 6,178 | 5,672 | |||||||||
| Research and technical | 774 | 628 | |||||||||
| Restructuring - Professional Fees | --- | 601 | |||||||||
| Operating income | 303 | 465 | |||||||||
| Interest expense | 4,922 | 5,103 | |||||||||
| Interest income | (12 | ) | (7 | ) | |||||||
| Loss before benefit from income taxes | (4,607 | ) | (4,631 | ) | |||||||
| Benefit from income taxes | (1,673 | ) | (293 | ) | |||||||
| Net loss | $ | (2,934 | ) | $ | (4,338 | ) | |||||
The accompanying notes are an integral part of these financial statements.
Page 4 of 23
HAYNES INTERNATIONAL, INC.
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(dollars in thousands)
| Three Months Ended December 31, |
|||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2002 Restated (Note 3) |
2003 (Unaudited) | ||||||||||
| Net loss | $ | (2,934 | ) | $ | (4,338 | ) | |||||
| Other comprehensive income, net of tax: | |||||||||||
| Foreign currency translation adjustment | 1,550 | 2,364 | |||||||||
| Other comprehensive income | 1,550 | 2,364 | |||||||||
| Comprehensive loss | $ | (1,384 | ) | $ | (1,974 | ) | |||||
The accompanying notes are an integral part of these financial statements.
Page 5 of 23
HAYNES INTERNATIONAL, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
(dollars in thousands)
| Three Months Ended December 31, |
|||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2002 Restated (Note 3) |
2003 (Unaudited) | ||||||||||
| Cash flows from operating activities: | |||||||||||
| Net loss | $ | (2,934 | ) | $ | (4,338 | ) | |||||
| Depreciation | 1,294 | 1,358 | |||||||||
| Amortization | 321 | 302 | |||||||||
| Deferred income taxes | (1,674 | ) | (246 | ) | |||||||
| Change in: | |||||||||||
| Inventories | 1,101 | (7,103 | ) | ||||||||
| Accounts receivable | 4,593 | 50 | |||||||||
| Accounts payable and accruals | 4,195 | 5,450 | |||||||||
| Other, net | (67 | ) | (277 | ) | |||||||
| Net cash provided by (used in) operating activities | 6,829 | (4,804 | ) | ||||||||
| Cash flows from investing activities: | |||||||||||
| Additions to property, plant and equipment | (913 | ) | (1,152 | ) | |||||||
| Proceeds from sale of property, plant and equipment | 704 | --- | |||||||||
| Net cash used in investing activities | (209 | ) | (1,152 | ) | |||||||
| Cash flows from financing activities: | |||||||||||
| Net increase (decrease) in revolving credit and long-term debt | (6,557 | ) | 4,316 | ||||||||
| Net cash provided by (used in) financing activities | (6,557 | ) | 4,316 | ||||||||
| Effect of exchange rates on cash | 206 | 146 | |||||||||
| Increase (decrease) in cash and cash equivalents | 269 | (1,494 | ) | ||||||||
| Cash and cash equivalents, beginning of period | 5,199 | 4,791 | |||||||||
| Cash and cash equivalents, end of period | $ | 5,468 | $ | 3,297 | |||||||
| Supplemental disclosures of cash flow information: | |||||||||||
| Cash paid (received) during period for: Interest | $ | 565 | $ | 711 | |||||||
| Income Taxes | $ | (12 | ) | $ | 28 | ||||||
The accompanying notes are an integral part of these financial statements.
Page 6 of 23
HAYNES INTERNATIONAL, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
For the three months ended December 31, 2003
(dollars in thousands, except share amounts)
Note 1. Going Concern
The accompanying consolidated financial statements have been prepared on the basis that the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. However, the Company’s financial performance, over the past fifteen months, has been adversely impacted by reduced customer demand caused by a weak economic environment, higher raw material cost and rising energy costs. As a result of these circumstances, the Company has entered into several amendments to the Company’s Credit Agreement dated as of November 22, 1999 (the “Credit Agreement”) certain of which provide additional availability, more flexible financial covenant requirements through January 31, 2004, full relief from the Senior Note Interest Reserve until February 29, 2004, at which time the full Senior Note Interest Reserve will again be in effect.
The Company is highly leveraged. Senior Notes, in the amount of $140 million, are scheduled to be retired on September 1, 2004. In addition, interest payments on the Senior Notes of $8.1 million each are due on March 1, 2004 and September 1, 2004. The revolving Credit Agreement, with an outstanding amount of $61.4 million as of December 31, 2003, is currently scheduled to expire on June 3, 2004. Furthermore, certain raw material suppliers and financial advisors who are assisting the Company with its debt refinancing and balance sheet restructuring activities have changed the Company’s payment terms to cash on delivery for material and fees which has caused a tightening of our cash availability.
In November 2003, the Company retained Conway, Del Genio, Gries & Co., LLC and Skadden, Arps, Slate, Meagher & Flom LLP to assist the Company in analyzing and evaluating possible transactions for the principal purpose of restructuring the Company’s balance sheet, which the Company’s management believes is essential to ensure that the Company has adequate working capital to operate its business. In addition, the Company commenced discussions beginning in January 2004 with holders of its Senior Notes regarding possible restructuring transactions. The Company anticipates that any such restructuring transaction will result in substantial dilution of the interest of existing equity holders of Haynes Holdings, Inc. There can be no assurance that the Company will be successful in implementing the contemplated balance sheet restructuring or in obtaining new bank financing.
In the event the Company does not succeed in its restructuring efforts, it is likely that liquidity will be inadequate to enable the Company to make the interest payments required with respect to the Senior Notes on March 1, 2004 and September 1, 2004, retire the Senior Notes on September 1, 2004, and repay the Credit Agreement on June 3, 2004. Moreover, one possible outcome of the restructuring could be the deferral or forgiveness of some or all of these obligations in return for other forms of consideration. In addition, in the event the Company is unable to modify the terms of its existing credit facility or obtain other sources of capital and liquidity, it is possible that the Company could be unable to satisfy other obligations as they become due.
The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.
Page 7 of 23
HAYNES INTERNATIONAL, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
For the three months ended December 31, 2003
(dollars in thousands, except share amounts)
Note 2. Basis of Presentation
The interim financial statements are unaudited and reflect all adjustments (consisting solely of normal recurring adjustments) that, in the opinion of management, are necessary for a fair statement of results for the interim periods presented. This report includes information in a condensed form and should be read in conjunction with the audited consolidated financial statements included in Form 10-K for the fiscal year ended September 30, 2003, filed by the Company with the Securities and Exchange Commission (“SEC”) on December 29, 2003. The results of operations for the three months ended December 31, 2003, are not necessarily indicative of the results to be expected for the full year or any other interim period.
Certain amounts in prior period financial statements have been reclassified to conform with current period presentation. (See Note 3)
Note 3. Inventories
Effective October 1, 2003, the Company changed its inventory costing method for domestic inventories from the last-in, first-out (LIFO) method to the first-in, first-out (FIFO) method. Management of the Company believes that the FIFO method is preferable to LIFO, due in part to factors discussed in Note 1, because (i) FIFO inventory values presented in the Company’s balance sheet will more closely approximate the current value of inventory (ii) costs of sales are still appropriately charged in the period of the related sales, and (iii) the change to FIFO method for domestic inventories results in the Company using a uniform method of inventory valuation globally.
The effect of the change in accounting principle was to decrease the net loss for the first quarter of fiscal 2004 by $2.2 million. In accordance with generally accepted accounting principles, the change has been applied by restating the prior years consolidated financial statements. The effect of this restatement was to decrease inventories at September 30, 2003 by $13.8 million, increase the accumulated deficit as of September 30, 2003 by $13.8 million, and increase the net loss for the first quarter of fiscal 2003 by $166,000.
The following is a summary of the major classes of inventories:
| September 30, 2003 (Restated) |
December 31, 2003 (Unaudited) | |||||||
|---|---|---|---|---|---|---|---|---|
| Raw Materials | $ | 5,385 | $ | 6,629 | ||||
| Work-in-process | 37,360 | 38,667 | ||||||
| Finished Goods | 41,875 | 47,887 | ||||||
| Other, net | 1,189 | 1,027 | ||||||
| Inventories | $ | 85,809 | $ | 94,210 | ||||
Note 4. Income Taxes
The income tax provision for the three months ended December 31, 2002 and 2003, differed from the U.S. federal statutory rate of 34% primarily due to state income taxes, differing tax rates on foreign earnings, and recording of a valuation allowance applied against tax benefits generated by the US operations in fiscal 2004. The reason no tax benefit was recorded in fiscal 2004 for the US operations is because it is more likely than not that the tax asset will not be realized. The tax benefit recorded for the three months ended December 31, 2003 represents only foreign tax benefits.
Page 8 of 23
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
References to years or portions of years in Management’s Discussion and Analysis of Financial Condition and Results of Operations refer to the Company’s fiscal years ended September 30, unless otherwise indicated. This discussion contains statements that constitute forward-looking statements within the meaning of the securities laws. Such statements may include statements regarding the intent, belief or current expectations of the Company or its officers with respect to (i) the Company’s strategic plans, (ii) the policies of the Company regarding capital expenditures, financing or other matters, and (iii) industry trends affecting the Company’s financial condition or results of operations. Readers of this discussion are cautioned that any such forward looking statements are not guarantees of future performance and involve risks and uncertainties and that actual results may differ materially from those in the forward looking statements as a result of various factors. This report should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Form 10-K for the fiscal year ended September 30, 2003, filed by the Company with the Securities and Exchange Commission on December 29, 2003.
In addition, the Company has based these forward-looking statements on its current expectations and projections about future events. Although the Company believes that the assumptions on which the forward-looking statements contained herein are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based upon those assumptions also could be incorrect. Risks and uncertainties which may affect the accuracy of forward looking statements include the following:
| • |
If the Company is unable to reach agreement with its various lenders on amending
or restructuring its existing debt and successfully implement a restructuring
plan, it is likely that the Company will not have adequate liquidity to satisfy
its debts and may become the subject of adverse legal proceedings. Moreover, one
possible outcome of the restructuring would be the deferral or forgiveness of
some or all of the Company’s existing debt in return for other forms of
consideration. |
| • |
If the Company is unable to comply with the operating and financial restrictions
imposed on it by the terms of its indebtedness, the maturity of the debt may be
accelerated and the Company may be unable to satisfy its debts. |
| • |
The earnings of the Company are susceptible to rapid increases in the prices of
its raw materials. To the extent that the price of nickel, a major component of
many of the Company’s products, continues to rise rapidly, as it did in
fiscal 2003 and the first quarter of fiscal 2004, there may be a negative effect
on the Company’s gross profit margins. |
| • |
The Company’s gross profit margins may also be negatively impacted by
increases in the cost of energy, transportation and labor. |
| • |
The Company depends on the continued growth in demand of the aerospace and
chemical processing industries and the continued access of its direct and
indirect customers to capital in order to fund their expansion. A decrease in
the growth rates for consumption in these industries or the inability for the
Company’s customers in these industries to raise capital could reduce the
demand for the Company’s products and adversely impact the Company’s
revenues and operating results. |
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.
Capital Restructuring
The Company’s financial performance, over the past fifteen months, has been adversely impacted by reduced customer demand caused by a weak economic environment, higher raw material cost and rising energy costs. As a result of these circumstances, the Company has entered into several amendments to the Company’s Credit Agreement dated as of November 22, 1999 (the “Credit Agreement”) certain of which provide additional availability, more flexible financial covenant requirements through January 31, 2004, and full relief from the Senior Note Interest Reserve until February 29, 2004, at which time the full Senior Note Interest Reserve will again be in effect. See Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” for a summary of specific requirements of the amendments to the Credit Agreement.
Page 9 of 23
The Company is highly leveraged. The Company’s 11 5/8% Senior Notes due 2004 (the “Senior Notes”), in the amount of $140 million, are scheduled to be retired on September 1, 2004. In addition, interest payments on the Senior Notes of $8.1 million each are due on March 1, 2004 and September 1, 2004. Finally, the Credit Agreement, with an outstanding amount of $61.4 million as of December 31, 2003, is currently scheduled to expire on June 3, 2004. Furthermore, certain raw material suppliers and financial advisors who are assisting the Company with its debt refinancing and balance sheet restructuring activities have changed our payment terms to cash on delivery for material and fees which has caused a tightening of our cash availability.
In November 2003, the Company retained Conway, Del Genio, Gries & Co., LLC and Skadden, Arps, Slate, Meagher & Flom LLP to assist the Company in analyzing and evaluating possible transactions for the principal purpose of restructuring the Company’s balance sheet, which the Company’s management believes is essential to ensure that the Company has adequate working capital to operate its business. The Company commenced discussions beginning in January 2004 with holders of its Senior Notes regarding possible restructuring transactions. The Company further anticipates that any such restructuring transaction will result in substantial dilution of the interest of the existing equity holders of Haynes Holdings, Inc. There can be no assurance that the Company will be successful in implementing the contemplated balance sheet restructuring or in obtaining new bank financing. See statement in Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” regarding forward-looking statements.
In the event the Company does not succeed in its restructuring efforts, it is likely that liquidity will be inadequate to enable the Company to make the interest payments required with respect to the Senior Notes on March 1, 2004 and September 1, 2004, retire the Senior Notes on September 1, 2004, and repay the Credit Agreement on June 3, 2004. Moreover, one possible outcome of the restructuring would be the deferral or forgiveness of some or all of these obligations in return for other forms of consideration. In addition, in the event the Company is unable to modify the terms of its existing credit facility or obtain other sources of capital and liquidity, it is possible that the Company could be unable to satisfy other obligations as they become due. See Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” regarding forward-looking statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources”.
As reported in the Company’s Form 10-K for the fiscal year ended September 30, 2003, filed on December 29, 2003, due to various factors including the uncertainty regarding the capital restructuring and its effect on liquidity, the Company’s auditor’s report on the consolidated financial statements for fiscal year ended September 30, 2003 contains a “going concern” comment. See Form 10-K for the fiscal year ended September 30, 2003, Item 8 “Financial Statements and Supplementary Data” for a copy of the auditor’s report.
Notwithstanding increased sales volume, selling prices, backlog and order entry, the ability of the Company to continue as a going concern and meet obligations as they come due is uncertain at December 31, 2003.
Results of Operations
Three Months Ended December 31, 2003 Compared to Three Months Ended December 31, 2002
Net Revenues. Net revenues increased approximately $3.7 million or 8.6% to approximately $46.6 million in the first quarter of fiscal 2004 from approximately $42.9 million in the first quarter of fiscal 2003. Volume increased 6.5% to approximately 3.3 million pounds in the first quarter of fiscal 2004 from approximately 3.1 million pounds in the first quarter of fiscal 2003. The average selling price decreased 0.8% to $13.87 per pound in the first quarter of fiscal 2004 from $13.98 per pound in the first quarter of fiscal 2003. The Company’s consolidated backlog has increased approximately $4.1 million or 8.1% to approximately $54.7 million at December 31, 2003 from approximately $50.6 million at September 30, 2003. Order entry increased $9.1 million or 22.2% for the quarter ended December 31, 2003, as compared to the quarter ended December 31, 2002.
Sales to the aerospace industry increased by 5.5% to approximately $19.3 million in the first quarter of fiscal 2004 from approximately $18.3 million for the same period a year earlier. The improved revenue can be attributed to a 10.0% increase in volume to approximately 1.1 million pounds from approximately 1.0 million pounds which was offset slightly by a 1.1% decrease in the average selling price per pound. The slight decrease in the average selling price is due to sales of a greater proportion of the lower valued nickel-base alloys and product forms in fiscal 2004. The volume increase was primarily caused by stronger domestic sales of nickel-base and cobalt-base alloy flat products to the gas turbine engine fabricators. Sales to the European and export market segments continue at lower levels in most alloys and product forms as compared to the same period a year earlier.
Page 10 of 23
Sales to the chemical process industry increased by 23.8% to approximately $12.5 million in the first quarter of fiscal 2004 from approximately $10.1 million for the same period a year earlier, due to a 25.0% increase in volume along with a 4.2% increase in the average selling price per pound. The volume increased approximately 200,000 pounds to approximately 1.0 million pounds for the first quarter of fiscal 2004 from approximately 800,000 pounds for the first quarter of fiscal 2003. The higher volume is attributed to improved project related and maintenance related businesses in the European geographic sector diluted by reduced demand from US and export geographic sectors. The increase in the average selling price is due to sales of a greater proportion of the higher valued product forms in fiscal 2004 and improved pricing in the marketplace.
Sales to the land-based gas turbine industry decreased by 16.5% to approximately $6.6 million in the first quarter of fiscal 2004 from approximately $7.9 million for the same period a year earlier, due to a 14.3% decrease in volume combined with a 1.4% decrease in the average selling price per pound. The volume decreased approximately 100,000 pounds to approximately 600,000 pounds for the first quarter of fiscal 2004 from approximately 700,000 pounds for the first quarter of fiscal 2003. The decrease in volume is mostly attributed to reduced European sales of proprietary alloy round and flat products as the alloy reprocessors and fabricators meet the reduced level of demand for the gas turbine manufacturers. The decrease in the average selling price is attributed to sales of a greater proportion of the lower valued commodity alloys and product forms in fiscal 2004.
Sales to other industries increased by 24.2% to approximately $8.2 million in the first quarter of fiscal 2004 from approximately $6.6 million for the same period a year earlier, due to a 20.0% increase in volume which was partially offset by an 11.2% decrease in the average selling price per pound. The volume increased approximately 100,000 pounds to approximately 600,000 pounds in the first quarter of fiscal 2004 from approximately 500,000 pounds in the first quarter of fiscal 2003. The increase in volume is mainly due to the effects of sales related to several domestic and export flue gas desulfurization (FGD) projects in the first quarter of fiscal 2004 that were not in process in the prior year. A reduced volume in the remaining minor market segments in this category partially reduced the FGD growth in this comparable time period. The decrease in the average selling price can be attributed to a higher proportion of the lower valued flat products for the FGD market in fiscal 2004.
Cost of Sales. Cost of sales as a percent of net revenues remained relatively flat when comparing the first quarter of fiscal 2003 with the first quarter of fiscal 2004. The pounds sold, the revenue, and the cost of sales all increased slightly with the cost of sales slightly outpacing the increase of the other two. This can be attributed primarily to the 57.8% increase in the cost of nickel, which is partially offset by reduced costs relating to the startup of a new sheet cutting program.
Effective October 1, 2003, the Company changed its inventory costing method for domestic inventories from the LIFO method to the FIFO method. Management of the Company believes that the FIFO method is preferable to LIFO, due in part to factors discussed in Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Restructuring”, because (i) FIFO inventory values presented in the Company’s balance sheet will more closely approximate the current value of inventory (ii) costs of sales are still appropriately charged in the period of the related sales, and (iii) the change to FIFO method for domestic inventories results in the Company using a uniform method of inventory valuation globally. The effect of the change in accounting principle was to decrease the net loss for the first quarter of fiscal 2004 by $2.2 million and to increase the net loss for the first quarter of fiscal 2003 by $166,000.
Selling and Administrative Expenses. Selling and administrative expenses decreased by approximately $500,000 to approximately $5.7 million in the first quarter of fiscal 2004 from approximately $6.2 million in the first quarter of fiscal 2003. The decrease in selling and administrative expenses was primarily due to lower management fees, lower employee costs, and reduced foreign exchange losses.
Research and Technical Expense. Research and technical expenses decreased by approximately $200,000 to approximately $600,000 in the first quarter of fiscal 2004 from approximately $800,000 in the first quarter of fiscal 2003. The decrease in research and technical expense was primarily due to lower employee costs, lower consultant costs, and lower patent legal expenses.
Restructuring – Professional Fees. During the first quarter of fiscal 2004, the Company incurred approximately $600,000 of professional fees related to restructuring and refinancing activities. There was no corresponding expense for the first quarter of fiscal 2003.
Operating Income. As a result of the above factors, operating income for the first quarter of fiscal 2004 was approximately $500,000 compared to approximately $300,000 for the first quarter of fiscal 2003.
Page 11 of 23
Interest Expense. Interest expense increased by approximately $200,000 to approximately $5.1 million in the first quarter of fiscal 2004 from approximately $4.9 million in the first quarter of fiscal 2003. Higher revolving credit borrowings and higher interest rates contributed to the increase when comparing the two quarters.
Income Taxes. The income tax benefit decreased by approximately $1.4 million to approximately $300,000 for the first quarter of fiscal 2004 from approximately $1.7 million for the first quarter of fiscal 2003. No deferred tax benefit for the first quarter of fiscal 2004 was recorded for NOL carryforwards except for the benefit from European operations.
Net Loss. As a result of the above factors, the net loss was approximately $4.3 million for the first quarter of fiscal 2004 compared to the net loss of approximately $2.9 million for the first quarter of fiscal 2003.
Liquidity and Capital Resources
Net cash used in operating activities in the first quarter of fiscal 2004 was approximately $4.8 million, as compared to net cash provided by operating activities in the first quarter of fiscal 2003 of approximately $6.8 million. The cash used in operating activities for the first quarter of fiscal 2004 was primarily the result of an increase in inventories of approximately $7.1 million, a decrease of approximately $200,000 in deferred income taxes, a net loss of approximately $4.3 million, and approximately $300,000 in other uses, which were partially offset by an increase in accounts payable of approximately $5.5 million, and non-cash depreciation and amortization of approximately $1.6 million. Net cash used in investing activities increased to approximately $1.2 million for the first quarter of fiscal 2004 from approximately $200,000 for the first quarter of fiscal 2003, due to the increase in capital expenditures partially offset by a decrease in proceeds from the sale of fixed assets. Net cash provided by financing activities for the first quarter of fiscal 2004 was approximately $4.3 million compared to net cash used in financing activities of approximately $6.6 million in the first quarter of fiscal 2003, primarily due to a net increase in borrowings under the Credit Agreement.
Cash for the first quarter of fiscal 2004 decreased by approximately $1.5 million resulting in a December 31, 2003 cash balance of approximately $3.3 million. Cash for the first quarter of fiscal 2003 increased approximately $300,000 resulting in a December 31, 2002 cash balance of approximately $5.5 million. The Company had available additional borrowing capacity of approximately $6.6 million on the Credit Agreement at December 31, 2003. The Company will require additional cash for expenses relating to the restructuring of the Senior Note debt.
The Company is highly leveraged and, absent a restructuring, it is unlikely that it will have sufficient operating cash flow to both service its indebtedness and fund its daily operating requirements. The Company’s primary sources of capital have been from the issuance of debt securities, borrowings under the Company’s Credit Agreement, and internally generated cash from operations. At December 31, 2003, outstanding indebtedness consisted of $140.0 million of Senior Notes, $61.4 million outstanding under the Credit Agreement and $4.4 million of other debt. Interest on the Senior Notes is payable semi-annually on March 1 and September 1. The Company’s leverage and debt service requirements (i) increase its vulnerability to economic downturns, (ii) potentially limit the Company’s ability to respond to competitive pressures, and (iii) may limit the Company’s ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, strategic investments or general corporate purposes. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Restructuring” for information on the Company’s efforts to restructure its indebtedness.
The Senior Notes and the Credit Agreement contain a number of covenants limiting the Company’s access to capital, including covenants that restrict the ability of the Company and its subsidiaries to (i) incur additional indebtedness, (ii) make certain restricted payments, (iii) engage in transactions with affiliates, (iv) create liens on assets, (v) sell assets, (vi) issue and sell preferred stock of subsidiaries, and (vii) engage in consolidations, mergers and transfers. In addition, the Credit Agreement requires the Company to meet certain financial covenants and maintain reserves for certain purposes, including the Fixed Charge Reserve of $7.0 million until June 3, 2004, the Senior Note Interest Reserve and the requirement for the average daily Revolving Credit Availability (as defined in the Credit Agreement) for the thirty-day period preceding any day on which the Company makes an interest or principal payment on the Senior Notes to be in excess of $4.5 million after giving effect to each payment. Failure to comply with these covenants and reserves constitutes a default under the applicable instrument entitling the holders of the Senior Notes or Credit Agreement lenders, as the case may be, to accelerate the maturity of the indebtedness, and, in the case of the Credit Agreement, enforce security interests in the Company’s assets and refuse to make further advances to the Company.
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The Credit Agreement has been amended four times since the end of fiscal year 2002 to respond to certain economic fluctuations occurring since that time including reduced customer demand caused by the weak economic environment, higher raw material costs and rising energy costs. On November 1, 2002, the Company entered into Amendment No. 3 to the Credit Agreement. This amendment extends the revolving loan termination date to the earlier of October 31, 2005, or ninety days prior to the scheduled maturity date of the Senior Notes, a date that currently equates to June 3, 2004, and increases the maximum availability for foreign subsidiaries from $12.0 million to $17.0 million less a foreign subsidiary reduction amount that totals $1.0 million ratably over the course of a year until such time as the entire $5.0 million initial increase is amortized.
On August 26, 2003, the Company entered into Amendment No. 4 to the Credit Agreement. The amendment requires that the Company not permit the average daily Revolving Credit Availability (as defined in the Credit Agreement) for the thirty-day period preceding any day on which the Company makes a principal or interest payment on the Senior Notes to be less than $4.5 million, after giving effect to the amount of the applicable payment. Also, beginning on August 26, 2003, and ending on January 31, 2004, the Fixed Charge Coverage Ratio (“FCCR”) must be at least 0.65 to 1.0 instead of at least 0.75 to 1.0. At December 31, 2003 the Company was in compliance with the FCCR, as amended.
On November 19, 2003, the Company entered into Amendment No. 5 to the Credit Agreement. This amendment fixes the amount of the Fixed Charge Reserve at $7.0 million for the period beginning November 1, 2003 and ending June 3, 2004. In addition, relief was provided for the Senior Note Interest Reserve such that it is: (i) zero through December 31, 2003; (ii) $1.4 million from January 1, 2004 through January 31, 2004; (iii) $5.4 million from February 1, 2004 through February 14, 2004; (iv) $6.8 million from February 15, 2004 through February 27, 2004; and (v) $8.1 million on February 28, 2004. The amendment also requires that the Company not permit the average daily Revolver Credit Availability (as defined in the Credit Agreement) for the thirty-day period preceding any day on which the Company makes a principal or interest payment on the Senior Notes to be less than $4.5 million, after giving effect to the amount of the applicable payment. The Company was in compliance with its financial covenants as of December 31, 2003.
During January 2004, five of the Company’s major material suppliers required cash in advance of delivery of goods which is continuing. Therefore on January 30, 2004, the Company entered into Amendment No. 6 to the Credit Agreement which temporarily suspends application of the Senior Note Interest Reserve discussed above until the earlier of (i) February 29, 2004 or (ii) the occurrence of any default (as defined in the Credit Agreement). Other amendments relate to reporting requirements including reporting changes in inventory from monthly to weekly and an eight week rolling cash flow forecast on a weekly basis.
The Company’s primary uses of capital in 2004, other than providing working capital for normal operating expenses, including cash on delivery terms with certain raw material suppliers, are expected to consist primarily of expenditures related to capital improvements, professional fees in connection with the Company’s capital restructuring project, and principal and interest payments on outstanding indebtedness. Planned fiscal 2004 capital spending is targeted at $5.6 million with the main projects being the electric arc furnace split shell electro slag remelt upgrade, environmental compliance projects, and the Arcadia plant’s anneal furnace upgrade. The Company’s ability to complete its planned capital expenditures in fiscal 2004 will be dependent upon its ability to successfully complete a restructuring of its existing indebtedness. Capital expenditures were approximately $1.2 million in the first quarter of fiscal 2004 as co