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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
 

 
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended September 29, 2012
 
[  ]
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 0-19687
Synalloy Corporation
(Exact name of registrant as specified in its charter)
 

 
Delaware
 
57-0426694
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification Number)
     
775 Spartan Blvd. Suite 102
Spartanburg, South Carolina
 
 
29301
(Address of principal executive offices)
 
(Zip code)
 

 
(864) 585-3605
(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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes (X)       No ( )

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

Larger accelerated filer (  )
Accelerated filer (X) 
Non-accelerated filer (  ) (Do not check if a smaller reporting company)
Smaller reporting company  (  )

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes  (  )    No  (X)  
 
The number of shares outstanding of the registrant's common stock as of November 8, 2012 was 6,352,733.
 

 
1

 

 
Synalloy Corporation
 
 
Index
 
 
 PART I.                      FINANCIAL INFORMATION
 
 Item 1.
Financial Statements (unaudited)
 
Condensed consolidated balance sheets – September 29, 2012 and December 31, 2011
 
Condensed consolidated statements of operations – Three and nine months ended September 29, 2012 and October 1, 2011
 
Condensed consolidated statements of cash flows - Nine months ended September 29, 2012 and October 1, 2011
 
Notes to condensed consolidated financial statements
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
   
 
PART II.                      OTHER INFORMATION
 
Item 1A.
Risk Factors
Item 6.
Exhibits
 
Signatures and Certifications
 

 
 
 
2

 
 
 

PART I
           
Item 1. FINANCIAL STATEMENTS
           
Synalloy Corporation
           
Condensed Consolidated Balance Sheets
 
(Unaudited)
       
   
Sep 29, 2012
   
Dec 31, 2011
 
Assets
           
Current assets
           
Cash and cash equivalents
  $ 5,588     $ 110,138  
Accounts receivable, less allowance
               
for doubtful accounts
    36,215,132       26,582,279  
Inventories, net
    51,878,470       43,062,738  
Deferred income taxes
    2,565,077       2,632,145  
Prepaid expenses and other current assets
    3,262,230       2,250,735  
Total current assets
    93,926,497       74,638,035  
                 
Cash value of life insurance
    2,573,660       3,092,430  
Property, plant & equipment, net of accumulated
               
depreciation of $40,468,802 and $39,833,076
    26,527,533       18,713,524  
Goodwill
    24,494,854       2,354,730  
Deferred charges, net and other non-current assets
    200,691       117,645  
Total assets
  $ 147,723,235     $ 98,916,364  
                 
Liabilities and Shareholders' Equity
               
Current liabilities
               
Current portion of long-term debt
  $ 2,274,000     $ -  
Accounts payable
    10,465,502       13,043,153  
Advances from customers
    1,733,093       1,146,559  
Accrued expenses
    8,392,766       3,966,103  
Current portion of environmental reserves
    162,050       138,000  
Current portion of contingent consideration
    2,500,000       -  
Total current liabilities
    25,527,411       18,293,815  
                 
Long-term debt
    39,911,517       8,650,431  
Environmental reserves
    502,000       502,000  
Deferred compensation
    288,638       293,555  
Deferred income taxes
    3,657,884       2,557,662  
Long-term portion of contingent consideration
    5,652,031       -  
                 
Shareholders' equity
               
Common stock, par value $1 per share – authorized
 
12,000,000 shares; issued 8,000,000 shares
    8,000,000       8,000,000  
Capital in excess of par value
    1,280,735       1,153,889  
Retained earnings
    77,468,168       74,198,151  
Less cost of common stock in treasury:
               
1,655,067 and 1,674,156 shares
    (14,565,149 )     (14,733,139 )
Total shareholders' equity
    72,183,754       68,618,901  
Commitments and Contingencies – See Note 11
               
Total liabilities and shareholders' equity
  $ 147,723,235     $ 98,916,364  
Note: The balance sheet at December 31, 2011 has been derived from the audited consolidated financial statements at that date.
 
            See accompanying notes to condensed consolidated financial statements.
               
 

 
 
3

 
 

 
Synalloy Corporation
                   
Condensed Consolidated Statements of Operations
       
(Unaudited)
       
     Three Months Ended     Nine Months Ended
    Sep 29, 2012      
Oct 1, 2011
 
Sep 29, 2012
     
Oct 1, 2011
 
                   
Net sales
  $ 50,270,629     $ 46,193,059     $ 144,520,839     $ 130,334,163  
                                 
Cost of goods sold
    44,587,646       42,563,266       128,485,465       114,027,261  
                                 
Gross profit
    5,682,983       3,629,793       16,035,374       16,306,902  
                                 
Selling and administrative expense
    3,581,497       2,702,843       10,247,648       8,746,229  
                                 
Operating income
    2,101,486       926,950       5,787,726       7,560,673  
                                 
Other (income) and expense
                               
  Interest expense
    159,686       36,646       251,709       93,037  
  Acquisition related costs
    599,850       -       628,759       -  
  Change in fair value of interest
                               
      rate swap
    175,780       -       175,780       -  
  Other, net
    (391 )     (335 )     (135,539 )     (365 )
                                 
Income before income taxes
    1,166,561       890,639       4,867,017       7,468,001  
                                 
Provision for income taxes
    324,000       320,000       1,597,000       2,688,000  
                                 
Net income
  $ 842,561     $ 570,639     $ 3,270,017     $ 4,780,001  
                                 
                                 
Net income per common share:
                               
Basic
  $ 0.13     $ 0.09     $ 0.52     $ 0.76  
Diluted
  $ 0.13     $ 0.09     $ 0.51     $ 0.75  
                                 
Weighted average shares outstanding:
                               
Basic
    6,344,933       6,325,295       6,338,756       6,310,609  
  Dilutive effect from stock
                               
    options and grants
    52,817       44,600       52,322       48,285  
Diluted
    6,397,750       6,369,895       6,391,078       6,358,894  
                                 
See accompanying notes to condensed consolidated financial statements.
         
 

 
 

 
4

 
 
 
 
Synalloy Corporation
           
Condensed Consolidated Statements of Cash Flows
           
(Unaudited)
 
Nine Months Ended,
 
   
Sep 29, 2012
   
Oct 1, 2011
 
Operating activities
           
 Net income
  $ 3,270,017     $ 4,780,001  
 Adjustments to reconcile net income to net cash
               
    used in operating activities:
               
    Depreciation expense
    2,148,879       2,289,789  
    Amortization of deferred charges
    21,454       20,685  
    Deferred income taxes
    67,068       62,072  
    (Reduction of) provision for reserve for losses on accounts receivable
    (87,450 )     246,293  
    Provision for losses on inventory
    544,802       1,259,000  
    Gain on sale of property, plant and equipment
    (12,347 )     (37,025 )
    Cash value of life insurance
    (215,436 )     (54,001 )
    Environmental reserves
    24,050       (202,667 )
    Issuance of treasury stock for director fees
    99,995       78,704  
    Employee stock option and stock grant compensation
    239,917       199,866  
    Changes in operating assets and liabilities:
               
        Accounts receivable
    (3,755,657 )     (8,884,756 )
        Inventories
    (3,821,881 )     (11,706,393 )
        Other assets and liabilities
    (134,803 )     (112,967 )
        Accounts payable
    (4,210,118 )     3,436,697  
        Accrued expenses
    1,759,841       1,875,991  
        Income taxes payable
    (145,351 )     (154,970 )
Net cash used in operating activities
    (4,207,020 )     (6,903,681 )
                 
Investing activities
               
     Purchases of property, plant and equipment
    (2,568,479 )     (1,985,046 )
     Proceeds from sale of property, plant and equipment
    77,500       49,301  
     Proceeds from life insurance
    734,206       -  
     Cash paid for Palmer of Texas acquisition, net
    (27,609,412 )     -  
Net cash used in investing activities
    (29,366,185 )     (1,935,745 )
                 
Financing activities
               
     Net borrowings from long-term debt
    33,468,655       8,688,180  
     Proceeds from exercised stock options
    -       161,903  
Net cash provided by financing activities
    33,468,655       8,850,083  
                 
     (Decrease) increase in cash and cash equivalents
    (104,550 )     10,657  
     Cash and cash equivalents at beginning of period
    110,138       108,902  
                 
Cash and cash equivalents at end of period
  $ 5,588     $ 119,559  
                 
See accompanying notes to condensed consolidated financial statements.
               
 

 

 
5

 

 
Synalloy Corporation
 
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 
September 29, 2012
 
 
NOTE 1--BASIS OF PRESENTATION
 
The accompanying unaudited condensed consolidated financial statements of Synalloy Corporation and subsidiaries (“the Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included as required by Regulation S-X, Rule 10-01. Operating results for the nine-month period ended September 29, 2012, are not necessarily indicative of the results that may be expected for the year ending December 29, 2012. For further information, refer to the consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the period ended December 31, 2011.
 
 
NOTE 2--RECENTLY ADOPTED ACCOUNTING STANDARDS
 
In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS”, to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and IFRS. The amended guidance changes certain fair value measurement principles and enhances the disclosure requirements particularly for Level 3 fair value measurements. The Company adopted the provisions of this ASU in the first quarter of 2012 and it did not have a material impact on its condensed consolidated financial statements.
 
In September 2011, the FASB issued ASU 2011-08, "Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment”, which modifies the impairment test for goodwill. Under the new guidance, an entity is permitted to make a qualitative assessment of whether it is more likely than not that the reporting unit’s fair value is less than the carrying value before applying the two-step goodwill impairment model that is currently in place. If it is determined through the qualitative assessment that a reporting unit's fair value is more likely than not greater than its carrying value, the remaining impairment steps would be unnecessary. The qualitative assessment is optional, allowing companies to go directly to the quantitative assessment. The Company adopted the provisions of this ASU in the first quarter of 2012 and it did not have a material impact on its condensed consolidated financial statements.
 
 
NOTE 3--INVENTORIES
 
Inventories are stated at the lower of cost (first-in, first-out method) or market.  The components of inventories, net are as follows:
 
   
Sep 29, 2012
   
Dec 31, 2011
 
Raw Materials
  $ 15,816,898     $ 10,120,408  
Work-in-process
    16,325,977       12,632,301  
Finished goods
    19,735,595       20,310,029  
    $ 51,878,470     $ 43,062,738  
 

 
 
 
6

 

 
 
Synalloy Corporation
 
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 
September 29, 2012
 
 
NOTE 4--STOCK OPTIONS AND EMPLOYEE STOCK GRANTS
 
 
On February 9, 2012, the Compensation & Long-Term Incentive Committee of the Board of Directors of the Company approved stock option grants under the Company’s 2011 Plan.  A total of 36,740 options, with an exercise price of $11.35 per share, were granted under the Plan to certain management employees of the Company. The exercise price was determined using the average of the high and low stock price on the day prior to the grant date. The per share weighted-average fair value of the stock options granted during 2012 was $5.03. The fair value of the option grant was estimated using the Black-Scholes option-pricing model based on a risk-free interest rate of 2.04 percent, an expected life of seven years, an expected volatility of 53 percent and a dividend yield of 2.10 percent.
 
 
On August 21, 2012, a total of 75,000 options, with an exercise price of $12.73, were granted to the President of Palmer of Texas (“Palmer”) pursuant to the Stock Purchase Agreement discussed in Note 9.  The exercise price was determined using the average of the high and low stock price on the day prior to the grant date. The per share weighted-average fair value of the stock options granted was $5.44.  The fair value of the option grant was estimated using the Black-Scholes option-pricing model based on a risk-free interest rate of 1.80 percent, an expected life of seven years, an expected volatility of 51 percent and a dividend yield of 1.80 percent.
 
All stock options vest in 20 percent increments annually on a cumulative basis, beginning one year after the date of grant. In order for the options to vest, the employee must be in the continuous employment of the Company since the date of the grant.
 
On April 27, 2012 the Company issued to each of its non-employee directors 1,598 shares of its common stock from shares held in Treasury (an aggregate of 7,990 shares) in lieu of $20,000 of their annual cash retainer fees.
 
 
NOTE 5--INCOME TAXES
 
 
The Company did not have any unrecognized tax benefits accrued at September 29, 2012 and December 31, 2011. The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of multiple state jurisdictions. The Company is no longer subject to U.S. federal or state income tax examinations for years before 2008. The Company’s continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense.
 
 
NOTE 6--PAYMENT OF DIVIDENDS
 
 
During 2011, the Company declared and paid a $0.25 per share dividend on December 5, 2011 for a total of $1,580,000. The Board presently plans to review at the end of each fiscal year the financial performance and capital needed to support future growth to determine the amount of cash dividend, if any, which is appropriate.
 

 
7

 

 
Synalloy Corporation
 
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 
September 29, 2012
 
 
NOTE 7--SEGMENT INFORMATION
 
   
THREE MONTHS ENDED
   
NINE MONTHS ENDED
 
   
Sep 29, 2012
   
Oct 1, 2011
   
Sep 29, 2012
   
Oct 1, 2011
 
Net sales
                       
Metals Segment
  $ 35,580,000     $ 35,817,000     $ 106,234,000     $ 97,753,000  
Specialty Chemicals Segment
    14,691,000       10,376,000       38,287,000       32,581,000  
    $ 50,271,000     $ 46,193,000     $ 144,521,000     $ 130,334,000  
Operating income
                               
Metals Segment
  $ 1,282,000     $ 912,000     $ 4,314,000     $ 7,390,000  
Specialty Chemicals Segment
    1,536,000       686,000       3,741,000       2,318,000  
      2,818,000       1,598,000       8,055,000       9,708,000  
Unallocated expenses
                               
Corporate
    716,000       671,000       2,267,000       2,147,000  
Acquisition related costs
    600,000       -       629,000       -  
Interest and debt expense
    159,000       36,000       251,000       93,000  
Change in fair value of
     interest rate swap
    176,000       -       176,000       -  
Other income
    -       -       (135,000 )     -  
                                 
Income before income taxes
  $ 1,167,000       891,000       4,867,000       7,468,000  
  
 
 
 Identifiable assets:
   
Sep 29, 2012
   
Dec 31, 2011
 
             
    Metals Segment
  $ 119,064,000     $ 72,722,000  
    Specialty Chemicals Segment
    22,535,000       18,465,000  
    Corporate
    6,124,000       7,729,000  
                 
    $ 147,723,000     $ 98,916,000  
 

NOTE 8--FAIR VALUE OF FINANCIAL INSTRUMENTS
 
The Company determines the fair values of its financial instruments for disclosure purposes by maximizing the use of observable inputs and minimizing the use of unobservable inputs when measuring fair value. Fair value disclosures for assets and liabilities are grouped in three levels.  The levels prioritize the inputs used to measure the fair value of the assets or liabilities.  These levels are:
 
·  
Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities.
 
 
·  
Level 2 – Inputs other than quoted prices that are observable for assets and liabilities, either directly or indirectly.  These inputs include quoted prices for similar assets or liabilities in active markets or quoted prices for identical or similar assets or liabilities in markets that are less active.
 
 
 
8

 

 
Synalloy Corporation
 
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 
September 29, 2012
 
 
 
·  
Level 3 – Unobservable inputs that are supported by little or no market activity for assets or liabilities and includes certain pricing models, discounted cash flow methodologies and similar techniques.
 
As of September 29, 2012 and December 31, 2011, the carrying amount for cash and cash equivalents, accounts receivable, accounts payable and borrowings under the Company’s line of credit and term loan, which are based on variable interest rates, approximates their fair value.
 
Cash surrender value of life insurance policies and the interest rate swap discussed in Note 10 are classified as Level 2 financial instruments.  The fair value of the life insurance policies was determined by the underwriting insurance company’s valuation models and represents the guaranteed value the Company would receive upon surrender of these policies.  The interest rate swap was priced using discounted cash flow techniques which are corroborated by using non-binding market prices.  Significant inputs to the discounted cash flow model include projected future cash flows based on projected one-month LIBOR, and the average margin for companies with similar credit ratings and similar maturities.  These are classified as Level 2 as they are not actively traded and are valued using pricing models that use observable market inputs.
 
 
The contingent consideration (“earn-out”) payments, discussed below in Note 9, are classified as Level 3.  The amount of the total earn-out liability to the prior owners was determined using management’s best estimate of earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the three-year earn-out period which will determine the amount of the ultimate payment to be made.  Factors, such as volume increases, selling price increases and inflation were used to develop a base projection. The Company believes additional costs will be required to improve employee turnover, safety, internal controls, etc.  These estimated costs were deducted in order to determine projected EBITDA.  The Company’s current cost of borrowing was used to determine the present value of these expected payments.  Each quarter-end, the Company will re-evaluate their assumptions and adjust to the estimated present value of the expected payments to be made.
 
There were no transfers of assets or liabilities between Level 1 and Level 2 in the nine month period ended September 29, 2012 or year ended December 31, 2011.
 
 
NOTE 9—ACQUISITION
 
 
On August 21, 2012, the Company completed the purchase of all of the outstanding shares of capital stock of Lee-Var, Inc., a Texas corporation doing business as Palmer of Texas (“Palmer”).  Palmer is a manufacturer of liquid storage solutions and separation equipment for the petroleum, municipal water, wastewater, chemical and food industries.
 
 
The purchase price for the acquisition was $25,575,000.  The preliminary adjustment for working capital at closing increased the purchase price to $28,054,000.  The closing price will be further adjusted after closing based on actual working capital levels.  In addition, the amount of maintenance capital expenditures over the 18-month period following closing and the final cost of a production expansion capital project currently underway could also result in purchase price adjustments. Currently, the Company does not expect to realize any material purchase price adjustments from these two items.  The sellers will also have the ability to receive earn-out payments ranging from $2,500,000 to $10,500,000 if the business unit achieves targeted levels of EBITDA over a three year period following closing; and the Company will have the ability to claw-back portions of the purchase price over a two- year period following closing if EBITDA falls below baseline levels.  Palmer had recorded liabilities of approximately $1,200,000 related to certain contingencies for which the Palmer shareholders have agreed to indemnify the Company.  Accordingly, the Company has carried over these liabilities in its consolidated
 
 

 
9

 
 
 
Synalloy Corporation
 
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 
September 29, 2012
 
financial statements and has recorded an asset of approximately $1,200,000 reflecting the indemnification against these potential payments.
 
At the end of each year for the next three years, if EBITDA for the year is below $5,825,000, there will not be an earn-out paid for that year.  If EBITDA for the year is greater than $5,825,000 but less than $6,825,000, the sellers will be paid $2,500,000.  If EBITDA exceeds $6,825,000 for the year, the earn-out would be $3,500,000.  At the conclusion of the three-year earn-out period, in the event that the cumulative adjusted EBITDA for the earn-out period is more than $17,475,000, the sellers will receive an additional earn-out payment, if any, as follows.  In the event that the cumulative EBITDA for the earn-out period is greater than $17,475,000 but less than $20,475,000, the Company will make an additional earn-out payment so that the total cumulative earn-out payments for the three-year earn-out period equals $7,500,000.  If the cumulative EBITDA exceeds $20,475,000, the Company will make an additional earn-out payment so that the total cumulative earn-out payments for the three-year period equals $10,500,000.  The Company is currently forecasting earn out payments totaling $8,500,000, which was discounted to a present value of $8,152,000 using our incremental borrowing rate of 2%.  $2,500,000 of this liability was classified as a current liability since the first payment is expected to be made within the next year.
 
Pursuant to the Stock Purchase Agreement, the Company has entered into a three-year employment agreement with the current President of Palmer and a one-year employment agreement with the current Controller of Palmer.
 
The purchase price for the Palmer acquisition was funded through an increase in the Company’s current credit facility and a new term loan with the Company’s bank which is discussed below in Note 10.
 
A summary of sources and uses of proceeds for the Palmer acquisition is as follows:
 
Sources of funds:
     
Proceeds of revolving loan
  $ 6,591,597  
Proceeds of term loan
    22,500,000  
Total sources of funds
  $ 29,091,597  
         
Uses of funds:
       
Acquisition of Palmer
  $ 25,575,000  
Cash paid at closing for preliminary
       
    working capital adjustment
    2,479,467  
Cash paid to escrow agent  for the retention
       
    of and the termination of the employment
       
   agreement for the Controller
    450,000  
Cash paid for portion of sellers investment banker
    500,000  
         
Other transaction costs
    87,130  
Total uses of funds
  $ 29,091,597  

 
The total consideration transferred was allocated to Palmer’s net tangible and identifiable assets based on their fair value as of August 21, 2012.  The excess of the consideration transferred over the net tangible and identifiable
 
 
10

 
 
Synalloy Corporation
 
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 
September 29, 2012
 
 
assets is reflected as goodwill.  Since the Company purchased the stock of Palmer, goodwill is not deductible for tax purposes. The Company is currently in the process of identifying and valuing any and all intangible assets that are associated with the acquisition.  Once this process is complete, the intangible asset will be recorded and goodwill reduced accordingly. The preliminary allocation of the total consideration to the fair value of the assets acquired and liabilities assumed as of August 21, 2012 is as follows:
 

 
         
Purchase accounting
       
   
As recorded by
   
and fair value
   
As recorded by
 
   
Palmer
   
adjustments
   
Synalloy
 
Cash and cash equivalents
  $ 1,389,054     $ -     $ 1,389,054  
Accounts receivable, net
    5,789,745       -       5,789,745  
Inventories, net
    5,538,652       -       5,538,652  
Prepaid expenses
    75,804       1,536,000       1,611,804  
Net fixed assets
    4,799,692       2,659,870       7,459,562  
Goodwill
    -       22,288,126       22,288,126  
Contingent consideration
    -       (8,152,031 )     (8,152,031 )
Other liabilities assumed
    (6,833,315 )     -       (6,833,315 )
    $ 10,759,632     $ 18,331,965     $ 29,091,597  

 
The purchase accounting and fair value adjustment for prepaid expenses represents the indemnification provided by the sellers for certain liabilities assumed at acquisition, as mentioned earlier in this note, plus the indemnification of the Controller’s retention bonus.  The adjustment for net fixed assets increases the book value of the property, plant and equipment to their estimated fair value as of the acquisition date.  Contingent consideration is the present value of projected earn-out payments to the prior owners of Palmer.
 
The amount of Palmer’s revenues and pre-tax earnings included in the Condensed Consolidated Statements of Operations for the three and nine months ended September 29, 2012 were $4,297,000 and $878,000, respectively. The following unaudited pro forma information is provided to present a summary of the combined results of the Company’s operations with Palmer as if the acquisition had occurred on January 1, 2011.  The unaudited pro forma financial information is for information purposes only and is not necessarily indicative of what the results would have been had the acquisition been completed on the date indicated above.
 
   
Three Months Ended
   
Nine Months Ended
 
   
Sep 29, 2012
   
Oct 1, 2011
   
Sep 29, 2012
   
Oct 1, 2011
 
                         
Pro forma revenues
  $ 55,336,000     $ 56,147,000     $ 167,817,000     $ 155,147,000  
Pro forma net income
    1,234,000       428,000       4,503,000       6,132,000  
Earnings per share:
                               
Basic
    0.19       0.07       0.71       0.97  
Diluted
    0.19       0.07       0.70       0.96  
 

 

 
11

 

 
Synalloy Corporation
 
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 
September 29, 2012
 
 
NOTE 10--FINANCING ARRANGEMENT
 
In connection with the Palmer acquisition discussed in Note 9, on August 21, 2012, the Company entered into a Credit Agreement with its current bank (the “Credit Agreement”) to increase the limit of its existing line of credit facility by $5,000,000 to a maximum of $25,000,000, and extended the maturity date to August 21, 2015.  Interest on the Credit Agreement continues to be calculated using the One Month LIBOR (as defined in the Credit Agreement), plus a pre-defined spread, based on the Company’s Total Funded Debt to EBITDA ratio (as defined in the Credit Agreement). Borrowings under the line of credit are limited to an amount equal to a borrowing base calculation that includes eligible accounts receivable, inventories and other non-capital assets.
 
The Credit Agreement also provided for a ten-year term loan in the amount of $22,500,000 that requires equal monthly payments of $187,500 plus interest.  The interest rate on the term loan is LIBOR plus 2.25 percent.
 
Pursuant to the Credit Agreement, the Company was required to pledge all of its tangible and intangible properties, including the acquired shares of Palmer.  Covenants under the Credit Agreement include maintaining a certain Funded Debt to EBITDA ratio, a minimum tangible net worth, and total liabilities to tangible net worth ratio. The Company will also be limited to a maximum amount of capital expenditures per year, which is in line with the Company’s currently projected needs.  Management does not believe that these covenants and restrictions will have an adverse effect on its operations and the Company is in compliance with all covenants at September 29, 2012.
 
In conjunction with the new term loan, to mitigate the variability of the interest rate risk, the Company entered into an interest rate swap contract on August 21, 2012 with its current bank (the “interest rate swap”). The interest rate swap is for an initial notional amount of $22,500,000 with a fixed interest rate of 3.74 percent, and runs for ten years to August 21, 2022, which equates to the date of the term loan. The notional amount of the interest rate swap decreases as monthly principal payments are made. Although the swap is expected to effectively offset variable interest in the borrowing, hedge accounting will not be utilized. Therefore, changes in its fair value are being recorded in current assets or liabilities, as appropriate, with corresponding offsetting entries to other income (expense).
 
 
NOTE 11 --LEGAL CONTINGENCIES
 
The Company is from time-to-time subject to various claims, other possible legal actions for product liability and other damages, and other matters arising out of the normal conduct of the Company’s business. Other than environmental contingencies, management is not currently aware of any other asserted or unasserted matters which could have a significant effect on the financial condition or results of operations of the Company.
 
 
NOTE 12 --SUBSEQUENT EVENTS
 
On October 22, 2012, the Company modified is current Credit Agreement with its current bank (the “Credit Agreement”) to increase the limit of its existing line of credit facility by $5,000,000 to a maximum of $30,000,000. The increase will be in effect for one year and the maximum line of credit availability will revert back to $25,000,000 on October 22, 2013.  None of the other provisions of the credit agreement were changed as a result of this modification.  The Company will use the additional line to purchase inventory for the Nuclear Facility project that was announced on August 22, 2012.
 

 
12

 

 
Synalloy Corporation
 
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 
September 29, 2012
 
 
The Company performs an evaluation of events that occur after the balance sheet date but before its financial statements are issued for potential recognition or disclosure of such events in its financial statements. The Company evaluated subsequent events through the date that the financial statements were issued.
 

 
13

 

 
Synalloy Corporation
 
Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations
 
The following is managements’ discussion of certain significant factors that affected the Company during the three and nine month periods ended September 29, 2012.

Consolidated sales for the third quarter of 2012 increased nine percent to $50,271,000 compared to $46,193,000 for the same period one year ago.  The Company had net earnings of $843,000 or $0.13 per share for the third quarter of 2012 compared to $571,000 or $0.09 per share for the third quarter of 2011. For the first nine months, net sales for 2012 were $144,521,000, up eleven percent compared to net sales of $130,334,000 for the first nine months of 2011.  Net earnings were $3,270,000 or $0.51 per share for the first nine months of 2012 compared to $4,780,000 or $0.75 per share for the same period of 2011. Inventory losses in our Metals Segment had a larger negative impact on the Company’s reported earnings in this year’s third quarter and first nine months compared to the same periods of the prior year. The approximate effect of inventory losses on this year’s third quarter and first nine months results was a reduction of reported earnings by $0.15 and $0.37 per share, respectively, while reducing reported earnings per share for the same periods of the prior year by $0.13 and $0.08 per share, respectively.  In addition, the Company recorded $600,000 of acquisition costs associated with our acquisition of Palmer of Texas (“Palmer”) in the third quarter of 2012.  The acquisition costs reduced earnings per share for the third quarter and first nine months of 2012 by $0.07.

 
 
Metals Segment
 
Sales in the third quarter of 2012 totaled $35,580,000, a decrease of one percent from the same quarter last year. Operating income was $1,282,000 and $912,000 for the third quarters of 2012 and 2011, respectively. Excluding Palmer results, sales for the third quarter of 2012 would have been 13 percent lower than the prior year. The sales decrease resulted from a 15 percent decrease in average selling prices partially offset by a two percent increase in unit volumes. In the third quarter, the Segment experienced non-commodity unit volumes increasing nine percent while commodity unit volume decreased two percent. Selling prices for both commodity and non-commodity prices decreased approximately 16 percent from the prior year.  Average raw material surcharges, which result from fluctuating nickel prices, were $0.37 per pound lower for the third quarter of 2012 as compared to 2011.  As surcharges decrease, selling prices decrease and customers delay their purchases as long as possible. The Segment is focusing on international sales efforts, which continue to show year-over-year sales growth. Operating income increased due to the addition of Palmer plus selling an increased percentage of higher-priced, higher margin special alloys in the third quarter of 2012 as compared to 2011.
 
Sales for the first nine months of 2012 increased nine percent to $106,234,000 and operating income of $4,314,000 was 42 percent lower compared to the same period of the prior year.  Similar to the third quarter, the sales increase for the first nine months was comprised of the addition of Palmer for six weeks in 2012, plus a 13 percent increase in unit volumes partially offset by an eight percent decrease in average selling prices.
 
Operating income for the third quarter and first nine months of 2012 and 2011 was impacted by the following three factors:
 
 
a)  
Declining nickel prices resulted in inventory losses in the third quarter and first nine months of this year of approximately $1,286,000 and $3,495,000, respectively.  For the same periods last year, fluctuating nickel prices produced inventory losses of $1,323,000 and $766,000, respectively.  The impact to reported earnings was a negative swing of approximately $0.02 per share for the third quarter 2012 and $0.29 for the first nine months of 2012.
 

 
14

 

 
Synalloy Corporation
 
Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
b)  
In the third quarter and first nine months of the prior year, operating income for the fabrication unit of our Metals Segment was favorably affected by higher unit selling prices associated with the completion of several large scale lump-sum jobs. The unit realized $405,000 and $4,524,000 of additional billings during the third quarter and first nine months of 2011, respectively, from these completed jobs which added approximately $0.04 per share and $0.46 per share, respectively.
 
 
c)  
In the third quarter of 2011, the Company experienced a favorable adjustment as repair parts and manufacturing supplies previously expensed were inventoried and reflected as a prepaid asset in the October 1, 2011 Balance Sheet.  These costs were expensed in subsequent periods as they were used in the production process.  This adjustment increased earnings per share by $0.04 for the third quarter and first nine months of the prior year.
 
 
Demand for manufactured pipe remains relatively strong, while the fabrication unit continues to deal with excess capacity in the industry which results in margin compression and impacts our sales and profits.
 
On August 21, 2012, the Company acquired all of the outstanding stock of Palmer, a leading manufacturer of liquid storage solutions and separation equipment for the petroleum, municipal water, wastewater, chemical and food industries.  In recent years, Palmer’s business has been focused on providing fiberglass (FRP) and steel tanks to the oil industry.  Their primary facility in Andrews, Texas, is strategically located in the heart of the Permian Basin of west Texas and also serves other liquid rich shale areas including the Anadarko Basin, Eagle Ford Shale and the Barnett Shale. With approximately 130 employees, Palmer generated $36 million in revenues for the trailing twelve months ended July 31, 2012.
 
The Company paid approximately $28,998,000 for this acquisition.  This amount is higher than the amount of cash paid to the owners, as discussed in Note 9, due to the inclusion of approximately $950,000 of capitalizable closing costs in the determination of the overall cost of the Palmer acquisition. The prior shareholders of Palmer have the ability to receive earn-out payments ranging from $2,500,000 to $10,500,000 if the business unit achieves targeted levels of EBITDA over a three year period following closing; the Company will have the ability to claw-back portions of the purchase price over a two year period following closing if EBITDA falls below baseline levels.  The Company funded the purchase price through an increase in its existing credit facility and new long-term debt in the amount of $22.5 million.  The transaction is expected to be immediately accretive to Synalloy’s earnings.  At Palmer’s current level of revenues, Synalloy is projecting a contribution of approximately $0.30 per share to its annual earnings.  The operating results of Palmer are included in the Metals Segment.
 
Specialty Chemicals Segment
 
Sales for the Specialty Chemicals Segment in the third quarter of 2012 were $14,691,000, an increase of $4,315,000 or 42 percent from the third quarter of 2011.   Overall selling prices decreased five percent during the third quarter of 2012 compared to the same quarter of 2011 and pounds shipped were up 49 percent over that same period. Sales for the first nine months of 2012 increased 18 percent from the same period of 2011, with selling prices and pounds sold increasing five percent and 13 percent respectively.
 
Operating income for the third quarter of 2012 was $1,536,000, up $850,000 or 124 percent from 2011 and was $3,741,000 for the first nine months of 2012 compared to $2,318,000 for the same period of 2011, an increase of 61 percent. Sales and operating income for the third quarter and first nine months were favorably affected by additional defoamer production for a global chemical manufacturer which began in late May 2012 and reached targeted production levels during the third quarter of 2012. The increase in operating income also resulted from the Segment increasing contract sales and strengthening textile/carpet sales.  The Segment continues to change its product mix to higher priced/higher margin products and focus on controlling operating and support costs.
 

 
15

 
 
Synalloy Corporation
 
Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Consolidated selling, general and administrative expense increased $878,000 to $3,581,000 or seven percent of   sales from $2,703,000 or six percent of sales for the third quarter of 2012 compared to 2011, respectively. For the first nine months of 2012 compared to the same period of 2011, these expenses increased $1,502,000 to $10,248,000 or seven percent of sales from $8,746,000 or seven percent of sales.  Higher projected incentive based bonuses for key personnel, sales commissions, employee benefits and travel costs were partially offset by lower bad debt expense.
 
During the third quarter and first nine months of 2012, there were $600,000 and $629,000, respectively, of acquisition related costs associated with the Palmer acquisition. The Company estimates that approximately $250,000 of additional Palmer acquisition costs will be incurred during the fourth quarter of 2012.
 
Other income for the nine months ended September 29, 2012 is comprised of life insurance proceeds received in excess of its cash surrender value for a former officer of the Company.
 
During the first nine months of 2012, the Company’s cash balance decreased from $110,000 at the end of 2011 to $6,000 as of September 29, 2012.  On August 21, 2012, the Company acquired the stock of Palmer for $28,998,000. As a result of the Specialty Chemicals Segment’s sales increasing 43 percent during the third quarter of 2012 compared to the fourth quarter 2011 and the Metals Segment’s sales increasing 19 percent for the same periods, net accounts receivable increased at September 29, 2012 by $3,863,000 from the prior year end, after reducing the third quarter 2012 amount by the initial Palmer accounts receivable balance. Net inventories, excluding the initial Palmer inventory, increased $3,277,000 as of the end of the third quarter 2012 compared to the end of the fourth quarter 2011 in support of projected sales increases for both segments.  The Company also used cash during the first nine months of 2012 as accounts payable decreased $4,210,000 as of the end of the third quarter of 2012, excluding Palmer’s initial accounts payable balance. Capital expenditures for the first nine months of 2012 were $2,568,000 and the Company received life insurance proceeds of $734,000 for a former officer of the Company. These items contributed to the Company having $42,186,000 of bank debt outstanding as of September 29, 2012.
 
On August 21, 2012, the Company entered into a Credit Agreement with its current bank to increase the limit of its line of credit by $5,000,000 to a maximum of $25,000,000 and extended the maturity date to August 21, 2015.  Interest on the Credit Agreement continues to be calculated using the One Month LIBOR, plus a pre-defined spread, based upon the Company’s Total Funded Debt to EBITDA ratio. Borrowings under the line of credit are limited to an amount equal to a borrowing base calculation that includes eligible accounts receivable, inventories and other non-capital assets.
 
The Credit Agreement also included a ten-year term loan for $22,500,000 that requires equal monthly payments of $187,500 plus interest.  The interest rate on the term loan is LIBOR plus 2.25 percent.
 
The credit facility required mortgages on all real estate assets of the Company and perfected liens on all other capital assets.  Covenants under the debt agreement include maintaining a certain Funded Debt to EBITDA ratio, a minimum tangible net worth, and total liabilities to tangible net worth ratio. The Company will also be limited to a maximum amount of capital expenditures per year, which is in line with the Company’s currently projected needs.  Management does not believe that these covenants and restrictions will have an adverse effect on its operations and the Company is in compliance with all covenants at September 29, 2012.
 
In conjunction with the new term loan, to mitigate the variability of the interest rate risk, the Company entered into a derivative/swap contract on August 21, 2012 with the Company’s current bank (an “interest rate swap”). The interest rate swap is for an initial notional amount of $22,500,000 with a fixed interest rate of 3.74 percent, and runs for ten years to August 21, 2022, which equates to the date of the term loan. The notional amount of the
 
 
 
16

 
 
Synalloy Corporation
 
Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations
 
interest rate swap decreases as monthly principle payments are made. Although the swap is expected to effectively offset variable interest in the borrowing, hedge accounting will not be utilized. Therefore, changes in its fair value are being recorded in current assets or liabilities, as appropriate, with corresponding offsetting entries to other income (expense), which will be separately disclosed in the Company’s financial statements.
 
We have updated the contractual obligations and other commitments since those presented in our Annual Report on Form 10-K, Part II, Item 7, for the fiscal year ended December 31, 2011. Contractual obligations for operating leases, purchase obligations and deferred compensation did not change from what was previously reported.
 

         
Payment obligations
 
         
3 months
   
For the year ended
 
   
Total
   
2012
   
2013
   
2014
   
2015
   
2016
   
2017
   
Thereafter
 
Line of credit
  $ 19,623,068     $ -     $ -     $ -     $ 19,623,068     $ -     $ -     $ -  
Term loan (1)
    22,500,000       750,000       2,250,000       2,250,000       2,250,000       2,250,000       2,250,000       10,500,000  
Vehicle loan
    62,450       6,117       24,468       24,468       7,397       -       -       -  
Interest:
                                                               
  Line of credit
    928,549       84,414       337,654       337,654       168,827       -       -       -  
  Term loan
    4,147,894       206,869       771,375       687,225       603,075       518,925       434,775       925,650  
Contingent
                                                               
  consideration
    8,500,000       -       2,500,000       2,500,000       3,500,000       -       -       -  
                                                                 
(1) Four payments are included in the fourth quarter 2012. The first payment which was due on 9/21/12 was not applied until October 2012.
         

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
 
This Form 10-Q includes and incorporates by reference "forward-looking statements" within the meaning of the securities laws. All statements that are not historical facts are "forward-looking statements." The words "estimate," "project," "intend," "expect," "believe," " should," "anticipate," "hope", "optimistic", "plan," "outlook" and similar expressions identify forward-looking statements. The forward-looking statements are subject to certain risks and uncertainties, including without limitation those identified below, which could cause actual results to differ materially from historical results or those anticipated. In conjunction with our Palmer acquisition, our expectations for future sales and profits which were included in our financial projections were our best estimates at the time and actual results could be significantly different. Readers are cautioned not to place undue reliance on these forward-looking statements. The following factors could cause actual results to differ materially from historical results or those anticipated: adverse economic conditions; the impact of competitive products and pricing; product demand and acceptance risks; raw material and other increased costs; raw materials availability; customer delays or difficulties in the production of products; new fracking regulations; a prolonged decrease in oil prices; unforeseen delays in completing the integration of Palmer; risks associated with other acquisitions and expansion activities; environmental issues; unavailability of debt financing on acceptable terms and exposure to increased market interest rate risk; inability to comply with covenants and ratios required by our debt financing arrangements; ability to weather the current economic downturn; loss of consumer or investor confidence and other risks detailed from time-to-time in Synalloy's Securities and Exchange Commission filings. Synalloy Corporation assumes no obligation to update any forward-looking information included in this Form 10-Q.

Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
Information about the Company’s exposure to market risk was disclosed in its Annual Report on Form 10-K for the year ended December 31, 2011, which was filed with the Securities and Exchange Commission on March 13, 2012. There have been no material quantitative or qualitative changes in market risk exposure since the date of that filing.
 

 
17

 

 
Synalloy Corporation
 
Item 4. Controls and Procedures
 
Based on the evaluation required by 17 C.F.R. Section 240.13a-15(b) or 240.15d-15(b) of the Company's disclosure controls and procedures (as defined in 17 C.F.R. Sections 240.13a-15(e) and 240.15d-15(e)), the Company's chief executive officer and chief financial officer concluded that such controls and procedures, as of the end of the period covered by this quarterly report, were effective.  The Company is currently evaluating and documenting the internal control over financial reporting at Palmer and will include them in their internal control testing in 2013.
 
There has been no change in the registrant's internal control over financial reporting during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting.
 

 
18

 

 
Synalloy Corporation
 
PART II: OTHER INFORMATION
 
Item 1A.  Risk Factors
 



 
We have updated the risk factors affecting our business since those presented in our Annual Report on Form 10-K, Part I, Item 1A, for the fiscal year ended December 31, 2011.  Except for revisions to the risk factors below, there have been no material changes in our assessment of our risk factors from those set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.
 
 
Cyber security risks and cyber incidents could adversely affect our business and disrupt operations.  Cyber incidents can result from deliberate attacks or unintentional events.  These incidents can include, but are not limited to, gaining unauthorized access to digital systems for purposes for misappropriating assets or sensitive information, corrupting data, or causing operational disruption.  The result of these incidents could include, but are not limited to, disrupted operations, misstated financial data, liability for stolen assets or information, increased cyber security protection costs, litigation and reputational damage adversely affecting customer or investor confidence.
 
 
Federal, state and local legislative and regulatory initiatives relating to hydraulic fracturing, as well as governmental reviews of such activities could result in delays or eliminate new wells from being started, thus reducing the demand for our fiberglass and steel storage tanks. Hydraulic fracturing (“fracking”) is currently an essential and common practice to extract oil from dense subsurface rock formations and this lower cost extraction method is a significant driving force behind the recent surge of oil exploration and drilling in several locations in the United States. However, the Environmental Protection Agency, Congress and state legislatures have considered adopting legislation to provide additional regulations and disclosures surrounding this process.  In the event that new legal restrictions surrounding the fracking process are adopted in the areas that our customers operate in, we may see a dramatic decrease in tank revenues, which would have a material adverse effect on our business and results of operations.
 
 
Oil prices are extremely volatile.  A substantial or extended decline in the price of oil could adversely affect our financial condition and results of operations. Prices for oil can fluctuate widely.  Palmer’s revenues are highly dependent on our customers adding oil well drilling and pumping locations.  Should oil prices decline whereby drilling becomes unprofitable for our customers, they will cap many of their current wells and cease expansion.  This will decrease the demand for our tanks.
 
 
Our results of operations could be adversely affected by goodwill impairments. As a result of our acquisitions, we have approximately $24.5 million of goodwill on our Consolidated Balance Sheet.  Goodwill must be tested at least annually for impairment, and more frequently when circumstances indicate likely impairment.  Goodwill is considered impaired to the extent that its carrying amount exceeds its implied fair value. An impairment of goodwill could have a substantial negative effect on our profitability.
 
 
The loss of key members of our management team, or difficulty attracting and retaining experienced technical personnel, could reduce our competitiveness and prospects for future success. The successful implementation of our strategies and handling of other issues integral to our future success will depend, in part, on our experienced management team. The loss of key members of our management team could have an adverse effect on our business.  Also, if we cannot retain our technical personnel or attract additional experienced technical personnel, our ability to compete could be harmed.
 
The integration of Palmer might not be completed timely or with the cost assumptions included in our acquisition models.   We could experience difficulties in integrating the Palmer operations into our operating and control procedures combined with timely and accurate financial reporting.  If there are problems with the integration, the Company could experience higher than expected costs, customer loss, business disruption including difficulties in maintaining relationships with key personnel and failure to meet SEC reporting deadlines.


 
19

 


 
Synalloy Corporation
 

 Item 6.
 
Exhibits
   
The following exhibits are included herein:
 
  10.14
 Employment Agreement, dated August 21, 2012 between Registrant and Jimmie D. Lee
 
 
31.1
Rule 13a-14(a)/15d-14(a) Certifications of Chief Executive Officer
 
 
31.2
Rule 13a-14(a)/15d-14(a) Certifications of Chief Financial Officer and Principal Accounting Officer
 
 
32
Certifications Pursuant to 18 U.S.C. Section 1350
 
 
101.INS*
XBRL Instance Document
 
 
101.SCH*
XBRL Taxonomy Extension Schema
 
 
101.CAL*
XBRL Taxonomy Extension Calculation Linkbase
 
 
101.LAB*
XBRL Taxonomy Extension Label Linkbase
 
 
101.PRE*
XBRL Taxonomy Extension Presentation Linkbase
 
 
101.DEF*
XBRL Taxonomy Extension Definition Linkbase
 
 
*In accordance with Regulation S-T, the XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall be deemed "furnished" and not "filed."
 

 
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Synalloy Corporation
 
 
SIGNATURES
 
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
   
 
SYNALLOY CORPORATION
   
(Registrant)
     
     
Date: November 8, 2012
By:
/s/ Craig C. Bram                 
   
Craig C. Bram
   
President and Chief Executive Officer
     
Date:  November 8, 2012
By:
/s/ Richard D. Sieradzki                   
   
Richard D. Sieradzki
   
Chief Financial Officer and Principal Accounting Officer
     
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 

 
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