Haynes International 10-K 2005
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the transition period from to
Commission file number 033-32617
HAYNES INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code (765) 456-6000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to section 12(g) of the Act: None
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 þ Yes o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) o Yes þ No
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). o Yes þ No
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrants most recently completed second fiscal quarter. $130,957,164.
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. þ Yes oNo.
Indicate the number of shares outstanding of each of the registrants classes of common stock, as of the latest practicable date. 10,000,000 shares of Haynes International, Inc. common stock were outstanding as of December 15, 2005.
DOCUMENTS INCORPORATED BY REFERENCE
There are no documents incorporated by reference into this Form 10-K
This report contains statements that constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Those statements appear in a number of places in this Report and may include, but are not limited to, statements regarding the intent, belief or current expectations of the Company or its management with respect to, but are not limited to (i) the Companys strategic plans; (ii) trends in the demand for the Companys products; (iii) trends in the industries that consume the Companys products; (iv) the Companys ability to refinance its debt; (v) the ability of the Company to develop new products; and (vi) the ability of the Company to make capital expenditures and finance operations. Readers are cautioned that any such forward looking statements are not guarantees of future performance and involve risks and uncertainties. Actual results may differ materially from those in the forward looking statements as a result of various factors, many of which are beyond the control of the Company.
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, some of which are discussed in Exhibit 99 to this Form 10-K, may affect the accuracy of forward looking statements.
The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Haynes International, Inc. (Haynes or the Company) develops, manufactures and markets technologically advanced, high-performance alloys, which are used primarily in the aerospace, land based gas turbine, and chemical processing industries. The Companys high performance alloy products are high temperature resistant alloys, or HTA products, and corrosion resistant alloys, or CRA products. The Companys HTA products are used by manufacturers of equipment that is subjected to extremely high temperatures, such as jet engines for the aerospace industry, gas turbine engines for power generation, waste incineration, and industrial heating equipment. The Companys CRA products are used in applications that require resistance to extreme corrosion, such as chemical processing, power plant emissions control and hazardous waste treatment. The Company produces its high-performance alloy products primarily in sheet, coil and plate forms, which in the aggregate represented approximately 69% of the Companys net revenues in fiscal 2005, as well as seamless and welded tubulars, and in bar, billet and wire forms.
High-performance alloys are characterized by highly engineered, often proprietary, metallurgical formulations made primarily of nickel, cobalt and other metals with complex physical properties. The complexity of the manufacturing process for high-performance alloys is reflected in the Companys relatively high average selling price per pound, compared to the average selling price of other metals, such as carbon steel sheet, stainless steel sheet and aluminum. Demanding end-user specifications, a multi-stage manufacturing process and the technical sales, marketing and manufacturing expertise required to develop new applications combine to create significant barriers to entry in the high-performance alloy industry.
Haynes began operations in 1912 as the Haynes Stellite Works, which was purchased by Union Carbide and Carbon Corporation in 1920. In 1972, the operations were sold to Cabot Corporation. In 1987, Haynes was incorporated as a stand-alone corporation in Delaware, and in 1989 Haynes was sold by Cabot Corporation to Morgan Lewis Githens & Ahn Inc., a private investment firm. The Blackstone Group, a private investment firm, purchased Haynes from Morgan Lewis Githens & Ahn Inc. in 1997. As a result of concurrent downcycles in its largest markets, rising raw material and energy costs, and its debt
service obligations, Haynes encountered liquidity difficulties throughout fiscal 2003 and the first half of fiscal 2004 and could not generate sufficient cash to both satisfy its debt service obligations and fund operations. On March 29, 2004, Haynes and its U.S. subsidiaries and U.S. affiliates as of that date filed voluntary petitions for reorganization relief under Chapter 11 of the U.S. Bankruptcy Code. The plan of reorganization was confirmed on August 16, 2004, and became effective when Haynes emerged from bankruptcy on August 31, 2004. In connection with the reorganization, Haynes Holdings, Inc. (the former parent of Haynes) and Haynes International, Inc. were merged and Haynes International, Inc. was the surviving corporation of the merger. Pursuant to the plan of reorganization, all of the shares of the Companys common stock which were outstanding prior to the merger were cancelled, and 10.0 million new shares of the Companys common stock were issued to the former holders of the 115¤8% senior notes due September 1, 2004 and the former holders of the shares of common stock of Haynes Holdings, Inc.
The Company believes it has attained a reputation for quality and reliability in the high-performance alloy industry. The Companys core competencies include the following:
Metallurgical expertise and proprietary knowledge. The Company continues to develop, manufacture and test high-performance nickel- and cobalt-base alloys. Over the last five years, the Companys technical programs have yielded five new proprietary alloys, four of which are protected by U.S. patents, and one of which has a patent pending.
Technical marketing support. The Companys engineering and technology group maintains a high level of manufacturing and customer metallurgical support. Through the combined efforts of this group and the Companys direct sales organization, the Company works closely with its customers to identify, develop and support diverse applications for its alloys and to anticipate its customers future materials requirements.
Flexible manufacturing capabilities. The Companys four-high Steckel mill, in conjunction with its sophisticated, multi-stage, melting and refining operation, produces a broad array of sheet, coil and plate products made to exacting specifications. The Company also operates a three-high mill and a two-high mill that enable the Company to produce small batch orders that generally are not practical or economical for competitors to manufacture.
The Company intends to capitalize on its core competencies to implement its business strategy, which includes the following principal elements:
Expand export sales and foreign service and sales center locations. The Company believes there are significant opportunities to increase its sales in international markets. In fiscal 2005, approximately 40% of the Companys net revenues came directly from customers outside the U.S., primarily in European markets where the Company has established sales facilities. Although no specific data is available, a portion of the material that is sold to U.S. distributors and fabricators is resold and shipped overseas. In addition, the Company continues to pursue significant growth opportunities in other regions, particularly Central Europe and Asia, with both a Shanghai, China service center and Chennai, India sales center opened in fiscal 2005.
Expand sales of value added products offered at service and sales centers. The Companys service and sales centers stock many of the Companys products on site to provide timely and efficient customer service. In addition, precision processing, such as shearing, saw cutting, plasma cutting, waterjet cutting and laser cutting are available to provide customizing options and fulfill the specific requirements of individual customers for cut-to-size, unusual shapes and precise dimensions.
Develop new applications for existing alloys. The Company actively seeks to develop new applications and new market segments for its existing products. The technical marketing staff and the sales force, in
coordination with the engineering and technology group, work closely with end-users to identify applications for the Companys existing products that address its customers specialized needs. The Company has identified and is pursuing new applications for its alloys, including applications for the automotive, medical, instrumentation and emerging fuel cell industries. Fuel cell technology, which shows promise for next-generation automotive propulsion or auxiliary power plants, is a developing area which lends itself to the Companys technological strengths and marketing abilities. The commercialization of this market may take five to ten years.
Continue customer-driven new product development. The Company emphasizes customer contact and an awareness of customer needs in its product development process. The Company believes that new opportunities in end-markets are best identified through close contact with customers. This approach allows the Company to focus its engineering and technology development efforts and enables the Companys products to be readily specified for use in the production of customers products.
Increase productivity through strategic equipment investment. The Company believes that current and future investment in plant and equipment will allow it to increase capacity, reduce unplanned equipment outages, and produce higher quality products at reduced costs. The Company spent $11.6 million in fiscal 2005 on plant and equipment upgrades, which includes Branfords property, plant and equipment acquired in 2004 (described below in Branford Wire Acquisition). The Company anticipates making further significant upgrades, spending a total of an additional $24.0 million over the course of fiscal 2006 and 2007, as compared to $3.6 million which was spent in fiscal 2003 and $5.4 million in fiscal 2004. This increase in investment is necessary due to an under investment in prior years, as well as increases in demand. The principal benefits of these investments are expected to be improved machine reliability, improved product quality, increased processing efficiency, and reduced maintenance costs. The improved reliability will help reduce the risk of unplanned outages, such as those that occurred in the fourth quarter of fiscal 2005. An additional benefit of increased equipment reliability is improved working capital management.
Expand product capability through strategic acquisitions. The Company will examine opportunities and investments which will enable it to offer customers an enhanced and more complete product line that complements the Companys core flat products, cold finished flats and hot finished flats. This would include product line enhancement, such as provided by the Companys acquisition of a wire plant in 2004 (described below in Branford Wire Acquisition). The wire acquisition has enabled the Company to provide a broader product line to customers, has expanded the markets which the Company can penetrate, increased production capacity in high performance wire and reduced the Companys cost structure of wire production. The Company will continue to look for these kinds of opportunities which will enhance the portfolio of products provided to customers such as wire, tubing, fittings and bar.
On November 5, 2004, Haynes Wire Company, a wholly owned subsidiary of the Company, acquired certain assets of The Branford Wire and Manufacturing Company and certain of its affiliates for a purchase price of $8.3 million, which was paid in cash (the Branford Acquisition). As part of the transaction, Haynes Wire acquired a wire manufacturing plant in Mountain Home, North Carolina, manufacturing equipment, accounts receivable and inventory. Haynes Wire also entered into a non-compete agreement with the former president and owner of Branford, restricting his ability to compete with Haynes Wires operations for a period of seven years following the closing date. The non-compete agreement requires Haynes Wire to make total payments of $770,000, with $110,000 paid at closing and the remaining $660,000 paid in equal installments on the next six anniversaries of the closing date.
Management believes this acquisition provides good opportunities for increasing wire sales through improvements in quality and manufacturing processes in the high performance alloy wires produced by the Company, and by offering the expanded wire product line through the Companys service and sales centers worldwide. The Companys expertise in producing high quality wire products should enable it to expand its product offerings and increase its participation in the nickel and cobalt based alloy welding market.
The alloy market consists of four primary segments: stainless steel, super stainless steel, nickel alloys and high-performance alloys. The Company competes exclusively in the high-performance alloy segment, which includes HTA products and CRA products. The Company believes that the high-performance alloy segment represents less than 10% of the total alloy market. In fiscal 2003, 2004 and 2005, HTA products accounted for approximately 75%, 73% and 75%, respectively; of the Companys net revenues. In fiscal 2003, 2004, and 2005, CRA products accounted for approximately 25%, 27% and 25%, respectively, of the Companys net revenues. These percentages of the Companys total product revenue are based on data which include revenue associated with sales by the Company to its foreign subsidiaries, but exclude revenue associated with sales by foreign subsidiaries to their customers. Management believes, however, that the effect of including revenue data associated with sales by its foreign subsidiaries would not materially change the percentages presented in this section.
High Temperature Resistant Alloys. HTA products are used primarily in manufacturing components for the hot sections of gas turbine engines. Stringent safety and performance standards in the aerospace industry result in development lead times typically as long as eight to ten years in the introduction of new aerospace-related market applications for HTA products. However, once a particular new alloy is shown to possess the properties required for a specific application in the aerospace industry, it tends to remain in use for extended periods. HTA products are also used in gas turbine engines produced for use in applications such as naval and commercial vessels, electric power generators, and power sources for offshore drilling platforms, gas pipeline booster stations and emergency standby power stations. The following table sets forth information with respect to the Companys significant high temperature resistant alloys, applications and features:
(1) Aero refers to aerospace; LBGT refers to land based gas turbines; CPI refers to the chemical processing industry.
(2) Represents a patented product or a product with respect to which the Company believes it has limited or no competition.
Corrosion Resistant Alloys. CRA products are used in a variety of applications, such as chemical processing, power plant emissions control, hazardous waste treatment, sour gas production and pharmaceutical vessels. Historically, the chemical processing industry has represented the largest end-user segment for CRA products. Due to maintenance, safety and environmental considerations, the Company believes this industry continues to represent an area of potential long-term growth. Unlike aerospace applications within the HTA product market, the development of new market applications for CRA products generally does not require long lead times. The following table sets forth information with respect to certain of the Companys significant corrosion resistant alloys, applications and features:
(1) CPI refers to the chemical processing industry; FGD refers to the flue gas desulfurization industry
(2) Represents a patented product or a product with respect to which the Company believes it has limited or no competition.
Over the last 26 years, the Companys technical programs have yielded 12 new proprietary alloys and 27 U.S. patents, with one U.S. patent application pending. The Company currently maintains a total of approximately 20 U.S. patents and approximately 200 foreign counterpart patents and applications targeted at countries with significant or potential markets for the patented products. While the Company believes its patents are important to its competitive position, significant barriers to entry continue to exist beyond the expiration of any patent period. Seven of the patented alloys considered by management to be of future commercial significance, HAYNES HR-120, HAYNES 242, ULTIMET, HASTELLOY C-2000, HASTELLOY B-3, HASTELLOY G-35 and HASTELLOY C-22HS alloys, are protected by U.S. patents that continue until the years 2008, 2008, 2009, 2018, 2020, 2022 and 2023, respectively. In addition, HAYNES 282 alloy, which management believes has very significant commercial potential, is the subject of a patent application filed in fiscal 2004, which, if granted, will provide protection until 2024. Trademarks on the names of many of the Companys alloys have also been applied for or granted in certain foreign countries.
Patents or other proprietary rights are an essential element of the Companys business. The Companys strategy is to file patent applications in the U.S. and any other country that represents an important potential commercial market to the Company. In addition, the Company seeks to protect its
technology which is important to the development of the Companys business. The Company also relies upon trade secret rights to protect its technologies and its development of new applications and alloys. The Company protects its trade secrets in part through confidentiality and proprietary information agreements with its customers.
Aerospace. The Company has manufactured HTA products for the aerospace market since the late 1930s, and has developed numerous proprietary alloys for this market. Customers in the aerospace market tend to be the most demanding with respect to meeting specifications within very low tolerances and achieving new product performance standards. Stringent safety standards and continuous efforts to reduce equipment weight require close coordination between the Company and its customers in the selection and development of HTA products. As a result, sales to aerospace customers tend to be made through the Companys direct sales force. Demand for the Companys products in the aerospace industry is based on the new and replacement market for jet engines and the maintenance needs of operators of commercial and military aircraft. The hot sections of jet engines are subjected to substantial wear and tear and accordingly require periodic maintenance and replacement.
Chemical Processing. The chemical processing market represents a large base of customers with diverse CRA applications driven by demand for key end use industries such as automobiles, housing, health care, agriculture, and metals production. CRA products supplied by the Company have been used in the chemical processing industry since the early 1930s. Demand for the Companys products in this industry is based on the level of maintenance, repair, and expansion of existing chemical processing facilities as well as the construction of new facilities. The Company believes the extensive worldwide network of Company-owned service and sales centers, as well as its network of independent distributors and sales agents who supplement the Companys direct sales efforts in Europe and Asia, is a competitive advantage in marketing its CRA products.
Land Based Gas Turbines. Demand for the Companys products in this market is driven by the construction of cogeneration facilities such as base load for electric utilities or as backup sources to fossil fuel-fired utilities during times of peak demand. Demand for the Companys alloys in the land based gas turbine industry has also been driven by concerns regarding lowering emissions from generating facilities powered by fossil fuels. Land based gas turbine generating facilities have gained acceptance as clean, low-cost alternatives to fossil fuel-fired electric generating facilities. Land based gas turbines are also used in power barges with mobility and as temporary base-load-generating units for countries that have numerous islands and a large coastline. Further demand is generated in mechanical drive units used for oil and gas production and pipeline transportation, as well as microturbines that are used as back up sources of power generation for hospitals and shopping malls.
Other Markets. In addition to the industries described above, the Company also targets a variety of other markets. Other industries to which the Company sells its HTA products and CRA products include FGD, oil and gas, waste incineration, industrial heat treating, automotive and instrumentation. The FGD industry has been driven by both legislated and self-imposed standards for lowering emissions from fossil fuel-fired electric generating facilities. The Company also sells its products for use in the oil and gas industry, primarily in connection with sour gas production. In addition, incineration of municipal, biological, industrial and hazardous waste products typically produces very corrosive conditions that demand high-performance alloys. Markets capable of providing growth are being driven by increasing performance, reliability and service life requirements for products used in these markets which could provide further applications for the Companys products. Finally, the Company also entered the high-quality stainless-steel wire market with the Branford Acquisition.
Providing technical assistance to customers is an important part of the Companys marketing strategy. The Company provides analyses of its products and those of its competitors for its customers. These analyses enable the Company to evaluate the performance of its products and to make recommendations as to the substitution of Company products for other materials in appropriate applications, enabling the Companys products to be specified for use in the production of customers products. Market development professionals are assisted by the engineering and technology staff of the Company in directing the sales force to new opportunities. The Company believes its combination of direct sales, technical marketing, engineering, and customer support provides an advantage over other manufacturers in the high-performance alloy industry. This activity allows the Company to obtain direct insight into customers alloy needs and allows the Company to develop proprietary alloys that provide solutions to customers problems.
The Company sells its products primarily through its direct sales organization, which operates from fourteen locations in the U.S., Europe and Asia. All of the Companys service and sales centers are operated either directly by the Company or though its wholly-owned subsidiaries. Approximately 81% of the Companys net revenues in fiscal 2005 was generated by the Companys direct sales organization. The remaining 19% of the Companys fiscal 2005 net revenues was generated by a network of independent distributors and sales agents who supplement the Companys direct sales in the U.S., Europe and Asia, some of whom have been associated with the Company for over 30 years.
Although there is a concentrated effort to expand foreign sales, the effort to grow domestic business also continues. The majority of revenue and profits continue to be provided by sales to U.S. customers and the Company continues to pursue opportunities to expand this market. The Companys domestic expansion effort includes, but is not limited to, continued expansion of ancillary product forms, such as wire through the Branford Acquisition, the continued development of new alloys, the utilization of external conversion resources to expand and improve the product form quality of mill-produced product, the addition of equipment in U.S. service and sales centers to improve the Companys ability to provide a product closer to the form required by the customer, and the continued effort through the technical expertise of the Company to find solutions to customer challenges.
The following table sets forth the approximate percentage of the Companys fiscal 2005 net revenues generated through each of the Companys distribution channels.
The Companys top twenty customers accounted for approximately 34% of the Companys net revenues in both fiscal 2004 and 2005. No customer or group of affiliated customers of the Company accounted for more than 10% of the Companys net revenues in fiscal 2003, 2004 or 2005.
The Companys foreign and export sales were approximately $74.5 million, $90.2 million, and $128.5 million for fiscal 2003, 2004 and 2005, respectively. Additional information concerning foreign operations and export sales is set forth in Note 16 to the consolidated financial statements included elsewhere in this Form 10-K.
High-performance alloys require a lengthier, more complex production process and are more difficult to manufacture than lower-performance alloys, such as stainless steels. The alloying elements in high-performance alloys must be highly refined during melting, and the manufacturing process must be tightly controlled to produce precise chemical properties. The resulting alloyed material is more difficult to process because, by design, it is more resistant to deformation. Consequently, high-performance alloys require that a greater force be applied when hot or cold working and are less susceptible to reduction or thinning when rolling or forging. This results in more cycles of rolling, annealing and pickling compared to a lower-performance alloy to achieve proper dimensions. Certain alloys may undergo as many as 40 distinct stages of melting, remelting, annealing, forging, rolling and pickling before they achieve the specifications required by a customer. The Company manufactures products in various forms, including sheet, plate, billet/ingot, tubular, wire and other forms.
The manufacturing process begins with raw materials being combined, melted and refined in a precise manner to produce the chemical composition specified for each alloy. For most alloys, this molten material is cast into electrodes and additionally refined through electroslag remelting. The resulting ingots are then forged or rolled to an intermediate shape and size depending upon the intended final product form. Intermediate shapes destined for flat products are then sent through a series of hot and cold rolling, annealing and pickling operations before being cut to final size.
The argon oxygen decarburization gas controls in the Companys primary melt facility remove carbon and other undesirable elements, thereby allowing more tightly-controlled chemistries, which in turn produce more consistent properties in the alloys. The argon oxygen decarburization gas control system also allows for statistical process control monitoring in real time to improve product quality.
The Company has a four-high Steckel mill for use in hot rolling material. The four-high mill was installed in 1982 at a cost of approximately $60.0 million and is one of only two such mills in the high-performance alloy industry. The mill is capable of generating approximately 12.0 million pounds of separating force and rolling a plate up to 72 inches wide. The mill includes integrated computer controls (with automatic gauge control and programmed rolling schedules), two coiling Steckel furnaces and five heating furnaces. Computer-controlled rolling schedules for each of the hundreds of combinations of alloy shapes and sizes the Company produces allow the mill to roll numerous widths and gauges to exact specifications without stoppages or changeovers.
The Company also operates a three-high rolling mill and a two-high rolling mill, each of which is capable of custom processing much smaller quantities of material than the four-high mill. These mills provide the Company with significant flexibility in running smaller batches of varied products in response to customer requirements. The Company believes the flexibility provided by the three-high and two-high mills provides the Company an advantage over its major competitors in obtaining smaller specialty orders.
The Company believes that current and future investment in plant and equipment will allow it to increase capacity, reduce unplanned equipment outages, and produce higher quality products at reduced costs. The Company spent $11.6 million in fiscal 2005 on plant and equipment upgrades, which includes Branfords property, plant and equipment acquired in 2004. The Company anticipates making further significant upgrades, spending a total of an additional $24.0 million over the course of fiscal 2006 and 2007, as compared to $3.6 million which was spent in fiscal 2003 and $5.4 million in fiscal 2004. This increase in investment is a result of under investment in prior years and current increase in volume. The principal benefits of these investments are expected to be improved machine reliability, improved product quality, increased processing efficiency, and reduced maintenance costs. The improved reliability will help reduce the risk of unplanned outages similar to what occurred in the fourth quarter of fiscal year 2005. Planned outages are scheduled for fiscal 2006 to complete these upgrades.
As of September 30, 2005, the Companys backlog orders in the aggregate were approximately $188.4 million, compared to approximately $93.5 million as of September 30, 2004, and approximately $50.6 million as of September 30, 2003. The backlog as of September 30, 2005 increased by $94.9 million, or 101.5%, as compared to the same date in the prior year. Order entry increased by $128.8 million, or 46.8% as of September 30, 2005, as compared to the same date in the prior year. Substantially all orders in the backlog at September 30, 2005 are expected to be shipped within the twelve months beginning October 1, 2005. Due to the cyclical nature of order entry experienced by the Company, it is possible that order entry may not continue at historical or current levels. The historical and current backlog amounts shown in the following table are also indicative of relative demand over the past few years. The backlog for years prior to fiscal 2005 has been adjusted to reflect the consolidated backlog inclusive of the service and sales centers.
Raw material costs account for approximately 50% of the total cost of sales. Nickel, a major component of many of the Companys products, accounts for approximately 50% of our raw material costs, or approximately 25% of our total cost of sales. Each pound of alloy contains, on average, 48% nickel. Other raw materials include cobalt, chromium, molybdenum and tungsten. Melt materials consist of virgin raw material, purchased scrap and internally produced scrap.
The following table sets forth the average price per pound for nickel for 30-day cash buyers, as reported by the London Metals Exchange for the fiscal years indicated.
Since most of the Companys products are produced pursuant to specific orders, the Company purchases materials against known production schedules. The materials are purchased from several different suppliers through consignment arrangements, annual contracts and spot purchases and involve a variety of pricing mechanisms. Because the Company maintains a policy of pricing its products at the time of order placement, the Company attempts to establish selling prices with reference to known costs of materials thereby reducing the risk associated with changes in the cost of raw materials. However to the extent that the price of nickel rises rapidly, there may be a negative effect on our gross profit margins.
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 because (i) FIFO inventory values presented in the Companys 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. Although management believes that FIFO is preferable to LIFO for the reasons stated, the use of FIFO during a
period of rapidly rising or falling commodity prices can result in an imprecise matching of revenues and expenses in the short-term.
The Companys technology facilities are located at the Kokomo headquarters and consist of 19,000 square feet of offices and laboratories, as well as an additional 90,000 square feet of paved storage area. The Company has seven fully equipped technology testing laboratories, including a mechanical test lab, a metallographic lab, an electron microscopy lab, a corrosion lab, a high temperature lab, and a welding lab. These facilities also contain a reduced scale, fully equipped melt shop and process lab. As of September 30, 2005, the technology, engineering and technological testing staff consisted of 27 persons, 13 of whom have engineering or science degrees, including five with doctoral degrees, with the majority of degrees in the field of metallurgical engineering.
Research and technical support costs primarily relate to efforts to develop new proprietary alloys and in the development of new applications for already existing alloys. The Company spent approximately $2.7 million, $2.5 million and $2.6 million for research and technical support activities for fiscal 2003, 2004 and 2005, respectively.
During fiscal 2005, research and development projects were focused on new alloy development, new product form development, and new alloy concept validation, all relating to products for the aerospace, land based gas turbine, chemical processing, and oil and gas industries. In addition, significant projects were conducted to generate technical data in support of major market application opportunities in areas such as solid oxide fuel cells, biotechnology, chemical processing and power generation.
The high-performance alloy market is a highly competitive market in which eight to ten producers participate in various product forms. The Companys primary competitors include Special Metals Corporation which is now a part of Precision Cast Parts, Allegheny Technologies, Inc., and Krupp VDM GmbH, a subsidiary of Thyssen Krupp Stainless. The Company faces strong competition from domestic and foreign manufacturers of both high-performance alloys (similar to those the Company produces) and other competing metals. The Company may face additional competition in the future to the extent new materials are developed, such as plastics or ceramics, that may be substituted for the Companys products. The Company also believes that it will face increased competition from non-U.S. entities in the next five to ten years, especially from competitors located in Eastern Europe and Asia, with respect to the manufacture of high-performance alloys. Additionally, in recent years the Company has benefited from a weak U.S. dollar, which makes the goods of foreign competitors more expensive to import into the U.S. In the event that the U.S. dollar strengthens, we may face increased competition from foreign competitors.
As of September 30, 2005 we employed approximately 1,060 full-time employees worldwide. All eligible hourly employees at the Kokomo plant and the Lebanon, Indiana service and sales center (approximately 511 in the aggregate) are covered by a collective bargaining agreement. As part of negotiations with the United Steelworkers of America related to our emergence from bankruptcy, the collective bargaining agreement has been extended until June 2007. None of the employees of the Companys Arcadia, Louisiana, Mountain Home, North Carolina or European operations are represented by a labor union. Management considers its employee relations in each of the facilities to be satisfactory.
The Companys facilities and operations are subject to certain foreign, federal, state and local laws and regulations relating to the protection of human health and the environment, including those governing the discharge of pollutants into the environment and the storage, handling, use, treatment and disposal of hazardous substances and wastes. Violations of these laws and regulations can result in the imposition of substantial penalties and can require facilities improvements. In addition, the Company may be required in the future to comply with additional regulations pertaining to the emission of hazardous air pollutants under the Clean Air Act. However, since these regulations have not been proposed or promulgated, the Company cannot predict the cost, if any, associated with compliance with such regulations. Expenses related to environmental compliance (including air pollution control improvements, as discussed below) were approximately $1.6 million for fiscal 2005 and are expected to be approximately $1.8 million for fiscal 2006. Although there can be no assurance, based upon current information available to the Company, the Company does not expect that costs of environmental contingencies, individually or in the aggregate, will have a material adverse effect on the Companys financial condition, results of operations or liquidity.
The Companys facilities are subject to periodic inspection by various regulatory authorities, who from time to time have issued findings of violations of governing laws, regulations and permits. In the past five years, the Company has paid administrative fines, none of which has had a material effect on the Companys financial condition, for alleged violations relating to environmental matters, including the handling and storage of hazardous wastes, requirements relating to its Title V Air Permit, requirements relating to the handling of polychlorinated biphenyls and violations of record keeping and notification requirements relating to industrial waste water discharge. Capital expenditures of approximately $542,000 were made for pollution control improvements during fiscal 2005, with additional expenditures of $333,000 planned for 2006.
The Company has received permits from the Indiana Department of Environmental Management, or IDEM, and the U.S. Environmental Protection Agency, or EPA, to close and to provide post-closure monitoring and care for certain areas at the Kokomo facility previously used for the storage and disposal of wastes, some of which are classified as hazardous under applicable regulations. Construction was completed in May 1994 and closure certification was received in fiscal 1999 for one area at the Kokomo facility and post-closure care is ongoing there. The Company has an application pending for approval of closure and post-closure care for another area at its Kokomo facility and in the lagoon at its Mountain Home, North Carolina facility. The Company is required to monitor groundwater and to continue post-closure maintenance of the former disposal areas. The Company is aware of elevated levels of certain contaminants in the groundwater. If it is determined that the disposal areas or other solid waste management units at the Kokomo facility have impacted the groundwater underlying the Kokomo facility, additional corrective action by the Company could be required. The Company is unable to estimate the costs of such action, if any. There can be no assurance, however, that the costs of future corrective action would not have a material effect on the Companys financial condition, results of operations or liquidity. Additionally, it is possible that the Company could be required to undertake other corrective action commitments for any other solid waste management unit existing or determined to exist at its facilities.
As a condition of the post-closure permits, the Company must provide and maintain assurances to IDEM and EPA of the Companys capability to satisfy closure and post-closure groundwater monitoring requirements, including possible future corrective action as necessary. The Company provides these required assurances through a statutory financial assurance test as provided by Indiana law. Additionally, the Company is also required to provide assurances to the North Carolina Department of Environment and Natural Resources and the EPA of the Companys ability to satisfy closure and post-closure monitoring requirements, including possible future corrective actions, due to a closed lagoon at the plant that the Company acquired from The Branford Wire and Manufacturing Company in North Carolina. These assurances are provided through letters of credit.
The Company may also incur liability for alleged environmental damages associated with the off-site transportation and disposal of hazardous substances. The Companys operations generate hazardous substances, and, while a large percentage of these substances are reclaimed or recycled, the Company also accumulates hazardous substances at each of its facilities for subsequent transportation and disposal off-site by third parties. Generators of hazardous substances which are transported to disposal sites where environmental problems are alleged to exist are subject to claims under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, or CERCLA, and state counterparts. CERCLA imposes strict, joint and several liabilities for investigatory and cleanup costs upon hazardous substance generators, site owners and operators and other potentially responsible parties. The Company may have generated hazardous substances disposed of at other sites potentially subject to CERCLA or equivalent state law remedial action. Thus, there can be no assurance that the Company will not be named as a potentially responsible party at sites in the future or that the costs associated with those sites would not have a material adverse effect on the Companys financial condition, results of operations of liquidity.
The owned and leased facilities of the Company and its subsidiaries, and the products and services provided at each facility, are as follows:
Arcadia, Louisianamanufactures and sells welded and seamless tubular goods
Kokomo, Indianamanufactures and sells all product forms, other than tubular goods
Openshaw, England(1)stocks and sells all product forms
Mountain Home, North Carolinamanufactures and sells stainless and nickel alloy wire
Zurich, Switzerland(1)stocks and sells all product forms
La Mirada, Californiastocks and sells all product forms(1)
Houston, Texasstocks and sells all product forms(1)
Lebanon, Indianastocks and sells all product forms(1)
Milan, Italystocks and sells all product forms(1)
Paris, Francestocks and sells all product forms(1)
Shanghai, Chinastocks and sells all product forms(1)
Windsor, Connecticutstocks and sells all product forms(1)
Singaporesells all product forms(2)
Chennai, Indiasells all product forms(2)
(1) Service and sales centers
(2) Sales centers
The Kokomo plant, the primary production facility, is located on approximately 180 acres of industrial property and includes over 1.0 million square feet of building space. There are three sites consisting of (1) a headquarters and research laboratory; (2) primary and secondary melting, annealing furnaces, forge press and several smaller hot mills; and (3) the four-high breakdown mill and sheet product cold working equipment, including two cold strip mills. All alloys and product forms other than tubular goods are produced in Kokomo.
The Arcadia plant is located on approximately 42 acres of land, and includes 135,000 square feet of buildings on a single site. Arcadia uses feedstock produced in Kokomo to fabricate welded and seamless superalloy pipe and tubing and purchases extruded tube hollows to produce seamless titanium tubing.
Manufacturing processes at Arcadia require cold pilger mills, weld mills, draw benches, annealing furnaces and pickling facilities.
The Mountain Home plant is located on approximately 29 acres of land, and includes approximately 100,000 square feet of building space. The Mountain Home facility is primarily used to manufacture finished specialty stainless, nickel and a limited amount of cobalt alloy wire products. A limited amount of warehousing is also done at this facility.
The owned facilities located in the U.S. are subject to a mortgage which secures the Companys obligations under the Companys Loan and Security Agreement with Congress Financial Corporation (Central). See Managements Discussion and Analysis of Financial Condition and Results of Operations and Note 9 to the consolidated financial statements included elsewhere in this Form 10-K for more information regarding the Companys credit facility with Congress.
The Openshaw plant, located near Manchester, England, consisted of approximately 7 acres of land and over 200,000 square feet of buildings on a single site. The Company has closed the manufacturing portion of the Openshaw plant and is sourcing the required bar product for customers from external vendors. This closure did not have a material effect on the overall revenue of the U.K. operation, the overall operation of the Company, or the Companys financial position. In April 2005, the Company sold eight acres of the Openshaw site for a gain of $2.1 million. It is anticipated that the Company will continue to own and operate the balance of the land and the buildings.
All owned and leased service and sales centers not described in detail above are single site locations and are less than 100,000 square feet. The service centers contain equipment capable of precision processing to cut and shape products to customers precise specifications.
The Company is regularly involved in routine litigation, both as a plaintiff and as a defendant, relating to its business and operations, and in federal and/or state EEOC administrative actions. In addition, the Company is subject to extensive federal, state and local laws and regulations. While the Companys policies and practices are designed to ensure compliance with all laws and regulations, future developments and increasingly stringent regulations could require the Company to make additional unforeseen expenditures for these matters.
The Company is a defendant in 21 lawsuits alleging that the Companys welding-related products harmed the users of such products through the inhalation of welding fumes containing manganese. The suits are currently ongoing in the state courts of California, and were instituted against the Company starting in fiscal year 2005. The claims for damages in these cases, alone or in the aggregate, do not exceed 1% of the Companys current assets of September 30, 2005. Additionally, the Company believes that it has insurance coverage for these cases.
The Company further believes that any and all claims arising out of conduct or activities that occurred prior to March 29, 2004 are subject to dismissal. On March 29, 2004, the Company and certain of its subsidiaries and affiliates filed voluntary petitions for relief under Chapter 11 of Title 11 of the United States Code in the United States Bankruptcy Court for the Southern District of Indiana (the Bankruptcy Court). On August 16, 2004, the Bankruptcy Court entered its Findings of Fact, Conclusions of Law, and Order Under 11 U.S.C. 1129(a) and (b) and Fed. R. Bankr. P. 3020 Confirming the First Amended Joint Plan of Reorganization of Haynes International, Inc. and its Affiliated Debtors and Debtors-in-Possession as Further Modified (the Confirmation Order). The Confirmation Order and related Chapter 11 Plan, among other things, provide for the release and discharge of prepetition claims and causes of action. The Confirmation Order further provides for an injunction against the commencement of any actions with respect to claims held prior to the Effective Date of the Plan. The Effective Date occurred on August 31, 2004. The
Company intends to pursue the dismissal of any lawsuits premised upon claims or causes of action discharged in the Confirmation Order and related Chapter 11 Plan. It is possible, however, that the Company will be named in additional suits in welding-rod litigation cases, in which case, the aggregate claims for damages cannot be estimated and, if the Company is found liable, may have a material adverse effect on the Companys financial condition unless such claims are also subject to insurance coverage and/or subject to dismissal, as discussed above.
The Company is also routinely involved in litigation and/or administrative actions relating to environmental matters. Please see Our BusinessEnvironmental Matters in Item 1 for further information.
Although the level of future expenditures for legal matters cannot be determined with any degree of certainty, based on the facts presently known, management does not believe that such expenditures will have a material effect on the Companys financial position, results of operations or liquidity.
Following the Companys emergence from bankruptcy in August 2004, trading in the Companys common stock has occurred from time to time on an unsolicited basis on the pink sheets under the trading symbol HYNI.PK. The following table sets forth the range of high and low closing bid prices by fiscal quarter for the common stock as reported through Pink Sheets LLC. Prior to the Companys emergence from bankruptcy, the Companys common stock was held by its parent company and was not traded. For that reason, prices cannot be provided for any time prior to August 31, 2004. Over-the-counter market quotations reflect inter-dealer prices without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
As of November 29, 2005, there were approximately 27 record holders of the Companys common stock.
In the past three fiscal years, the Company has not declared cash dividends on shares of its common stock. The terms of the Companys debt agreements limit its ability to pay cash dividends, and the Company does not anticipate paying cash dividends or making any other distributions on shares of the Companys common stock in the foreseeable future. Instead, the Company intends to retain any earnings for use in the operation and expansion of its business.
The Company did not issue any unregistered securities or repurchase any of its equity securities during fiscal 2005.
The following table provides information as of September 30, 2005 regarding shares of the Companys common stock issuable pursuant to its stock option plan:
(1) For a description of the Companys equity compensation plans, see Note 14 to the Consolidated Financial Statements in Item 8 and Executive CompensationStock-Based Plans in Item 11.
(2) These stock options were issued pursuant to the Haynes International, Inc. Stock Option Plan, as amended, which was approved by the bankruptcy court in connection with the Companys emergence from bankruptcy on August 31, 2004.
On March 29, 2004, the Company and its U.S. subsidiaries and U.S. affiliates on that date filed for bankruptcy protection. A plan of reorganization was filed on May 25, 2004, amended on June 29, 2004, confirmed by order of the bankruptcy court on August 16, 2004, and became effective on August 31, 2004. The historical consolidated financial statements of predecessor Haynes International, Inc. included elsewhere in this Form 10-K have been prepared on a going concern basis, which assumes continuity of operations and realization of assets and satisfaction of liabilities in the ordinary course of business, and, for periods subsequent to March 29, 2004, in accordance with the American Institute of Certified Public Accountants Statement of Position 90-7, Financial Reporting by Entities in Reorganization Under the Bankruptcy Code. As of August 31, 2004, the effective date of the plan of reorganization, successor Haynes International, Inc. began operating its business under a new capital structure and adopted fresh start reporting for its consolidated financial statements. Because of the emergence from bankruptcy and adoption of fresh start reporting, the historical consolidated financial information for predecessor Haynes International, Inc. is not comparable to financial information of successor Haynes International, Inc. for periods after August 31, 2004.
Set forth below are selected financial data of predecessor Haynes International, Inc. and successor Haynes International, Inc. This information should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and related notes thereto included elsewhere in this Form 10-K. The selected historical consolidated financial data as of September 30, 2004 and 2005 and for the period September 1, 2004 through September 30, 2004, and for the year ended September 30, 2005 are derived from the consolidated financial statements of successor Haynes International, Inc. The selected historical consolidated financial data for the period October 1, 2003 through August 31, 2004, and as of and for the years ended September 30, 2003, 2002 and 2001 are derived from the consolidated financial statements of predecessor Haynes International, Inc.
Amounts below are in thousands, except backlog, which is in millions, share and per share information and average nickel price.
(1) Restated. Effective October 1, 2003, the Company changed its inventory costing method from the last-in, first-out (LIFO) method to the first-in, first-out (FIFO) method. In accordance with generally accepted accounting principles, the change has been applied by restating the 2001-2003 consolidated financial data. Please see Note 3 to the consolidated financial statements included in Item 8 of this Form 10-K for more information regarding this change in accounting method.
(2) As of August 31, 2004, the effective date of the plan of reorganization, the Company adopted fresh start reporting for its consolidated financial statements. Because of the emergence from bankruptcy and adoption of fresh start reporting, the historical financial information for periods after August 31, 2004 is not comparable to periods before September 1, 2004.
(3) As part of fresh start reporting, inventory was increased by approximately $30,497 to reflect its fair value at August 31, 2004. The fair value adjustment was recognized ratably in cost of sales as inventory was sold and was fully recognized by the end of the second quarter of fiscal 2005. Cost of sales for the one month ended September 30, 2004 and the year ended September 30, 2005 include non-cash charges of $5,083 and $25,414, respectively, for this fair value adjustment. Also, as part of fresh start reporting, machinery and equipment, buildings, and patents were increased by $49,436 to reflect fair value at August 31, 2004. These values will be recognized in costs of sales over periods ranging from 2 to 14 years. Cost of sales for the one month ended September 30, 2004 and the year ended September 30, 2005 include $403 and $4,788, respectively, for this fair value adjustment.
(4) In fiscal 2003, $676 of terminated acquisition costs were accounted for as selling, general and administrative expense related to a failed attempt to acquire Special Metals Corporation (Inco Alloys International).
(5) Selling, general and administrative expense included $123 and $1,302 of stock compensation expense for the one month ended September 2004 and the year ended September 30, 2005, respectively, related to stock options granted by the Company upon emergence from bankruptcy. Also included in selling, general and administration expense in fiscal 2005 are non-recurring costs of $1,200 related to the process of preparation for compliance with Section 404 of the Sarbanes-Oxley Act of 2002 and $1,400 related to filing a registration statement on Form S-1.
(6) Consists primarily of professional fees and credit facility fees related to the restructuring and refinancing activities.
(7) During fiscal 2004, the Company recognized approximately $177,653 in reorganization items of which approximately $7,298 were expenses relating to professional fees, amendment fees, travel expenses, directors fees, write offs of bond discount and debt issuance costs, and other expenses, and approximately $184,951 was income relating to the gain on cancellation of 115¤8% senior notes due September 1, 2004 and fresh start reporting adjustments as a result of the reorganization. Please see Note 8 to the consolidated financial statements included in Item 8 of this Form 10-K for more information.
(8) Reflects a valuation allowance of approximately $60,307 at September 30, 2003 on the Companys U.S. net deferred tax assets as a result of the Companys determination that, as of that date, it was more likely than not that certain future tax benefits would not be realized. Please see Note 6 to the consolidated financial statements included in Item 8 of this Form 10-K for more information.
(9) Average price for a 30 day cash buyer as reported by the London Metals Exchange.
Please refer to page 1 of this Form 10-K for a cautionary statement regarding forward-looking information.
On March 29, 2004, the Company and its U.S. subsidiaries and U.S. affiliates as of that date filed voluntary petitions for reorganization relief under Chapter 11 of the U.S. Bankruptcy Code. The Company emerged from Chapter 11 bankruptcy on August 31, 2004 pursuant to a plan of reorganization. Among other things, the plan of reorganization provided that all of the shares of the Companys common stock, which had been held by Haynes Holdings, Inc., were cancelled and 10.0 million new shares of the Companys common stock, par value $0.001 per share, were issued in connection with the Companys emergence from bankruptcy.
The Companys historical results for the period from October 1, 2003 through August 31, 2004 (the predecessor Company) are being presented in this Item 7 along with the Companys financial results from September 1, 2004 through September 30, 2004, and for the fourth quarter and full year of fiscal 2005 (the successor Company). As of August 31, 2004, the effective date of the plan of reorganization, the successor Company began operating under a new capital structure and adopted fresh start reporting for its financial statements. Because of the emergence from bankruptcy and adoption of fresh start reporting, the predecessor Companys historical financial information is not comparable to the successor Companys financial information for periods after August 31, 2004.
The Company is providing the following supplemental comparative financial information on a pro forma and combined basis for the predecessor Company and the successor Company for the fourth quarter and full year of fiscal 2004. This pro forma and combined financial information is presented on a consolidated basis as if the plan of reorganization were effective at the beginning of fiscal 2004. The usefulness of this information may be limited due to the aforementioned factors, including the application of fresh start reporting. Unless otherwise indicated, references in this Item 7 to results for the fourth quarter and full year of fiscal 2004 reflect pro forma or combined results of the predecessor and successor Company and are unaudited.
The following unaudited pro forma consolidated statement of operations for the year ended September 30, 2004, is derived from the application of pro forma adjustments to the historical statement of operations of the predecessor Company for the period October 1, 2003 to August 31, 2004 as if the effective date of the plan of reorganization were October 1, 2003. The pro forma combined statement of operations for the year ended September 30, 2004 includes the historical results of operations of the successor Company for the period September 1, 2004 to September 30, 2004 combined with the pro forma results of operations of the predecessor Company for the period October 1, 2003 to August 31, 2004. The pro forma statement of operations should be read in conjunction with the consolidated financial statements, related notes and other financial information included elsewhere in this Form 10-K.
The pro forma adjustments are described in the notes to the pro forma statement of operations and are based on available information and assumptions that management believes are reasonable. The pro forma statement of operations is not necessarily indicative of the future results of operations of the successor Company or results of operations of the successor Company that would have actually occurred had the plan of reorganization been consummated as of October 1, 2003.
(1) The pro forma adjustments do not include the non-recurring charge to expense of the flow through fair value adjustment to inventory of $25,415. The effect of this adjustment flowed through cost of sales as additional expense as inventory was sold during the first five months of fiscal 2005.
(2) To reflect the net change in historical cost of sales of the predecessor company resulting from the application of fresh start reporting. The change is due to an increase in historical depreciation expense
of $239 per month for a period of eleven months and the addition of patent amortization expense of $164 per month for a period of eleven months. Each of these adjustments was calculated using the new basis of accounting resulting from the adoption of fresh start reporting.
(3) To reflect compensation expense for the stock options granted by the successor company of approximately $123 per month for a period of eleven months.
(4) To eliminate interest expense on the $140,000 11 5¤8% senior notes due September 1, 2004 of $9,363.
(5) To eliminate reorganization items.
(6) To reflect the net change between the historical income tax benefit and the expected income tax benefit on the pro forma operations in order to achieve our expected effective tax rate of 38%.
The global alloy market consists of four primary segments: stainless steel, super stainless steel, nickel and high-performance. The Company competes exclusively in the high-performance alloy segment, which includes high temperature resistant alloy, or HTA, and corrosion resistant alloy, or CRA, products. HTA and CRA products accounted for 73% and 27%, respectively, of the Companys net revenues in fiscal 2004, and 75% and 25%, respectively, of the Companys net revenues in fiscal 2005. Based on available industry data, the Company believes that it is one of three principal producers of high-performance alloys in flat product form, which includes sheet, coil and plate forms. The Company also produces its alloys in round and tubular forms. Flat products accounted for 73% of shipment pounds and 68% of net revenues in fiscal 2004, and 72% of shipment pounds and 69% of net revenues in fiscal 2005, respectively. On a historical basis, flat products have accounted for approximately 75% of the Companys net revenues, and it is anticipated that flat products will continue to account for approximately three quarters of the Companys net revenues on a prospective basis.
The Company sells its products primarily through its direct sales organization, which includes nine service and sales centers in the U.S., Europe and Asia. During fiscal 2005, the Company opened a service and sales center in China and a sales office in India. All of the Companys service and sales centers are operated by the Company. The Companys direct sales organization generated approximately 77% and 81% of the Companys net revenues in fiscal 2004 and fiscal 2005, respectively. The remaining 23% and 19% of the Companys net revenues in fiscal 2004 and fiscal 2005, respectively, were generated by a network of independent distributors and sales agents who supplement the Companys direct sales efforts in all markets, some of whom have been associated with the Company for over 30 years. On a prospective basis, the Company expects its direct sales force to continue to generate approximately 80% of its of total sales. This percentage may increase, however, as the Company opens new service and sales centers and makes acquisitions of companies that sell directly, such as Branford.
Sales to customers outside the U.S. represented approximately 40% of the Companys net revenues in both fiscal 2004 and fiscal 2005. It is anticipated that sales to customers outside of the U.S. will continue to grow with the addition of foreign service and sales centers.
The high-performance alloy industry is characterized by high capital investment and high fixed costs, and profitability is, therefore, very sensitive to changes in volume and even small changes in volume can result in significant variations in earnings. The cost of raw materials is the primary variable cost in the high-performance alloy manufacturing process and represents approximately 50% of the total manufacturing costs. Other manufacturing costs, such as labor, energy, maintenance and supplies, often thought of as variable, have a significant fixed element.
Lead times from order to shipment can be a competitive factor, as well as an indication of the strength of the demand for high temperature resistant alloys. The Companys current average lead times from order
to shipment for mill-produced products, depending on product form, are approximately 10 to 30 weeks. An order from a service and sales center can be filled in less than one week, depending upon the availability of materials in stock.
On November 21, 2005, the Company announced that its Board of Directors has appointed a Special Committee of independent directors to explore strategic alternatives, including a potential sale of the Company to a third party or merger that could result in a change of control of the Company, and that Houlihan Lokey Howard & Zukin has been retained to serve as the financial advisor to assist the Special Committee in identifying and exploring strategic alternatives. There can be no assurance that the Company will enter into or consummate any transaction; or as to the terms or timing thereof.
The following table includes a breakdown of net revenues, shipments and average selling prices to the markets served by the Company for the periods shown.
(1) This information was derived from and should be read in conjunction with the Pro Forma Financial Information and footnotes therto included this Item 7 of this Form 10-K
(2) Other revenue consists of toll conversion and royalty income.
(3) During fiscal 2005, the Other Markets category includes $15.8 million in revenue and 4.8 million pounds of stainless wire as a result of the Branford Wire acquisition in November 2004.
Aerospace. Demand for the Companys products in the aerospace industry is largely driven by orders for new jet engines, as well as requirements for spare parts and replacement parts for jet engines. The Company experienced strong growth in the late 1990s through fiscal 2001 due to the aerospace demand cycle. As a result of increased new aircraft production during this cycle and maintenance requirements, the Companys net revenues from sales to the aerospace supply chain peaked in fiscal 2001. The Companys
sales to the aerospace market declined throughout fiscal 2002 and fiscal 2003, but started to improve with the turn-around of the aerospace cycle in late fiscal 2003. Excluding any catastrophic economic or political events, based on forecasted engine and airframe build schedules, aerospace market should continue to improve through fiscal 2007 and possibly 2008.
Net revenues to the aerospace market in fiscal 2005 increased by 28.5% from fiscal 2004 as commercial aircraft production by the major manufacturers continued to increase from the prior year, resulting in improvements in aircraft orders and aircraft maintenance requirements, which are expected to continue for the next three years. Aerospace sales have increased due primarily to a 10.9% increase in the number of pounds shipped and a 15.6% increase in the average selling price per pound, which reflects generally improved market pricing as a result of higher raw material costs, changes in product mix and improving market conditions.
Chemical Processing. Growth in the chemical processing industry tends to track overall economic activity. Demand for the Companys products is driven by maintenance requirements of chemical processing facilities and the expansion of existing chemical processing facilities or the construction of new facilities in niche markets within the overall industry. In fiscal 2005, sales of the Companys products to the chemical processing industry increased by 24.1% from those in fiscal 2004. Revenues from the chemical processing industry in fiscal 2003 represented the Companys lowest levels in the previous five fiscal years. Net revenues from this market increased due primarily to a 35.7% increase in average selling price per pound, which reflects generally improved market pricing as a result of higher raw material costs and improved product mix, partially offset by a 9.5% decline in the number of pounds shipped. The decline in volume reflects an emphasis by the Company on more specialty higher margin product versus large project lower margin commodity grades.
The Company believes that the basic elements that drive the use of the Companys products in the chemical processing industry are still present, but the focus for new plant construction will be in Asia, while maintenance and debottlenecking projects to avoid capital expansion will be the trend in Europe and North America. Concerns regarding the reliability of chemical processing facilities, their potential impact on the environment and the safety of their personnel, as well as the need for higher chemical throughput, should support future demand for more sophisticated alloys, such as the Companys CRA products. The Companys key proprietary CRA products, including HASTELLOY C-2000, which the Company believes provides better overall corrosion resistance and versatility than any other readily available CRA products, and HASTELLOY C-22, are expected to contribute to the Companys improving activity in this market, although this may not be the case.
Land Based Gas Turbines. The Company has leveraged its metallurgical expertise to develop land based gas turbine applications for alloys it had historically sold to the aerospace industry. Land based gas turbines are favored in electric generating facilities due to low capital cost at installation, low cycle installation time, flexibility in use of alternative fuels, and fewer SO2 emissions than traditional fossil fuel-fired facilities. In addition to power generation, land based gas turbines are required as mechanical drivers primarily for production and transportation of oil and gas, as well as emerging applications in commercial marine propulsion and micro turbines for standby or emergency power systems. The Company believes these factors have historically been primarily responsible for creating demand for its products in the land based gas turbine industry.
Prior to the enactment of the Clean Air Act, land based gas turbines were used primarily to satisfy peak power requirements. The Company believes that land based gas turbines are the clean, low-cost alternative to fossil fuel-fired electric generating facilities. In the early 1990s when Phase I of the Clean Air Act was being implemented, selection of land based gas turbines to satisfy electric utilities demand firmly established this power source. The Company believes that the mandated Phase II of the Clean Air
Act and certain advantages of land based gas turbines relative to coal-fired generating plants will further contribute to demand for its products over the next three to five years.
In fiscal 2005, shipments of the Companys products to the land based gas turbine industry increased from those in fiscal 2004 due to a significant increase in maintenance and repair for gas turbines from the power generation industry. The significant improvement in fiscal 2004 and fiscal 2005 as compared to fiscal 2003 is reflective of a decline in the land based gas turbine industry in fiscal 2003, which was the result of both the economic slowdown and the energy crisis precipitated by the Enron bankruptcy. During fiscal 2002, land based gas turbine projects which were in progress were completed; however, projects not yet started were put on hold and new projects were not initiated. During fiscal 2003, projects put on hold were restarted and new projects were initiated, which contributed to the significantly improved performance in this industry in fiscal 2004 as compared to fiscal 2003. Revenue growth has continued during fiscal 2005 for the land based gas turbine market as compared to fiscal 2004. Revenue has increased 63.3% in fiscal 2005 as compared to fiscal 2004, due to a 34.3% increase in the number of pounds shipped and a 21.4% increase in average selling price per pound which reflects generally improved market pricing as a result of higher raw material costs, market demand, and increasing levels of maintenance business.
Other Markets. In addition to the industries described above, the Company also targets a variety of other markets. Representative industries served in fiscal 2005 include flue gas desulfurization, or FGD, oil and gas, waste incineration, industrial heat-treating, automotive, and medical and instrumentation. The Clean Air Act and comparable legislation in Europe and Asia, which create regulatory imperatives requiring the reduction of sulfur emissions, are the primary factor in determining the demand for high-performance alloys in the FGD industry. The Companys participation in the oil and gas industry consists primarily of providing tubular goods for sour gas production. The automotive and industrial heat-treating markets are highly cyclical and very competitive. Opportunities continue to exist, however, in the automotive market due to new safety-related technology, higher operating temperatures, engine control systems, and emission control systems. Also, increasing requirements for improved materials performance in industrial heating are expected to increase demand for the Companys products.
Waste incineration presents opportunities for the use of the Companys alloys to reduce the use of landfill space and to respond to government concerns over land disposal of waste, pollution, chemical weapon stockpiles, and chemical and nuclear waste handling. Markets capable of providing growth are being driven by increasing performance, reliability and service life requirements for products used in these markets, which could provide further applications of the Companys products.
In connection with the Branford Acquisition in the first quarter of fiscal 2005, Haynes acquired a facility that manufactures both stainless wire and high performance wire. The Company will continue to produce stainless wire at the Branford facility. The high performance alloy wire produced is reflected within the appropriate category where such wire is sold; for example, high performance alloy wire produced for use in the chemical processing market is reflected in that category. The stainless wire is reflected in the Other Markets category and increased revenue within that category while reducing the average selling price per pound on a comparative basis.
In fiscal 2005, net revenues from the Companys products in the Other Markets category increased by 71.1% when compared to those in fiscal 2004. During fiscal 2005, this category included $15.8 million of net revenues, which included 4.7 million pounds of stainless wire product, as a result of the Branford acquisition.
Upon implementation of the plan of reorganization, fresh start reporting was adopted by the Company in accordance with SOP-90-7. Under fresh start reporting, the reorganization value is allocated to the Companys net assets based on their relative fair values in a manner similar to the accounting provisions applied to business combinations under Statement of Financial Standards No. 141, Business Combinations (SFAS No. 141).
The Companys operating income was reduced by the recognition of the fair market value adjustments to the Companys assets required by the adoption of fresh start reporting. Cost of sales included $5.5 million and $30.2 million of these costs in the one month period ended September 30, 2004 and year ended September 30, 2005, respectively. In addition, selling, general and administrative expense included $123,000 and $1,302,000 of stock compensation expense for the one month period ended September 30, 2004 and the year ended September 30, 2005, respectively, related to stock options granted by the Company upon emergence from bankruptcy. See Notes 1 and 2 to the consolidated financial statements included in Item 8 in this Form 10-K for more information.
The fair market value adjustments to the historical basis of assets are being recognized as follows (dollars in thousands):
(1) Under applicable accounting rules, goodwill and trademarks are not amortized but are assessed to determine impairment at least annually.
(2) Estimated length of time for one complete inventory turn.
(3) Non-cash expenses for inventory, machinery and equipment, buildings and patents are reflected in cost of goods sold.
The following table is presented for comparative purposes. Amounts are in thousands, except share and per share information.
The following table sets forth, for the periods indicated, consolidated statements of operations data as a percentage of net revenues: