Titanium Metals 10-K 2008
Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2007
Commission file number 1-14368
5430 LBJ Freeway, Suite 1700, Dallas, Texas 75240>
(Address of principal executive offices, including zip code)
Registrant’s telephone number, including area code: (972) 233-1700
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
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 and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s 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 o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined in Rule 12b-2 of the Act).
Large accelerated filer þ Accelerated filer o Non-accelerated filer o Smaller reporting company o
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes o No þ
The aggregate market value of the 87.8 million shares of voting stock held by nonaffiliates of Titanium Metals Corporation as of June 30, 2007 approximated $2.8 billion. There are no shares of non-voting stock outstanding. As of February 21, 2008, 183,077,755 shares of common stock were outstanding.
Documents incorporated by reference:
The information required by Part III is incorporated by reference from the Registrant’s definitive proxy statement to be filed with the Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.
The statements contained in this Annual Report on Form 10-K (“Annual Report”) that are not historical facts, including, but not limited to, statements found in the Notes to Consolidated Financial Statements and in Item 1 - Business, Item 1A – Risk Factors, Item 2 – Properties, Item 3 - Legal Proceedings and Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), are forward-looking statements that represent our beliefs and assumptions based on currently available information. Forward-looking statements can generally be identified by the use of words such as “believes,” “intends,” “may,” “will,” “looks,” “should,” “could,” “anticipates,” “expects” or comparable terminology or by discussions of strategies or trends. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we do not know if these expectations will prove to be correct. Such statements by their nature involve substantial risks and uncertainties that could significantly affect expected results. Actual future results could differ materially from those described in such forward-looking statements, and we disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Among the factors that could cause actual results to differ materially are the risks and uncertainties discussed in this Annual Report, including risks and uncertainties in those portions referenced above and those described from time to time in our other filings with the Securities and Exchange Commission (“SEC”) which include, but are not limited to:
Should one or more of these risks materialize (or the consequences of such a development worsen), or should the underlying assumptions prove incorrect, actual results could differ materially from those forecasted or expected.
ITEM 1: BUSINESS
General>. Titanium Metals Corporation was formed in 1950 and was incorporated in Delaware in 1955. Unless otherwise indicated, references in this report to “we”, “us” or “our” refer to TIMET and its subsidiaries, taken as a whole. We are one of the world’s leading producers of titanium melted and mill products. We are the only producer with major titanium production facilities in both the United States and Europe, the world’s principal markets for titanium consumption. We are currently the largest U.S. producer of titanium sponge, a key raw material, and a major recycler of titanium scrap.
Titanium was first manufactured for commercial use in the 1950s. Titanium’s unique combination of corrosion resistance, elevated-temperature performance and high strength-to-weight ratio makes it particularly desirable for use in commercial and military aerospace applications where these qualities satisfy essential design requirements for certain critical parts such as wing supports and jet engine components. While aerospace applications have historically accounted for a substantial portion of the worldwide demand for titanium, other end-use applications for titanium in military and industrial markets have continued to develop, including the use of titanium-based alloys in armor plating, structural components, chemical plants, power plants, desalination plants and pollution control equipment. Demand for titanium is also increasing in emerging markets with diverse uses including oil and gas production installations, automotive, geothermal facilities and architectural applications.
Our products include titanium sponge, melted products, mill products and industrial fabrications. The titanium industry is comprised of several manufacturers that, like us, produce a relatively complete range of titanium products and a significant number of producers worldwide that manufacture a limited range of titanium mill products.
Our long-term strategy is to maximize the value of our core aerospace business while expanding our presence in non-aerospace markets and developing new applications and products. In the near-term, we intend to continue to utilize our operating cash flow and capital resources to support increased levels of investment in the expansion of our productive capacity and the expansion of our secure third-party conversion capabilities in response to the industry’s long-term favorable demand trend. Opportunities to expand our existing production and conversion capacities will continue to be accomplished through internal expansion and long-term third-party arrangements, as well as potential joint ventures and acquisitions.
Titanium industry.> We develop certain industry estimates based on our extensive experience within the titanium industry as well as information obtained from publicly available external resources (e.g., United States Geological Survey, International Titanium Association and Japan Titanium Society). We estimate that we accounted for approximately 20% of 2006 and 16% of 2007 worldwide industry shipments of titanium mill products and approximately 7% of 2006 and 6% of 2007 worldwide titanium sponge production. The following chart illustrates our estimates of aggregate industry mill product shipments over the past ten years:
Mill Product Shipments by Industry Sector
(Volumes Exclude Shipments within China and Russia)
The cyclical nature of the commercial aerospace sector has been the principal driver of the historical fluctuations in the performance of most titanium product producers. Over the past 30 years, the titanium industry has had various cyclical peaks and troughs in mill product shipments. Since 1998, titanium mill product demand in the military, industrial and emerging market sectors has increased, primarily due to the continued development of innovative uses for titanium products in these other industries. Over the last several years we, and the industry as a whole, have experienced significantly increased demand. We estimate that industry shipments approximated 79,000 metric tons in 2006 and 89,000 metric tons in 2007, with each year setting a new industry shipment record, and we currently expect 2008 total industry mill product shipments to increase by approximately 4% to 12% as compared to the estimated 12% growth in 2007.
Demand for titanium products within the commercial aerospace sector is derived from both jet engine components (e.g., blades, discs, rings and engine cases) and airframe components (e.g., bulkheads, tail sections, landing gear, wing supports and fasteners). The commercial aerospace sector has a significant influence on titanium companies, particularly mill product producers. Deliveries of titanium generally precede aircraft deliveries by about one year, and our business cycle generally correlates to this timeline, although the actual timeline can vary considerably depending on the titanium product. We estimate that 2008 industry mill product shipments into the commercial aerospace sector will increase 6% to 12% from 2007.
Our business is more dependent on commercial aerospace demand than is the overall titanium industry. We shipped approximately 60% of our mill products to the commercial aerospace sector in 2007, whereas we estimate approximately 44% of the overall titanium industry’s mill products were shipped to the commercial aerospace sector in 2007 levels.
The Airline Monitor, a leading aerospace publication, traditionally issues worldwide forecasts for commercial aircraft deliveries each January and July, approximately one-third of which is expected to be required by the U.S. over the next 20 years. The Airline Monitor’s most recently issued forecast (January 2008) estimates deliveries of large commercial aircraft (aircraft with over 100 seats) totaled 888 (including 191 twin aisle aircraft) in 2007, and the following table summarizes the forecasted deliveries of large commercial aircraft over the next five years:
The latest forecast from The Airline Monitor reflects a 6% increase in forecasted deliveries over the next five years compared to the July 2007 forecast over the next five years, in large part due to the record level of new orders placed for Boeing and Airbus models over the past three years. Total order bookings for Boeing and Airbus in 2007 were 2,863 planes, a significant increase over the record bookings in 2005 and 55% higher than the bookings in 2006. The Airline Monitor forecasts aggregate new orders in 2008 will be lower than 2007, but the strong bookings in 2005 through 2007 have increased the order backlog for both Boeing and Airbus, which will be delivered over the next several years.
Changes in the economic environment and the financial condition of airlines can result in rescheduling or cancellation of orders. Accordingly, aircraft manufacturer backlogs are not necessarily a reliable indicator of near-term business activity, but may be indicative of potential business levels over a longer-term horizon. The latest forecast from The Airline Monitor estimates Airbus’ firm order backlog at 904 twin aisle planes and 2,517 single aisle planes and Boeing’s firm order backlog at 1,351 twin aisle planes and 2,045 single aisle planes. Although The Airline Monitor’s latest forecast reflects a reduced near-term delivery forecast for the Boeing 787 commercial aircraft, Boeing has not yet quantified the overall impact of their recently announced delay.
Twin aisle planes (e.g., Boeing 747, 767, 777 and 787 and Airbus A330, A340, A350 and A380) tend to use a higher percentage of titanium in their airframes, engines and parts than single aisle planes (e.g., Boeing 737 and 757 and Airbus A318, A319 and A320), and newer models tend to use a higher percentage of titanium than older models. Additionally, Boeing generally uses a higher percentage of titanium in its airframes than Airbus. For example, based on information we receive from airframe and engine manufacturers and other industry sources, we estimate that approximately 59 metric tons, 45 metric tons and 18 metric tons of titanium are purchased for the manufacture of each Boeing 777, 747 and 737, respectively, including both the airframes and engines. Based on these sources, we estimate that approximately 32 metric tons, 18 metric tons and 12 metric tons of titanium are purchased for the manufacture of each Airbus A340, A330 and A320, respectively, including both the airframes and engines.
At year-end 2007, a total of 189 firm orders had been placed for the Airbus A380, a program officially launched in 2000 with its first delivery in late-2007. Based on information we receive from airframe and engine manufacturers and other industry sources, we estimate that approximately 146 metric tons of titanium (120 metric tons for the airframe and 26 metric tons for the engines) will be purchased for each A380 manufactured. Additionally, at year-end 2007, a total of 817 firm orders have been placed for the Boeing 787, a program officially launched in April 2004 with anticipated first deliveries in 2009. Although the 787 will contain more composite materials than a typical Boeing aircraft, based on these sources, we estimate that approximately 134 metric tons of titanium (125 metric tons for the airframe and 9 metric tons for the engines) will be purchased for each 787 manufactured. We believe significant additional titanium will be required in the early years of 787 manufacturing until the program reaches maturity. Additionally, during 2006, Airbus officially launched the A350 XWB program, which is a major derivative of the Airbus A330, with first deliveries scheduled for 2012/2013. As of December 31, 2007, a total of 320 firm orders had been placed for the A350 XWB. These A350 XWBs will use composite materials and new engines similar to those used on the Boeing 787 and are expected to require significantly more titanium as compared with earlier Airbus models. Based on these sources, our preliminary estimates are that at least 74 metric tons (65 metric tons for the airframe and 9 metric tons for the engines) will be purchased for each A350 XWB manufactured. However, the final titanium buy weight may change as the A350 XWB is still in the design phase.
Titanium shipments into the military sector are largely driven by government defense spending in North America and Europe. Military aerospace programs were the first to utilize titanium’s unique properties on a large scale, beginning in the 1950s. Titanium shipments to military aerospace markets reached a peak in the 1980s before falling to historical lows in the early 1990s after the end of the Cold War. In recent years, titanium has become an accepted use in ground combat vehicles as well as in naval vessels. The importance of military markets to the titanium industry is expected to continue to rise in coming years as defense spending budgets increase in reaction to terrorist activities and global conflicts and to replace aging conventional armaments. Defense spending for most systems is expected to remain strong until at least 2010. Current and anticipated future military strategy leading to light armament and mobility favor the use of titanium due to light weight and improved ballistic performance.
As the strategic environment demands a greater need for global lift and mobility, the U.S. military needs more airlift capacity and capability. Airframe programs are expected to drive the military market demand for titanium through 2015. Several of today’s active U.S. military programs, including the C-17 and F-15, are currently expected to continue in production through the end of the current decade, while other programs, such as the F/A 18 and F-16, are expected to continue into the middle of the next decade. European military programs also have active aerospace programs offering the possibility for increased titanium consumption. Production levels for the Saab Gripen, Eurofighter Typhoon, Dassault Rafale and Dassault Mirage 2000 are all forecasted to remain steady through the end of the decade.
In addition to the established programs, newer U.S. programs offer growth opportunities for increased titanium consumption. The F/A-22 Raptor was given full-rate production approval in April 2005. Additionally, the F-35 Joint Strike Fighter, now known as the Lightning II, is expected to enter low-rate initial production in late 2008, with delivery of the first production aircraft in 2010. Although no specific delivery patterns have been established, according to The Teal Group, a leading aerospace publication, procurement is expected to extend over the next 30 to 40 years and may include as many as approximately 3,500 planes, including sales to foreign nations.
Utilization of titanium on military ground combat vehicles for armor appliqué and integrated armor or structural components continues to gain acceptance within the military market segment. Titanium armor components provide the necessary ballistic performance while achieving a mission critical vehicle performance objective of reduced weight in new generation vehicles. In order to counteract increased threat levels globally, titanium is being utilized on vehicle upgrade programs in addition to new builds. Based on active programs, as well as programs currently under evaluation, we believe there will be additional usage of titanium on ground combat vehicles that will provide continued growth in the military market sector. In armor and armament, we sell plate and sheet products for fabrication into appliqué plate and reactive armor for protection of the entire ground combat vehicle as well as the vehicle’s primary structure.
The number of end-use markets for titanium has continued to expand significantly. Established industrial uses for titanium include chemical plants, power plants, desalination plants and pollution control equipment. Rapid growth of the Chinese and other Southeast Asian economies has brought unprecedented demand for titanium-intensive industrial equipment. In November 2005, we entered into a joint venture with XI'AN BAOTIMET VALINOX TUBES CO. LTD. (“BAOTIMET”) to produce welded titanium tubing in the Peoples Republic of China. BAOTIMET's production facilities are located in Xi'an, China, and production began in January 2007.
Titanium continues to gain acceptance in many emerging market applications, including transportation, energy (including oil and gas) and architecture. Although titanium is often more expensive than other competing metals, over the entire life cycle of the application, we believe that titanium is a less expensive alternative due to its durability, longevity and overall environmental impact. In many cases customers also find the physical properties of titanium to be attractive from the standpoint of weight, performance, design alternatives and other factors. The oil and gas market, a relatively new and potentially large growth area, utilizes titanium for down-hole casing, critical riser components, tapered stress joints, fire water systems and saltwater-cooling systems. Additionally, as offshore development of new oil and gas fields moves into the ultra deep-water depths and as geothermal energy production expands, market demand for titanium’s light-weight, high-strength and corrosion-resistance properties is creating new opportunities for the material. We have focused additional resources on development of alloys and production processes to promote the expansion of titanium use in this market and in other non-aerospace applications.
Although we estimate that emerging market demand presently represents only about 6% of the 2007 total industry demand for titanium mill products, we believe emerging market demand, in the aggregate, could grow at double-digit rates over the next several years. We have ongoing initiatives to actively pursue and expand our presence in these markets.
Products and operations>. We are a vertically integrated titanium manufacturer whose products include:
During the past three years, all of our net sales were generated by our integrated titanium operations (our “Titanium melted and mill products” segment), which is our only business segment. Business and geographic financial information is included in Note 17 to the Consolidated Financial Statements.
Titanium sponge is the commercially pure, elemental form of titanium metal with a porous and sponge-like appearance. The first step in our sponge production involves the combination of titanium-containing rutile ores (derived from beach sand) with chlorine and petroleum coke to produce titanium tetrachloride. Titanium tetrachloride is purified and then reacted with magnesium in a closed system, producing titanium sponge and magnesium chloride as co-products. Our titanium sponge production facility in Henderson, Nevada uses vacuum distillation process (“VDP”) technology, which removes the magnesium and magnesium chloride residues by applying heat to the sponge mass while maintaining a vacuum in a chamber. The combination of heat and vacuum boils the residues from the sponge mass, and then the sponge mass is mechanically pushed out of the distillation vessel, sheared and crushed. The residual magnesium chloride, a by-product of the VDP process, is electrolytically separated and recycled.
Melted products (ingot, electrodes and slab) are produced by melting sponge and titanium scrap, either alone or with alloys, to produce various grades of titanium products suited for the ultimate application of the product. By introducing other alloys such as vanadium, aluminum, molybdenum, tin and zirconium, the melted titanium product is engineered to produce quality grades with varying combinations of certain physical attributes such as strength-to-weight ratio, corrosion-resistance and milling compatibility. Titanium ingot is a cylindrical solid shape that, in our case, weighs up to 8 metric tons. Titanium slab is a rectangular solid shape that, in our case, weighs up to 16 metric tons. The melting process for ingot and slab is closely controlled and monitored utilizing computer control systems to maintain product quality and consistency and to meet customer specifications. In most cases, we use our ingot and slab as the intermediate material for further processing into mill products. However, we also sell ingot, electrodes and slab to third parties.
Mill products are forged or rolled from our melted products (ingot or slab). Mill products include long products (billet and bar), flat products (plate, sheet and strip) and pipe. Our mill products can be further machined to meet customer specifications with respect to size and finish using specified grades of material.
We send certain products to outside vendors for further processing (e.g., certain rolling, forging, finishing and other processing steps in the U.S., and certain melting and forging steps in France) before being shipped to customers. In France, our primary processor is also a partner in our 70%-owned subsidiary, TIMET Savoie, S.A. During 2006, we entered into a 20-year conversion services agreement with Haynes International, Inc., whereby Haynes will provide an annual output capacity of 4,500 metric tons of titanium mill rolling services at their facility in Kokomo, Indiana until 2026, with our option to increase the output capacity to 9,000 metric tons. Additionally, during 2007, we entered into a long-term agreement with Carpenter Technologies, Inc., whereby Carpenter is providing us dedicated annual forging capacity of 3,000 metric tons beginning in 2008 and increasing to 8,900 metric tons for 2011 through at least 2019. These agreements provide us with long-term secure sources for processing round and flat products, resulting in a significant increase in our existing mill product conversion capabilities, which allows us to assure our customers of our long-term ability to meet their needs.
During the production process and following the completion of manufacturing, we perform extensive testing on our products. Sonic inspection as well as chemical and mechanical testing procedures are critical to ensuring that our products meet our customers’ high quality requirements, particularly in aerospace component production. We certify that our products meet customer specification at the time of shipment for substantially all customer orders.
Titanium scrap is a by-product of the forging, rolling and machining operations, and significant quantities of scrap are generated in the production process for finished titanium products and components. Scrap by-product from our mill production processes is typically recycled and introduced into the melting process once the scrap is sorted and cleaned.
Distribution.> We sell our products through our own sales force based in the U.S. and Europe and through independent agents and distributors worldwide. We also own eight service centers (five in the U.S. and three in Europe), which we use to sell our products on a just-in-time basis. The service centers primarily sell value-added and customized mill products, including bar, sheet, plate, tubing and strip. We believe our service centers provide a competitive advantage because of our ability to foster customer relationships, customize products to suit specific customer requirements and respond quickly to customer needs.
Raw materials.> The principal raw materials used in the production of titanium ingot, slab and mill products are titanium sponge, titanium scrap and alloys. The following table summarizes our 2007 raw material usage requirements in the production of our melted and mill products:
The primary raw materials used in the production of titanium sponge are titanium-containing rutile ore, chlorine, magnesium and petroleum coke. Rutile ore is currently available from a limited number of suppliers around the world, principally located in Australia, South Africa and Sri Lanka. We purchase the majority of our supply of rutile ore from Australia. We believe the availability of rutile ore will be adequate for the foreseeable future and do not anticipate any interruptions of our rutile supplies.
We currently obtain chlorine from a single supplier near our sponge plant in Henderson. While we do not anticipate any chlorine supply problems, we have taken steps to mitigate this risk in the event of supply disruption, including establishing the feasibility of certain equipment modifications to enable us to utilize material from alternative chlorine suppliers or to purchase and utilize an intermediate product which will allow us to eliminate the purchase of chlorine if needed. Magnesium and petroleum coke are generally available from a number of suppliers.
We are currently the largest U.S. producer of titanium sponge. In 2007, we completed an expansion of our existing premium-grade titanium sponge facility at our Henderson plant. This expansion increased our annual productive sponge capacity to approximately 12,600 metric tons, an increase of approximately 47% over the previous productive sponge capacity levels. During 2006 and 2007, other sponge producers also increased capacity and began construction on additional capacity expansion projects. However, we do not know the degree to which quality and cost of the sponge produced by our competitors will be comparable to the premium-grade sponge we produce in our Henderson facility. Because we cannot supply all of our needs for all grades of titanium sponge internally, we continue to purchase a portion of our raw material requirements from third parties. During 2007, we entered into new long-term sponge supply agreements that require us to make minimum annual purchases, including agreements with Toho Titanium Co., Ltd. and Ardor (UK) Ltd. (together with its Ust-Kamenogorsk titanium plant in Kazakhstan, collectively referred to as "UST"). In connection with our titanium sponge supply agreement with UST, we are also providing toll melting conversion services to UST. These long-term supply agreements, together with our current sponge production capacity in Henderson, provide us with a total annual available sponge supply at levels ranging from 18,000 metric tons up to 28,000 metric tons through 2024. These third-party agreements, in part, allowed us to indefinitely delay construction of an additional premium-grade titanium sponge facility. Titanium melted and mill products require varying grades of sponge and/or scrap depending on the customers’ specifications and expected end use. We will continue to purchase sponge from a variety of sources in 2008, including those sources under existing supply agreements, and we will continue to evaluate sources of sponge supply.
The titanium scrap we utilize for melted products is internally generated from our melted and mill product production processes, purchased from certain of our customers under contractual agreements or acquired in the open metals market. Such scrap consists of alloyed and commercially pure solids and turnings. Scrap obtained through customer arrangements provides a “closed-loop” arrangement resulting in certainty of supply and cost stability. Externally purchased scrap comes from a wide range of sources, including customers, collectors, processors and brokers. Due to our successful efforts to increase the volume of scrap obtained through “closed-loop” arrangements, we only purchased 20% to 30% of our scrap requirement from external suppliers in 2007. We expect our scrap purchases to remain at the same rate during 2008, despite the large increase in our scrap consumption during 2007 as our electron beam cold hearth (“EB”) melting activity increased. We also occasionally sell scrap, usually in a form or grade we cannot economically use in our production operations.
Overall market forces can significantly impact the supply or cost of externally produced scrap, as the amount of scrap generated in the supply chain varies during the titanium business cycles. Early in the titanium cycle, the demand for titanium melted and mill products begins to increase the scrap requirements for titanium manufacturers which precedes the increase in scrap generation by downstream customers and the supply chain. The pressure on scrap generation and the supply chain places upward pressure on the market price of scrap. The opposite situation occurs when demand for titanium melted and mill products begins to decline, resulting in greater availability of supply and downward pressure on the market price of scrap. During the middle of the cycle, scrap generation and consumption are in relative equilibrium, minimizing disruptions in supply or significant changes in the available supply and market prices for scrap. Increasing or decreasing cycles tend to cause significant changes in both the supply and market price of scrap. These supply chain dynamics result in selling prices for melted and mill products which tend to correspond with the changes in raw material costs.
All of our major competitors also utilize scrap as a raw material in their melt operations. In addition to use by titanium manufacturers, titanium scrap is used in steel-making operations during production of interstitial-free steels, stainless steels and high-strength-low-alloy steels. Prices for all forms and grades of titanium scrap declined steadily during 2007, both for scrap used by titanium manufacturers and steel makers. Although demand from both sectors was strong during 2007, a combination of increased scrap generation by the titanium supply chain and increased sponge supply helped reduce scrap prices to levels experienced prior to 2005.
Various alloys used in the production of titanium products are also available from a number of suppliers. The recent high level of global demand for steel products has also resulted in a significant increase in the costs for several alloys, such as vanadium and molybdenum. In 2007, the costs of these alloys remained above historical levels of the past 10 years but were below the cost peaks we experienced in the spring of 2005. Although availability is not expected to be a concern and we have negotiated certain price and cost protection with suppliers and customers, alloy costs may continue to fluctuate in the future.
Customer agreements.> We have long-term agreements (“LTAs”) with certain major customers, including, among others, The Boeing Company (“Boeing”), Rolls-Royce plc and its German and U.S. affiliates (“Rolls-Royce”), United Technologies Corporation (“UTC,” Pratt & Whitney and related companies), Société Nationale d΄Etude et de Construction de Moteurs d΄Aviation (“Snecma”), Wyman-Gordon Company (“Wyman-Gordon,” a unit of Precision Castparts Corporation (“PCC”)) and VALTIMET SAS. These agreements expire at various times through 2017, are subject to certain conditions and generally provide for (i) minimum market shares of the customers’ titanium requirements or firm annual volume commitments, (ii) formula-determined prices (including some elements based on market pricing) and (iii) price adjustments for certain raw material, labor and energy cost fluctuations. Generally, the LTAs require our service and product performance to meet specified criteria and contain a number of other terms and conditions customary in transactions of these types. Certain provisions of these LTAs have been amended in the past and may be amended in the future to meet changing business conditions. Our 2007 sales revenues to customers under LTAs were 47% of our total sales revenues.
In certain events of nonperformance by us or the customer, the LTAs may be terminated early. Although it is possible that some portion of the business would continue on a non-LTA basis, the termination of one or more of the LTAs could result in a material effect on our business, results of operations, financial position or liquidity. The LTAs were designed to limit selling price volatility to the customer, while providing us with a committed volume base throughout the titanium industry business cycles and certain mechanisms to adjust pricing for changes in certain cost elements.
Markets and customer base.> The following table summarizes our sales revenue by geographical location:
Further information regarding our external sales, net income, long-lived assets and total assets can be found in our Consolidated Balance Sheets, Consolidated Statements of Income and Notes 5 and 17 to the Consolidated Financial Statements.
Substantially all of our sales and operating income are derived from operations based in the U.S., the U.K., France and Italy. More than half of our sales revenue is from sales to the commercial aerospace sector. We have LTAs with several major aerospace customers, including Boeing, Rolls-Royce, UTC, Snecma and Wyman-Gordon. This concentration of customers may impact our overall exposure to credit and other risks, either positively or negatively, in that all of these customers may be similarly affected by the same economic or other conditions. The following table provides supplemental sales revenue information:
The primary market for titanium products in the commercial aerospace sector consists of two major manufacturers of large commercial airframes, Boeing Commercial Airplanes Group (a unit of Boeing) and Airbus, as well as manufacturers of large civil aircraft engines including Rolls-Royce, General Electric Aircraft Engines, Pratt & Whitney and Snecma. We sell directly to these major manufacturers, as well as to companies (including forgers such as Wyman-Gordon) that use our titanium to produce parts and other materials for such manufacturers. Approximately 57% of our sales revenue in both 2005 and 2006 and 55% of sales revenue in 2007 was generated by sales into the commercial aerospace sector. If any of the major aerospace manufacturers were to significantly reduce aircraft and/or jet engine build rates from those currently expected, there could be a material adverse effect, both directly and indirectly, on our business, results of operations, financial position and liquidity.
The market for titanium in the military sector includes sales of melted and mill titanium products engineered for applications for military aircraft (both engines and airframes), armor and component parts, armor appliqué on ground combat vehicles and other integrated armor or structural components. We sell directly to many of the major manufacturers associated with military programs on a global basis. Approximately 12% in 2005, 15% in 2006 and 19% in 2007 of our sales revenue was generated by sales into the military sector.
Outside of commercial aerospace and military sectors, we manufacture a wide range of products for customers in the chemical process, oil and gas, consumer, sporting goods, automotive and power generation sectors. Approximately 16% in 2005, 17% in 2006 and 16% in 2007 of our sales revenue was generated by sales into industrial and emerging market sectors.
In addition to melted and mill products, which are sold into all market sectors, we sell certain other products such as titanium fabrications, titanium scrap and titanium tetrachloride. Sales of these other products represented 15% of our sales revenue in 2005, 11% in 2006 and 10% in 2007.
Our backlog has grown significantly from approximately $0.9 billion at December 31, 2005, to $1.1 billion at December 31, 2006 and to $1.0 billion at December 31, 2007. Over 87% of the 2007 year-end backlog is scheduled for shipment during 2008. Our order backlog may not be a reliable indicator of future business activity.
We have explored and will continue to explore strategic arrangements in the areas of product development, production and distribution. We will also continue to work with existing and potential customers to identify and develop new or improved applications for titanium that take advantage of its unique qualities.
Competition.> The titanium metals industry is highly competitive on a worldwide basis. Producers of melted and mill products are located primarily in the United States, Japan, France, Germany, Italy, Russia, China and the United Kingdom. Additionally, producers of other metal products, such as steel and aluminum, maintain forging, rolling and finishing facilities that could be used or modified to process titanium products. There are also several producers of titanium sponge in the world, at least four of which are currently in some stage of increasing sponge production capacity. We believe entry as a new producer of titanium sponge would require a significant capital investment, substantial technical expertise and significant lead time.
Our principal competitors in the aerospace titanium market are Allegheny Technologies Incorporated (“ATI”) and RTI International Metals, Inc. (“RTI”), both based in the United States, and Verkhnaya Salda Metallurgical Production Organization (“VSMPO”), based in Russia. UNITI (a joint venture between ATI and VSMPO), RTI and certain Japanese producers are our principal competitors in the industrial and emerging markets. We compete primarily on the basis of price, quality of products, technical support and the availability of products to meet customers’ delivery schedules.
In the U.S. market, the increasing presence of foreign participants has become a significant competitive factor. Prior to 1993, imports of foreign titanium products into the U.S. were not significant, primarily attributable to relative currency exchange rates and, with respect to Japan, Russia, Kazakhstan and Ukraine, import duties (including antidumping duties). However, since 1993, imports of titanium sponge, ingot and mill products, principally from Russia and Kazakhstan, have increased and have had a significant competitive impact on the U.S. titanium industry. To the extent we are able to take advantage of this situation by purchasing sponge from such countries for use in our own operations, the negative effect of these imports on us can be somewhat mitigated.
Generally, imports of titanium products into the U.S. are subject to a 15% “normal trade relations” tariff. For tariff purposes, titanium products are broadly classified as either wrought (billet, bar, sheet, strip, plate and tubing) or unwrought (sponge, ingot and slab). Because a significant portion of end-use products made from titanium products are ultimately exported, we, along with our principal competitors and many customers, actively utilize the duty-drawback mechanism to recover most of the tariff paid on imports.
From time-to-time, the U.S. government has granted preferential trade status to certain titanium products imported from particular countries (notably wrought titanium products from Russia, which carried no U.S. import duties from approximately 1993 until 2004). It is possible that such preferential status could be granted again in the future.
The Japanese government has raised the elimination or harmonization of tariffs on titanium products, including titanium sponge, for consideration in multi-lateral trade negotiations through the World Trade Organization (the so-called “Doha Round”). As part of the Doha Round, the United States has proposed the staged elimination of all industrial tariffs, including those on titanium. The Japanese government has specifically asked that titanium in all its forms be included in the tariff elimination program. We have urged that no change be made to these tariffs, either on wrought or unwrought products. The negotiations are ongoing and are expected to continue during 2008.
We will continue to resist efforts to eliminate duties on titanium products, although we may not be successful in these activities. Further reductions in, or the complete elimination of, any or all of these tariffs could lead to increased imports of foreign sponge, ingot and mill products into the U.S. and an increase in the amount of such products on the market generally, which could adversely affect pricing for titanium sponge, ingot and mill products and thus our results of operations, financial position or liquidity.
In 2006, legislation formerly known as the “Berry Amendment,” was re-enacted by Congress with minor changes. In general, the Berry Amendment requires that the United States Department of Defense (“DoD”) expend funds for products containing specialty metals, including titanium, that have been melted only in the United States. In 2007, the DoD adopted regulations implementing the revised law which reduced the effectiveness of the law. During 2007, progress was achieved to move toward a successful implementation of the revised specialty metals provision and legislation was enacted into law in early 2008 which is expected to solidify the effectiveness of the law. A weakening in the enforcement of the specialty metals clause could increase foreign competition for sales of titanium for defense products, adversely affecting our business, results of operations, financial position or liquidity.
Research and development.> Our research and development activities are directed toward expanding the use of titanium and titanium alloys in all market sectors. Key research activities include the development of new alloys, development of technology required to enhance the performance of our products in the traditional industrial and aerospace markets and applications development for emerging markets. In addition, we continue to work in partnership with the United States Defense Advanced Research Projects Agency ("DARPA") and others to explore means to reduce the cost of titanium production. The work with DARPA complements our research, development and exploration of innovative technologies and improvements to the existing processes such as Vacuum Distillation of sponge and Vacuum Arc Remelting processes. We conduct the majority of our research and development activities at our Henderson Technical Laboratory in Henderson, with additional activities at our Witton, England facility. We incurred research and development costs of $3.2 million in 2005, $4.7 million in 2006 and $4.2 million in 2007.
Patents and trademarks.> We hold U.S. and non-U.S. patents applicable to certain of our titanium alloys and manufacturing technology, which expire at various times from 2007 through 2025 and we have certain other patent applications pending. We continually seek patent protection with respect to our technical base and have occasionally entered into cross-licensing arrangements with third parties. We believe the trademarks TIMET® and TIMETAL®, which are protected by registration in the U.S. and other countries, are important to our business. However, the majority of our titanium alloys and manufacturing technologies do not benefit from patent or other intellectual property protection.
Employees.> Our employee headcount varies due to the cyclical nature of the aerospace industry and its impact on our business. Our employee headcount includes both our full and part-time employees. The increases in our headcount during 2006 and 2007 reflect the increase in demand for titanium products during those periods. The following table shows our approximate employee headcount at the end of the past 3 years:
Our production, maintenance, clerical and technical workers in Toronto, Ohio, and our production and maintenance workers in Henderson (approximately half of our total U.S. employees) are represented by the United Steelworkers of America under contracts expiring in July 2008 and January 2011, respectively. Employees at our other U.S. facilities are not covered by collective bargaining agreements. A majority of the salaried and hourly employees at our European facilities are represented by various European labor unions. Our labor agreement with our U.K. production and maintenance employees runs through December 2008, and our labor agreement with our U.K. managerial and professional employees runs through April 2008. Our labor agreements with our French and Italian employees are renewed annually.
We currently consider our employee relations to be good. However, it is possible that there could be future work stoppages or other labor disruptions that could materially and adversely affect our business, results of operations, financial position or liquidity.
Regulatory and environmental matters.> Our operations are governed by various Federal, state, local and foreign environmental and worker safety laws and regulations. In the U.S., such laws include the Occupational, Safety and Health Act, the Clean Air Act, the Clean Water Act and the Resource Conservation and Recovery Act. We use and manufacture substantial quantities of substances that are considered hazardous, extremely hazardous or toxic under environmental and worker safety and health laws and regulations. We have used and manufactured such substances throughout the history of our operations. Although we have substantial controls and procedures designed to reduce continuing risk of environmental, health and safety issues, we could incur substantial cleanup costs, fines and civil or criminal sanctions, third party property damage or personal injury claims as a result of violations or liabilities under these laws or non-compliance with environmental permits required at our facilities. In addition, government environmental requirements or the enforcement thereof may become more stringent in the future. It is possible that some, or all, of these risks could result in liabilities that would be material to our business, results of operations, financial position or liquidity.
We believe our operations are in compliance in all material respects with applicable requirements of environmental and worker health and safety laws. Our policy is to continually strive to improve environmental, health and safety performance. We incurred capital expenditures related to health, safety and environmental compliance and improvement of approximately $25.1 million in 2005 (including $23.4 million related to the construction of a water conservation facility at our Henderson location), $2.0 million in 2006 and $3.0 million in 2007.
From time to time, we may be subject to health, safety or environmental regulatory enforcement under various statutes, resolution of which typically involves the establishment of compliance programs. Occasionally, resolution of these matters may result in the payment of penalties. However, the imposition of more strict standards or requirements under environmental, health or safety laws and regulations could result in expenditures in excess of amounts currently estimated to be required for such matters. See Note 15 to the Consolidated Financial Statements.
Related parties.> At December 31, 2007, Contran Corporation and other entities or persons related to Harold C. Simmons held approximately 51.7% of our outstanding common stock. See Notes 1 and 14 to the Consolidated Financial Statements.
Available information.> We maintain an Internet website at www.timet.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and any amendments thereto, are or will be available free of charge on our website as soon as reasonably practicable after they are filed or furnished, as applicable, with the SEC. Additionally, our (i) Corporate Governance Guidelines, (ii) Code of Business Conduct and Ethics and (iii) Audit Committee, Management Development and Compensation Committee and Nominations Committee charters are also available on our website. Information contained on our website is not part of this Annual Report. We will provide these documents to shareholders upon request. Requests should be directed to the attention of our Investor Relations Department at our corporate offices located at 5430 LBJ Freeway, Suite 1700, Dallas Texas 75240.
The general public may read and copy any materials on file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549 and may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. We are an electronic filer, and the SEC maintains an Internet website at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.
ITEM 1A: RISK FACTORS
Listed below are certain risk factors associated with our business. In addition to the potential effect of these risk factors discussed below, any risk factor that could result in reduced earnings, liquidity or operating losses, could in turn adversely affect our ability to meet our liabilities or adversely affect the quoted market prices for our securities.
The cyclical nature of the commercial aerospace industry, which represents a significant portion of our business, creates uncertainty regarding our future profitability. In addition, adverse changes to, or interruptions in, our relationships with our major commercial aerospace customers could reduce our revenues.> The commercial aerospace sector has a significant influence on titanium companies, particularly mill product producers. Our business is more dependent on commercial aerospace demand than is the overall titanium industry. We shipped approximately 60% of our mill products to commercial aerospace customers in 2007, whereas we estimate approximately 44% of the overall titanium industry’s mill products were shipped to commercial aerospace customers in 2007. The cyclical nature of the commercial aerospace sector has been the principal driver of the historical fluctuations in the performance of most titanium product producers. Our product sales, including melted and mill products, to commercial aerospace customers accounted for 57% of our net sales for each of 2005 and 2006 and for 55% in 2007. Events that could adversely affect the commercial aerospace sector, such as future terrorist attacks, world health crises or unforeseen reductions in orders from commercial airlines, could significantly decrease our results of operations and financial condition.
Sales under LTAs with certain customers in the commercial aerospace sector account for a significant percentage of our annual sales revenue. If we are unable to maintain our relationships with our major commercial aerospace customers, including Boeing, Rolls-Royce, Snecma, UTC and Wyman-Gordon, under the LTAs we have with these customers, our sales could decrease substantially.
The titanium metals industry is highly competitive, and we may not be able to compete successfully.> The global titanium markets in which we operate are highly competitive. Competition is based on a number of factors, such as price, product quality and service. Some of our competitors may be able to drive down prices for our products because their costs are lower than our costs. In addition, some of our competitors' financial, technological and other resources may be greater than our resources, and such competitors may be better able to withstand changes in market conditions. Our competitors may be able to respond more quickly than we can to new or emerging technologies and changes in customer requirements. Further, consolidation of our competitors or customers in any of the industries in which we compete may result in reduced demand for our products. In addition, producers of metal products, such as steel and aluminum, maintain forging, rolling and finishing facilities. Such facilities could be used or modified to process titanium mill products, which could lead to increased competition and decreased pricing for our titanium products. In addition, many factors, including the historical presence of excess capacity in the titanium industry, work to intensify the price competition for available business at low points in the business cycle.
Our dependence upon certain critical raw materials that are subject to price and availability fluctuations could lead to increased costs or delays in the manufacture and sale of our products.> We rely on a limited number of suppliers around the world, and principally on those located in Australia, for our supply of titanium-containing rutile ore, one of the primary raw materials used in the production of titanium sponge. While chlorine, another of the primary raw materials used in the production of titanium sponge, is generally widely available, we currently obtain our chlorine from a single supplier near our sponge plant in Henderson. Also, we cannot supply all our needs for all grades of titanium sponge and scrap internally and are therefore dependent on third parties for a substantial portion of our raw material requirements. All of our major competitors utilize sponge and scrap as raw materials in their melt operations. Titanium scrap is also used in certain steel-making operations, and demand for these steel products, especially from China, has produced a significant increase in demand for titanium scrap. Purchase prices and availability of these critical materials are subject to volatility. At any given time, we may be unable to obtain an adequate supply of these critical materials on a timely basis, on price and other terms acceptable to us, or at all. To help stabilize our supply of titanium sponge, we have entered into LTAs with certain sponge suppliers that contain fixed annual supply obligations. These LTAs also contain minimum annual purchase requirements. See “Business – Products and Operations – Raw materials,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – Contractual commitments” and Note 15 to the Consolidated Financial Statements.
Although inflationary trends in recent years have been moderate, during the same period certain critical raw material costs including titanium sponge and scrap have been volatile. While we are able to mitigate some of the adverse impact of fluctuating raw material costs through LTAs with suppliers and customers, rapid increases in raw material costs may adversely affect our results of operations.
The rapid increase in titanium prices may cause our customers to look for alternatives to titanium in their products.> Our average selling prices for melted and mill titanium have on average increased 50% and 28%, respectively, in each of the last two years as a result of a sharp increase in titanium demand that has exceeded industry expansion. If prices for titanium are sustained at this record level, new markets and application opportunities for titanium may diminish as the use of titanium becomes too costly for many manufacturers. In addition, manufacturers that currently use titanium for their products may look for less expensive alternatives for titanium in existing products and applications. If these events were to occur, our sales and operating results could decrease substantially, resulting in decreased profitability and our continued dependence on the military and commercial aerospace industries.
We change prices on certain of our products from time-to-time. Our ability to implement price increases is dependent on market conditions, economic factors, raw material costs and availability, competitive factors, operating costs and other factors, some of which are beyond our control. The benefits of any price increases may be delayed due to long manufacturing lead times and the terms of existing contracts. These factors have had, and may have, an adverse impact on our revenues, operating results and financial condition.
Our failure to develop new markets would result in our continued dependence on the cyclical commercial aerospace sector, and our operating results would, accordingly, remain cyclical. In an effort to reduce dependence on the commercial aerospace market and to increase participation in other markets, we have devoted certain resources to developing new markets and applications for our products. Developing these emerging market applications involves substantial risk and uncertainties due to the fact that titanium must compete with less expensive alternative materials in these potential markets or applications. We may not be successful in developing new markets or applications for our products, significant time may be required for such development and uncertainty exists as to the extent to which we will face competition in this regard.
Because we are subject to environmental and worker safety laws and regulations, we may be required to remediate the environmental effects of our operations or take steps to modify our operations to comply with these laws and regulations, which could reduce our profitability.> Various Federal, state, local and foreign environmental and worker safety laws and regulations govern our operations. Throughout the history of our operations, we have used and manufactured, and currently use and manufacture, substantial quantities of substances that are considered hazardous, extremely hazardous or toxic under environmental and worker safety and health laws and regulations. Although we have substantial controls and procedures designed to reduce continuing risk of environmental, health and safety issues, we could incur substantial cleanup costs, fines and civil or criminal sanctions, third party property damage or personal injury claims as a result of violations or liabilities under these laws or non-compliance with environmental permits required at our facilities. In addition, government environmental requirements or the enforcement thereof may become more stringent in the future. Some or all of these risks may result in liabilities that could reduce our profitability.
Reductions in, or the complete elimination of, any or all tariffs on imported titanium products into the United States could lead to increased imports of foreign sponge, ingot and mill products into the U.S. and an increase in the amount of such products on the market generally, which could decrease pricing for our products.> In the U.S. titanium market, the increasing presence of foreign participants has become a significant competitive factor. Until 1993, imports of foreign titanium products into the U.S. had not been significant. This was primarily attributable to relative currency exchange rates and, with respect to Japan, Russia, Kazakhstan and Ukraine, import duties (including antidumping duties). However, since 1993, imports of titanium sponge, ingot and mill products, principally from Russia and Kazakhstan, have increased and have had a significant competitive impact on the U.S. titanium industry.
Generally, imports of titanium products into the U.S. are subject to a 15% “normal trade relations” tariff. For tariff purposes, titanium products are broadly classified as either wrought (billet, bar, sheet, strip, plate and tubing) or unwrought (sponge, ingot and slab). From time-to-time, the U.S. government has granted preferential trade status to certain titanium products imported from particular countries (notably wrought titanium products from Russia, which carried no U.S. import duties from approximately 1993 until 2004). It is possible that such preferential status could be granted again in the future, and we may not be successful in resisting efforts to eliminate duties or tariffs on titanium products. See discussion of Doha Round in “Business – Competition.”
We may be unable to reach or maintain satisfactory collective bargaining agreements with unions representing a significant portion of our employees.> Our production, maintenance, clerical and technical workers in Toronto, and our production and maintenance workers in Henderson, are represented by the United Steelworkers of America under contracts expiring in July 2008 and January 2011, for the respective locations. A majority of the salaried and hourly employees at our European facilities are represented by various European labor unions. Each of our labor agreements with our U.K. employees expires in 2008, and the agreements with our French and Italian employees are renewed annually. A labor dispute or work stoppage could materially decrease our operating results. We may not succeed in concluding collective bargaining agreements with the unions to replace expiring agreements or to maintain satisfactory relations under existing collective bargaining agreements. If our employees were to engage in a strike, work stoppage or other slowdown, we could experience a significant disruption of our operations or higher ongoing labor costs.
ITEM 1B: UNRESOLVED STAFF COMMENTS
ITEM 2: PROPERTIES
Set forth below is a listing of our major production facilities. In addition to our U.S. sponge capacity discussed below, our worldwide melting capacity aggregates approximately 44,650 metric tons (estimated 18% of world capacity) as of December 31, 2007, and our mill product capacity aggregates approximately 22,600 metric tons (estimated 20% of world capacity) as of December 31, 2007. Of our worldwide melting capacity, 35% is represented by EB melting furnaces, 63% by vacuum arc remelting (“VAR”) furnaces and 2% by a vacuum induction melting (“VIM”) furnace.
(1) Owned facility.
(2) Leased facility.
(3) Practical capacities are variable based on product mix and are not additive. These capacities are as ofDecember 31, 2007 and do not reflect the increases expected to be realized
during 2008 as a result of capacity expansion projects, several of which are mentioned below.
(4) Practical capacities are based on the approximate maximum equivalent product that CEZUS is contractuallyobligated to provide.
During the past three years, our major production facilities have operated at varying levels of practical capacity. Overall our plants operated at approximately 88% of practical capacity in 2006 and 2007 and 80% in 2005. In 2008, our plants are expected to operate at approximately 93% of practical capacity. However, practical capacity and utilization measures can vary significantly based upon the mix of products produced.
United States production.> In 2007, we completed the expansion of our existing premium-grade titanium sponge facility in Henderson and reached practical capacity for commercial production in early 2008. This expansion increases our annual productive capacity to approximately 12,600 metric tons, an increase of approximately 47% over the previous productive sponge capacity levels.
Our U.S. melting facilities in Henderson, Morgantown and Vallejo produce ingot and slab, which are either used as feedstock for our mill products operations or sold to third parties, and we are in the process of expanding our melt capacity. Our melting facilities are expected to operate at approximately 94% of annual practical capacity in 2008, which is consistent with our capacity utilization in 2007. Melt capacities will increase throughout 2008 as we complete and ramp up certain expansion projects.
In early 2008, we completed an 8,500 metric ton expansion of our EB melt capacity in Morgantown. In addition, we have commenced efforts to add another EB furnace at the same facility, which is currently on schedule to be completed in the last half of 2009. We also commenced an addition to our VAR capacity in Morgantown during 2007, which is expected to be completed by mid-2008. Upon completion, these melt capacity additions will increase our EB melt capacity by approximately 107% and our VAR capacity by approximately 34%. Our raw materials processing facility in Morgantown primarily processes scrap used as melting feedstock, either in combination with sponge or separately.
We produce titanium mill products in the U.S. at our forging and rolling facility in Toronto, which receives ingot or slab principally from our U.S. melting facilities. Our U.S. forging and rolling facility is expected to operate at approximately 92% of annual practical capacity in 2008, up from 83% in 2007. Capacity utilization across our individual mill product lines varies.
Under various conversion services agreements with third-party vendors, we have access to a dedicated annual capacity at certain of our vendors’ facilities. Our access to outside conversion services includes dedicated annual rolling capacity of at least 4,500 metric tons until 2026, with the option to increase the output capacity to 9,000 metric tons. Additionally, we have access to dedicated annual forging capacity of 3,300 metric tons beginning in 2008 and ramping up to 8,900 metric tons for 2011 through at least 2019. These agreements provide us with a long-term secure source for processing round and flat products, resulting in a significant increase in our existing mill product conversion capabilities, which allows us to assure our customers of our long-term ability to meet their needs.
European production.> We conduct our operations in Europe primarily through our wholly owned subsidiaries, TIMET UK, Ltd. and Loterios S.p.A., and our 70% owned subsidiary, TIMET Savoie. TIMET UK’s Witton laboratory and manufacturing facilities are leased pursuant to long-term operating leases expiring in 2014 and 2024, respectively. TIMET UK’s melting facility in Witton produces VAR ingot used primarily as feedstock for our Witton forging operations. TIMET UK forges the ingot into billet products for sale to third parties or into an intermediate product for further processing into bar or plate at our facility in Waunarlwydd (Swansea). TIMET UK’s melting and mill products production in 2008 is expected to operate at approximately 93% and 80%, respectively, of annual practical capacity, compared to 82% and 75%, respectively, in 2007. During 2007 we also commenced construction of a new VAR furnace at our Witton location, which is expected to be completed by mid-2008. Loterios manufactures large industrial use fabrications, generally on a project engineering and design basis, and therefore, measures of annual capacity are not practical or meaningful.
TIMET Savoie has the right to utilize portions of the Ugine plant of Compagnie Européenne du Zirconium-CEZUS, S.A. (“CEZUS”), the 30% minority partner in TIMET Savoie, pursuant to a conversion services agreement which runs through 2015. TIMET Savoie’s capacity is to a certain extent dependent upon the level of activity in CEZUS’ zirconium business, which may from time to time provide TIMET Savoie with capacity in excess of that which CEZUS is contractually required to provide. During 2007, TIMET Savoie utilized 92% of the maximum annual capacity CEZUS was contractually required to provide in 2007, and we expect to utilize approximately 100% of the maximum annual capacity CEZUS is required to provide in 2008. Our agreement with CEZUS provides for the expansion of the maximum annual melt capacity that CEZUS is contractually required to provide to us to 2,900 metric tons. We expect the expansion to be fully operational by mid-2008.
ITEM 3: LEGAL PROCEEDINGS
From time to time, we are involved in litigation relating to our business. See Note 15 to the Consolidated Financial Statements.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our security holders during the quarter ended December 31, 2007.
ITEM 5: MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is traded on the New York Stock Exchange (symbol: TIE). The high and low sales prices for our common stock during 2006, 2007 and the first two months of 2008 are set forth below. All prices (as well as all share numbers referenced herein) have been adjusted to reflect previously affected stock splits.
On February 21, 2008, the closing price of TIMET common stock was $23.83 per share and there were approximately 2,350 stockholders of record of TIMET common stock.
We previously issued $201.3 million of 6.625% mandatorily redeemable convertible preferred securities, beneficial unsecured convertible securities (“BUCS”) which, among other things, were redeemable for a certain number of shares of our common stock. Prior to 2005, we issued 3.9 million shares of our Series A Preferred Stock in exchange for 3.9 million BUCS. During 2005 and 2006, all of the BUCS that were not exchanged for shares of our Series A Preferred Stock were redeemed for approximately 0.6 million shares of our common stock and a nominal amount of cash.
Our Series A Preferred Stock is not mandatorily redeemable but is redeemable at our option at any time after September 1, 2007. Holders of the Series A Preferred Stock are entitled to receive cumulative cash dividends at the rate of 6.75% of the $50 per share liquidation preference per annum per share (equivalent to $3.375 per annum per share), when, as and if declared by our board of directors. Whether or not declared, cumulative dividends on Series A Preferred Stock are deducted from net income to arrive at net income attributable to common stockholders. Our U.S. long-term credit agreement contains certain financial covenants that may restrict our ability to make dividend payments on the Series A Preferred Stock.
During 2005, 2006 and 2007, an aggregate of 0.9 million, 1.3 million and 1.6 million shares of our Series A Preferred Stock were converted into 12.4 million, 17.2 million and 21.3 million shares of our common stock, respectively. As a result of these conversions, approximately 0.1 million shares of Series A Preferred Stock remain outstanding as of December 31, 2007.
We paid a regular quarterly dividend on our common stock of $13.7 million, or $0.075 per common share, on December 21, 2007. However, declaration and payment of future dividends on our common stock, and the amount thereof, is discretionary and is dependent upon our results of operations, financial condition, cash requirements for our business, contractual requirements and restrictions and other factors deemed relevant by our Board of Directors. The amount and timing of past dividends is not necessarily indicative of the amount and timing of future dividends which we might pay. In this regard, our U.S. long-term credit agreement contains certain financial covenants that may restrict our ability to make dividend payments on our common stock. Subsequent to December 31, 2007, our board of directors declared a dividend of $0.075 per share, payable on March 25, 2008 to holders of record of our common stock as of the close of trading on March 11, 2008.
On November 12, 2007 our board of directors authorized the repurchase of up to $100 million of our common stock in open market transactions or in privately negotiated transactions, and any repurchased shares will be retired and cancelled. We did not purchase any shares under this repurchase program as of December 31, 2007, but from January 1, 2008 through February 21, 2008, we purchased 0.1 million shares of our common stock in an open market transaction for an aggregate purchase price of $1.9 million or $18.72 per share.
Performance graph. >Set forth below is a line graph comparing, for the period December 31, 2002 through December 31, 2007, the cumulative total stockholder return on our common stock against the cumulative total return of (a) the S&P Composite 500 Stock Index and (b) a self-selected peer group, comprised solely of RTI International Metals, Inc. (NYSE: RTI), our principal U.S. competitor with significant operations primarily in the titanium metals industry for which meaningful stockholder return information is available. The graph shows the value at December 31 of each year, assuming an original investment of $100 in each and reinvestment of cash dividends and other distributions to stockholders.
Comparison of Cumulative Return among Titanium Metals Corporation,
S&P 500 Composite Index and Self-Selected Peer Group
The information contained in the performance graph shall not be deemed “soliciting material” or “filed” with the SEC, or subject to the liabilities of Section 18 of the Securities Exchange Act, except to the extent we specifically request that the material be treated as soliciting material or specifically incorporates this performance graph by reference into a document filed under the Securities Act or the Securities Exchange Act.
Equity compensation plan information>. We have certain equity compensation plans, all of which were approved by our stockholders, which provide for the discretionary grant to our employees and directors of, among other things, options to purchase our common stock and stock awards. As of December 31, 2007, there were a total of approximately 0.1 million options outstanding under all such plans to purchase shares of our common stock at a weighted average exercise price of $3.50 per share, and approximately 7.7 million shares were available for future grant or issuance. Our Board of Directors has approved a new equity compensation plan that we intend to submit to our stockholders for approval at our 2008 annual meeting of stockholders. Although no equity securities have been issued under the new equity compensation plan, up to 0.5 million shares may be issued under this plan if it is adopted and approved. We do not have any equity compensation plans that were not approved by our stockholders. See Note 10 to the Consolidated Financial Statements.
ITEM 6: SELECTED FINANCIAL DATA
The selected financial data set forth below should be read in conjunction with our Consolidated Financial Statements and Item 7 – MD&A.
ITEM 7: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General overview.> We are a vertically integrated producer of titanium sponge, melted products and a variety of mill products for commercial aerospace, military, industrial and other applications. We are one of the world’s leading producers of titanium melted products (ingot, electrodes and slab) and mill products (billet, bar, plate, sheet and strip). We are the only producer with major titanium production facilities in both the United States and Europe, the world’s principal markets for titanium. We are currently the largest producer of titanium sponge, a key raw material, in the United States.
We sell our titanium melted and mill products into four worldwide market sectors. Aggregate shipment volumes for titanium mill products in 2007 were derived from the following sectors:
The titanium industry derives a substantial portion of its demand from the highly cyclical commercial aerospace sector. As shown in the table above, our business is more dependent on commercial aerospace demand than is the overall titanium industry.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare our Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States of America. In the preparation of these financial statements, we are required to make estimates and judgments, and select from a range of possible estimates and assumptions, that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reported period. On an on-going basis, we evaluate our estimates, including those related to allowances for uncollectible accounts receivable, inventory allowances, asset lives, impairments of investments, the recoverability of other long-lived assets, including property and equipment, pension and other postretirement benefit obligations and the related underlying actuarial assumptions, the realization of deferred income tax assets, and accruals for asset retirement obligations, environmental remediation, litigation, income tax and other contingencies. We base our estimates and judgments, to varying degrees, on historical experience, advice of external specialists and various other factors we believe to be prudent under the circumstances. Actual results may differ from previously estimated amounts and such estimates, assumptions and judgments are regularly subject to revision.
We consider the policies and estimates discussed below to be critical to an understanding of our financial statements because their application requires our most significant judgments in estimating matters for financial reporting that are inherently uncertain. See Notes to Consolidated Financial Statements for additional information on these policies and estimates, as well as discussion of additional accounting policies and estimates.
Inventory valuation.> We provide reserves for estimated obsolete or unmarketable inventories equal to the difference between the cost of inventories and the estimated net realizable value using assumptions about future demand for our products, alternate uses of the inventory and market conditions. If actual market conditions are less favorable than those projected by us, we may be required to recognize additional inventories reserves.
Impairment of long-lived assets.> Generally, when events or changes in circumstances indicate that the carrying amount of long-lived assets, including property and equipment and intangible assets, may not be recoverable, we undertake an evaluation of the assets or asset group. If this evaluation indicates that the carrying amount of the asset or asset group is not recoverable, the amount of the impairment would typically be calculated using discounted expected future cash flows or appraised values. All relevant factors are considered in determining whether an impairment exists.
Income taxes>. We record a valuation allowance if realization of our gross deferred income tax assets is not more-likely-than-not after giving consideration to recent historical results and near-term projections, and we also consider the availability of tax planning strategies that might impact either the need for, or amount of, any valuation allowance. We record reserves for uncertain tax positions in accordance with Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertain Tax Positions, for tax positions where we believe it is more-likely-than-not our position will not prevail with the applicable tax authorities. See “Results of Operations – Income taxes” for discussion of our analysis of our deferred income tax valuation allowances and Note 2 to Consolidated Financial Statements for a discussion of our uncertain tax positions.
Pension and OPEB expenses and obligations.> Our pension and OPEB expenses and obligations are calculated based on several estimates, including discount rates, expected rates of returns on plan assets and expected health care trend rates. We review these rates annually with the assistance of our actuaries. See further discussion of the factors considered and potential effect of these estimates in “Liquidity and Capital Resources – Defined benefit pension plans” and “Liquidity and Capital Resources – Postretirement benefit plans other than pensions.”
RESULTS OF OPERATIONS
Comparison of 2007 to 2006
Summarized financial information>. The following table summarizes certain information regarding our results of operations for the years ended December 31, 2006 and 2007. Our reported average selling prices are a reflection of actual selling prices after the effects of currency exchange rates, customer and product mix and other related factors throughout the periods presented.
Net sales>. During 2007, net sales increased 8% to $1,278.9 million. Overall industry fundamentals and outlook continue to support a long-term favorable trend in demand for titanium across all major market sectors. Average selling prices for melted and mill products increased 6% and 16%, respectively, in 2007 compared to 2006. We expect the current trend in customer demands to continue to influence a shift of our product mix toward an increased proportion of mill products, which require additional processing and resources and also command higher sales prices as compared to melted products. While our combined melted and mill product shipment volume declined during 2007, our mill product shipment volume increased slightly in 2007 compared to the prior year. The long-term demand outlook for our products continues to be favorable despite the near-term effects of certain commercial aircraft production delays and other adjustments to build-out schedules, fluctuations in customer inventory levels and product mix. The increased pricing on our products and the favorable shift in product mix more than offset the effects of lower aggregate sales volume for 2007 compared to 2006.
Cost of sales>. Our cost of sales increased $84.4 million, or 11%, in 2007 as compared to 2006 due to an increase in certain raw material costs, including titanium sponge and scrap, and higher production costs associated with our shift in product mix to a greater percentage of mill products. The higher cost of sponge in 2007 is partially due to our final utilization in the first half of 2006 of lower-cost sponge previously purchased from the U.S. Defense Logistics Agency (“DLA”) stockpile and the rapid rise in titanium sponge and scrap market prices experienced through the first half of 2007. Over the past year, increases in global titanium sponge capacity and increased use of titanium in the manufacture of components and products have resulted in the increased availability of titanium sponge and scrap. As a result, our cost of purchased titanium sponge and scrap has been declining during the latter part of 2007, and we anticipate this trend will continue into 2008. These declining raw material costs will also, in certain cases, result in indexed adjustments to selling prices under our long-term sales agreements. Despite these recent trends in titanium sponge and scrap costs, the majority of the products sold during 2007 include higher cost raw materials acquired during prior periods due to the elapsed time required to convert these raw materials into their final form and to deliver them to our customers.
Gross margin>. During 2007, our gross margin increased 3% to $447.4 million as compared to 2006. Our gross margin percentage decreased from 37% in 2006 to 35% in 2007. Cost of sales increases associated with our higher raw material costs and higher cost of production, as discussed above, were partially offset by the increases in average selling prices.
Operating income>. Our operating income for 2007 was $372.0 million compared to $382.8 million in the same period in 2006. The 2007 period includes a $6.0 million expense related to previously capitalized costs associated with the planning and engineering for a new VDP sponge plant due to our decision to delay the project indefinitely. The 2006 period was positively impacted by $14.1 million of equity in earnings related to our interest in the VALTIMET joint venture that we sold in December 2006, partially offset by $8.6 million of travel, relocation and severance expenses incurred in connection with the relocation of our headquarters to Dallas, Texas and our operational management and information technology group to Exton, Pennsylvania.
Net other non-operating income and expense>. During 2007, we recognized other non-operating income of $24.2 million compared to other non-operating income of $39.0 million during 2006. As discussed in Note 4 to the Consolidated Financial Statements, we realized an $18.3 million gain on the sale of our investment in CompX during 2007, and we realized a $40.9 million gain on the sale of our investment in VALTIMET during 2006.
Income taxes. >Our effective income tax rate was 30% in 2007 compared to 31% in 2006. We operate in multiple tax jurisdictions and, as a result, the geographic mix of our pre-tax income or loss can impact our overall effective tax rate. Our effective income tax rate for 2007 was lower than the U.S. statutory rate primarily due to a change in the mix of our pre-tax earnings, with a higher percentage of earnings in lower tax rate jurisdictions in 2007 primarily as a result of the implementation of an internal corporate reorganization in 2007. See Note 12 to the Consolidated Financial Statements for a tabular reconciliation of our statutory income tax expense to our actual tax expense. Some of the more significant items impacting this reconciliation are summarized below.
Our income tax expense in 2007 includes:
Our income tax expense in 2006 includes:
Comparison of 2006 to 2005
Summarized financial information>. The following table summarizes certain information regarding our results of operations for the years ended December 31, 2005 and 2006. Our reported average selling prices are a reflection of actual selling prices after the effects of currency exchange rates, customer and product mix, and other related factors throughout the periods presented.
Net sales>. We experienced significant sales growth during 2006, as net sales increased 58%, or $433.4 million, compared to 2005. We, and the industry as a whole, benefited significantly from strong demand for titanium across all major industry market sectors that drove melted and mill titanium prices to record levels. In addition, during 2005 we had a higher mix of sales to customers under LTAs whose terms contained pricing provisions that limited our ability to immediately adjust selling prices in response to increased production costs, particularly raw materials, or other market changes. As certain of those LTAs expired, or as prices were adjusted as permitted under the LTAs, continued sales to these customers in 2006 were at pricing terms that more closely reflected market pricing. As a result of these factors, average selling prices for melted and mill products increased 93% and 39%, respectively, compared to 2005. In addition to the improved pricing, we delivered 4% more melted products and 12% more mill products compared to 2005. Further, other product sales increased 27% compared to 2005 due principally to improved demand for our fabrication products related primarily to increased construction of chemical, power and other industrial facilities.
Cost of sales>. Our cost of sales increased $196.7 million, or 36%, in 2006 compared to 2005 due to increased sales volumes and higher average cost of raw materials, including purchased titanium sponge and titanium scrap. The higher cost of our purchased sponge was due principally to our utilization in 2005 of lower-cost sponge purchased from the DLA stockpile. We purchased sponge from the DLA stockpile since 2000, but the stockpile became fully depleted in 2005. The higher cost of our purchased titanium scrap was due to increased industry-wide demand as well as demand in non-titanium markets that use titanium as an alloying agent. The impact of market increases in the cost of sponge and scrap was mitigated, in part, because certain of our raw material purchases were subject to long-term agreements. In addition to the impact of higher raw material costs, our cost of sales increased as our energy costs increased and as we increased our manufacturing employee headcount by approximately 150 full time equivalents compared to 2005 in order to support the continued growth of our business. Our cost of sales was favorably impacted by our increased production levels, as our overall plant operating rates improved to 88% in 2006 compared to the prior year plant operating rate of 80%. Despite these overall increases, cost of sales was reduced to 63% of sales for 2006 compared to 73% for 2005, as increases in selling prices more than offset the higher costs.
Gross margin>. During 2006, our gross margin increased 119% to $436.1 million compared to 2005. Our gross margin percentage increased from 27% in 2005 to 37% in 2006. Our improved profitability was generally driven by the increase in sales prices for our products and improved plant operating rates, which more than offset the effect of our higher raw material and energy costs.
Operating income>. Our operating income for 2006 increased 124% to $382.8 million compared to 2005, and our operating income percentage increased from 23% in 2005 to 32% in 2006. The increase in operating income was driven primarily by an increase in gross margin which is somewhat offset by increases in selling, general, administrative and development (“SGA&D”) expense and a decrease in other operating income.
During 2006, our SGA&D expense increased $13.4 million to $67.0 million compared to 2005 primarily due to (i) $8.6 million of travel, relocation and severance expenses incurred in connection with the relocation of our headquarters to Dallas, Texas and our operational management and information technology group to Exton, Pennsylvania, (ii) increased employee compensation as a result of additional personnel to support expansion of our business and (iii) increased audit and consulting fees associated with the expansion of our business. SGA&D expense decreased from 7% of sales in 2005 to 6% of sales in 2006 due to the significant sales growth.
Our other operating income for 2006 decreased $11.6 million from $25.3 million in 2005 to $13.7 million in 2006, primarily related to our LTA with Boeing. During 2005, we recorded $17.1 million of other operating income related to the take-or-pay provisions which were part of our previous LTA with Boeing. As discussed in Note 11 to the Consolidated Financial Statements, beginning in 2006 under our current LTA with Boeing, the take-or-pay provisions under the previous LTA were replaced with an annual makeup payment early in the following year in the event Boeing purchases less than its annual commitment in any year. Based on the provisions of the new LTA, no makeup payment was required for 2006. Other operating income in 2005 also includes $1.8 million related to our settlement of a customer claim regarding prior order cancellations. Somewhat offsetting these decreases was our equity in earnings of VALTIMET, which increased $9.0 million to $14.1 million in 2006 due to their higher earnings resulting from stronger demand and increased pricing in the industrial welded tubing market.
Net other non-operating income and expense>. During 2006, we recognized other non-operating income of $39.0 million compared to other non-operating income of $18.2 million during 2005. As discussed previously, we realized a $40.9 million gain on the sale of our investment in VALTIMET during 2006. Net other non-operating income during 2005 included a gain on the sale of certain real property of $13.9 million. Additionally, during 2006, the U.S. dollar weakened relative to the British pound sterling and the euro, which resulted in net currency transaction losses of $4.0 million as compared to net currency transaction gains of $2.3 million in 2005 as the U.S. dollar strengthened relative to the British pound sterling and the euro.
Income taxes>. Our effective income tax rate was 31% in 2006 compared to 13% in 2005. We operate in multiple tax jurisdictions and, as a result, the geographic mix of our pre-tax income or loss can impact our overall effective tax rate. Our effective income tax rate for 2006 was lower than the U.S. statutory rate primarily due to a change in the mix of our pre-tax earnings, with a higher percentage of earnings in lower tax rate jurisdictions in 2006. Our effective income tax rate for 2005 was lower than the U.S. statutory rate primarily due to an income tax benefit of $50.1 million related to the reversal of our deferred income tax asset valuation allowance related to the U.S. and the U.K;. See Note 12 to the Consolidated Financial Statements for a tabular reconciliation of our statutory income tax expense to our actual tax expense. Some of the more significant items impacting this reconciliation are summarized below.
Our income tax expense in 2006 includes:
Our income tax expense in 2005 includes:
Minority interest>. Minority interest relates principally to our French subsidiary, TIMET Savoie, which is 30% owned by CEZUS. Minority interest increased $3.8 million from 2005, to $8.7 million during 2006, due to increased net income at TIMET Savoie, whose results of operations were favorably impacted by increased sales prices for melted and mill products during 2006.
Dividends on Series A Preferred Stock>. Our Series A Preferred Stock accrues a cumulative cash dividend of 6.75% of the $50 per share liquidation preference per year. Shares of our Series A Preferred Stock are also convertible to shares of our common stock at any time by the shareholder. During 2005, 0.9 million shares of our Series A Preferred Stock were converted into 12.4 million shares of our common stock, as compared to 1.3 million shares of our Series A Preferred Stock converted to 17.2 million shares of common stock during 2006. Based on the number of Series A Preferred shares outstanding throughout each year, cumulative dividends attributable to our Series A Preferred Stock were $12.5 million during 2005, compared to $7.2 million during 2006.
We have substantial operations located in the U.K., France and Italy. Approximately 35% of our sales originated in Europe for 2007, of which approximately 52% were denominated in the British pound sterling or the euro. Certain purchases of raw materials, principally titanium sponge and alloys, for our European operations are denominated in U.S. dollars, while labor and other production costs are primarily denominated in local currencies. The functional currencies of our European subsidiaries are those of their respective countries, and the European subsidiaries are subject to exchange rate fluctuations that may impact reported earnings and may affect the comparability of period-to-period operating results. Borrowings of our European operations may be in U.S. dollars or in functional currencies. Our export sales from the U.S. are denominated in U.S. dollars and are not subject to currency exchange rate fluctuations.
We do not use currency contracts to hedge our currency exposures. At December 31, 2007, consolidated assets and liabilities denominated in currencies other than functional currencies were approximately $87.3 million and $54.2 million, respectively, consisting primarily of U.S. dollar cash, accounts receivable and accounts payable.
We achieved record levels of net sales in 2007, reflecting strong demand for titanium metal across all major market sectors (commercial aerospace, industrial, military and emerging markets). These results were largely driven by higher average selling prices for both melted and mill products, as well as favorable changes in product mix. Our backlog remains strong at $1.0 billion as of December 31, 2007 compared to $1.1 billion at December 31, 2006.
We continue to pursue our strategic plans that focus on anticipated long-term favorable trends in demand by expanding our productive capacity with a focus on opportunities to improve our operating flexibility, efficiency and cost structure. In particular, we continue to expand our operating capabilities in the demanding aerospace industry segment in order to enhance our ability to meet our current and prospective customers’ needs and strengthen our position as a reliable supplier in markets where technical ability and precision are critical. These efforts include strategic initiatives to assure we have the necessary availability of raw materials, melt capacity and mill product processing capabilities. While the recently announced delays of initial deliveries of the Boeing 787 DreamlinerTM commercial aircraft may contribute to short-term volatility in the overall market demand for our products as adjustments are made at various levels in the aircraft supply chain, we expect current industry-wide demand trends will continue to be favorable. With our current plant production levels near practical capacity, we have taken several actions to significantly expand our productive capacity across all areas of our manufacturing operations, including the following:
Raw materials. During 2007, w>e entered into long-term sponge supply agreements with three manufacturers that, together with our current sponge production capacity at our facility in Henderson, provide us with a total annual available sponge supply at levels ranging from 18,000 metric tons up to 28,000 metric tons through 2024. The completion of the additional long-term sponge supply agreements, together with reaching full productive capacity at our Henderson sponge facility and initiatives to increase our scrap recycling and melt capabilities, provide TIMET with additional options and greater flexibility with regard to its future raw material supply requirements.
In addition, we continue to explore other opportunities to secure long-term titanium sponge supply agreements and utilize sponge acquired from established suppliers to supplement the titanium scrap utilized for melted products that is internally generated at our production facilities, purchased from certain customers under contractual agreements or acquired in the open metals market. In anticipation of a significant increase in the availability of titanium scrap and moderation in its cost relative to levels experienced during the past 18 months, we are increasing our capacity to recycle scrap and use EB melt capacity to efficiently use a combination of sponge and scrap to produce melted titanium products.
Our goal is to have assured and flexible availability of raw materials which affords us the ability to respond to industry demands in a timely and cost-efficient manner. We believe our projected mix of internally generated sponge and scrap, along with our assured long-term third party sources of sponge and scrap, will assist in controlling cost for the products we produce compared to that which could be achieved solely through additional internal production of sponge.
Melted products.> We are in the process of expanding our global melt capacity. We recently completed an 8,500 metric ton expansion of our EB melt capacity in Morgantown, and we have commenced construction of another EB furnace at the same facility, which is currently on schedule to be completed in the last half of 2009. During 2007 we also commenced construction of new VAR furnaces at our Witton, Morgantown and Savoie locations, all of which are expected to be completed by mid-2008. These additions will more than double our EB melt capacity and will increase our VAR melt capacity by approximately one-third. As we continue to adjust our long-term business plan in response to industry trends, we will consider more additions to our melt capacity based on our raw material sources and product mix. We have also been able to leverage our melt capacity and expertise as integral components of certain arrangements for additional and alternative sources of raw materials and conversion services.
Mill products and conversion services.> We have numerous capital projects in process to improve and expand our production capacity for mill products. Also, under various conversion services agreements with third-party vendors, we have access to a dedicated annual capacity at certain of our vendors’ facilities. Our access to outside conversion services includes dedicated annual rolling capacity of at least 4,500 metric tons until 2026, with the option to increase the output capacity to 9,000 metric tons. Additionally, we have access to dedicated annual forging capacity of 3,300 metric tons beginning in 2008 and increasing to 8,900 metric tons for 2011 through at least 2019. These agreements provide us with a long-term secure source for processing round and flat products, resulting in a significant increase in our existing mill product conversion capabilities, which allows us to assure our customers of our long-term ability to meet their needs.
Customer agreements.> During 2007 and early 2008, we completed renewals, extensions and, in certain cases, expansions of our long-term supply agreements with several of our customers that supply components to the major aerospace jet engine manufacturers. As a result, we have enhanced our position as the major supplier of titanium to the aerospace jet engine market, including long-term supply agreements with terms up to 10 years and aggregate estimated revenues of up to approximately $4 billion. Based on existing customer agreements and relationships, we currently estimate that we will supply approximately two thirds of the global commercial aerospace jet engine market requirements for titanium. We also have existing long-term supply agreements with other commercial aerospace and industrial customers and continue to explore opportunities to expand or renew these existing arrangements, as well as to enter into new long-term agreements in these and other industry segments.
General.> We intend to continue to explore other opportunities to expand our existing production and conversion capacities through internal expansion and long-term third-party arrangements, as well as potential joint ventures and acquisitions. We believe our efforts to allocate resources across our entire manufacturing process, supplemented with committed capacity from third-party sources, will allow us to achieve profitable growth and enhance long-term return on invested capital.
We estimate that 2008 industry mill product shipments into the commercial aerospace sector will increase 6% to 12%, as compared to 2007. The latest forecast issued in January 2008 by The Airline Monitor reflects a 6% increase in forecasted aircraft deliveries over the next five years compared to the July 2007 forecast, in large part due to the record level of new orders placed for Boeing and Airbus models during 2005 and a stronger than expected order rate in 2006. Defense spending for most systems is expected to remain strong until at least 2010. Current and future military strategy leading to light armament and mobility favor the use of titanium due to light weight and strong ballistic performance. Although we estimate that emerging market demand presently represents only about 6% of the 2007 total industry demand for titanium mill products, we believe emerging market demand, in the aggregate, could grow at double-digit rates over the next several years.
Overall industry outlook continues to support a long-term favorable trend in demand for titanium across all major market sectors, including commercial aerospace, military, industrial and emerging markets. Commercial aerospace is the leading driver for the anticipated increase in demand, in large part due to the record level of new orders placed for Boeing and Airbus models during 2005 and a stronger than expected order rate in 2006. With approximately 60% of our mill products sold for commercial aerospace applications, we are particularly impacted by demand trends in that market sector, and we anticipate that commercial aerospace demand will continue to favorably impact demand for our products for the foreseeable future.
LIQUIDITY AND CAPITAL RESOURCES
Our consolidated cash flows for each of the past three years are presented below. The following should be read in conjunction with our Consolidated Financial Statements and notes thereto.
Operating activities.> Cash flow from operations is considered a primary source of our liquidity. Changes in pricing, production volume and customer demand, among other things, could significantly affect our liquidity. Cash provided by operating activities increased $113.0 million, from $79.1 million in 2006 to $192.1 million in 2007. The net effects of the following significant items contributed to the overall increase in cash provided by operating activities:
Our working capital requirements have changed significantly since 2005 as our net sales and sales volume have increased dramatically. Cash outflows to support our working capital requirements for 2006 were influenced by increasing unit cost for inventory as well as increased inventory purchases to support higher levels of sales volume. In contrast, as sales volumes have decreased somewhat and purchased inventory costs per unit have declined during 2007, the cash outflow to support our working capital requirements was not as significant during the 2007 compared to 2006.
Cash provided by operating activities increased $6.2 million, from $72.9 million in 2005 to $79.1 million in 2006. The net effects of the following significant items contributed to the overall increase in cash provided by operating activities:
Investing activities>. Cash flows used in our investing activities changed from $61.5 million in 2005 to $26.5 million in 2006 to $108.2 million in 2007. Our capital expenditures were $61.1 million during 2005, compared to $100.9 million during both 2006 and 2007 and included the following:
Financing activities>. We had net borrowings of $8.3 million in 2005 under our U.S. and U.K. bank credit facilities which were used primarily to fund our working capital and capital expenditures. We had net repayments of $52.7 million in 2006, funded primarily with a portion of the proceeds from the sale of our interest in VALTIMET. We had no borrowing activity during 2007. Other significant items included in our cash flows from financing activities included:
Future cash requirements
Liquidity>. Our primary source of liquidity on an on-going basis is our cash flows from operating activities and borrowings under various credit facilities. We generally use these amounts to (i) fund capital expenditures, (ii) repay indebtedness incurred primarily for working capital purposes and (iii) provide for the payment of dividends (including first quarter 2008 regular quarterly common stock dividends declared by our Board of Directors aggregating to $13.7 million). From time-to-time we will incur indebtedness, generally to (i) fund short-term working capital needs, (ii) refinance existing indebtedness, (iii) make investments in marketable and other securities (including the acquisition of securities issued by our subsidiaries and affiliates) or (iv) fund major capital expenditures or the acquisition of other assets outside the ordinary course of business.
We routinely evaluate our liquidity requirements, capital needs and availability of resources in view of, among other things, our alternative uses of capital, debt service requirements, the cost of debt and equity capital and estimated future operating cash flows. As a result of this process, we have in the past, or in light of our current outlook, may in the future, seek to raise additional capital, modify our common and preferred dividend policies, restructure ownership interests, incur, refinance or restructure indebtedness, repurchase shares of common stock, purchase or redeem Series A Preferred Stock, sell assets, or take a combination of such steps or other steps to increase or manage our liquidity and capital resources. In the normal course of business, we investigate, evaluate, discuss and engage in acquisition, joint venture, strategic relationship and other business combination opportunities in the titanium, specialty metal and other industries. In the event of any future acquisition or joint venture opportunities, we may consider using then-available liquidity, issuing equity securities or incurring additional indebtedness.
At December 31, 2007, we had aggregate borrowing availability under our existing U.S and European credit facilities of $227.0 million, and we had an aggregate of $90.0 million of cash and cash equivalents. Our U.S. credit facility matures in February 2011, and our U.K. credit facility matures in July 2010. See Note 8 to the Consolidated Financial Statements. Based upon our expectations of our operating performance, the anticipated demands on our cash resources, borrowing availability under our existing credit facilities and anticipated borrowing capacity after the maturity of these credit facilities, we expect to have sufficient liquidity to meet our obligations for the short-term (defined as the next twelve-month period) and our long-term obligations, including our planned capacity expansion projects, some of which are discussed below. If actual developments differ from our expectations, our liquidity could be adversely affected.
Capital expenditures>. We currently estimate we will invest a total of approximately $120 million to $140 million for capital expenditures during 2008, primarily for improvements in and expansion of existing productive capacity.
We are currently expanding our melt capacity at our Morgantown, Witton and Savoie locations in response to industry demand trends, and we expect to complete these additions during 2008 and 2009.
We continue to evaluate additional opportunities to expand our productive capacity including capital projects, acquisitions or other investments which, if consummated, any required funding would be provided by borrowings under our U.S. or European credit facilities.
Contractual commitments>. As more fully described in Notes 14 and 15 to the Consolidated Financial Statements, we were a party to various agreements at December 31, 2007 that contractually commit us to pay certain amounts in the future. The following table summarizes such contractual commitments that are enforceable and legally binding on us and that specify all significant terms, including pricing, quantity and date of payment:
The above table does not reflect any amounts that we might pay to fund our defined benefit pension plans and OPEB plans, as the timing and amount of any such future fundings are unknown and dependent on, among other things, the future performance of defined benefit pension plan assets, interest rate assumptions and actual future retiree medical costs. See Note 13 to the Consolidated Financial Statements and “Liquidity and Capital Resources - Defined benefit pension plans” and “Liquidity and Capital Resources - Postretirement benefit plans other than pensions.”
Off-balance sheet arrangements.> We do not have any off-balance sheet financing agreements other than the outstanding letters of credit and operating leases discussed in Notes 8 and 15 to our Consolidated Financial Statements.
Recent accounting pronouncements. See Note 2 to the Consolidated Financial Statements.
Defined benefit pension plans.> As of December 31, 2007, we maintain three defined benefit pension plans – one each in the U.S., the U.K. and France. The majority of the discussion below relates to the U.S. and U.K. plans, as the French plan is not material to our Consolidated Balance Sheets, Statements of Income or Statements of Cash Flows.
We recorded net consolidated pension expense of $7.9 million in 2005, $4.1 million in 2006 and $4.6 million in 2007. Pension expense or income for these periods was calculated based upon a number of actuarial assumptions, most significant of which are the discount rate and the expected long-term rate of return.
The discount rate we utilize for determining pension expense or income and pension obligations is based on a review of long-term bonds (10 to 15 year maturities) that receive one of the two highest ratings given by recognized rating agencies, composite indices provided by our actuaries and discount rates derived from our expected cash flows for each of our U.S. defined benefit pension and OPEB plans. Changes in our discount rate over the past three years reflect the fluctuations in such bond rates during that period. We establish a rate that is used to determine obligations as of the year-end date and expense or income for the subsequent year. We used the following discount rate assumptions for our defined benefit pension plans:
In developing our expected long-term rate of return assumptions, we evaluate historical market rates of return and input from our actuaries, including a review of asset class return expectations as well as long-term inflation assumptions. Projected returns are based on broad equity (large cap, small cap and international) and bond (corporate and government) indices as well as anticipation that the plans’ active investment managers will generate premiums above the standard market projections. We used the following long-term rate of return assumptions for our defined benefit pension plans:
Lowering the expected long-term rate of return on our U.S. plan’s assets by 0.5% (from 10.00% to 9.50%) would have decreased 2007 pension income by approximately $0.5 million, and lowering the discount rate assumption by 0.25% (from 5.90% to 5.65%) would have increased our U.S. plan’s 2007 pension income by approximately $0.1 million. Lowering the expected long-term rate of return on our U.K. plan’s assets by 0.5% (from 6.50% to 6.00%) would have increased 2007 pension expense by approximately $1.0 million, and lowering the discount rate assumption by 0.25% (from 5.10% to 4.85%) would have increased our U.K. plan’s 2007 pension expense by approximately $1.1 million.
All of our U.S. plan’s assets are invested in the Combined Master Retirement Trust ("CMRT"). The CMRT is a collective investment trust sponsored by Contran to permit the collective investment by certain master trusts which fund certain employee benefits plans sponsored by Contran and related companies. A sub account of the CMRT held 8.4% of TIMET common stock at December 31, 2007; however, our plan assets are invested only in the portion of the CMRT that does not hold TIMET common stock. See Note 14 to the Consolidated Financial Statements.
The CMRT's long-term investment objective is to provide a rate of return exceeding a composite of broad market equity and fixed income indices (including the S&P 500 and certain Russell indices) utilizing both third-party investment managers as well as investments directed by Mr. Simmons. Mr. Simmons is the sole trustee of the CMRT. The trustee of the CMRT, along with the CMRT’s investment committee, of which Mr. Simmons is a member, actively manage the investments of the CMRT. The trustee and investment committee periodically change the asset mix of the CMRT based upon, among other things, advice from third-party advisors and their respective expectations as to what asset mix will generate the greatest overall return. At December 31, 2007, the CMRT’s asset mix (based on an aggregate asset value of $757.1 million) was 90% U.S. equity securities, 8% foreign equity securities and 2% fixed income and other securities. During 2005, 2006 and 2007, the assumed long-term rate of return for our U.S. plan assets that invested in the CMRT was 10%. In determining the appropriateness of the long-term rate of return assumption, we considered, among other things, the historical rates of return of the CMRT, the current and projected asset mix of the CMRT and the investment objectives of the CMRT’s managers. During the history of the CMRT from its inception in 1987 through December 31, 2007, the average annual rate of return earned by the CMRT, as calculated based on the average percentage change in the CMRT’s net asset value per CMRT unit for each applicable year, has been 14% (with an 11% return for 2007).
For our U.K. plan, as a result of market fluctuations experienced and the strategic movement toward our long-term funding and asset allocation strategies, actual asset allocation as of December 31, 2007 was 78% equity securities and 22% fixed income securities. Our future expected long-term rate of return on plan assets for our U.K. plan is based on our target asset allocation assumption of 60% equity securities and 40% fixed income securities and all current contributions to the plan are invested wholly in fixed income securities in order to gradually affect the shift. Based on various factors, including economic and market conditions, gains on the plan assets during each of the preceding years and projected asset mix, our assumed long-term rate of return for our pension expense was 7.10% for 2005, 6.70% for 2006 and 6.50% for 2007. Because all contributions continue to be put into fixed income securities, we expect the asset mix for our U.K. plan to continue to move closer to the projected mix, which reflects a higher percentage of fixed income securities.
Although the expected rate of return is a long-term measure, we continue to evaluate our expected rate of return annually and adjust it as considered necessary. Actual returns on plan assets for a given year that are greater than the assumed rates of return result in an actuarial gain, while actual returns on plan assets for a given year that are less than the assumed rates of return result in an actuarial loss. All of these actuarial gains and losses are not recognized in earnings currently, but instead are deferred and amortized into income in the future as part of pension expense. However, any actuarial gains generated in future periods reduce the negative amortization effect of any cumulative actuarial losses, while any actuarial losses generated in future periods reduce the favorable amortization effect of any cumulative actuarial gains.
Based on an expected rate of return on plan assets of 10.00%, a discount rate of 5.90% and various other assumptions, we estimate that our U.S. plan will have pension income of approximately $4.3 million in 2008. A 0.25% increase or decrease in the discount rate would decrease or increase estimated pension income by approximately $0.1 million in 2008, respectively. A 0.5% increase or decrease in the long-term rate of return would increase or decrease estimated pension income by approximately $0.5 million in 2008, respectively.
Based on an expected rate of return on plan assets of 6.65%, a discount rate of 5.60% and various other assumptions (including an exchange rate of $1.98/£1.00), we estimate that pension expense for our U.K. plan will approximate $6.5 million in 2008. A 0.25% increase or decrease in the discount rate would decrease or increase estimated pension expense by approximately $1.1 million in 2008, respectively. A 0.5% increase in the long-term rate of return would decrease estimated pension expense in 2008 by approximately $1.0 million, and conversely, a 0.5% decrease in the long-term rate of return would increase estimated pension expense in 2008 by approximately $1.0 million. Actual future pension expense will depend on actual future investment performance, changes in future discount rates and various other factors related to the participants in our pension plans.
We made no cash contributions in 2005, $0.4 million in 2006 and $0.1 million in 2007 to our U.S. plan and cash contributions of approximately $9.1 million in 2005, $18.2 million in 2006 and $10.5 million in 2007 to our U.K. plan. The 2006 contribution to our U.K. plan included a $9.9 million discretionary contribution. Based upon the current funded status of the plans and the actuarial assumptions being used for 2007, we believe that we will be required to make 2008 contributions of $9.6 million to our U.K. plan and none to the U.S. plan.
The fair value of the plans’ assets has increased significantly over the past three years based mainly on performance of each plans’ equity securities. The fair value of the assets of the U.S. plan was $84.7 million at December 31, 2005, $93.6 million at December 31, 2006 and $98.4 million at December 31, 2007, and the fair value of the assets of the U.K. plan was $138.1 million at December 31, 2005, $189.5 million at December 31, 2006 and $202.6 million at December 31, 2007.
The combination of actual investment returns, changing discount rates and changes in other assumptions has a significant effect on our funded plan status (plan assets compared to projected benefit obligations). The effect of positive investment returns and an increase in the discount rate increased the over-funded status of the U.S. plan from $5.3 million at December 31, 2005 to $17.9 million at December 31, 2006 and to $23.4 million at December 31, 2007. In 2006 the effect of positive investment returns and an increase in the discount rate for our U.K. plan, more than offset the effect of the weakening dollar compared to the British pound sterling, thereby reducing the under-funded status of the U.K. plan from $54.8 million at December 31, 2005 to $51.1 million at December 31, 2006 and to $34.8 million at December 31, 2007.
Postretirement benefit plans other than pensions.> We provide limited OPEB benefits to a portion of our U.S. employees upon retirement. We fund such OPEB benefits as they are incurred, net of any retiree contributions. We paid OPEB benefits, net of retiree contributions, of $2.3 million in 2005, $1.8 million in 2006 and $1.3 million in 2007.
We recorded consolidated OPEB expense of $2.8 million in 2005, $3.6 million in 2006 and $3.1 million in 2007. OPEB expense for these periods was calculated based upon a number of actuarial assumptions, most significant of which are the discount rate and the expected long-term health care trend rate.
The discount rate we utilize for determining OPEB expense and OPEB obligations is the same as that used for our U.S. pension plan. Lowering the discount rate assumption by 0.25% (from 5.90% to 5.65%) would have had a nominal impact on our 2007 OPEB expense.
We estimate the expected long-term health care trend rate based upon input from specialists in this area, as provided by our actuaries. In estimating the health care trend rate, we consider industry trends, our actual healthcare cost experience and our future benefit structure. For 2007, we used a beginning health care trend rate of 7.17%. If the health care trend rate were increased or decreased by 1.0% for each year, OPEB expense would have increased or decreased by approximately $0.3 million in 2007, respectively. For 2008, we are using a beginning health care trend rate of 5.83%, which is projected to reduce to an ultimate rate of 4.0% in 2011.
Based on a discount rate of 5.90%, a health care trend rate as discussed above and various other assumptions, we estimate that OPEB expense will approximate $2.8 million in 2008. A 0.25% increase or decrease in the discount rate would have a nominal impact on estimated OPEB expense in 2008. A 1.0% increase or decrease in the health care trend rate for each year would increase or decrease the estimated service and interest cost components of OPEB expense by approximately $0.3 million in 2008, respectively. Based upon the actuarial assumptions being used in 2007, we believe we will be required to pay OPEB benefits of $2.1 million in 2008, net of retiree contributions and a Medicare Part D Federal subsidy.
Environmental matters.> See “Business – Regulatory and environmental matters” in Item 1 and Note 15 to the Consolidated Financial Statements for a discussion of environmental matters.
Affiliate transactions.> Corporations that may be deemed to be controlled by or affiliated with Mr. Simmons sometimes engage in (i) intercorporate transactions such as guarantees, management and expense sharing arrangements, shared fee arrangements, joint ventures, partnerships, loans, options, advances of funds on open account, and sales, leases and exchanges of assets, including securities issued by both related and unrelated parties, and (ii) common investment and acquisition strategies, business combinations, reorganizations, recapitalizations, securities repurchases, and purchases and sales (and other acquisitions and dispositions) of subsidiaries, divisions or other business units, which transactions have involved both related and unrelated parties and have included transactions which resulted in the acquisition by one related party of a publicly-held minority equity interest in another related party. We continuously consider reviews and evaluate such transactions, and understand that Contran, Valhi and related entities consider, review and evaluate such transactions. Depending upon the business, tax and other objectives then relevant, it is possible that we might be a party to one or more such transactions in the future.
See Notes 1 and 14 to the Consolidated Financial Statements for a discussion of certain related party transactions that we were a party to during 2005, 2006 and 2007.
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK>
Interest rates.> We are exposed to market risk from changes in interest rates related to indebtedness. We typically do not enter into interest rate swaps or other types of contracts in order to manage our interest rate market risk. We had no outstanding bank indebtedness at December 31, 2006 and 2007. Our borrowings accrue interest at variable rates, generally related to spreads over bank prime rates and LIBOR. Because our bank indebtedness reprices with changes in market interest rates, the carrying amount of such debt is believed to approximate fair value.
Foreign currency exchange rates.> We are exposed to market risk arising from changes in foreign currency exchange rates as a result of our international operations. We do not enter into currency forward contracts to manage our foreign exchange market risk associated with receivables, payables or indebtedness denominated in a currency other than the functional currency of the particular entity. See “Results of Operations – European operations” in Item 7 - MD&A for further discussion.
Commodity prices.> We are exposed to market risk arising from changes in commodity prices as a result of our long-term purchase and supply agreements with certain suppliers and customers. These agreements, which offer various fixed or formula-determined pricing arrangements, effectively obligate us to bear (i) the risk of increased raw material and other costs to us that cannot be passed on to our customers through increased titanium product prices (in whole or in part) or (ii) the risk of decreasing raw material costs to our suppliers that are not passed on to us in the form of lower raw material prices. However, our ability to offset increased material costs with higher selling prices increased in 2006 and 2007, as many of our LTAs have either expired or have been renegotiated with price adjustments that take into account raw material, labor and energy cost fluctuations.
Securities prices.> As of December 31, 2006 and 2007, we held certain marketable securities that are exposed to market risk due to changes in prices of the securities. The aggregate market value of these equity securities was $56.8 million at December 31, 2006 and $2.7 million at December 31, 2007. The potential change in the aggregate market value of these securities, assuming a 10% change in prices, would have been $5.7 million at December 31, 2006 and nominal at December 31, 2007. See Note 4 to the Consolidated Financial Statements.
Interest bearing note receivable.> At December 31, 2007, we held a note receivable from CompX in the principal amount of $50.5 million. Our note receivable accrues interest at variable rates, related to the spread over LIBOR. Because our note receivable reprices with changes in market interest rates, the carrying amount of such note receivable is believed to approximate fair value. See Note 4 to the Consolidated Financial Statements.
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is contained in a separate section of this Annual Report. See Index of Financial Statements on page F.
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTINGAND FINANCIAL DISCLOSURE
ITEM 9A: CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures.> We maintain a system of disclosure controls and procedures. The term "disclosure controls and procedures," as defined by Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), means controls and other procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit to the SEC under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit to the SEC under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and our principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions to be made regarding required disclosure. Each of Steven L. Watson, our Chief Executive Officer, and James W. Brown, our Chief Financial Officer, have evaluated the design and operating effectiveness of our disclosure controls and procedures as of December 31, 2007. Based upon their evaluation, these executive officers have concluded that our disclosure controls and procedures were effective as of December 31, 2007.
Scope of management’s report on internal control over financial reporting. >We also maintain internal control over financial reporting. The term "internal control over financial reporting," as defined by Rule 13a-15(f) of the Exchange Act, means a process designed by, or under the supervision of, our principal executive and principal financial officers, or persons performing similar functions, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP, and includes those policies and procedures that:
Section 404 of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”) requires us to include annually a management report on internal control over financial reporting and such report is included below. Our independent registered public accounting firm is also required to annually attest to our internal control over financial reporting.
Management’s report on internal control over financial reporting.> Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Our evaluation of the effectiveness of our internal control over financial reporting is based upon the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our evaluation under the COSO framework, management has concluded that our internal control over financial reporting was effective as of December 31, 2007.
The effectiveness of our internal control over financial reporting as of December 31, 2007 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included in this Annual Report on Form 10-K.
Changes in internal control over financial reporting. >There have been no changes to our internal control over financial reporting during the quarter ended December 31, 2007 that have materially affected our internal control over financial reporting.
Certifications.> Our chief executive officer is required to annually file a certification with the New York Stock Exchange (“NYSE”), certifying our compliance with the corporate governance listing standards of the NYSE. During 2007, our chief executive officer filed such annual certification with the NYSE, which was not qualified in any respect, indicating that he was not aware of any violations by us of the NYSE corporate governance listing standards. Our principal executive officer and principal financial officer are also required to, among other things, file quarterly certifications with the SEC regarding the quality of our public disclosures, as required by Section 302 of the Sarbanes-Oxley Act. Such certifications for the year ended December 31, 2007 have been filed as exhibits 31.1 and 31.2 to this Annual Report on Form 10-K.
ITEM 9B: OTHER INFORMATION