HAYNES INTERNATIONAL, INC. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(in thousands, except share and per share data)
Note 1. Basis of Presentation
Interim Financial Statements
The interim financial statements are unaudited and reflect all adjustments (consisting solely of normal recurring adjustments) that, in the opinion of management, are necessary for a fair presentation of results for the interim periods presented. This report includes information in a condensed form and should be read in conjunction with the audited consolidated financial statements for the fiscal year ended September 30, 2006 included in the annual report on Form 10-K, filed by Haynes International, Inc. with the Securities and Exchange Commission (“SEC”). The results of operations for the three months ended December 31, 2006, are not necessarily indicative of the results to be expected for the full fiscal year ending September 30, 2007 or any interim period.
Principles of Consolidation
The consolidated financial statements include the accounts of Haynes International, Inc. and its wholly-owned subsidiaries (collectively, the “Company”). All significant intercompany transactions and balances are eliminated.
Note 2. New Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, Accounting for uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 seeks to reduce the diversity in practice associated with certain aspects of measuring and recognition in accounting for income taxes. In addition, FIN 48 requires expanded disclosure with respect to the uncertainty in income taxes and is effective as of the beginning of the 2008 fiscal year. The Company is currently evaluating the impact, if any, that FIN 48 will have on its financial statements.
In September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurement (SFAS 157). SFAS 157 addresses standardizing the measurement of fair value for companies who are required to use a fair value measure for recognition or disclosure purposes. The FASB defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measure date.” The statement is effective for fiscal years beginning after November 15, 2007 and for interim periods within those fiscal years. The Company is required to adopt SFAS 157 beginning on October 1, 2008. The Company is currently evaluating the impact, if any, of SFAS 157 on its financial position, results of operations and cash flows.
In September 2006, the FASB issued FASB Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (SFAS 158). SFAS 158 requires companies to recognize the funded status of defined benefit pension and other postretirement plans as a net asset or liability in its financial statements. In addition, disclosure requirements related to such plans are affected by SFAS 158. The Company will begin recognition of the funded status of its defined benefit pension and postretirement plans and include the required disclosures under the provisions of SFAS 158 at the end of fiscal year 2007. Based on September 30, 2006 information, the impact on the Company’s financial position would be a reduction in pension and postretirement benefits liability of $5.2 million, an increase in stockholders’ equity accumulated other comprehensive income of $3.2 million, and a reduction of deferred tax asset of $2.0 million. The impact on the financial statements as of the adoption date of September 30, 2007 will be based on information as of September 30, 2007. The adoption of SFAS 158 is not expected to impact the Company’s debt covenants or cash position. Additionally, the Company does not expect the adoption of SFAS 158 to significantly affect the results of operations.
In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108 (“SAB 108”), which provides interpretive guidance on how the effects of the carryover or reversal of
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prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 is effective for the first fiscal year ending after November 15, 2006, which will be the fiscal year ending September 30, 2007. The adoption of this statement is not expected to have a material impact on the Company’s financial position or results of operations.
In February 2006, the FASB issued FASB Statement No. 155, Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140 (SFAS 155), that allows a preparer to elect fair value measurement at acquisition, at issuance, or when a previously recognized financial instrument is subject to a re-measurement (new basis) event, on an instrument-by-instrument basis, in cases in which a derivative would otherwise have to be bifurcated. It also eliminates the exemption from applying Statement 133 to interests in securitized financial assets so that similar instruments are accounted for similarly regardless of the form of the instruments. This Statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The adoption of this statement did not have a material impact on the Company’s results of operations or financial position.
Note 3. Inventories
The following is a summary of the major classes of inventories:
| | September 30, 2006 | | December 31, 2006 | |
Raw Materials | | $ | 7,214 | | $ | 13,593 | |
Work-in-process | | 96,674 | | 108,241 | |
Finished Goods | | 74,575 | | 80,710 | |
Other, net | | 1,249 | | 1,428 | |
| | $ | 179,712 | | $ | 203,972 | |
Note 4. Income Taxes
Income tax expense for the three months ended December 31, 2005 and 2006, differed from the U.S. federal statutory rate of 35% primarily due to state income taxes and differing tax rates on foreign earnings.
Note 5. Pension and Post-retirement Benefits
Components of net periodic pension and post-retirement benefit cost for the three months ended December 31, are as follows:
| | Three Months Ended December 31, | |
| | Pension Benefits | | Other Benefits | |
| | 2005 | | 2006 | | 2005 | | 2006 | |
Service cost | | $ | 894 | | $ | 990 | | $ | 694 | | $ | 427 | |
Interest cost | | 2,124 | | 2,306 | | 1,754 | | 1,319 | |
Expected return | | (2,407 | ) | (2,457 | ) | — | | — | |
Amortizations | | — | | — | | 354 | | (1,221 | ) |
Net periodic benefit cost | | $ | 611 | | $ | 839 | | $ | 2,802 | | $ | 525 | |
The Company contributed $0 to the Company sponsored domestic pension plans, $1,196 to its other post-retirement benefit plans and $281 to the U.K. pension plan for the three months ended December 31, 2006. The Company presently expects to additionally contribute $3,690 to its domestic pension plans, $3,804 to its other post-retirement benefit plans and $842 to the U.K. pension plans for the remainder of fiscal 2007.
During March 2006, the Company communicated to employees and plan participants a negative plan amendment that caps the Company’s liability related to total retiree health care costs at $5,000 annually effective January 1, 2007. An updated actuarial valuation was performed at March 31, 2006, which reduces the accumulated post-retirement benefit liability due to this plan amendment by $46,313, that will be amortized as a reduction to expense over an eight year period. This amortization period began in April 2006 thus reducing the
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amount of expense recognized for the second half of fiscal 2006 and the respective future periods.
Note 6. Environmental and Legal
The Company is periodically involved in litigation, both as a plaintiff and as a defendant, relating to its business and operations, including environmental matters. Future expenditures for environmental and other legal matters cannot be determined with any degree of certainty; however, based on the facts presently known, management does not believe that such costs will have a material effect on the Company’s financial position, results of operations or cash flows.
The Company believes that any and all claims arising out of conduct or activities that occurred prior to March 29, 2004 are subject to dismissal. On March 29, 2004, the Company and certain of its subsidiaries and affiliates filed voluntary petitions for relief under Chapter 11 of Title 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of Indiana (the “Bankruptcy Court”). On August 16, 2004, the Bankruptcy Court entered its Findings of Fact, Conclusions of Law, and Order Under 11 U.S.C. 1129(a) and (b) and Fed. R. Bankr. P. 3020 Confirming the First Amended Joint Plan of Reorganization of Haynes International, Inc. and its Affiliated Debtors and Debtors-in-Possession as Further Modified (the “Confirmation Order”). The Confirmation Order and related Chapter 11 Plan, among other things, provide for the release and discharge of prepetition claims and causes of action. The Confirmation Order further provides for an injunction against the commencement of any actions with respect to claims held prior to the Effective Date of the Plan. The Effective Date occurred on August 31, 2004. When appropriate, the Company pursues the dismissal of lawsuits premised upon claims or causes of action discharged in the Confirmation Order and related Chapter 11 Plan. The success of this strategy is dependent upon a number of factors, including the respective court’s interpretation of the Confirmation Order and the unique circumstances of each case.
The Company is currently, and has in the past, been subject to claims involving personal injuries allegedly relating to its products. For example, the Company is presently involved in two actions involving welding rod-related injuries. One lawsuit was filed in California state court against numerous manufactures, including the Company, in May 2006, alleging that the welding related products of the defendant manufacturers harmed the users of such products through the inhalation of welding fumes containing manganese. A second case with similar allegation is pending in Texas. The Company believes that it has defenses to these allegations and, that if found liable, the cases would not have a material effect on its financial position, results of operations or liquidity. In addition to these cases, the Company has in the past been named a defendant in several other lawsuits, including 52 filed in the state of California, alleging that welding related products harmed the users of such products through the inhalation of welding fumes containing manganese. The Company has since been voluntarily dismissed from all of these lawsuits on the basis of the release and discharge of claims contained in the Confirmation Order. While the Company contests such lawsuits vigorously, and may have applicable insurance, there are several risks and uncertainties that may affect the Company’s liability for claims relating to exposure to welding fumes and manganese. For instance, in recent cases (in which the Company was not a party), at least two courts have refused to dismiss claims relating to inhalation of welding fumes containing manganese based upon a bankruptcy discharge order. Although the Company believes the facts of those cases are distinguishable from the facts of its cases, the Company cannot assure you that the claims against us will be dismissed based upon the Confirmation Order. It is also possible that the Company could be named in additional suits alleging welding-rod injuries. Should such litigation occur, it is possible that the aggregate claims for damages, if the Company is found liable, could have a material adverse effect on its financial condition, results of operations or liquidity.
The Company is conducting remedial activities at its Kokomo, Indiana and Mountain Home, North Carolina facilities. The Company has received permits from the Indiana Department of Environmental Management, or IDEM, and the US Environmental Protection Agency, or EPA, to close and to provide post-closure monitoring and care for certain areas at the Kokomo facility previously used for the storage and disposal of wastes, some of which are classified as hazardous under applicable regulations. Construction of the South Landfill was completed in May 1994 and closure certification was received in fiscal 1999 for one area at the Kokomo facility and post-closure care is ongoing there. The Company has an application with IDEM pending for approval of closure and post-closure care for another area at its Kokomo facility. In addition, the Company is currently evaluating known groundwater contamination at its Kokomo site and is developing a plan to address it. Accordingly, additional corrective action may be necessary. The Company has also received permits from the North Carolina Department of Environmental
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Natural Resources, or NC DENR, and the EPA to close and provide post-closing monitoring and care for the lagoon at the Mountain Home, North Carolina facility. The lagoon area has been closed and is currently undergoing post-closure monitoring. The Company is required to monitor groundwater and to continue post closure maintenance of the former disposal areas at this site. As a result, the Company is aware of elevated levels of certain contaminants in the groundwater and additional corrective action could be required. The Company is currently unable to estimate the costs of any further corrective action at either site if required. Accordingly, the Company cannot assure you that the costs of any future corrective action at these or any other current or former sites would not have a material effect on its financial condition, results of operations or liquidity. Additionally, it is possible that the Company could be required to undertake other corrective action commitments for any other solid waste management unit existing or determined to exist at any of its facilities.
As of September 30, 2006 and December 31, 2006, the Company has accrued $1,483 for post-closure monitoring and maintenance activities. In accordance with SFAS 143, Accounting for Asset Retirement Obligations, accruals for these costs are calculated by estimating the cost to monitor and maintain each post-closure site and multiplying that amount by the number of years remaining in the 30 year post-closure monitoring period referred to above. At each fiscal year-end, or earlier if necessary, the Company evaluates the accuracy of the estimates for these monitoring and maintenance costs for the upcoming fiscal year. The accrual was based upon the undiscounted amount of the obligation of $1,871 which was then discounted using an appropriate discount rate. The cost associated with closing the sites has been incurred in financial periods prior to those presented, with the remaining cost to be incurred in future periods related solely to post-closure monitoring and maintenance. Based on historical experience, the Company estimates that the cost of post-closure monitoring and maintenance will approximate $98 per year over the remaining obligation period.
Note 7. Deferred Revenue
On November 17, 2006, the Company entered into a twenty-year agreement to provide conversion services to Titanium Metals Corporation (“TIMET”) for up to ten million pounds of titanium metal annually at prices established by the terms of the agreement. The transaction is documented by an Access and Security Agreement and a Conversion Services Agreement, both dated November 17, 2006. TIMET paid the Company a $50.0 million up-front fee and will also pay the Company for its processing services during the term of the agreement (20 years) at prices established by the terms of the agreement. In addition to the volume commitment, the Company has granted TIMET a security interest on its four-high Steckel rolling mill, along with certain rights of access. TIMET may exercise an option to have ten million additional pounds of titanium converted annually, provided that it offers to loan up to $12.0 million to the Company for certain capital expenditures which would be required to expand capacity. The Company has the option to purchase titanium sheet and plate products from TIMET and has agreed not to manufacture its own titanium products (other than cold reduced titanium tubing). The Company has also agreed not to provide titanium conversion services to any entity other than TIMET for the term of the Conversion Services Agreement. The cash received of $50.0 million will be recognized in income on a straight-line basis over the 20-year term of the agreement. The portion not recognized in income will be shown as deferred revenue on the consolidated balance sheet. The Company has used the proceeds, net of expenses, of the $50 million up-front fee paid by TIMET to reduce the balance of its U.S. revolving credit facility. Upon certain instances of a change in control, a violation of the non-compete provisions or a performance default or upon the occurrence of a force majeure event which results in a performance default, the Company is required to return the unearned portion (as defined) of the up-front fee. Revenue of $296 has been recognized related to this agreement, during the three months ended December 31, 2006. Taxes will be paid on the up-front fee primarily in fiscal year 2008.
Note 8. Intangible Assets and Goodwill
Goodwill was created as a result of the Company’s reorganization pursuant to Chapter 11 of the U.S. Bankruptcy Code and fresh start accounting. The Company adopted SFAS No. 142, Goodwill and Other Intangible Assets. Pursuant to SFAS No. 142 goodwill is not amortized and the value of goodwill is reviewed annually for impairment. If the carrying value exceeds the fair value (determined on a discounted cash flow basis or other fair value method), impairment of goodwill may exist resulting in a charge to earnings to the extent of goodwill impairment.
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The Company also has patents, trademarks and other intangibles. As the patents have a definite life, they are amortized over lives ranging from two to fourteen years. As the trademarks have an indefinite life, the Company tests them for impairment annually. If the carrying value exceeds the fair value (determined by calculating a fair value based upon a discounted cash flow of an assumed royalty rate), impairment of the trademark may exist resulting in a charge to earnings to the extent of impairment. Amortization of the patents and other intangibles was $492 and $282 for the three months ending December 31, 2005 and 2006, respectively.
The following represents a summary of intangible assets and goodwill at September 30, 2006 and December 31, 2006:
September 30, 2006 | | Gross Amount | | Accumulated
Amortization | | Adjustments | | Carrying
Amount | |
Goodwill | | $ | 43,055 | | $ | — | | $ | (790 | ) | $ | 42,265 | |
Patents | | 8,667 | | (3,800 | ) | — | | 4,867 | |
Trademarks | | 3,800 | | — | | — | | 3,800 | |
Non-compete | | 590 | | (161 | ) | — | | 429 | |
Other | | 465 | | (139 | ) | — | | 326 | |
| | $ | 56,577 | | $ | (4,100 | ) | $ | (790 | ) | $ | 51,687 | |
December 31, 2006 | | Gross Amount | | Accumulated
Amortization | | Adjustments | | Carrying
Amount | |
Goodwill | | $ | 42,265 | | $ | — | | $ | — | | $ | 42,265 | |
Patents | | 8,667 | | (4,028 | ) | — | | 4,639 | |
Trademarks | | 3,800 | | — | | — | | 3,800 | |
Non-compete | | 590 | | (182 | ) | — | | 408 | |
Other | | 465 | | (172 | ) | — | | 293 | |
| | $ | 55,787 | | $ | (4,382 | ) | $ | — | | $ | 51,405 | |
Estimate of Aggregate Amortization Expense:
Year Ended September 30, | | | |
2007 (remainder of fiscal year) | | $ | 847 | |
2008 | | 983 | |
2009 | | 708 | |
2010 | | 376 | |
2011 | | 363 | |
| | | | |
Note 9. Net Income Per Share
Basic and diluted net income per share were computed as follows:
| | Three Months Ended
December 31, | |
(in thousands except share and per share data) | | 2005 | | 2006 | |
Numerator: | | | | | |
Net Income | | $ | 3,333 | | $ | 13,184 | |
Denominator: | | | | | |
Weighted average shares outstanding - Basic | | 10,000,000 | | 10,000,000 | |
Effect of dilutive stock options | | 163,993 | | 398,994 | |
Weighted average shares outstanding - Diluted | | 10,163,993 | | 10,398,994 | |
| | | | | |
Basic net income per share | | $ | 0.33 | | $ | 1.32 | |
Diluted net income per share | | $ | 0.33 | | $ | 1.27 | |
A total of 6,858 and 0 anti-dilutive weighted average shares with respect to outstanding stock options have been excluded from the computation of diluted net income per share for the three months ended December 31, 2005 and 2006, respectively. Contingently issuable shares related to stock rights are excluded from the diluted net income per share computation, because the condition under which the stock rights can be exercised has not occurred as of December 31, 2006.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
References to years or portions of years in Management’s Discussion and Analysis of Financial Condition and Results of Operations refer to the Company’s fiscal years ended September 30, unless otherwise indicated.
This discussion contains statements that constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Those statements appear in a number of places in this discussion and may include, but are not limited to, statements regarding the intent, belief or current expectations of the Company or its management with respect to, but are not limited to (i) the Company’s strategic plans; (ii) any significant change in customer demand for its products or in demand for its customers’ products; (iii) the Company’s dependence on production levels at its Kokomo facility and its ability to make capital improvements at that facility; (iv) rapid increases in the cost of nickel, energy and other raw materials; (v) the Company’s ability to continue to develop new commercially viable applications and products; (vi) the Company’s ability to recruit and retain key employees; (vii) the Company’s ability to comply, and the costs of compliance, with applicable environmental laws and regulations; (viii) economic and market risks associated with foreign operations and U.S. and world economic and political conditions ..Readers are cautioned that any such forward looking statements are not guarantees of future performance and involve risks and uncertainties. Actual results may differ materially from those in the forward looking statements as a result of various factors, many of which are beyond the control of the Company.
The Company has based these forward-looking statements on its current expectations and projections about future events. Although the Company believes that the assumptions on which the forward-looking statements contained herein are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based upon those assumptions also could be incorrect. Risks and uncertainties, some of which are discussed in Item 1A. of Part 1 to the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2006, and in Part II, Item 1A. of this report, may affect the accuracy of forward looking statements.
The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Overview
Haynes International, Inc. is one of the world’s largest producers of high-performance nickel- and cobalt-based alloys. The Company is focused on developing, manufacturing, marketing and distributing technologically advanced, high-performance alloys, which are used primarily in the aerospace, chemical processing and land based gas turbine industries. The global specialty alloy market consists of three primary sectors: stainless steel, general purpose nickel alloys and high-performance nickel- and cobalt-based alloys. Except for its stainless wire products, the Company competes exclusively in the high-performance nickel- and cobalt-based alloy sector, which includes high temperature resistant alloys, or HTA products, and corrosion resistant alloys, or CRA products. The Company believes it is one of four principal producers of high-performance alloys in sheet, coil and plate forms. The Company also produces its products as seamless and welded tubulars, and in bar, billet and wire forms.
The breadth and quality of the Company’s products, combined with its superior customer service delivered through its service and sales center network, have resulted in long-standing relationships with many of its customers. The Company has supplied high-performance alloys to its top 10 customers, based on fiscal 2006 sales, for an average of 20 years. The Company supplies high-performance alloys that are used by a broad range of end use customers including General Electric Co.; Pratt & Whitney; Rolls Royce plc; The Boeing Co.; SNECMA; E.I. DuPont de Nemours & Co.; The Dow Chemical Co.; Siemens Westinghouse; Solar Turbines, Inc.; British Petroleum p.l.c.; Celanese AG; and Eli Lilly and Co. None of these customers, or any of the Company’s other customers, accounted for more than 10% of its sales in fiscal 2006. The Company’s top 20 customers accounted for approximately 38% of sales in fiscal 2006.
The Company has manufacturing facilities in Kokomo, Indiana; Arcadia, Louisiana; and Mountain Home, North Carolina. The Kokomo and Arcadia facilities specialize in flat and tubular products, respectively, and the
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Mountain Home facility manufactures stainless steel and high-performance alloy wire. The Company sells its products primarily through its direct sales organization, which includes 11 service and/or sales centers in the United States, Europe, Asia and India. All of these centers are company-operated.
The Company continues to achieve growth through a combination of capitalizing on the growth of its end markets, increasing value added services provided to its customers, increasing its presence in international markets and, to a lesser extent, selected strategic initiatives such as the November 2004 acquisition of assets of The Branford Wire and Manufacturing Company, or Branford Wire.
Recent investment in equipment has significantly improved operating efficiency by increasing capacity, reducing downtime and manufacturing costs and improving working capital management and product quality. Management anticipates continuing to invest in its equipment and spent approximately $3.1 million in the first quarter of fiscal 2007. Total planned fiscal 2007 capital spending is targeted at approximately $13.0 million.
On November 17, 2006, the Company entered into a 20 year agreement to provide conversion services to Titanium Metals Corporation, or TIMET, for up to ten million pounds of titanium metal annually at prices established in the agreement. TIMET paid a $50.0 million up-front fee and will also pay for its process services during the term of the agreement at prices established in the agreement. In addition to the volume commitment, the Company has granted TIMET a security interest in the four-high steckel rolling mill, along with certain rights of access. TIMET may exercise an option to have ten million additional pounds of titanium converted annually, provided that it offers to loan up to $12.0 million to the Company for certain capital expenditures which would be required to expand furnace reheat capacity. In addition, the Company has the option to purchase titanium sheet and plate products from TIMET and has agreed not to manufacture titanium product (other than cold reduced titanium tubing). The Company also agreed not to provide titanium conversion services to any entity other than TIMET for the term of the agreement. The cash received of $50.0 million (up-front fee) will be recognized in income on a straight-line basis over the 20-year term of the agreement. The portion not recognized in income will be shown as deferred revenue on the consolidated balance sheet. Income taxes associated with the up-front fee will be primarily paid in fiscal 2008. The Company used the net proceeds of the $50.0 million payment to reduce the balance of its U.S. revolving credit facility. Upon certain instance of a change in control, a violation of the non-compete provisions or a performance default or upon the occurrence of an event of a force majeure which results in a performance default, the Company is required to return the unearned portion of the up-front fee.
Upon implementation of the plan of reorganization in fiscal 2004, the Company adopted fresh start reporting in accordance with SOP 90-7. Under fresh start reporting, the reorganization value is allocated to net assets based on their relative fair values in a manner similar to the accounting provisions applied to business combinations under Statement of Financial Standards No. 141, Business Combinations (“SFAS No. 141”). The Company’s operating income was reduced by the recognition of the fair market value adjustments to its assets required by the adoption of fresh start reporting. In the first quarter of fiscal 2007 fresh start charges increased cost of sales by $1.0 million versus $1.2 million for the same period last year.
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Results of Operations
| | Three Months Ended | |
| | December 31, | |
| | 2005 | | 2006 | |
| | $ (in
thousands) | | % | | $ (in thousands) | | % | |
| | | | | | | | | |
Net revenues | | $ | 94,407 | | 100.0 | % | $ | 120,463 | | 100.0 | % |
Cost of sales | | 77,095 | | 81.7 | % | 86,842 | | 72.1 | % |
Selling, general and administrative expense | | 9,391 | | 9.9 | % | 9,420 | | 7.8 | % |
Research and technical expense | | 668 | | 0.7 | % | 697 | | 0.6 | % |
Operating income | | 7,253 | | 7.7 | % | 23,504 | | 19.5 | % |
Interest expense, net | | 1,788 | | 1.9 | % | 1,809 | | 1.5 | % |
Income before income taxes | | 5,465 | | 5.8 | % | 21,695 | | 18.0 | % |
Provision for income taxes | | 2,132 | | 2.3 | % | 8,511 | | 7.1 | % |
Net income | | $ | 3,333 | | 3.5 | % | $ | 13,184 | | 10.9 | % |
Three months ended December 31, 2006 compared to three months ended December 31, 2005
Net Revenues. Net revenues increased by $26.1 million, or 27.6%, to $120.5 million in the first quarter of fiscal 2007 from $94.4 million in the same period of fiscal 2006. Volume for all products increased by 7.8% to 5.5 million pounds in the first quarter of fiscal 2007 from 5.1 million pounds in the same period of fiscal 2006. Volume of high-performance alloys increased by 14.3% to 4.8 million pounds in the first quarter of fiscal 2007 from 4.2 million pounds in the same period of fiscal 2006. Volume of stainless steel wire decreased by 22.2% to 0.7 million pounds in the first quarter of fiscal 2007 from 0.9 million pounds in the same period of fiscal 2006 as a result of the Company’s strategy to reduce production of stainless steel wire and increase production of high-performance alloy wire due to the higher margins available on high-performance alloy wire. The average selling price per pound for all products increased by 18.3% to $22.08 per pound in the first quarter of fiscal 2007 from $18.66 per pound in the same period of fiscal 2006, due primarily to improved market demand and passing through higher raw material prices. The Company’s consolidated backlog increased by $0.5 million, or 0.2%, to $207.4 million at December 31, 2006 from $206.9 million at September 30, 2006. Order entry increased by $9.4 million, or 8.9%, for the first quarter of fiscal 2007 from the same period of fiscal 2006. Management expects the demand for high-performance alloys to be positively driven by the continuation of favorable trends in the aerospace, chemical processing (including new construction and maintenance) and land-based gas turbine markets.
Sales to the aerospace market increased by 12.6% to $43.8 million in the first quarter of fiscal 2007 from $38.9 million in the same period of fiscal 2006, due to a 17.6% increase in the average selling price per pound, which was partially offset by a 4.2% decrease in volume. The increase in the average selling price per pound is due to improved product mix and the effect of passing through higher raw material costs. Product mix has improved as a result of sales of a higher percentage of products and forms with a higher average selling price when compared to the same period of fiscal 2006, as a result of the generally improved economy. Volume has decreased due to a shift by aerospace fabricators away from large mill-direct orders towards smaller service and sales center orders. Management believes that this shift is a temporary response to fluctuating nickel prices by aerospace fabricators, because it is believed that aerospace fabricators have more flexibility in the purchasing of raw materials in the short-term compared to customers in the Company’s other end markets.
Sales to the chemical processing market increased by 41.1% to $38.8 million in the first quarter of fiscal 2007 from $27.5 million in the same period of fiscal 2006, due to a 2.9% increase in the average selling price per pound and a 36.9% increase in volume. The increase in the average selling price is due to improved market demand and the effect of passing through higher raw material costs. This increase was partially offset by a change in product mix, which reflects a higher percentage of lower average selling price products and forms as compared to the same period last year. Volume has improved due to the improved market demand, and
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particularly as a result of new chemical processing facilities in China.
Sales to the land-based gas turbine market increased by 36.7% to $20.1 million for the first quarter of fiscal 2007 from $14.7 million in the same period of fiscal 2006, due to an increase of 15.0% in the average selling price per pound and a 18.9% increase in volume. The increase in the average selling price is due to improved market demand and the effect of passing through higher raw material cost. Volume improved as a result of the generally improved economy, and higher demand for power generation, oil and gas production and alternative power systems applications.
Sales to other markets increased by 25.6% to $15.7 million in the first quarter of fiscal 2007 from $12.5 million in the same period of fiscal 2006, due to a 38.3% increase in average selling price per pound, which was partially offset by a 9.1% decrease in volume. The increase in average selling price is due to improved market demand for both high-performance alloys and stainless steel wire and passing through higher raw material costs. The primary reason for the reduction in total volume was a decrease in the volume of stainless steel wire as a result of the Company’s strategy to reduce production of stainless steel wire to allow greater production of high-performance alloy wire. Volume of stainless steel wire decreased by 22.0%, while volume of high-performance alloys increased 29.7% in the first quarter of fiscal 2007 as compared to the same period of fiscal 2006.
Other Revenue. Other revenue increased by 157.9% to $2.1 million in the first quarter of fiscal 2007 from $0.8 million for the same period of fiscal 2006. The increase is due to higher activity in toll conversion, revenue recognized from the TIMET agreement of $0.3 million, scrap sales and miscellaneous sales.
Cost of Sales. Cost of sales as a percentage of net revenues decreased to 72.1% in the first quarter of fiscal 2007 from 81.7% in the same period of fiscal 2006. The decrease in the percentage of cost of sales can be attributed to a combination of the following factors: (i) improved product pricing combined with an overall improvement in volume, which resulted in the increased absorption of fixed manufacturing costs, (ii) reductions in manufacturing cost resulting from the capital improvements program, and (iii) decreases in energy costs (primarily natural gas). These positive factors were partially offset by higher raw material costs. Higher raw material costs result from a significant increase in the cost of nickel, which makes up approximately 51% of the Company’s raw material costs. The average price for a cash buyer of nickel as reported by the London Metals Exchange for the 30 days ending December 31, 2006 was $15.68 compared to $6.09 for the 30 days ending December 31, 2005.
Selling, General and Administrative Expenses. Selling, general and administrative expenses remained flat at $9.4 million in the first quarter of fiscal 2007 and for the same period of fiscal 2006. Selling, general and administrative expenses as a percentage of net revenues decreased to 7.8% in the first quarter of fiscal 2007 compared to 9.9% for the same period of fiscal 2006 due primarily to the increased level of revenues combined with the successful efforts to control spending.
Research and Technical Expense. Research and technical expense remained flat at $0.7 million in the first quarter of fiscal 2007 and the same period of fiscal 2006.
Operating Income. As a result of the above factors, operating income in the first quarter of fiscal 2007 was $23.5 million compared to $7.3 million in the same period of fiscal 2006.
Interest Expense. Interest expense remained flat at $1.8 million in the first quarter of fiscal 2007 and for the same period of fiscal 2006. Although the average interest rate was higher in the first quarter of fiscal 2007 as compared to the same period in fiscal 2006, the higher interest rate was offset by a lower average balance outstanding.
Income Taxes. Income tax expense increased to $8.5 million in the first quarter of fiscal 2007 from $2.1 million in the same period of fiscal 2006. The effective tax rate for the first quarter of fiscal 2007 was 39.2% compared to 39.0% in the same period of fiscal 2006. The slight increase in effective tax rate is primarily attributable to more taxable income in the U.S. at a higher tax rate as compared to foreign taxable income at a lower tax rate.
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Net Income. As a result of the above factors, net income increased by $9.9 million to $13.2 million in the first quarter of fiscal 2007 from $3.3 million in the same period of fiscal 2006.
Liquidity and Capital Resources
Comparative cash flow analysis
During the first quarter of fiscal 2007, the Company’s primary sources of cash were borrowings under its U.S. revolving credit facility with a group of lenders led by Wachovia Capital Finance Corporation (Central) (described below), cash from operations, and the proceeds, net of expenses, of the $50.0 million up-front payment received from TIMET. At December 31, 2006, Haynes had cash and cash equivalents of approximately $5.0 million compared to cash and cash equivalents of approximately $6.2 million at September 30, 2006.
Net cash provided from operating activities was $52.8 million in the first quarter of fiscal 2007, as compared to cash used of $7.3 million in the same period of fiscal 2006. At December 31, 2006, inventory balances were approximately $23.0 million higher than fiscal 2006 year end balances (net of foreign currency adjustments), as a result of the continued increase in the costs of the raw materials (nickel, molybdenum and cobalt), and a higher level of inventory required to be maintained to support the increased level of sales. Net cash used in investing activities was $3.0 million in the first quarter of fiscal 2007, primarily as a result of the continuing capital expenditure program. Borrowings on the revolving credit facility decreased by $51.0 million as a result of cash generated from operations plus the proceeds, net of expenses, of the $50.0 million up-front payment received from TIMET. Taxes will be paid related to the TIMET transaction primarily in fiscal year 2008.
Future sources of liquidity
The Company’s sources of cash for the remainder of fiscal 2007 are expected to consist primarily of cash generated from operations, cash on hand, and borrowings under both the U.S. revolving credit facility and the U.K. revolving credit facility (described below). The U.S. revolving credit facility and the U.K. revolving credit facility combine to provide borrowings in a maximum amount of $145.0 million, subject to a borrowing base formula and certain reserves. At December 31, 2006, the Company had access to a total of approximately $78.3 million ($69.1 million in the United States and $9.2 million in the U.K.) under both revolving credit facilities (subject to borrowing base and certain reserves) and cash of approximately $5.0 million. Management believes that the resources described above will be sufficient to fund planned capital expenditures and working capital requirements over the next twelve months, although there can be no assurance that this will be the case.
U.S. revolving credit facility. The U.S. revolving credit facility provides for revolving loans in a maximum amount of $130.0 million. Borrowings under the U.S. revolving credit facility bear interest at either Wachovia Bank, National Association’s “prime rate,” plus up to 1.5% per annum, or the adjusted Eurodollar rate used by the lender, plus up to 3.0% per annum, at the Company’s option. As of December 31, 2006, the U.S. revolving credit facility had an outstanding balance of $64.6 million and bore interest at a weighted average interest rate of 8.44%. In addition, the Company must pay monthly in arrears a commitment fee of 0.375% per annum on the unused amount of the U.S. revolving credit facility total commitment. For letters of credit, the Company must pay 2.5% per annum on the daily outstanding balance of all issued letters of credit, plus customary fees for issuance, amendments, and processing. The Company is subject to certain covenants as to adjusted EBITDA and fixed charge coverage ratios and other customary covenants, including covenants restricting the incurrence of indebtedness, the granting of liens, the sale of assets and the declaration of dividends and other distributions on the Company’s capital stock. As of December 31, 2006, the most recent required measurement date under the agreement documentation, the Company was in compliance with these covenants. The U.S. revolving credit facility matures on April 12, 2009. Borrowings under the U.S. revolving credit facility are collateralized by a pledge of substantially all of the U.S. assets of the Company, including equity interests in its U.S. subsidiaries, but excluding its four-high steckel rolling mill and related assets, which are pledged to TIMET. The U.S. revolving credit facility is also secured by a pledge of 65% of the equity interests in each of its foreign subsidiaries.
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U.K. revolving credit facility. The Company’s U.K. subsidiary, Haynes International, Ltd., or Haynes U.K., has entered into an agreement with a U.K.-based lender providing for a $15.0 million revolving credit facility maturing on April 2, 2007. Management expects to renew or replace the U.K. revolving credit facility with one of similar availability. Haynes U.K. is required to pay interest on loans made under the U.K. revolving credit facility in an amount equal to LIBOR (as calculated in accordance with the terms of the U.K. revolving credit facility), plus 3% per annum. As of December 31, 2006, the U.K. revolving credit facility had an outstanding balance of $1.2 million and bore interest at a weighted average interest rate of 8.33%. Availability under the U.K. revolving credit facility is limited by the receivables available for sale to the lender, the net of stock and inventory and certain reserves established by the lender in accordance with the terms of the U.K. revolving credit facility. Haynes U.K. must meet certain financial covenants relating to tangible net worth and cash flow. As of December 31, 2006, the most recent measurement date required under the U.K. revolving credit facility, Haynes U.K. was in compliance with these covenants. The U.K. revolving credit facility is secured by a pledge of substantially all of the assets of Haynes U.K.
Future uses of liquidity
The Company’s primary uses of cash over the next twelve months are expected to consist of expenditures related to:
· increasing levels of working capital due to increased levels of operations and rising raw material cost;
· income tax payments, including obligations associated with the TIMET conversion agreement;
· capital spending to increase capacity, improve reliability and performance of the equipment;
· reduction of debt;
· pension plan funding; and
· interest payments on outstanding indebtedness.
Planned fiscal 2007 capital spending is targeted at $13.0 million. The main projects for fiscal 2007 include the completion of the projects already started related to the electroslag remelt equipment, rolling mills and the upgrade of the annealing equipment at the Kokomo, Indiana facility and a new pilger mill at the Arcadia, Louisiana facility. Management believes that the completion of these capital projects and the related improvements in reliability and performance of the equipment will have a positive effect on profitability and working capital management. Planned downtime is scheduled for fiscal 2007 to implement these capital improvements.
The Company is also evaluating the desirability of possible additional capital expansion projects to capitalize on current market opportunities. Additionally, acceleration of future capital spending beyond what is currently planned may occur in order to accelerate the realization of the benefits such as improved working capital management, reduced manufacturing cost and increased capacity. Consideration will also be given to potential acquisitions similar to the Branford Wire acquisition which complement the Company’s product line, reduce production costs and increase capacity.
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Contractual Obligations
The following table sets forth the Company’s contractual obligations for the periods indicated, as of December 31, 2006:
| | Payments Due by Period | |
Contractual Obligations (in thousands) | | Total | | Less than
1 year | | 1-3 Years | | 3-5 Years | | More than
5 years | |
| | | | | | | | | | | |
Debt obligations (including interest)(1) | | $ | 80,626 | | $ | 5,670 | | $ | 74,956 | | $ | — | | $ | — | |
Operating lease obligations | | 9,055 | | 3,148 | | 5,446 | | 461 | | — | |
Raw material contracts | | 81,652 | | 79,740 | | 1,912 | | — | | — | |
Mill supplies contracts | | 177 | | 177 | | — | | — | | — | |
Capital projects | | 11,945 | | 10,000 | | 1,945 | | — | | — | |
Pension plan(2) | | 5,491 | | 5,091 | | 400 | | — | | — | |
Other post-retirement benefits(3) | | 50,000 | | 5,000 | | 10,000 | | 10,000 | | 25,000 | |
Non-compete obligations(4) | | 440 | | 110 | | 220 | | 110 | | — | |
Total | | $ | 239,386 | | $ | 108,936 | | $ | 94,879 | | $ | 10,571 | | $ | 25,000 | |
(1) Interest is calculated annually using the principal balance and current interest rates as of December 31, 2006.
(2) The Company has a current funding obligation to contribute $4.6 million to the domestic pension plan and all benefit payments under the domestic pension plan will come from the plan and not the Company. The Company expects its U.K. subsidiary to contribute an additional $0.8 million in fiscal 2007 to the U.K. Pension Plan arising from an obligation in the U.K. revolving credit facility.
(3) Represents expected post-retirement benefits only.
(4) Pursuant to an escrow agreement, as of April 11, 2005, the Company established an escrow account to satisfy its obligation to make payments under a non-compete agreement entered into as part of the Branford Wire acquisition. This amount is reported as restricted cash.
At December 31, 2006, the Company also had $0.3 million outstanding under letters of credit. The letters of credit are outstanding primarily in connection with post closure environmental assurance and building lease obligations.
Critical Accounting Policies and Estimates
Overview
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to bad debts, inventories, income taxes, retirement benefits and environmental matters. The process of determining significant estimates is fact specific and takes into account factors such as historical experience, current and expected economic conditions, product mix and in some cases, actuarial techniques, and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The Company constantly reevaluates these significant factors and makes adjustments where facts and circumstances dictate. Actual results may differ from these estimates under different assumptions or conditions.
The Company’s accounting policies are more fully described in the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2006, filed by the Company with the Securities and Exchange Commission.
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Fresh Start Reporting
On March 29, 2004, the Company and certain of its U.S. subsidiaries and U.S. affiliates, filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code. As part of the Company’s Chapter 11 proceedings, it filed its plan of reorganization and related disclosure statement on May 25, 2004. The plan of reorganization was amended on June 29, 2004 and became effective on August 31, 2004. As a result of the reorganization, the Company implemented fresh start reporting in accordance with AICPA Statement of Position 90-7, or SOP 90-7, Financial Reporting by Entities in Reorganization under the Bankruptcy Code. Accordingly, the Company’s consolidated financial statements for periods subsequent to August 31, 2004 reflect a new basis of accounting and are not comparable to the historical consolidated financial statements of the Company for periods prior to August 31, 2004.
Under fresh start reporting, the reorganization value is allocated to the Company’s net assets based on their relative fair values in a manner similar to the accounting provisions applied to business combinations under Statement of Financial Accounting Standards No. 141, Business Combinations (“SFAS No. 141”). Information concerning the determination of the Company’s reorganization value is included in note 1 to the audited consolidated financial statements included in Form 10-K. The reorganization value of $200 million was greater than the fair value of the net assets acquired pursuant to the plan of reorganization. In accordance with SFAS No. 141, the reorganization value was allocated to identifiable assets and liabilities based on their fair values with the excess amount allocated to goodwill. Liabilities existing at the effective date of the plan of reorganization are stated at the present value of amounts to be paid. Deferred taxes are recorded for asset and liability basis differences between book and tax value in conformity with existing generally accepted accounting principles.
Revenue Recognition
Revenue is recognized when title passes to the customer which is generally at the time of shipment (F.O.B. shipping point) or at a foreign port for certain export customers. Allowances for sales returns are recorded as a component of net revenues in the periods in which the related sales are recognized. Management determines this allowance based on historical experience and have not had any history of returns that have exceeded recorded allowances.
Pension and Post-Retirement Benefits
The Company has defined benefit pension and post-retirement plans covering most of its current and former employees. Significant elements in determining the assets or liabilities and related income or expense for these plans are the expected return on plans assets (if any), the discount rate used to value future payment streams, expected trends in health care costs, and other actuarial assumptions. Annually, the Company evaluates the significant assumptions to be used to value its pension and post-retirement plan assets and liabilities based on current market conditions and expectations of future costs. If actual results are less favorable than those projected by management, additional expense may be required in future periods. As a result of the reorganization there were no changes to terms of these benefits.
The following table demonstrates the estimated effect of a 1% change in the following assumptions:
| | Estimated change in expense | |
Pension plan expense | | | |
1% change in discount rate | | $ | 1.5 Million | |
1% change in the return on assets assumption | | $ | 1.0 Million | |
1% change in the salary scale assumption | | $ | 1.6 Million | |
| | | |
Post-retirement medical and life insurance expense | | | |
1% change in the discount rate | | $ | 0.65 Million | |
The Company believes the expected rate of return on plan assets of 8.5% is a reasonable assumption based on its target asset allocation of 60% equity, 35% fixed income and 5% real estate. The Company’s assumption for
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expected weighted average rate of return forplan assets for equity, fixed income, and real estate are 10.25%, 5.5% and 8.5%, respectively. This position is supported through a review of investment criteria, and consideration of historical returns over a several year period.
Salaried employees hired after December 31, 2005 are not covered by the pension plan; however, they are eligible for an enhanced matching program of the defined contribution plan (401(k)).
Impairment of Long-lived Assets, Goodwill and Other Intangible Assets
The Company reviews long-lived assets for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of long-lived assets to be held and used is measured by a comparison of the carrying amount of the asset to the undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount exceeds the fair value of the asset. The Company reviews goodwill for impairment annually or more frequently if events or circumstances indicate that the carrying amount of goodwill may be impaired. Recoverability of goodwill is measured by a comparison of the carrying value to the fair value or a reporting unit in which the goodwill resides. If the carrying amount of a reporting unit exceeds its fair value, an impairment charge is recognized to the extent that the implied fair value of the reporting unit’s goodwill exceeds its carrying value. The implied fair value of goodwill is the residual fair value, if any, after allocating the fair value of the reporting unit to all of the assets (recognized and unrecognized) and all of the liabilities of the reporting unit. The fair value of reporting units is generally determined using a discounted cash flow approach. Assumptions and estimates with respect to estimated future cash flows used in the evaluation of long-lived assets and goodwill impairment are subject to a high degree of judgment and complexity. The Company reviewed goodwill and trademarks for impairment as of August 31, 2006, and concluded no impairment adjustment was necessary. No events or circumstances have occurred that would indicate the carrying value of goodwill or trademarks may be impaired since its testing date.
Share-Based Compensation
The Company has two stock option plans that authorize the granting of non-qualified stock options to certain key employees and non-employee directors for the purchase of a maximum of 1,500,000 shares of the Company’s common stock. The original option plan was adopted in 2004 pursuant to the plan of reorganization and provides the grant of options to purchase up to 1,000,000 shares of the Company’s common stock. In January 2007, the Company’s Board of Directors adopted a new option plan that provides for options to purchase up to 500,000 shares of the Company’s common stock. Unless the Compensation Committee determines otherwise, options granted under the option plans are exercisable for a period of ten years for the date of grant and vest 33 1/3% per year over three years from the grant date.
On October 1, 2005, the Company adopted SFAS No. 123 (R), Share-Based Payment, a replacement of SFAS No. 123, Accounting for Stock-Based Compensation, and a rescission of APB Opinion No. 25, Accounting for Stock Issued to Employees. The statement requires compensation costs related to share-based payment transactions to be recognized in the financial statements. This statement applies to all awards granted after the effective date and to modifications, repurchases or cancellations of existing awards. Additionally, under the modified prospective method of adoption, the Company recognizes compensation expense for the portion of outstanding awards on the adoption date for which the requisite service period has not yet been rendered based on the grant-date fair value of those awards calculated under SFAS No. 123 and 148 for pro forma disclosures. The amount of compensation cost will be measured based upon the grant date fair value. The fair value of the option grants is estimated on the date of grant using the Black-Scholes option pricing model with assumptions on dividend yield, risk-free interest rate, expected volatilities, and expected lives of the options.
Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes (“SFAS No. 109”), which requires deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between book and tax basis of recorded assets and liabilities. SFAS No. 109 also requires deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or
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all of the deferred tax assets will not be realized. The determination of whether or not a valuation allowance is needed is based upon an evaluation of both positive and negative evidence. In addition to the reorganization of the Company, the results of operations have improved due to improved market conditions as evidenced by its increasing backlog. In its evaluation of the need for a valuation allowance, the Company assesses prudent and feasible tax planning strategies. The ultimate amount of deferred tax assets realized could be different from those recorded, as influenced by potential changes in enacted tax laws and the availability of future taxable income.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the potential loss arising from adverse changes in market rates and prices. The Company is exposed to various market risks, including changes in interest rates, foreign currency exchange rates and the price of nickel, which is a commodity.
Changes in interest rates affect the Company’s interest expense on variable rate debt. All of the Company’s outstanding debt was variable rate debt at December 31, 2006. A hypothetical 10% increase in the interest rate on variable rate debt would have resulted in additional interest expense of approximately $604,000 for the three months ended December 31, 2006. The Company has not entered into any derivative instruments to hedge the effects of changes in interest rates.
The foreign currency exchange risk exists primarily because the three foreign subsidiaries maintain receivables and payables denominated in currencies other than their functional currency or the U.S. dollar. The foreign subsidiaries manage their own foreign currency exchange risk. The U.S. operations transact their foreign sales in U.S. dollars, thereby avoiding fluctuations in foreign exchange rates. Any U.S. dollar exposure aggregating more than $500,000 requires approval from the Company’s Chief Financial Officer, Vice President of Finance. Most of the currency contracts to buy U.S. dollars are with maturity dates less than six months. At December 31, 2006, the Company had no foreign currency exchange contracts outstanding.
Fluctuations in the price of nickel, the Company’s most significant raw material, subject the Company to commodity price risk. The Company manages its exposure to this market risk through internally established policies and procedures, including negotiating raw material escalators within product sales agreements, and continually monitoring and revising customer quote amounts to reflect the fluctuations in market prices for nickel. The company does not use derivative instruments to manage this market risk. The Company monitors its underlying market risk exposure from a rapid increase in nickel prices on an ongoing basis and believes that it can modify or adapt its strategies as necessary.
Item 4. Controls and Procedures
The Company has performed, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, an evaluation of the effectiveness and the design and operation of the Company’s disclosure controls and procedures (as defined by Exchange Act rules 13a-15(e) and 15d-15(e)) pursuant to Rule 13a-15(b) of the Exchange Act as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2006 in providing reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.
During the fiscal quarter ended December 31, 2006 and since the date of the Company’s most recent evaluation described above and made as of December 31, 2006, there were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls and no corrective actions with regard to significant deficiencies and material weaknesses were taken.
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