EXHIBIT 13
Brush Engineered Materials Inc.
2003
Annual Report
About The Company
Brush Engineered Materials Inc. is a global leader in high performance
engineered materials that enable customers to meet superior levels of product
strength, reliability, miniaturization and weight savings, thermal dissipation,
electrical conductivity and reflectivity.
Around the world, the Company's engineered materials can be found in
end-use products within the telecommunications and computer, automotive
electronics, optical media, industrial components, aerospace and defense, and
appliance markets.
The Company's subsidiaries are organized into two reportable segments:
the Metal Systems Group and the Microelectronics Group.
Metal Systems includes Brush Wellman Inc. (Alloy and Beryllium
Products) and Technical Materials, Inc. Brush Wellman is the only fully
integrated producer of beryllium, beryllium alloys and beryllia ceramic in the
world. Technical Materials, Inc. produces engineered material systems including
clad metals, plated metal, and electron beam welded, solder-coated and reflow
materials.
Microelectronics includes Williams Advanced Materials Inc. and
Electronic Products, which consists of Brush Ceramic Products Inc. (a wholly
owned subsidiary of Brush Wellman Inc.) and Zentrix Technologies Inc. Williams
Advanced Materials manufactures precious metal and specialty alloy products.
Brush Ceramics produces beryllia ceramic materials and Zentrix Technologies
manufactures electronic packaging and circuitry.
The Company has operating, service center and major office locations
throughout North America, Europe and Asia. The Company has 1,833 employees
worldwide. Brush Engineered Materials Inc. common stock (ticker symbol: BW) is
listed on the New York Stock Exchange.
Financial Highlights
(Dollars in millions except per share amounts) 2003 2002 2001
---- ---- ----
Sales .................................................................... $ 401.0 $ 372.8 $ 472.6
Loss before income taxes ................................................. (12.7) (25.9) (17.4)
Net loss ................................................................. (13.2) (35.6) (10.3)
Net loss per share (diluted) ............................................. (0.80) (2.15) (0.62)
Dividends per share ...................................................... - - 0.24
Shareholders' equity per share ........................................... 9.27 9.61 12.98
[PI CHART]
Revenue By Segment Revenue By Market Revenue By Geographic Area
60% Metal Systems Group 35% Telecommunications 69% Domestic
39% Microelectronics Group and Computer 31% International
1% Other 14% Automotive Electronics
13% Optical Media
11% Industrial Components
9% Aerospace and Defense
7% Appliance
11% Other
Contents
Letter to Shareholders ............................................................................................ 2
Business Unit Growth Initiatives .................................................................................. 6
Management's Discussion and Analysis .............................................................................. 14
Reports of Independent Auditors and Management .................................................................... 29
Consolidated Financial Statements ................................................................................. 30
Notes to Consolidated Financial Statements ........................................................................ 34
Selected Financial Data ........................................................................................... 52
Directors, Officers, Facilities and Subsidiaries .................................................................. 54
Corporate Data .................................................................................................... 55
1
To Our Shareholders:
[PHOTO]
I believe that 2003 was a year of significant progress for Brush
Engineered Materials, despite a continuing difficult business environment. As in
the preceding two challenging years, we remained aggressively focused on those
factors within our direct control. Since our sales peak in 2000 and the
subsequent collapse of the telecommunications and computer market, which
resulted in a nearly $200 million decline in our revenue, we have improved our
variable margins (sales less materials and direct manufacturing costs) to 42% of
sales, cut our annual overhead spending by over $40 million, reduced our
breakeven point by approximately $100 million and reduced debt each year. This
is a real credit to the organization. We are working diligently to create a
better future and continue to find ways to be more productive, more innovative
and more effective. The commitment, hard work and dedication of our employees is
making Brush a better company.
In 2003, while sales grew a modest 7.5%, or $28 million to $401
million, we were able to reduce our pre-tax loss by more than $13 million to
$12.7 million. If adjusted for the $6.0 million charge taken in the fourth
quarter related to our debt refinancing, the pre-tax loss for the year was $6.7
million. Particularly encouraging are the results of the fourth quarter when
sales grew by 19% or $16.6 million and the Company achieved breakeven on the
operating profit line, adjusted for the refinancing charge.
Since the mid-2001 downturn in the telecommunications and computer
market, we have consistently maintained that there are five keys to our
turnaround. During 2003, we again made considerable progress in each:
1. REDUCING DEBT
Our expectation was that we would reduce our debt by strong working
capital management and capital spending control. As of the end of 2003, Brush
has achieved three consecutive years of debt reduction. Total balance sheet
[BAR CHART]
PERCENT CHANGE IN SALES AND EBIT: 2003 VS. 2002
Sales 8%
EBIT 59%
LEVERAGE FROM THE OPERATING PERFORMANCE IMPROVEMENTS IS SIGNIFICANT.
[BAR CHART]
TOTAL DEBT AND OFF-BALANCE SHEET OBLIGATIONS* (MILLIONS)
2000 $209
2001 $189
2002 $153
2003 $128
*(INCLUDING KEY OFF-BALANCE SHEET MANUFACTURING EQUIPMENT AND BUILDING LEASES,
AND PRECIOUS METAL CONSIGNED INVENTORIES.)
SINCE 2000, TOTAL DEBT AND OFF-BALANCE SHEET OBLIGATIONS HAVE BEEN LOWERED BY
39% OR $81 MILLION.
2
debt plus off-balance sheet financing and precious metal consignment obligations
have been reduced by more than $80 million since the end of 2000. For 2003 the
reduction was approximately $25 million, or 16% as inventories declined by an
additional $7 million and our accounts receivables as measured by days sales
outstanding dropped to 47 days. Importantly, at the end of 2003, Brush completed
a five-year refinancing agreement that lowers costs, improves cash flow, and
provides the liquidity needed to support future growth.
2. REDUCING OVERHEAD
We targeted a $10 million per quarter reduction in overhead costs from
early 2001 levels based on lower headcount and spending for services. We
exceeded that target in each quarter of 2003, which lowered our breakeven by
$100 million. We remain committed to keeping overhead growth down.
3. IMPROVING MARGINS
I am extremely proud of the progress made by our operations, especially
throughout Alloy Products where performance has improved significantly. Using
Lean Six Sigma and other continuous improvement techniques, we have steadily
improved our operating performance company wide. In 2003 for example, Alloy
Products reduced manufacturing cycle times by 18%, improved inventory turns by
48%, raised yields by 11% and shipped 23% more pounds per employee. At Technical
Materials, Inc. (TMI), margins improved and earnings increased despite lower
sales. At Williams Advanced Materials Inc. (WAM), after considering metal
prices, operating margin increased approximately 10%. Margins also improved in
all of our other units. These are lasting improvements which will leverage our
profits in the years ahead.
[BAR CHART]
INVENTORY (MILLIONS)
2000 $115.6
2001 $109.1
2002 $ 94.3
2003 $ 87.4
INVENTORY HAS BEEN REDUCED $28 MILLION OVER THE PAST THREE YEARS.
[ACCOUNTS RECEIVABLE DAYS SALES OUTSTANDING BAR CHART]
2001 5.3 DAYS
2003 47 DAYS
WE ARE COLLECTING RECEIVABLES FASTER.
3
4. EXPANDING OUR REVENUE BASE
Given the collapse of the telecommunications and computer market, which
at its peak accounted for 50% of Brush's revenue, it was imperative to broaden
our revenue base. This is a long-term goal focused on new products as well as
new end-use and new geographic markets. Here too, we made good progress in 2003
but fell short of our goal of adding $20 million in sales in the year. Sales of
new products were closer to $12 million as field evaluations and approval times
have been longer than expected.
To highlight our progress and to demonstrate our confidence in Brush's
growth potential, we have dedicated several pages in this year's report to our
most promising growth initiatives. Among these is our $15 million contract to
supply the primary mirror material for NASA's James Webb Space Telescope.
Additionally, the Company continues to extend its international reach. For the
year, Brush's international revenue grew 19% and represented 31% of our total
sales. Demonstrating the strength of our sales and marketing team in Asia,
Alloy's revenue from the region grew by 31% in 2003.
While it has taken longer than anticipated, we remain enthusiastic
about the prospects for our new products including ToughMet(R), Alloy 390(TM),
selective plating at TMI and thin film products for magnetic and optical data
storage at Williams. In the fourth quarter, nearly 20% of Alloy's sales growth
was generated from new products and applications.
5. MARKET GROWTH
It is essential that the broader economic environment continue to
improve for Brush to fully realize the benefits of its efforts. The 19% increase
in fourth quarter revenue and the resulting improvement in our profitability
give us reason to be encouraged. With our global reach and expanded product
line, I believe we are solidly placed to capture market growth wherever it
occurs.
OTHER HIGHLIGHTS
Of all the positive achievements for 2003, I am most proud of our
talented employees for their dedication in making our facilities safe places to
work. Employees across the Company delivered a consistent year of safety
improvement, turning in the best safety results in the Company's history. In
May, the Ohio Bureau of Workers' Compensation, in cooperation with the Safety
Council of Northwest Ohio, presented Brush with its Achievement Award,
recognizing our Elmore, Ohio plant's outstanding efforts to reduce employee
workplace accidents.
QUARTERLY OVERHEAD COSTS* (MILLIONS)
[BAR CHART]
2001 $53.6
2003 $42.9
*(Including non-variable manufacturing costs plus SG&A, R&D and other. Excluding
One-time refinancing charge of $6.0 million in 2003.)
Overhead savings of more than $10 million per quarter has driven our breakeven
point down by approximately $100 million. Figures compare first quarter 2001
with 2003 quarterly average.
[BAR CHART]
Gross Margin
2002 12.9%
2003 18.2%
Steadily improving operating performance is driving margins higher.
4
We also continue to be pleased with our progress throughout the year to
find answers to the complicated medical issues associated with occupational
exposure to beryllium. Improvements in our industrial hygiene practices, based
upon what we have learned in our extensive research efforts, are demonstrating
very positive results.
Moreover, we have had substantial further progress in reducing our
litigation caseload.
This past year, two significant additions to the Board of Directors
were made. Jerry Pryor, the retired President of Van Dorn DeMag Corporation,
joined the Board in May and Bill Lawrence, the former Executive Vice President
and General Counsel for TRW, Inc., joined us in August.Charles F.Brush, III, a
distinguished director for more than 45 years, was appointed to the position of
Director Emeritus at the end of the year. We are fortunate to have a strong,
independent Board of Directors committed to high standards and excellence in all
aspects of corporate governance.
I would also like to acknowledge and thank Jack Paschall, who retired
as Williams Advanced Materials' Chairman and CEO at the end of the year, for his
outstanding leadership and contributions. During the 12 years under Jack's
direction, WAM has grown dramatically in sales and profitability and expanded
its global presence. Jack also ensured that there would be a smooth transition
in leadership and at the start of the year, Dick Sager, who joined WAM in 1989,
assumed full responsibility for Williams as President.
OUTLOOK
Economic indicators at the start of 2004 are favorable. Our key markets
appear to be improving and our incoming order rate is the strongest it has been
in over two years. I believe we have built a solid foundation and am optimistic
that the combination of our continued focus on margin improvement and product
and market development will position us well to take advantage of an improving
global economy. This in turn should result in stronger revenue growth and a
return to profitability in 2004.
As always, I thank you for your support and confidence in Brush
Engineered Materials.
/s/ GORDON D. HARNETT
- ------------------------------
GORDON D. HARNETT
CHAIRMAN, PRESIDENT AND CEO
ALLOY MANUFACTURING CYCLE TIME CUT IN HALF
[BAR CHART]
2001 100%
2002 66%
2003 55%
IN 2003, Alloy manufacturing cycle times were 45% faster than in 2001.
[BAR CHART]
INTERNATIONAL SALES (MILLIONS)
2002 $104
2003 $124
INTERNATIONAL SALES GREW 19% IN 2003.
5
M E T A L S Y S T E M S G R O U P
Alloy Products
Market by market and throughout the world, Alloy Products is growing
its customer base. We're developing innovative materials and applications to
make our customers' products work in new and better ways. And, we're applying
our global reach and lean manufacturing capabilities to ensure our place in
tomorrow's technologies.
TOUGHMET(R)
Based on its successes in rigorous end uses, our ToughMet(R)
copper-nickel-tin alloy is gaining considerable interest from several growth
markets, including heavy equipment for surface mining. Manufacturers of giant
trucks boasting payloads greater than 300 tons are turning to ToughMet(R) as the
standard bearings and bushings material. ToughMet's(R) excellent lubricity and
wear resistance provides greater equipment reliability and productivity,
benefiting both equipment makers and their customers.
For a global manufacturer of large agricultural equipment, ToughMet(R)
presented a winning solution to a costly and longstanding problem with aluminum
bronze bushings in the undercarriages of track-type tractors, eliminating claims
for the manufacturer and downtime for the user.
ToughMet(R) is also gaining favor in the growing market of oil and gas
drilling and well completions. Although high pressures, temperatures and
corrosion are punishing to other materials in deep well environments,
ToughMet(R) is providing superior performance in several critical components.
ALLOY 390(TM) - MATERIALS FOR THE NEXT GENERATION OF TECHNOLOGY
With Alloy 390(TM), our newest proprietary strip product for electronic
applications, Brush Wellman has broken through the performance barrier that has
long required materials users to select between strength and conductivity.
With these unrivaled properties, Alloy 390(TM) is gaining the interest
of makers of high power electronic devices within the computer and
telecommunications markets. Currently, it is being specified in applications
ranging from advanced burn-in and test sockets (BiTS) to input/output (I/O)
connectors, and is positioned for growth into land grid array contact
applications and power connectors - both significant volume markets.
Leveraging Strengths
[PICTURE]
Positioned for growth in the fast-paced electronics market, Alloy 390(TM) is
currently designed into advanced burn-in and test sockets (BITS), shown above,
and in input-output (I/O) connectors such as those in mobile phones (left).
6
Brush Wellman expects steady growth in the computer socket applications for
2004, with a significant increase in 2005.
Makers of handheld communications devices are also looking to Alloy
390(TM) for its potential to increase battery life and reduce charging times.
MEETING GLOBAL GROWTH FOR HIGH PERFORMANCE ALLOYS
The Alloy Products business is focused on expanding its foothold in the
high growth China and Asia/Pacific markets where consumer, personal computer and
wireless applications are key drivers to future development. Alloy's focus in
this region reinforces the solid foundations it has already established in
Europe. Sales to China increased at an annual rate of nearly 30% in 2003, while
sales to Europe were up approximately 25% in the year.
China, which is capturing a significant share of the world's electronic
products growth, is now home to Brush Wellman's newest technical marketing
office, opened in Shanghai in early 2004. This facility complements our other
technical marketing/service centers in Germany, United Kingdom, Japan, Singapore
and Hong Kong, which serve local customers with finished product stocks, value
added processing and extremely short lead times.
In the past two years, Brush Wellman has also augmented its
distribution presence with technical marketing and application engineering
centers in Korea, China, Taiwan and Italy, which support an extensive
independent distributor network of some 250 sales representatives, operating in
36 locations across 30 countries.
STREAMLINING THE WAY WE DO BUSINESS TO SUPPORT GLOBAL GROWTH
Over the past several years, Alloy Products has dramatically
transformed its manufacturing system by implementing Lean Six Sigma, Total
Predictive Maintenance and supply chain management methodologies. By reducing
manufacturing cycle times by 45% since 2001, we're responding quicker to our
customers. And, by increasing our own labor productivity significantly over the
same period, we've kept our materials cost competitive.
These capabilities allow us to offer what our customers need,
everywhere they need us to be.
ALLOY ASIA SALES GROWTH
[BAR CHART]
GROWTH IN MANUFACTURING OUTPUT BY EMPLOYEE
[BAR CHART]
to Grow the Base
Whether it's in commercial aircraft, high speed race cars, giant mining trucks
or deep sub-sea oil and gas wells, Toughmet is proving its reliability in a
variety of rugged environments. Used in equipment installed to prevent costly
blowouts in deep sea wells, this Toughmet Valve component (below) represents a
growing new application for the oil and gas market.
[LINE CHART]
TOUGHMET(R) OUTLASTS CONVENTIONAL BEARING MATERIALS
[PICTURE][LINE GRAPH]
[ ] HARDENED STEEL [ ] ALUMINUM BRONZE [ ] TOUGHMET 3 CX105
USING IDENTICAL BEARING DESIGNS IN THIS CUSTOMER TEST, THE AVERAGE SURFACE WEAR
RATE OF HARDENED STEEL IS 90 TIMES GREATER THAN THAT OF TOUGHMET(R) . TOUGHMET
ALSO WIDELY OUTPERFORMED ALUMINUM BRONZE WHICH GENERATED SURFACE WEAR RATES
SEVEN TIMES GREATER.
7
M E T A L S Y S T E M S G R O U P
Technical Materials, Inc.
TMI is stepping out from its conventional markets and developing growth
opportunities to further broaden its competitive edge.
We're leveraging our strong tradition of manufacturing excellence and
product innovation to provide new materials solutions across a more diversified
customer base.
Once primarily a producer of copper-based materials for electronics
applications, TMI now has aluminum, stainless steel, nickel alloys and exotic
refractory metals accounting for a larger share of its product offering and one
quarter of its product mix. And, increasingly, TMI products are requiring two or
more processing technologies to meet escalating performance needs of the
marketplace.
TMI'S NEW PLATING TECHNOLOGY
Engineering advances in plating technologies are helping electronic
component customers meet another significant performance hurdle: miniaturizing
components in step with the continued downsizing of cellular phones and other
portable consumer products.
As a result, the coatings for electrical connections must be placed
closer together, with ever-tighter tolerances. TMI can now cost effectively
position selectively plated stripes as close as 0.010" apart - perfect for the
challenges of miniaturization- and 10 to 20 times tighter than conventional gold
plating technology. Typical precious metal savings with this technology are in
the range of 10-15%.
GROWTH OPPORTUNITIES FOR CERDIP PRODUCTS
TMI's Cerdip material (an aluminum clad alloy) is a mature product, but
has recently been designed into new, potentially high growth applications. TMI
has developed new applications for this familiar product in Asia, including use
in imaging sensors in high tech applications such as digital cameras and
camcorders. This trend will provide an attractive growth opportunity for Cerdip
materials.
Setting the Course for New
[PICTURE]
Stove top igniter assemblies by saint-gobain rely on TMI's micro laminate
materials to provide vastly improved performance and safety over traditional
spark igniters.
[PICTURE]
GenCell Corporation is working with TMI clad materials to achieve performance
breakthroughs in polymer electrolyte (PEM) fuel cell designs. PEM technology has
tremendous potential for commercialization in a wide variety of target markets
from handheld communications devices to automotive.
[PICTURE]
New plating capabilities enable TMI to provide selectively plated stripes in
distance tolerances never before attainable - supporting downsizing of
electrical components and yielding significant precious metal savings.
8
NEW MARKETS - APPLIANCE
TMI has teamed with Saint-Gobain, the world's leading producer of
insulating materials, to develop a highly engineered composite material for the
premium hot surface appliance market. TMI's micro-laminate technology is used in
Saint-Gobain's latest proprietary stove top igniter designs.
Innovative materials solutions help these assemblies offer breakthrough
safety and performance improvements over traditional spark igniters - including
an exceedingly fast time of less than 2 seconds to temperature - for residential
and commercial gas ignition applications.
OPPORTUNITIES IN MEDICAL
TMI's cladding, electroplating and electron beam welding technologies
are also gaining ground in the high growth market for medical devices. Our
materials are increasingly being designed into pacemakers and defibrillators,
hearing aid components and state-of-the-art dosimetry materials used to detect
radiation exposure. One of our specialty clad metals is now the active element
in optically stimulated luminescence (OSL) badges worn daily by x-ray
technicians and other medical professionals.
HIGH PERFORMANCE RETAIL PRODUCT
Our technologies enable customers to achieve breakthroughs in design,
and in turn, offer new products that drive end-use demand. Working closely with
leading companies in cosmetics and skin care, for example, we're providing a
multi-gauge, dual-temper stainless steel strip for this industry's next
generation tweezers.
MATERIAL SYSTEMS FOR FUEL CELLS
We're also gearing up for one of the most anticipated technologies in
decades: fuel cells. Fuel cells are expected to penetrate everywhere energy is
used - ranging from small handheld devices to supporting entire military bases,
hospitals and, ultimately, individual homes. For TMI, this developing market
offers far-reaching potential.
At GenCell Corporation, our bi-polar plate materials are helping to
solve some difficult corrosion and electrical performance issues in polymer
electrolyte (PEM) fuel cell designs. Clad metal solutions are expected to play a
key role in overcoming some of the remaining challenges to fuel cell
commercialization. TMI is now actively developing products for all three leading
fuel cell technologies: PEM, solid oxide and molten carbonate systems.
Market Growth in Specialty Strip
[PICTURE]
In Asia, skyrocketing demand for digital cameras and photo-capable cellular
phones is driving growth in the imaging sensing technologies served by TMI's
Cerdip aluminum clad alloys.
[PICTURE]
Our specialty clad materials shown here are the active detection elements in the
latest generation dosimeter badges worn by medical professionals to monitor
radiation exposure.
[PICTURE]
9
M E T A L S Y S T E M S G R O U P
Beryllium Products
Beryllium products from Brush Wellman are helping to save lives, defend
our homeland and national security, and lead the way to new discoveries in the
outer reaches of space.
Our growing share of the aerospace and defense, and medical imaging
markets is built on unique products offering unmatched capabilities. Brush
materials meet the performance requirements of some of the most demanding end
uses imaginable.
Sales continue to increase across our product range and have been
especially strong for AlBeMet(R). Designers and specifiers increasingly rely on
this proprietary aluminum beryllium metal matrix composite for its cost savings
and ease of fabrication over competitive materials. AlBeMet(R) sales climbed to
nearly $11 million in 2003, a 40% increase over 2002 and double the 2001 level.
SNIPER XR
At nearly 20% of Beryllium Products' sales and gaining each year,
precision targeting systems for military aircraft are a key demand generator for
our metallic beryllium and AlBeMet(R). These highly accurate systems incorporate
forward-looking infrared sensing equipment (FLIRs) to provide fighter pilots
with pinpoint identification, tracking and target designation.
Lockheed Martin Corporation requires our materials for optical mirror
and housing components in its Sniper XR next generation targeting system. To
meet Lockheed's ramp-up, Brush Wellman will supply materials for approximately
60 Sniper XR FLIR units in 2004. At full production, approximately 100 of the
Sniper XR FLIRs will be produced annually.
PUSHING NEW FRONTIERS IN SPACE
Since the early days of NASA, when beryllium heat shields protected
Mercury spacecraft, materials made by Brush Wellman have had a front seat in our
nation's extraordinary exploration of space. Beryllium's unique properties --
stiffness, strength, lightweight, temperature resistance and reflectivity - are
mission-critical to NASA programs. For Beryllium Products, 2003 was a banner
year for our support of the space program.
Soaring to New Heights
[PICTURE]
The impressive feat of landing and deploying two golf cart-sized robotic rovers
on the martian surface can be credited in part to the high performance of our
AlbeMet(R) materials. The rovers' exploration tools, which also contain
AlbeMet(R) materials, have already provided evidence that life on the red planet
was once possible.
[PICTURE]
Metallic beryllium and AlbeMet materials, such as those shown here after
machining by L.A. Gauge Company, are used in the optical targeting systems of
military fighter jets.
10
Northrop Grumman Space Technology selected beryllium as the optical
system technology for NASA's $825 million James Webb Space Telescope. The
selection means approximately $17 million in sales of Brush Wellman's optical
grade beryllium over 2004 and 2005, involving $15 million in materials for the
Webb Telescope's primary mirror and the remainder for related structures. It
also allows us to contribute to one of the most significant peacetime
applications of the material.
The Webb Telescope will help scientists answer fundamental questions
about the birth and evolution of galaxies, and the size and shape of the
universe. Webb production is now underway at Brush Wellman's Elmore, Ohio
facility.
While the Webb is still years from launch, beryllium materials from
Brush Wellman are already sending back breathtaking images from the Spitzer
Space Telescope, launched by NASA in August. Most of the telescope is
constructed of Brush Wellman beryllium.
BRINGING MARS DOWN TO EARTH
If the solar system suddenly seems a little smaller following NASA's
latest landings on Mars, part of the credit goes to AlBeMet(R). More than 350
structural fittings made of AlBeMet(R) helped to protect NASA's Spirit and
Opportunity rovers on their landings, and then served again to unfold the
rovers' drive-off ramps. AlBeMet(R) parts are also used in rock exploration
tools on both rovers.
ELECTROFUSION - LIFESAVING MEDICAL APPLICATIONS
The use of beryllium transmission windows in diagnostic medical x-ray
equipment continues to drive growth in our Electrofusion Products group. With a
sales growth of 11% in 2003 - its best year ever, Electrofusion further
strengthened its position as the materials leader for this lifesaving medical
imaging application. Beryllium's high transparency to x-rays and its unique
combination of good mechanical properties and high thermal conductivity make it
a critical component in a number of diagnostic medical technologies.
[BAR CHART]
2001 $ 5.4
2002 $ 7.7
2003 $10.8
with Beryllium Products
High purity beryllium transmission windows from Electrofusion Products play an
enabling role in the effectiveness and efficiency of medical imaging components,
including this X-ray tube produced by Varian Medical Systems. Varian components
are contained within major scanners and x-ray machines throughout the medical
field.
[PICUTRE]
COURTESY OF VARIAN MEDICAL SYSTEMS
[PICUTRE]
The 6.5-meter primary mirror assembly of NASA's James Webb Space Telescope will
consist of 18 individual hexagonal mirror segments made from Brush Wellman
optical grade beryllium. The Webb Telescope will allow scientists to see 10 to
11 billion light years away.
11
M I C R O E L E C T R O N I C S G R O U P
Williams Advanced Materials
WAM is strategically positioned to capitalize on consumers' seemingly
endless appetites for smaller, smarter and more reliable information storage
devices, cellular phones, personal digital assistants (PDAs), portable computers
and digital versatile disc (DVD) technology.
Responding to these rapidly advancing - and increasingly global - high
tech innovations, our metal and metal alloy materials are satisfying the most
rigorous production requirements of today's major electronic products
manufacturers.
SEMICONDUCTORS
The need for high performing semiconductors is growing at an astounding
rate. Some 23 billion integrated circuits were produced in the final quarter of
2003, more than any quarter since 2000. And virtually every high tech device
manufactured today needs smaller, more reliable and faster components. To help
fill that need, semiconductor manufacturers depend on Williams' solid foundation
of experience in electronic packaging and wafer production materials.
Our semiconductor packaging products allow electronic components to
seamlessly function with other critical parts of a device. We are gearing up for
additional growth at the "front end" of the semiconductor industry - the silicon
semiconductor wafer market - with an offering of sputtering targets, refining
and related services. Industry wide, materials sales to this sector were
estimated at $750 million in 2003.
We're now serving 200 millimeter semiconductor wafer fabrication
facilities on a global basis and expanding into the growing 300 millimeter
copper-interconnect market.
DATA STORAGE
The proliferation of cellular phones, home digital video, electronic
games and the ability to store a lifetime collection of music on a tiny device
that fits in a pocket is driving unprecedented expansion in data storage. In
fact, industry associations predict 40%-plus growth in the production of hard
disk drives (HDD) for use outside of traditional computer platforms.
Meeting the Rising Tide
[PICTURE]
Global semiconductor makers are increasingly turning to Williams for high purity
sputtering targets that provide the metallic coatings on semiconductor wafers.
WAM is expanding its capabilities in this "front end" of the semiconductor
business with sputtering materials to serve the evolving 300 millimeter wafer
market.
12
Our expertise and technologies allow manufacturers of optical media,
HDD components and semiconductor memory devices to meet the materials challenges
of this increasingly powerful - but rapidly downsizing technology.
WAM's innovative PureCON(TM) and ME Grade(TM) line of sputtering
materials provide customers with unmatched opportunities to develop new and
higher performing target products at lower costs.
Williams' Sil-X(TM) line grew out of R&D efforts with leading producers
of one of today's hottest consumer level technologies, DVD. Disc replicators
around the world are lowering costs, improving performance and positioning
themselves for the next generation of storage solutions.
WIRELESS AND PHOTONICS
Williams' wireless and photonics technology materials are supporting
the resurging global telecommunications growth. The design technology of
wireless communication handsets, cell phones and solid-state lighting devices
continues at a relentless pace. WAM's pioneering EvaPRO(TM) thin film vacuum
evaporation materials provide the device manufacturers uniformity, reliability
and stability to perform under the toughest of environments. Time after time,
EVAPro(TM) outperforms other compound semiconductor metallization materials.
WAM's photonic technology provides a broad array of production
materials for optical components, lasers, fiber optics and electro-optics
devices of today and those eyed for the future. Microlid(TM) provides device
manufacturers a lower-cost alternative for sealing Surface Acoustical Wave (SAW)
devices in cellular phones and PDAs. Next generation optical components will
incorporate the innovative new Visi-Lid(TM) technology which provides a
hermetically sealed component and allows an optical pathway for the device to
communicate with other components.
EXTENDING OUR REACH
In early 2004, through acquisition of our minority partner's interest,
we became the sole owner of Williams Advanced Materials Taiwan Co., Ltd.,
enabling us to more fully serve the key Taiwanese markets and provide a platform
for entry into mainland China. Elsewhere in this important region, WAM operates
finishing operations in Singapore and Subic Bay, Philippines.
of Technology Growth
[PICTURE]
Williams' thin film and microelectronic packaging products are specified by high
technology manufacturing customers worldwide. A large number of the cellular
handsets produced today include materials supplied by wam.
[PICTURE]
Williams' VisiLid(TM) optical window assembly technology, as represented in this
illustration, hermetically seals microelectronic packages while creating an
optical pathway between the device and other electronics in the end product.
13
Management's Discussion and Analysis
OVERVIEW
The Company is an integrated producer of engineered materials used in a
variety of electrical, electronic, thermal and structural applications. After
achieving record sales of $563.7 million in 2000, the Company's sales declined
rapidly over the next two years mainly as a result of the collapse of the global
telecommunications and computer market. In light of the lower sales volumes,
beginning in 2001, the Company implemented various programs to sustain and
improve cash flow and to position the Company to return to profitability by
broadening its market base, increasing margins, controlling costs, improving
working capital utilization and reducing debt.
Sales rebounded in 2003, growing $28.2 million over 2002, due in part
to the Company's efforts to broaden its revenue base by developing new products
and expanding its market penetration. Gross margin in turn grew over $25.0
million in 2003 while the operating loss was reduced by $13.5 million. This
leverage resulted from a combination of an improved product mix (i.e., an
increase in sales of higher margin products), manufacturing efficiencies, cost
control and other factors. The manufacturing efficiencies helped to improve the
margin contribution rate and the manpower and other cost saving initiatives
initially implemented beginning in mid-2001 reduced the 2003 manufacturing
overhead by $25.8 million from the 2001 level. Selling, general and
administrative expenses and research and development expenses in 2003 were down
an additional $8.6 million from the annual expense two years earlier. Cost
control programs continued during 2003 and manpower levels by year-end 2003 were
27% lower than the peak level in 2001.
Working capital utilization improved through a $6.9 million reduction
in inventories in 2003 after a $14.8 million reduction in 2002. Buffer
inventories have been deployed to allow for faster customer response times and
inventory turns have increased over this time period as well. The accounts
receivable balance increased in 2003 due to the higher sales, but the average
collection period was shorter than at the end of the prior year.
The working capital, margin and cost improvements allowed the Company
to reduce its total outstanding debt, key leases and other off-balance sheet
obligations by $24.8 million in 2003 and $36.2 million in 2002. In addition,
late in the fourth quarter 2003, the Company refinanced its debt on a long-term
basis. The new structure provides increased borrowing capacity and extended
maturity dates while lowering the projected financing costs and required cash
payments in 2004.
RESULTS OF OPERATIONS
(Millions, except for share data) 2003 2002 2001
-------- -------- --------
Net sales ............................. $ 401.0 $ 372.8 $ 472.6
Operating loss......................... (9.3) (22.8) (14.1)
E.P.S.................................. (0.80) (2.15) (0.62)
Sales of $401.0 million in 2003 grew 8% over sales of $372.8 million in
2002 after having declined 21% in 2002 from sales in 2001. Approximately half of
the sales increase in 2003 was due to higher precious metal prices and favorable
foreign currency translation effect. For the year, domestic sales grew 3% and
international sales grew 19% as the Company aggressively pursued marketing
opportunities overseas. Sales in each quarter of 2003 were higher than the
comparable quarter in 2002. The lower sales in 2002 as compared to 2001 were
caused mainly by the significant decline in demand from the telecommunications
and computer market that began in the second quarter 2001 and continued
throughout that year. Demand for isolated applications from this key market,
which accounted for 35% of sales in 2003, compared to 30% of sales in 2002 and
42% of sales in 2001, increased in the early portion of 2003 while the overall
market demand started to show some improvement in the fourth quarter. Sales into
the automotive market, after improving slightly in 2002 over 2001, declined
slightly in 2003. Sales for defense applications remained strong during this
time period, as did sales into the optical media and magnetic head markets.
Demand from other key markets, including industrial components and plastic
tooling, remained weak through the majority of 2003, although certain sectors
started to improve at the end of the year. A portion of the sales growth in 2003
was attributable to market share gains and new product development. Sales from
both reportable segments - the Metal Systems Group and the Microelectronics
Group (MEG) - improved in 2003 after declining in 2002.
The sales order backlog entering 2004 was $65.5 million compared to
$57.7 million at the beginning of 2003 and $91.1 million at the beginning of
2002. Sales order entry rates improved in the fourth quarter 2003 and early in
2004. Lead times continued to be very short and the Company has made
improvements in its manufacturing processes and inventory positions to more
quickly respond to customers' needs.
The gross margin of $73.0 million was 18% of sales in 2003 compared to
a gross margin of $47.9 million and 13% of sales in 2002 and $68.0 million and
14% of sales in 2001. Approximately 89% of the sales increase in 2003 flowed
through to gross margin. In addition to the increased margin contribution due to
the higher sales, gross margin improved due to a favorable
14
product mix, operational improvements on the manufacturing floor, foreign
currency translation benefits and manufacturing overhead cost reductions.
Margins from both segments improved in 2003 over 2002. The decline in gross
margin in 2002 from 2001 was caused by the significant decline in sales volumes
offset in part by a favorable product mix and a reduction in manufacturing
overhead and inventory valuation adjustments.
Selling, general and administrative expenses (SG&A) were $68.8 million
(17% of sales) in 2003, $61.3 million in 2002 (16% of sales) and $75.3 million
(16% of sales) in 2001. Differences in the amounts charged or credited to
expense from movements in the legal reserves and insurance recovery accounts
caused $4.2 million of the increase in 2003 over 2002 and $6.3 million of the
decrease in 2002 from 2001. The Company negotiated legal settlements on various
cases involving chronic beryllium disease (CBD) while other cases were dismissed
in 2003 and 2002. In addition, the Company has also received several favorable
court rulings on its litigation during the last two years. As a result of a
court ruling in 2002, the Company increased the recovery portion on insured
legal claims that previously were subject to apportionment. Changes in the legal
reserve and insurance recoverable charged to SG&A expense were limited to $0.2
million in 2003 while in 2002 changes in the legal reserve and recoverable
accounts generated a credit (i.e., reduction to expense) of $4.0 million. In
2001, the comparable expense was $2.3 million.
In addition to the impact of the legal reserve and recoverable
accounts, SG&A expenses were higher in 2003 than 2002 due to an increase in
incentive compensation expense, as a result of operational improvements
implemented in the year, and an increase in costs under the company-owned life
insurance program, while the weaker dollar caused a $1.2 million increase in the
translated value of the international subsidiaries' expenses. SG&A expenses in
2003 also included $0.6 million of the $6.0 million one-time charge associated
with refinancing the debt in 2003 (as further explained under the Refinancing
section). SG&A manpower and other activity levels remained relatively unchanged
in 2003 as compared to the latter half of 2002. Cost saving initiatives and
manpower reductions (net of severance costs) implemented in the second half of
2001 and in 2002 in response to the decrease in sales volume also served to
reduce SG&A expenses in 2002 as compared to 2001. Offsetting a portion of these
savings in 2002 was an increase in incentive compensation expense as several
operating units achieved their objectives.
Research and development expenses (R&D) were $4.2 million in 2003, $4.3
million in 2002 and $6.3 million in 2001. R&D expenses were approximately 1% of
sales in each of the three years. Overall R&D spending was reduced during the
latter half of 2001 as part of the cost reduction initiatives and spending has
remained essentially unchanged since that time. Approximately two-thirds of the
R&D spending supports the Metal Systems Group and one-third supports the MEG.
Other-net expense was $9.3 million in 2003, $5.2 million in 2002 and
$0.4 million in 2001 as the expense in both 2003 and 2002 included significant
one-time items. The 2003 expense included $4.7 million of the $6.0 million
refinancing charge as more fully described in the Refinancing section. In 2002,
the Company recorded asset impairment charges of $4.4 million in accordance with
SFAS No. 144 that are described in further detail in the segment disclosures and
Note C to the Consolidated Financial Statements. In addition to the difference
in these two charges, other-net expense was higher in 2003 due to a combination
of other factors. Foreign exchange losses totaled $0.9 million in 2003 compared
to gains of $1.5 million in 2002 with the difference attributable to the decline
in the dollar's average value versus the euro, yen and pound sterling in 2003
compared to 2002. The unrealized valuation of the stock-based directors'
compensation plan was a $2.0 million swing between years. The valuation, and
therefore, the liability to the Company, is based upon the number of shares
outstanding and the current stock price; in 2003, the Company recorded an
expense of $0.9 million due to the increase in the share price of the Company's
stock while in 2002 the Company recorded income of $1.1 million due to the
decline in the share price that year. Metal financing fees were $0.6 million
lower in 2003 than in 2002, due to a decline in financed inventory on hand,
while the bad debt expense as well as changes in the allowance for doubtful
accounts was $0.3 million higher in 2003 than in 2002.
In addition to the asset impairment charge, other-net expense was
higher in 2002 than in 2001 as a result of a $0.8 million decline in exchange
gains in 2002 compared to 2001, which was offset in part by lower metal
financing fees and the elimination of goodwill amortization due to the adoption
of SFAS No. 142 in 2002. Other-net also includes amortization of intangible
assets, gain or loss on the disposal of fixed assets, cash discounts and other
non-operating income and expense items.
The operating loss was $9.3 million in 2003, a $13.5 million
improvement over the $22.8 million loss in 2002. The operating loss was $14.1
million in 2001.
Interest expense was $3.4 million in 2003 compared to $3.0 million in
2002 and $3.3 million in 2001. Balance sheet debt increased by over $50.0
million due to the purchase of previously leased assets as part of the fourth
quarter 2003 refinancing and resulted in an increase in interest expense of
approximately $0.4 million. Prior to the refinancing, average debt levels were
lower in 2003 than in 2002 and the effective interest rate was slightly higher.
The 2002 expense was lower
15
Management's Discussion and Analysis
than 2001 due to a lower average debt level and a lower effective interest rate.
Offsetting a portion of these benefits in 2002 was a $0.5 million decline in
interest capitalized in association with long-term capital projects from 2001.
The loss before income taxes was $12.7 million in 2003, a $13.2 million
improvement over 2002. The improvement resulted from the margin contribution on
the increase in sales, an increase in margin contribution rate and continued
manufacturing overhead control offset in part by higher SG&A expenses and the
impact of the one-time charges. The 2002 loss before income taxes of $25.9
million as compared to $17.4 million in 2001 resulted primarily from the lower
margins due to the significant drop in sales volumes, partially offset by
overhead cost reductions.
The 2003 income tax expense of $0.6 million included a favorable tax
provision of $4.7 million and a deferred tax valuation allowance of $5.3 million
while the 2002 expense of $9.7 million included a favorable provision of $10.2
million and a deferred tax valuation allowance of $19.9 million. The 2001 tax
benefit was $7.1 million. A valuation allowance was not required for 2001.
Prior to the recognition of the valuation allowances, tax benefit rates
of 37.3%, 39.4% and 40.9% were applied against the loss before income taxes to
calculate the favorable tax provisions in 2003, 2002 and 2001, respectively. The
effects of percentage depletion and foreign source income were the major causes
of the differences between the effective and statutory rates for all three
years. The relative impact of percentage depletion and the company-owned life
insurance program were the main differences between the 2003 and 2002 effective
rates.
The deferred tax valuation allowances were recorded in 2003 and 2002 in
accordance with SFAS No. 109, "Accounting for Income Taxes". This statement
requires a company to evaluate its deferred tax assets on its balance sheet for
impairment in the event of recent operating losses. This evaluation process is
not based upon the specific expiration date of the individual deferrals but
rather on the company's ability to demonstrate taxable income that will result
in utilization of those assets. As a result of a review in the fourth quarter
2002, the Company determined that the majority of its deferred tax assets were
impaired and a valuation allowance was recorded with $19.9 million charged
against expense and $7.3 million to other comprehensive income within
shareholders' equity. In 2003, the $5.3 million valuation allowance offset the
deferred tax assets that were created by the current year domestic federal and
various foreign tax benefits. The 2003 net tax expense of $0.6 million,
therefore, represents the provision for state, local and certain other foreign
taxes, which were not subject to a valuation allowance. An additional $1.9
million valuation allowance was charged against other comprehensive income in
2003 for deferred tax assets associated with the net charge to equity for the
change in derivative fair values and the accrued pension liability. See Note I
to the Consolidated Financial Statements.
As a result of the preceding, the net loss was $13.2 million, or $0.80
per share, in 2003 compared to $35.6 million, or $2.15 per share, in 2002 and
$10.3 million, or $0.62 per share, in 2001.
SEGMENT DISCLOSURES
The Company aggregates its businesses into two reportable segments -
the Metal Systems Group and the Microelectronics Group. The parent company and
other corporate expenses, as well as the operating results from BEM Services,
Inc. and Brush Resources Inc., two wholly owned subsidiaries, are not included
in either segment and are shown in the "All Other" column in the segment results
contained in Note M to the Consolidated Financial Statements. BEM Services
charges a management fee for the services it provides, primarily corporate,
administrative and financial oversight, to the other businesses within the
Company on a cost-plus basis. Brush Resources sells beryllium hydroxide,
produced through its Utah operations, to outside customers and to businesses
within the Metal Systems Group. The profitability within All Other declined in
2003 as compared to 2002 as a result of the $6.0 million one-time charge
associated with the debt refinancing, the $4.2 million difference in movements
in the legal reserve, the increase in the company-owned life insurance expense
and reduced profitability of Brush Resources primarily due to lower production
activity.
METAL SYSTEMS GROUP
(Millions) 2003 2002 2001
-------- -------- --------
Net sales.............................. $ 239.4 $ 227.9 $ 295.7
Operating loss......................... (16.6) (37.7) (20.1)
The Metal Systems Group is the larger of the Company's reportable
segments, accounting for approximately 60% of total sales and almost 70% of
total assets. The group consists of Alloy Products, Technical Materials, Inc.
(TMI), a wholly owned subsidiary of the Company, and Beryllium Products. These
units manufacture a variety of engineered materials that provide superior
performance in demanding applications and compete against beryllium and
non-beryllium-containing alloys. The Elmore, Ohio facility manufactures finished
goods for Alloy Products and Beryllium Products as well as materials for further
processing and sale by other operations within Alloy, Beryllium and TMI.
Customers typically use the Company's materials as their raw material input and
are also usually one or more tiers removed from the end-use demand generator in
a given market. After declining significantly in each of the last two
16
years, primarily as a result of softness in the telecommunications and computer
market, sales grew 5% in 2003 over 2002. Sales to external customers by business
unit within the Metal Systems Group during the 2001 to 2003 time frame were as
follows:
(Millions) 2003 2002 2001
------- -------- --------
Alloy Products......................... $ 162.3 $ 151.9 $ 217.5
Technical Materials, Inc............... 41.9 44.4 50.5
Beryllium Products..................... 35.2 31.6 27.7
-------- -------- --------
Total Segment Sales.................. $ 239.4 $ 227.9 $ 295.7
======== ======== ========
ALLOY PRODUCTS
Alloy Products, the largest unit within the Company, manufactures and
sells copper and nickel-based alloy systems, the majority of which also contain
beryllium, and consists of two major product families - strip and bulk products.
Strip products, which include thin gauge precision strip and thin diameter rod
and wire, provide a combination of high conductivity, high reliability and
formability for use as connectors, contacts, switches, relays and shielding.
Major markets for strip products include telecommunications and computer,
automotive electronics and appliances. Bulk products include plate, rod, bar,
tube and other customized forms that, depending upon the application, may
provide superior strength, corrosion or wear resistance or thermal conductivity.
Applications for bulk products include plastic mold tooling, bearings, bushings,
welding rods and telecommunications housing equipment. Alloy Products are
manufactured at the Company's facilities in Ohio and Pennsylvania and are
distributed worldwide through a network of Company-owned service centers and
outside distributors and agents.
Alloy Products' sales of $162.3 million improved 7% over sales in 2002
while sales of $151.9 million in 2002 were 30% lower than sales in 2001. The
improvement in sales in 2003 was due to strip products as sales of bulk products
declined during 2003. The strip sales growth was caused by an increase in demand
for the higher beryllium-containing and, therefore, higher priced alloys.
Underlying volumes of these products improved 22% in 2003 over 2002. Sales of
thin diameter rod and wire products also showed double-digit growth in 2003.
Bulk sales volumes were 9% lower in 2003 than in 2002.
The Alloy Products' sales growth in 2003 was in the international
markets as domestic sales declined slightly. A portion of this international
growth is due to domestic customers shifting manufacturing operations overseas,
particularly to Asia. Alloy recently established additional sales and marketing
offices in China to augment its existing service centers in Japan and Singapore
in order to maintain and grow sales applications in the region. The sales growth
also resulted from an increase in market share and the development of various
new products. Demand from the telecommunications and computer market was
unchanged for the first three quarters of 2003 and then showed some improvements
in the fourth quarter. Demand for strip products from the automotive market
remained sluggish in 2003. The lower bulk products sales was caused in part by
soft demand from the plastic tooling market for the majority of the year
(although demand started to improve in the fourth quarter), while demand from
the industrial components market declined during 2003. The increased demand from
the telecommunications and computer and plastic tooling markets continued into
early 2004. Orders for new products, including the non-beryllium-containing
ToughMet(R) alloy used in bearing applications in heavy equipment, also showed
improvement in late 2003 and early 2004.
Sales of strip and bulk products both declined significantly in 2002 as
compared to 2001. Strip volumes were down 17% and bulk volumes were down 33%.
The lower sales were due in large part to the precipitous decline in demand from
the telecommunications and computer market that began in the second quarter
2001. Automotive sales of strip products were essentially unchanged in 2002 as
compared to 2001. Bulk sales into the undersea telecommunications market, which
was the largest market segment for bulk products as recently as 2000, began to
decline in the second half of 2001 and were minimal in 2002 due to the severe
reduction in the number of new undersea fiber optic line installation projects
throughout the world. Bulk product sales for plastic tooling applications also
declined in 2002 due in part to customers adjusting their inventory positions.
TECHNICAL MATERIALS, INC.
TMI manufactures engineered materials systems, including clad inlay and
overlay metals, precious and base metal electroplated systems, electron beam
welded systems, contour profiled systems and solder-coated metal systems. These
specialty strip metal products provide a variety of thermal, electrical or
mechanical properties from a surface area or particular section of the material.
Major markets for TMI products include telecommunications and computer and
automotive electronics while major applications include connectors, contacts and
semiconductors.
TMI sales were $41.9 million in 2003, $44.4 million in 2002 and $50.5
million in 2001. The lower sales in each of the last two years were due to the
continued soft demand from the telecommunications and computer market.
Automotive sales, which had been relatively unchanged in the prior two years,
also softened during the third and fourth quarters of 2003. However, overall
sales order entry rates improved in the fourth quarter 2003 over the first nine
months of the year and this trend continued into early 2004.
17
Management's Discussion and Analysis
Production capacity within the markets served by TMI continued to be
transferred from the U.S. to Asia and TMI has aggressively managed its marketing
efforts and manufacturing and overhead cost structure in order to profitably
position itself to maintain and grow its base business while expanding into new
applications and markets. As a result, TMI's profits increased in 2003 over 2002
despite the 6% decline in sales.
BERYLLIUM PRODUCTS
Beryllium Products manufactures pure beryllium and beryllium aluminum
alloys in rod, tube, sheet and a variety of customized forms at the Elmore, Ohio
and Fremont, California facilities. These materials are used in applications
that require high stiffness and/or low density and they tend to be premium
priced due to their unique combination of properties. Defense and
government-related applications remain the largest market for Beryllium
Products, accounting for approximately two-thirds of sales, while other markets
served include automotive, electronics, medical and optical scanning.
Revenues from Beryllium Products were $35.2 million in 2003, $31.6
million in 2002 and $27.7 million in 2001. Revenues from Beryllium Products have
grown for four consecutive years, including annual growth rates of 11% and 14%
in 2003 and 2002, respectively. Sales for defense and government-related
applications remained strong throughout this period. Several system upgrades for
F-16 fighter jets and the new F-22 fighter are two of the largest platforms for
Beryllium Products. Sales to the electronics market for acoustic components
increased in 2003 over 2002 and represent a commercial growth opportunity for
Beryllium Products. Acoustic component sales had declined in 2002 due to
customers' excess inventory positions. Performance automotive sales contributed
to the sales growth in 2003 and 2002 as well; however, management is uncertain
as to the growth prospects for this market in the coming year. In the third
quarter 2003, the Company secured a material supply contract for NASA's James
Webb Space Telescope program that is anticipated to generate an additional $15.0
million in revenue, the majority of which should be invoiced in the 2004 to 2005
time frame.
METAL SYSTEMS GROSS MARGIN AND EXPENSES
The gross margin on Metal System sales was $39.5 million (16% of sales)
in 2003 compared to $18.0 million (8% of sales) in 2002. The increased sales
volume improved the margin contribution by $2.8 million in 2003 as compared to
2002. A favorable product mix, operational improvements and a favorable currency
effect increased margins by $12.1 million. The favorable mix resulted primarily
from strip products,although TMI and Beryllium Products had mix shifts due to
higher margin generating products as well. Operational improvements were made at
the Elmore, Ohio facility, including yield and machine utilization rates, and at
the TMI facility in Lincoln, Rhode Island, including yields and cost controls.
Manufacturing overhead costs and inventory valuation adjustments were $6.6
million lower in 2003 than in 2002, with the majority of savings coming from
manpower, supplies and services at the Elmore facility.
The 2002 gross margin of $18.0 million was $21.1 million lower than the
gross margin in 2001. The margin contribution decline due to the lower sales
volume in 2002 totaled $30.7 million. An unfavorable product mix, primarily from
Alloy Products, combined with a slightly unfavorable currency and copper impact,
reduced margins by an additional $6.3 million. Mitigating the impact of these
negative factors on margins was a reduction in manufacturing overhead expense
and inventory valuation adjustments of $15.9 million. Overhead costs were
reduced at all of the Metal Systems Group's manufacturing facilities in response
to the lower sales volume. This decrease in overhead in 2002 was net of a $4.7
million increase in rent expense from the off-balance sheet operating lease that
was subsequently refinanced in December 2003.
SG&A, R&D and other-net expenses were $0.5 million higher in 2003 than
in 2002 as a result of the foreign currency exchange gain/loss difference and an
increase to incentive compensation accruals. SG&A and R&D manpower levels were
relatively unchanged for the year. The $0.5 million increase was net of the
impact of a one-time asset impairment charge in 2002. The Company determined
that the projected cash flow from various assets used in the production of
beryllium was less than the carrying value. The assets were written down to
their net realizable values and a $3.1 million charge was recorded against
other-net expense in the fourth quarter 2002. The equipment has been shut down
due to the use of alternative input materials and manufacturing processes.
Expenses in 2002 were $3.5 million lower than 2001 as manpower and other cost
savings initiatives reduced expenses by $6.6 million in 2002 compared to the
prior year, the benefit of which was offset in part by the impairment charge.
The Metal Systems Group recorded an operating loss of $16.6 million, a
$21.1 million improvement over the $37.7 million loss in 2002. The improvement
was caused by the additional margin generated by the higher sales, favorable
mix, operational efficiencies and manufacturing overhead cost reductions. In
2001, the Metal Systems Group lost $20.1 million.
18
MICROELECTRONICS GROUP
(Millions) 2003 2002 2001
-------- -------- --------
Net sales.............................. $ 157.3 $ 139.2 $ 169.6
Operating profit....................... 12.6 3.8 4.6
The Microelectronics Group (MEG) includes Williams Advanced Materials
Inc. (WAM), a wholly owned subsidiary, and Electronic Products. These businesses
manufacture a variety of high quality precision parts that are sold to
assemblers and other fabricators of electronic components and equipment. Sales
grew 13% in 2003 over 2002 after declining 18% in 2002 from 2001. Operating
profit improved by $8.8 million in 2003. Sales to external customers by business
unit within the MEG during the 2001 to 2003 time frame were as follows:
(Millions) 2003 2002 2001
-------- -------- --------
Williams Advanced Materials Inc........ $ 127.8 $ 109.1 $ 135.3
Electronic Products.................... 29.5 30.1 34.3
-------- -------- --------
Total segment sales................. $ 157.3 $ 139.2 $ 169.6
======== ======== ========
WILLIAMS ADVANCED MATERIALS INC.
WAM manufactures precious, non-precious and specialty metal products at
its facilities in New York, California and Asia. Specific products include vapor
deposition targets, frame lid assemblies, clad and precious metal preforms, high
temperature braze materials and ultra fine wire. Major markets for WAM's
products include optical media, magnetic head, electron tube, performance film
and the wireless, semiconductor, photonic and hybrid segments of the
microelectronics market.
Sales from WAM were $127.8 million in 2003, $109.1 million in 2002 and
$135.3 million in 2001. WAM adjusts its selling prices daily to reflect the
current cost of the precious and non-precious metals sold. The cost of the metal
is a pass-through to the customer and WAM generates its margin on its
fabrication efforts irrespective of the type or cost of the metal used in a
given application. Therefore, the cost and mix of metals sold will affect sales
but not necessarily the margins generated by those sales. Metal prices increased
on average in 2003 over 2002 and the underlying volumes grew 7% compared to a
17% growth in sales. In 2002, a mix shift to lower priced metals as compared to
2001 caused the majority of the decrease in sales, as volumes were only 2% lower
than the prior year.
Sales of vapor deposition targets grew in 2003 from the 2002 level
driven by the continued strong end-use demand from the optical media market for
digital versatile disks. Demand for targets from the photonics and other
segments of the microelectronics market, which was soft and caused a slight
overall decline in target sales in 2002, started to improve in the latter part
of 2003. Sales of various products into the wireless segment demonstrated
improvement in 2003 over 2002. Demand for data storage applications for giant
magnetic resistive thin film applications remained strong throughout the 2001 to
2003 time period. Frame lid assembly sales grew in 2003 and in 2002 as a result
of acquiring various assets of competitors who exited the market in the second
quarter 2001 and the second quarter 2003.
Due to the precious metal content of many of its products, WAM's
customers continuously evaluate alternative lower cost materials and systems and
WAM faces stiff competition from other material providers. WAM strives to
develop new alloys and products that satisfy its customers' quality, cost and
service objectives. A key competitive advantage for WAM is its ability to
reclaim precious metals, from its own or customers' scrap, through its in-house
refinery. WAM also emphasizes new product and application development in order
to keep pace with technological advancements.
ELECTRONIC PRODUCTS
Electronic Products manufactures beryllia ceramics, electronic packages
and circuitry for sale into the telecommunications and computer, medical,
electronics, automotive and defense markets. These products provide specific
thermal and/or electrical conductivity characteristics and are used as
components in a variety of applications, including wireless telecommunications
equipment, fiber optics, lasers for medical and other electronic equipment,
automotive ignition module systems, satellites and radar systems. Electronic
Products are manufactured by Zentrix Technologies Inc. and Brush Ceramic
Products, two wholly owned subsidiaries. Sales from Electronic Products were
$29.5 million in 2003 compared to $30.1 million in 2002 and $34.3 million in
2001.
Sales of beryllia ceramics were essentially unchanged in 2003 compared
to 2002 after declining in 2002. This is a mature product line with established
applications but limited growth opportunities. A temporary disruption in the
sales order pattern from the largest ceramics customer during a plant relocation
offset mild improvements during 2003. Sales order entry levels for ceramics
strengthened in the fourth quarter 2003. Softer demand from the
telecommunications and computer market caused the lower sales of ceramics in
2002 as compared to 2001. Sales of electronic packages also declined in each of
the last two years due to the slowdown in build rates for telecommunications
infrastructure equipment. Sales into the automotive market declined in 2003
after growing in 2002 over 2001. Sales of circuitry, which are manufactured by
Circuits Processing Technology, Inc., a wholly owned subsidiary of Zentrix,
increased in 2003 due to strengthening defense orders after declining in 2002
due to softer demand for commercial applications.
19
Management's Discussion and Analysis
MEG GROSS MARGIN AND EXPENSES
The gross margin on MEG sales was $32.8 million, or 21% of sales, in
2003, compared to $26.4 million, or 19% of sales, in 2002 and $25.6 million, or
15% of sales, in 2001. The margin contribution in 2003 improved by $3.3 million
as a result of the increased sales. The product mix effect, as well as
operational efficiencies (primarily in Electronic Products), generated an
additional $1.6 million in gross margin while manufacturing overhead costs and
inventory adjustments were $1.4 million lower in 2003 than in 2002. The $0.8
million margin improvement in 2002 over 2001 resulted from an $8.1 million
favorable mix effect, primarily from WAM, combining with a $3.1 million
reduction in manufacturing overhead and inventory valuation adjustments to more
than offset the reduction in margin contribution from the lower sales volume.
SG&A, R&D and other-net expenses were $2.4 million lower in 2003 than
in 2002 in part due to one-time charges of $1.9 million recorded in 2002.
Management determined that the projected cash flow from various assets used by
Electronic Products was less than the carrying value. A charge of $1.3 million
was recorded in other-net expense to write down the assets to their fair value
as determined by an outside appraisal. See Note C to the Consolidated Financial
Statements. Expenses in 2002 also included severance costs of $0.6 million as
the Company restructured the management of Electronic Products, eliminating
various positions and closing two small foreign offices. In addition, expenses
were lower in 2003 due to the full-year benefit of the manpower reductions made
in 2002. The precious metal financing fee was lower in 2003 than in 2002 as
well. Offsetting a portion of these benefits were increased costs to support the
WAM sales growth and higher incentive accruals. Expenses were $1.6 million
higher in 2002 than in 2001. In addition to the $1.9 million one-time items,
WAM's SG&A and R&D expenses grew in 2002 over 2001 while the precious metal
financing fee declined by $0.7 million.
The MEG operating profit was $12.6 million, or 8% of sales, in 2003
compared to $3.8 million, or 3% of sales, in 2002. Improved margins and lower
expenses combined to generate the profit improvement. Operating profit for the
MEG was $4.6 million, or 3% of sales, in 2001.
INTERNATIONAL SALES AND OPERATIONS
(Millions) 2003 2002 2001
-------- -------- --------
From international operations.......... $ 89.0 $ 71.8 $ 86.8
Exports from U.S. operations........... 35.4 32.5 47.5
-------- -------- --------
Total international sales.............. $ 124.4 $ 104.3 $ 134.3
======== ======== ========
Percent of total net sales............. 31% 28% 28%
The international sales presented in the preceding table are included
in the Metal Systems Group and MEG sales figures previously discussed. The
majority of international sales are to the Pacific Rim, Europe and Canada. Sales
to the Pacific Rim and Europe showed strong growth in 2003 resulting from a
combination of additional market penetration, the relocation of U.S. production
to overseas locations, increased market share and a favorable currency exchange
effect. Sales into each major region were lower in 2002 than in 2001 with
European sales accounting for over 60% of the total fall off.
International operations include service centers in Germany, England,
Japan and Singapore that primarily focus on the distribution of alloy products
while providing additional local support to various other businesses within the
Company. WAM has finishing operations in Singapore and the Philippines and a
small joint venture that was established in Taiwan in 2003. The Company also has
branch sales offices in the Republic of China and in Taiwan as well as an
established network of independent distributors and agents.
As is the case domestically, telecommunications and computer and
automotive electronics are the largest international markets for the Company's
products. Defense applications are not as prevalent overseas while the appliance
market for Alloy Products is a more significant market, primarily in Europe,
than it is domestically. The Company's market share is smaller in the overseas
markets than it is domestically and given the macro-economic growth potential
for the international economies, the international markets may present greater
long-term growth opportunities for the Company.
Sales from the international operations are typically denominated in
the local currency, particularly in Europe and Japan. Exports from the U.S. and
sales from the Singapore operations are predominately denominated in U.S.
dollars. Movements in the foreign currency exchange rates will affect the
reported translated value of foreign currency-denominated sales while local
competition limits the Company's ability to adjust selling prices upwards to
compensate for short-term unfavorable exchange rate movements. The dollar was
weaker against the euro, yen and sterling over the course of 2003 compared to
2002, resulting in a favorable translation impact on sales of $6.4 million. The
dollar was slightly stronger in 2002 than in 2001, resulting in an unfavorable
translation impact on sales of $1.1 million in 2002. The Company has a hedge
program with the objective of minimizing the impact of fluctuating currency
values on its reported results.
20
LEGAL PROCEEDINGS
One of the Company's subsidiaries, Brush Wellman Inc., is a defendant
in proceedings in various state and federal courts brought by plaintiffs
alleging that they have contracted CBD or other lung conditions as a result of
exposure to beryllium. Plaintiffs in beryllium cases seek recovery under
theories of intentional tort and various other legal theories and seek
compensatory and punitive damages, in many cases of an unspecified sum. Spouses,
if any, claim loss of consortium.
The following table summarizes the associated activity with beryllium
cases. Settlement payment and dismissal for a single case may not occur in the
same period.
December 31,
2003 2002 2001
-------- -------- --------
Total cases pending.................... 15 33 76
Total plaintiffs (including spouses)... 33 70 193
Number of claims (plaintiffs) filed
during period ended.................. 11(22) 2(4) 19(37)
Number of claims (plaintiffs) settled
during period ended.................. 24(47) 34(107) 2(3)
Aggregate cost of settlements during
period ended (dollars in thousands).. $ 2,045 $ 4,945 $ 570
Number of claims (plaintiffs)
otherwise dismissed.................. 5(12) 11(20) 12(31)
Number of claims (plaintiffs)
voluntarily withdrawn................ 0(0) 0(0) 0(2)
The 2003 data includes five claims that were settled and dismissed late
in the fourth quarter 2003, with the settlement payments of $0.9 million
scheduled to be made in early 2004. Additional beryllium claims may arise.
Management believes that the Company has substantial defenses in these cases and
intends to contest the suits vigorously. Employee cases, in which plaintiffs
have a high burden of proof, have historically involved relatively small losses
to the Company. Third-party plaintiffs (typically employees of customers or
contractors) face a lower burden of proof than do employees or former employees,
but these cases are generally covered by varying levels of insurance. A reserve
was recorded for beryllium litigation of $2.9 million at December 31, 2003 and
$4.2 million at December 31, 2002. A receivable was recorded of $3.2 million at
December 31, 2003 and $4.9 million at December 31, 2002 from the Company's
insurance carriers as recoveries for insured claims.
Although it is not possible to predict the outcome of the litigation
pending against the Company and its subsidiaries, the Company provides for costs
related to these matters when a loss is probable and the amount is reasonably
estimable. Litigation is subject to many uncertainties, and it is possible that
some of these actions could be decided unfavorably in amounts exceeding the
Company's reserves. An unfavorable outcome or settlement of a pending beryllium
case or additional adverse media coverage could encourage the commencement of
additional similar litigation. The Company is unable to estimate its potential
exposure to unasserted claims.
While the Company is unable to predict the outcome of the current or
future beryllium proceedings, based upon currently known facts and assuming
collectibility of insurance, the Company does not believe that resolution of
these proceedings will have a material adverse effect on the financial condition
or the cash flow of the Company. However, the Company's results of operations
could be materially affected by unfavorable results in one or more of these
cases. As of December 31, 2003, two purported class actions were pending.
Standards for exposure to beryllium are under review by the United
States Occupational Safety and Health Administration, and by private
standard-setting organizations. One result of these reviews might be more
stringent worker safety standards. More stringent standards may affect buying
decisions by the users of beryllium-containing products. If the standards are
made more stringent or the Company's customers decide to reduce their use of
beryllium-containing products, the Company's operating results, liquidity and
capital resources could be materially adversely affected. The extent of the
adverse effect would depend on the nature and extent of the changes to the
standards, the cost and ability to meet the new standards, the extent of any
reduction in customer use and other factors that cannot be estimated.
FINANCIAL POSITION
WORKING CAPITAL
Cash flow from operations totaled $26.3 million in 2003 as
depreciation, other non-cash items and changes in working capital items more
than offset the net loss of $13.2 million. Cash flow from operations in 2003 was
a $10.6 million improvement over the $15.7 million generated in 2002. The cash
balance was $5.1 million at December 31, 2003, an increase of $0.7 million for
the year, as the balance of the cash generated from operations was used to
reduce debt and fund capital expenditures.
The accounts receivable balance was $55.1 million at year-end 2003, an
increase of $7.6 million from year-end 2002. The increase is largely due to the
higher sales in the fourth quarter 2003 relative to the fourth quarter 2002 as
the days sales outstanding (DSO), a measure of how quickly receivables are
collected, improved one day. The DSO improved despite an increase in
international sales, which typically take longer to collect. Accounts receivable
declined in 2002 as a result of lower sales and a five-day improvement in the
DSO.
21
Management's Discussion and Analysis
Inventories declined $6.9 million in 2003 to $87.4 million after
declining $14.8 million in 2002 as the Company continued to improve its
manufacturing efficiencies and inventory utilization in order to improve
customer response time and lower its working capital investment. The reduction
in inventories in 2002 was net of a $6.0 million increase due to the termination
of an off-balance sheet copper financing arrangement in the fourth quarter 2002.
Total Metal Systems Group inventory was down 12% on a first-in, first-out (FIFO)
valuation basis in 2003. Each unit within the Metal Systems Group lowered its
inventories in 2003, with Alloy Products responsible for the largest decline.
Alloy inventory pounds declined 15% during the year and were down 50% from their
peak levels in 2001. FIFO inventories within the MEG increased 13% as WAM's
inventories increased in order to support the higher sales volumes and as a
result of higher precious metal prices. Brush Resources also increased its
inventory, as ore was mined in excess of current production requirements in
order to extract the ore from the existing pits within the allowable safety time
frame. Overall inventory turns as of the fourth quarter 2003 improved over the
fourth quarter 2002. The majority of the inventory reduction in 2002 was in the
Metal Systems Group as MEG inventories declined only slightly.
Prepaid expenses declined during 2003 mainly due to the collection of a
$3.8 million federal income tax refund. The accounts payable balance was $0.9
million higher at year-end 2003 than at year-end 2002 due to higher activity
levels. Other liabilities and accruals increased $7.0 million as a result of
higher incentive compensation accruals, a change in the fair value of derivative
financial instruments, higher interest accruals and other miscellaneous items.
Other long-term liabilities of $14.7 million at December 31, 2003 were $2.8
million lower than at December 31, 2002 due to reductions in the legal reserves
and changes in the long-term portion of the fair value of derivatives. The
Company paid $1.2 million in 2003 for legal settlements, primarily for CBD
cases, and received $1.6 million from its insurance carriers as partial
reimbursement for the insured portions of claims paid in the current and prior
years. In 2002, the Company paid $4.9 million in settlements and recovered $2.3
million from its insurance carriers.
DEPRECIATION AND AMORTIZATION
Depreciation, amortization and depletion was $19.5 million in 2003 and
$20.4 million in 2002. The lower expense in 2003 resulted from the reduced level
of capital spending. Amortization of deferred mine development was $1.2 million
in 2003 and $0.3 million in 2002. Mine development costs are amortized based
upon the units-of-production method as ore is extracted from the pits.
CAPITAL EXPENDITURES
Capital expenditures for property, plant and equipment and mine
development totaled $6.3 million in 2003 compared to $5.4 million in 2002.
Spending by the Metal Systems Group totaled $2.8 million in 2003 and $1.9
million in 2002, while the MEG spending totaled $2.9 million in 2003 and $2.4
million in 2002. The majority of the spending was on small infrastructure and
other individual projects as in general the Company had sufficient production
capacity to meet the level of demand in 2003. The MEG spending included the
acquisition of various assets used to manufacture frame lid assemblies from a
competitor who exited the market. In addition to the $6.3 million of spending,
as part of the December 2003 refinancing, the Company purchased $51.8 million of
assets previously held under an operating lease that have been in use at the
Elmore facility since 1998 by the Metal Systems Group. Management anticipates
that capital expenditures should increase in 2004 over the $6.3 million spent in
2003, but will still be below the level of depreciation.
PENSION LIABILITY
SFAS No. 87, "Employers' Accounting for Pensions", requires the
recognition of a minimum pension liability if the present value of the
accumulated benefit obligation is greater than the market value of the pension
assets at year end. The market value of the Company's pension assets in its
domestic defined benefits plan was $85.8 million while the present value of the
accumulated benefit obligation was $95.4 million as of December 31, 2003. The
Company, therefore, reduced its minimum pension liability to $9.6 million (in
other long-term liabilities) by adjusting the intangible pension asset by $0.6
million in other assets and recording a pre-tax credit of $1.0 million against
other comprehensive income, a component of shareholders' equity, in the fourth
quarter 2003. The 2003 pension expense, which had increased the minimum
liability, was $1.6 million. The Company had initially recorded a $13.6 million
charge against other comprehensive income in the fourth quarter 2002 to adjust
the carrying value of the recognized pension asset and to establish a minimum
pension liability of $9.6 million based upon an asset market value of $78.1
million and an accumulated benefit obligation of $87.7 million at December 31,
2002. During 2003, the fair value of the pension assets increased as the
investment earnings exceeded the plan payouts and expenses by $7.7 million while
the accumulated benefit obligation increased a similar amount due to a lower
discount rate, an additional year of service earned and other actuarial
assumptions.
22
REFINANCING
The Company refinanced its debt on a long-term basis with the
completion of new debt facilities totaling $147.5 million in the fourth quarter
2003. The new financing includes an $85.0 million revolving line of credit
secured by the Company's working capital, $20.0 million of term loans secured by
real estate and machinery and equipment and a $7.5 million facility secured by
certain export accounts receivable. The remaining $35.0 million consists of a
subordinated term loan that is secured by a second lien on the Company's working
capital, real estate and machinery and equipment and is payable at the end of
five years. All of the new debt is variable rate based upon spreads over LIBOR
or prime. The new debt provides additional capacity to fund the Company's growth
and provides stability through extension of maturity dates. See Note E to the
Consolidated Financial Statements.
Proceeds from the refinancing were used to retire the existing
revolving credit agreement that was scheduled to mature in April 2004 and to
purchase $51.8 million of leased assets, thereby terminating an existing
off-balance sheet lease obligation. The leased assets have been used at the
Elmore facility in the manufacture of Alloy strip products since 1998. The $51.8
million purchase price was the notional value of the lease at the time of the
purchase, and therefore, while the balance sheet debt increased by $51.8 million
as result of this transaction, the Company's total obligations, as defined by
debt plus off-balance sheet obligations, were unchanged.
The refinancing increases the Company's liquidity and available credit
lines and the Company anticipates the related expense and repayments in 2004
will be lower than the projected expense and payments under the prior debt and
lease structure. Lease payments to be expensed against cost of sales under the
terminated lease would have been $10.4 million in 2004. Under the new structure,
this expense has been eliminated and replaced by approximately $4.0 million of
depreciation expense on the purchased assets. Therefore, cost of sales will be
$6.4 million lower and gross margin will be $6.4 million higher in 2004 than it
would have been under the prior financing arrangement. The margin improvement
will flow through the Metal Systems Group. This benefit will be partially offset
by an increase in the amortization of deferred financing fees and higher
interest costs due to the increase in debt and changes in the interest rate
structure. Based upon the interest rates and debt levels at the time of the
refinancing, the increase in these costs are estimated to be $5.0 million in
2004 and, therefore, management estimates that earnings before income taxes in
2004 will improve by $1.4 million as a result of the refinancing. In addition,
the increased interest payments plus the required debt repayments in 2004 are
estimated to be $5.2 million lower than the 2004 lease payment would have been.
As a result of the refinancing, the Company recorded a $6.0 million
one-time charge in the fourth quarter 2003 to write off deferred costs
associated with the prior financing arrangement and to record derivative
ineffectiveness on an associated interest rate swap. The Company has an interest
rate swap that initially was designated as a hedge of the equipment operating
lease payments. With the termination of the lease, the swap no longer qualified
for hedge accounting and the $4.6 million unfavorable fair value at the time of
the refinancing that previously was deferred into other comprehensive income on
the Consolidated Balance Sheet was charged against the other-net expense on the
Consolidated Income Statements. The Company kept this swap in place, as its cash
flows will serve to hedge a portion of the outstanding variable rate debt even
though the swap does not technically qualify for hedge accounting. See Note G to
the Consolidated Financial Statements. An additional $0.1 million was recorded
against other-net expense for other deferred costs while $0.7 million was
recorded against cost of sales and $0.6 million against SG&A expense as part of
the $6.0 million charge.
Debt issuance costs associated with the December 2003 refinancing
totaling $6.2 million were deferred and included in other assets on the
Consolidated Balance Sheet. The issuance costs included $4.6 million of cash
payments and $1.6 million representing the fair value of warrants to purchase
115,000 shares of Company common stock and are being amortized using the
effective interest method over the life of the debt.
DEBT AND OFF-BALANCE SHEET OBLIGATIONS
Total debt on the balance sheet was $99.1 million as of December 31,
2003 compared to $63.5 million as of December 31, 2002. The $35.6 million
increase resulted from the $51.8 million purchase of the leased assets and the
retirement of an existing off-balance sheet obligation as part of the
refinancing partially offset by a $15.8 million reduction paid by cash flow from
operations. Short-term debt totaled $13.4 million at year-end 2003 and included
$2.1 million borrowed under the new revolving credit agreement, $9.7 million of
gold-denominated debt and $0.1 million of foreign currency-denominated debt. The
gold loan is designed as a hedge against gold inventory. Short-term debt also
includes $1.5 million of the current portion of long-term debt obligations. In
addition to the new long-term debt obtained in the fourth quarter, the Company
also had an $8.3 million variable rate industrial development bond, a $3.0
million variable rate demand note and a $0.9 million promissory note outstanding
at December 31, 2003. The Company was in compliance with all of its debt
covenants as of December 31, 2003.
23
Management's Discussion and Analysis
In addition to the $99.1 million of balance sheet debt, the Company has
an off-balance sheet operating lease with a notional value of $14.4 million that
finances a building at the Elmore facility. Annual payments under this lease are
$2.3 million. See Note F to the Consolidated Financial Statements for further
leasing details.
The Company maintains a portion of its precious metal inventories on a
consignment basis in order to reduce its price exposure. See "Market Risk
Disclosures". The notional value of this inventory was $11.5 million at December
31, 2003 and $15.6 million at December 31, 2002. The value of the consigned
precious metals declined during 2003 due to inventory reduction efforts and
changes in the product mix. The impact of the decrease in quantity on hand was
offset in part by higher prices at year-end 2003 than at year-end 2002. Since
third parties own the consigned precious metal, its cost is not reflected in the
total inventory on the Company's balance sheet. The Company maintained an
off-balance sheet financing arrangement with a bank for a portion of its
copper-based inventories until it was terminated in the fourth quarter 2002. The
Company purchased the copper inventory for $6.0 million from the bank and added
it into its balance sheet inventory as the Company determined it was more cost
effective to finance these inventories with traditional balance sheet debt.
A summary of contractual payments under long-term debt agreements,
operating leases and material purchase commitments by year is as follows:
Payments Due In
--------------------------------------------------------------
There-
(Millions) Total 2004 2005 2006 2007 2008 after
------- ------ ------ ------ ------ ------- ------
Long-term debt
repayments................ $ 87.2 $ 1.5 $ 3.5 $ 3.5 $ 3.5 $ 65.6 $ 9.6
Elmore building
lease payments............ 18.6 2.3 2.3 2.3 2.3 2.3 7.1
Other operating
lease payments............ 10.5 2.7 1.9 1.3 1.0 1.0 2.6
------- ------ ------ ------ ------ ------- ------
Subtotal
non-cancelable
leases.................... 29.1 5.0 4.2 3.6 3.3 3.3 9.7
Purchase
obligations............... 47.7 12.0 11.8 11.9 12.0 - -
------- ------ ------ ------ ------ ------- ------
Total...................... $ 164.0 $ 18.5 $ 19.5 $ 19.0 $ 18.8 $ 68.9 $ 19.3
======= ====== ====== ====== ====== ======= ======
The new revolving credit agreement, the $35.0 million subordinated loan
and the $20.0 million term loans mature in 2008. Management anticipates that new
debt agreements will be negotiated prior to the maturation of these agreements
in 2008, as warranted. Quarterly installments against the term loans begin in
2004 while annual repayments are also required to be made against other portions
of the Company's long-term debt in each of the next five years. See Note E to
the Consolidated Financial Statements for additional debt information. The lease
payments represent payments under non-cancelable leases with initial lease terms
in excess of one year as of December 31, 2003. See Note F to the Consolidated
Financial Statements. The purchase obligations include $0.3 million for capital
equipment to be acquired in 2004. The balance of the obligations are for raw
materials to be acquired under long-term supply agreements. These commitments
end in 2007, although the Company has the opportunity to negotiate an extension
for one of the agreements. See Note L to the Consolidated Financial Statements.
OTHER
Management believes that cash flow from operations plus the available
borrowing capacity are adequate to support operating requirements, capital
expenditures, projected pension plan contributions and remediation projects. The
refinanced debt structure provides improved stability in terms of maturity dates
and improved flexibility in terms of available credit and covenant structures.
The Company's cost control and working capital management efforts have allowed
cash flow from operations to remain positive despite the operating losses the
last three years, while the capital expenditure limitations and the elimination
of the regular dividend in the third quarter 2001 have further helped to reduce
cash outlays. The Company's current debt-to-equity ratio, recent operating
losses or other financial measures may limit the ability to raise debt financing
in excess of the existing revolving credit agreement and other established
lines. However, availability under existing unused lines of credit totaled $36.9
million as of December 31, 2003.
The Company attempts to maintain cash balances at a minimum with any
excess cash used to reduce overnight or other short-term borrowings. Cash
balances, if any, are invested in high quality, highly liquid investments.
ENVIRONMENTAL
The Company has an active program of environmental compliance. The
Company estimates the probable cost of identified environmental remediation
projects and establishes reserves accordingly. The environmental remediation
reserve balance was $6.9 million at December 31, 2003 and $7.7 million at
December 31, 2002. The reserve was reduced in 2003 for changes in the estimated
cost for various projects based on analyses of the projected required
remediation effort and payments for current activity. See Note L to the
Consolidated Financial Statements.
24
ORE RESERVES
The Company's reserves of beryllium-bearing bertrandite ore are located
in Juab County, Utah. An ongoing drilling program has generally added to proven
reserves. Proven reserves are the measured quantities of ore commercially
recoverable through the open pit method. Probable reserves are the estimated
quantities of ore known to exist, principally at greater depths, but prospects
for commercial recovery are indeterminable. Ore dilution that occurs during
mining is approximately seven percent. Approximately 87% of beryllium in ore is
recovered in the extraction process. The Company augments its proven reserves of
bertrandite ore through the purchase of imported beryl ore (approximately 4%
beryllium), which is also processed at the Utah extraction facility.
The Company uses computer models to estimate ore reserves, which are
subject to economic and physical evaluation. Development drilling can also
affect the total ore reserves to some degree. The requirement that reserves pass
an economic test causes open-pit mineable ore to be found in both proven and
probable geologic settings. Proven reserves decreased slightly and probable
reserves were unchanged in 2003 while proven reserves decreased and probable
reserves increased in 2002. As of 2001, the Company owns, as opposed to leases,
approximately 95% of the proven reserves. Based upon average production levels
in recent years, proven reserves would last approximately 100 years. Ore
reserves classified as possible are excluded from the following table.
2003 2002 2001 2000 1999
------- ------- -------- -------- --------
Proven bertrandite ore
reserves at year end
(thousands of dry tons)..... 6,687 6,730 7,270 7,690 7,769
Grade % beryllium............. 0.267% 0.267% 0.268% 0.263% 0.265%
Probable bertrandite ore
reserves at year end
(thousands of dry tons)..... 3,519 3,519 3,081 3,166 3,081
Grade % beryllium............. 0.232% 0.232% 0.219% 0.217% 0.215%
Bertrandite ore processed
(thousands of
dry tons, diluted).......... 41 40 48 84 93
Grade % beryllium, diluted.... 0.224% 0.217% 0.224% 0.235% 0.240%
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements requires the inherent use of
estimates and management's judgment in establishing those estimates. The
following are the most significant accounting policies used by the Company that
rely upon management's judgment.
ACCRUED LIABILITIES. The Company has various accruals on its balance
sheet that are based in part upon management's judgment, including accruals for
litigation, environmental remediation and workers' compensation costs. The
Company establishes accrual balances at the best estimate determined by a review
of the available facts and trends by management and independent advisors and
specialists as appropriate. Absent a best estimate, the accrual is established
at the low end of the estimated reasonable range in accordance with SFAS No. 5,
"Accounting for Contingencies". Accruals are only established for identified
and/or asserted claims; future claims, therefore, could give rise to increases
to the accruals. The accruals are adjusted as the facts and circumstances
change. The accruals may also be adjusted for changes in the Company's
strategies or regulatory requirements. Since these accruals are estimates, the
ultimate resolution may be greater or less than the established accrual balance
for a variety of reasons, including court decisions, additional discovery,
inflation levels, cost control efforts and resolution of similar cases. Changes
to the accruals would then result in an additional charge or credit to income.
See Note L to the Consolidated Financial Statements.
The accrued legal liability only includes the estimated indemnity cost,
if any, to resolve the claim through a settlement or court verdict. The legal
defense costs are not included in the accrual and are expensed in the period
incurred, with the level of expense in a given year affected by the number and
types of claims the Company is actively defending. Certain legal claims are
subject to partial or complete insurance recovery. The accrued liability is
recorded at the gross amount of the estimated cost and the insurance
recoverable, if any, is recorded as a separate asset and is not netted against
the liability.
PENSIONS. The Company has a defined benefit pension plan that covers a
large portion of its current and former domestic employees. The Company accounts
for this plan in accordance with SFAS No. 87, "Employers' Accounting for
Pensions". Under Statement No. 87, the carrying values of the associated assets
and liabilities are determined on an actuarial basis using numerous actuarial
and financial assumptions. Differences between the assumptions and current
period actual results may be deferred into the net pension asset value and
amortized against future income under established guidelines. The deferral
process generally reduces the volatility of the recognized net pension asset or
liability and current period income or expense. The actuaries adjust their
assumptions to reflect changes in demographics and other factors, including
mortality rates and employee turnover, as warranted. The Company periodically
reviews other key assumptions, including the expected return on plan assets, the
discount rate and the average wage rate increase, against actual results, trends
and industry standards and makes adjustments accordingly. These adjustments may
then lead to a higher or lower expense in a future period.
25
Management's Discussion and Analysis
The Company maintained its expected long-term rate of return on plan
assets assumption at 9.0% as of December 31, 2003, unchanged from the previous
year end. While the Company's pension assets earned well in excess of 9.0% in
2003, the plan under performed this level for several years prior to 2003.
However, the Company's long-term experience indicates that a 9.0% return is
reasonable. The Company's pension plan investment strategies are governed by a
policy adopted by the Retirement Plan Review Committee of the Board of
Directors. The future return on pension assets is dependent upon the plan's
asset allocation, which changes from time to time, and the performance of the
underlying investments. Should the assets earn an average return less than 9.0%
over time, in all likelihood the future pension expense would increase.
Investment earnings in excess of 9.0% would tend to reduce the future expense.
The Company establishes the discount rate used to determine the present value of
the projected and accumulated benefit obligation at the end of each year based
upon the available market rates for high quality, fixed income investments. An
increase to the discount rate would reduce the future pension expense and,
conversely, a lower discount rate would raise the future pension expense. As of
December 31, 2003, the Company elected to use a discount rate of 6.375% compared
to a rate of 6.75% as of December 31, 2002. The Company estimates that the
change in the discount rate and other actuarial assumptions and valuations
combined with the amortization of prior differences between actual and expected
results will result in a $1.0 million increase in the net expense from its
qualified pension plan in 2004 over 2003 with the 2005 expense estimated to be
an additional $1.1 million higher than the 2004 expense. If the expected rate of
return assumption was changed by 50 basis points (0.50%) and all other pension
assumptions remained constant, the 2004 projected expense would change by
approximately $0.5 million. If the December 31, 2003 discount rate were reduced
by 25 basis points (0.25%) and all other pension assumptions remained constant,
the 2004 pension expense would increase by approximately an additional $0.3
million.
The $9.6 million additional minimum pension liability recorded as of
December 31, 2003 does not by itself indicate that a cash contribution to the
plan is required. This liability was recorded according to SFAS No. 87, while
cash contributions and funding requirements are governed by ERISA and IRS
guidelines. Based upon these guidelines and current assumptions and estimates,
the Company anticipates that a cash contribution to the pension plan of
approximately $1.7 million may be required in 2004. The inter-relationship of
the many factors affecting the plan assets and liabilities makes it difficult to
project contributions beyond one year out; however, a contribution may be
required in 2005 that is greater than the 2004 projected contribution. The
minimum pension liability under SFAS No. 87 will be recalculated at the
measurement date (December 31 of each year) and any adjustments to this account
and other comprehensive income within shareholders' equity will be recorded at
that time accordingly. See Note K to the Consolidated Financial Statements for
additional details on the Company's pension plan.
LIFO INVENTORY. The prices of certain major raw materials, including
copper, nickel, gold, silver and other precious metals purchased by the Company,
fluctuate during a given year. Such changes in costs are generally reflected in
selling price adjustments. The prices of labor and other factors of production
generally increase with inflation. Additions to capacity, while more expensive
over time usually result in greater productivity or improved yields. However,
market factors, alternative materials and competitive pricing affect the
Company's ability to offset wage, benefit and other cost increases. Therefore,
the Company uses the last-in, first-out (LIFO) method for costing the majority
of its domestic inventories. Under the LIFO method, inflationary cost increases
are charged against the current cost of goods sold in order to more closely
match the cost with revenue. The carrying value of the inventory is based upon
older costs and as a result, the LIFO cost of the inventory on the balance sheet
is typically lower than it would be under most alternative costing methods. The
LIFO impact on the income statement in a given year is dependent upon the
inflation rate effect on raw material purchases and manufacturing conversion
costs, the level of purchases in a given year and the inventory mix and balance.
In 2003, the average inflation rate was low and the Company reduced its
inventories. As a result, LIFO inventory layers were liquidated that reduced
cost of sales by $3.6 million in 2003. However, the cost of various raw
materials, including copper and nickel, increased near the end of the fourth
quarter 2003 and prices continued to rise in the early portion of 2004.
DEFERRED TAX ASSETS. The Company records deferred tax assets and
liabilities in accordance with SFAS No. 109, "Accounting For Income Taxes". The
deferrals are determined based upon the temporary difference between the
financial reporting and tax bases of assets and liabilities. The Company reviews
the expiration dates of the deferrals against projected income levels to
determine if the deferral will or can be realized. If it is determined that it
is not probable a deferral will be realized, a valuation allowance would be
established for that item. Certain deferrals, including the alternative minimum
tax credit, do not have an expiration date. See Note I to the Consolidated
Financial Statements for additional deferred tax details.
In addition to reviewing the deferred tax assets against their
expiration dates, the Company evaluated its deferred tax assets for impairment
due to the recent operating losses, as
26
previously described, and recorded valuation allowances of $7.2 million in 2003,
with $5.3 million charged to expense and $1.9 million charged to other
comprehensive income, and $27.2 million in 2002, with $19.9 million charged to
expense and $7.3 million charged to other comprehensive income. Should the
Company generate a domestic pre-tax profit in subsequent periods, the valuation
allowance will be reversed against the current period domestic federal tax
expense, resulting in higher net income and net income per share for that
period. Once the Company establishes a trend of consistent actual and projected
positive earnings, significant portions or all of the remaining valuation
allowance may be reversed back to income. Should the Company generate domestic
pre-tax losses in subsequent periods, a domestic federal tax benefit will not be
recorded and the valuation allowance recorded against the net deferred tax
assets will increase. This will result in a larger net loss and net loss per
share for that period versus a comparable period when a favorable tax benefit
was recorded. The Company will continue to record tax provisions or benefits as
appropriate for state and local taxes and various foreign taxes regardless of
the status of this valuation allowance.
DERIVATIVES. The Company may use derivative financial instruments to
hedge its foreign currency, commodity price and interest rate exposures. The
Company applies hedge accounting when an effective hedge relationship can be
documented and maintained. If a hedge is deemed effective, changes in its fair
value are recorded in other comprehensive income until the underlying hedged
item matures. If a hedge does not qualify as effective, changes in its fair
value are recorded against income in the current period. The Company secures
derivatives with the intention of hedging existing or forecasted transactions
only and does not engage in speculative trading or holding derivatives for
investment purposes. The Company's annual budget and quarterly forecasts serve
as the basis for determining forecasted transactions. The use of derivatives is
governed by policies established by the Board of Directors. The level of
derivatives outstanding may be limited by the availability of credit from
financial institutions. See Note G to the Consolidated Financial Statements and
the "Market Risk Disclosures" section in this Management's Discussion and
Analysis for more information on the Company's derivatives.
MARKET RISK DISCLOSURES
The Company is exposed to precious metal and commodity price, interest
rate and foreign exchange rate differences. While the degree of exposure varies
from year to year, the Company's methods and policies designed to manage these
exposures have remained fairly consistent. The Company attempts to minimize the
effects of these exposures through a combination of natural hedges and the use
of derivatives. The Company's use of derivatives is governed by policies adopted
by the Board of Directors.
The Company uses gold and other precious metals in manufacturing
various MEG and Metal Systems products. To reduce the exposure to market price
changes, precious metals are maintained on a consigned inventory basis. The
metal is purchased out of consignment when it is ready to ship to a customer as
a finished product. The Company's purchase price forms the basis for the price
charged to the customer for the precious metal content and, therefore, the
current cost is matched to the selling price and the price exposure is
minimized. The Company maintains a certain amount of gold in its own inventory,
which is typically balanced out by having a loan denominated in gold for the
same number of ounces. Any change in the market price of gold, either higher or
lower, will result in an equal change in the fair value of the asset and
liability recorded on the balance sheet.
The Company is charged a consignment fee by the financial institutions
that actually own the precious metals. This fee, along with the interest charged
on the gold-denominated loan, is partially a function of the market price of the
metal. Because of market forces and competition, the fee, but not the interest
on the loan, can be charged to customers on a case-by-case basis. To further
limit price and financing rate exposures, under some circumstances the Company
will require customers to furnish their own metal for processing. This practice
is used more frequently when the rates are high and/or more volatile. Should the
market price of precious metals used by the Company increase by 15% from the
prices on December 31, 2003, the additional pre-tax cost to the Company on an
annual basis would be approximately $0.2 million. This calculation assumes no
changes in the quantity of inventory or the underlying fee and interest rates
and that none of the additional fee is charged to customers.
The Company also uses base metals, primarily copper, in its production
processes. Fluctuations in the market price of copper are passed on to customers
in the form of price adders or reductions for the majority of the copper sales
volumes. However, when the Company cannot pass through the price of copper,
margins can be reduced by increases in the market price of copper. To hedge this
exposure, the Company may enter into copper swaps with financial institutions
that exchange a variable price of copper for a fixed price. By so doing, the
difference between the Company's purchase price and selling price of copper will
be a known, fixed value for the quantities covered by the swaps. The Company did
not have any copper swaps outstanding as of December 31, 2003, in part due to
credit constraints. The notional value of the outstanding copper swaps was $1.8
million as of December 31, 2002.
27
Management's Discussion and Analysis
The Company is exposed to changes in interest rates on its debt and
cash. This interest rate exposure is managed by maintaining a combination of
short-term and long-term debt and variable and fixed rate instruments. The
Company also uses interest rate swaps to fix the interest rate on variable debt
obligations, as it deems appropriate. Excess cash, if any, is typically invested
in high quality instruments that mature in seven days or less. The Company had
$95.2 million in variable rate debt and variable-to-fixed interest rate swaps
with a notional value of $55.9 million outstanding at December 31, 2003. If
interest rates were to increase 200 basis points (2.0%) from the December 31,
2003 rates and assuming no changes in debt or cash from the December 31, 2003
levels, the additional annual net expense would be $0.8 million on a pre-tax
basis. The calculation excludes any additional expense on fixed rate debt that
upon maturity may or may not be extended at the prevailing interest rates.
The Company's international operations sell products priced in foreign
currencies, mainly the euro, yen and sterling, while the majority of these
products' costs are incurred in U.S. dollars. The Company is exposed to currency
movements in that if the U.S. dollar strengthens, the translated value of the
foreign currency sale and the resulting margin on that sale will be reduced. The
Company typically cannot increase the price of its products for short-term
exchange rate movements because of its local competition. To minimize this
exposure, the Company may purchase foreign currency forward contracts, options
and collars. Should the dollar strengthen, the decline in the translated value
of the margins should be offset by a gain on the contract. A decrease in the
value of the dollar would result in larger margins but potentially a loss on the
contract, depending upon the method used to hedge the exposure. The notional
value of the outstanding currency contracts was $39.8 million as of December 31,
2003 compared to $26.4 million as of December 31, 2002. If the dollar weakened
10% against all currencies from the December 31, 2003 exchange rates, the
increased loss on the outstanding contracts as of December 31, 2003 would reduce
pre-tax profits by approximately $4.5 million. This calculation does not take
into account the increase in margins as a result of translating foreign currency
sales at the more favorable exchange rate, any changes in margins from potential
volume fluctuations caused by currency movements or the translation effects on
any other foreign currency-denominated income statement or balance sheet item.
The Company records the fair values of derivatives on its balance sheet
in accordance with SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" and SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities". The fair values are determined by
financial institutions and represent the market price for the instrument between
two willing parties as of the balance sheet dates. Changes in the fair value of
outstanding derivatives are recorded in equity or against income as appropriate
under the statement guidelines. The fair value of the outstanding foreign
currency contracts was a liability of $2.9 million at December 31, 2003,
indicating that the average hedge rates were unfavorable compared to the actual
year-end market exchange rates. The fair value of the interest rate swaps was a
loss of $5.3 million as the available interest rates were lower than the rates
fixed under the swap contracts. The net derivative loss recorded in other
comprehensive income within shareholders' equity was $3.2 million as of December
31, 2003 compared to $7.8 million at December 31, 2002.
OUTLOOK
Shipment and sales order trends entering 2004 were positive. Key
markets for the Company's products, including telecommunications and computer
and plastic tooling, showed signs of improvement while other markets, including
defense and optical media, remained strong. Shipments for the new James Webb
Space Telescope have begun and this will add to the expected revenue growth in
2004. New products from Alloy, TMI and WAM offer realistic opportunities for
further growth in 2004. The Company also plans on increasing its international
presence in 2004 in efforts to continue to position itself to capture
applications in the rapidly changing and growing international markets.
The Company remains committed to cost control and improving operational
efficiencies. The margin improvements generated in 2003 demonstrated the
leverage to be gained through increasing yields, optimizing machinery and
inventory utilization and various cost control programs. The principles of Lean
Six Sigma will continue to be used to help drive further improvements in margins
and working capital in 2004.
Improved profitability combined with working capital management should
help to reduce debt in 2004. In addition, the refinanced debt brings stability
to the Company's capital structure and provides the borrowing capacity to
support the Company's growth.
The Company made additional progress on its CBD litigation in 2003,
reducing the number of outstanding claims without a material impact on cash
flows or financial position. The Company is encouraged by this progress but
cautions that it is difficult to predict the outcome of the remaining claims or
the probability and the potential impact of future claims. The progress made
thus far is a testament to the Company's health and safety measures and its
investment in worker protection, education and medical research.
28
Reports of Independent Auditors and Management
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders Brush
Engineered Materials Inc.
We have audited the accompanying Consolidated Balance Sheets of Brush
Engineered Materials Inc. and subsidiaries as of December 31, 2003 and 2002, and
the related Consolidated Statements of Income, Shareholders' Equity, and Cash
Flows for each of the three years in the period ended December 31, 2003. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Brush
Engineered Materials Inc. and subsidiaries at December 31, 2003 and 2002, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 2003 in conformity with
accounting principles generally accepted in the United States.
/s/ Ernst & Young LLP
---------------------
Cleveland, Ohio
January 28, 2004
REPORT OF MANAGEMENT
The management of Brush Engineered Materials Inc. is responsible for
the contents of the financial statements, which are prepared in conformity with
generally accepted accounting principles. The financial statements necessarily
include amounts based on judgments and estimates. Financial information
elsewhere in the annual report is consistent with that in the financial
statements.
The Company maintains a comprehensive accounting system, which includes
controls designed to provide reasonable assurance as to the integrity and
reliability of the financial records and the protection of assets. However,
there are inherent limitations in the effectiveness of any system of internal
controls and, therefore, it provides only reasonable assurance with respect to
financial statement preparation. An internal audit staff is employed to
regularly test and evaluate both internal accounting controls and operating
procedures, including compliance with the Company's Statement of Policy
regarding ethical and lawful conduct. The role of the independent auditors is to
provide an objective review of the financial statements and the underlying
transactions in accordance with generally accepted auditing standards.
The Audit Committee of the Board of Directors, comprised solely of
Directors who are not members of management, meets regularly with management,
the independent auditors, and the internal auditors to ensure that their
respective responsibilities are properly discharged. The independent auditors
and the internal audit staff have full and free access to the Audit Committee.
/s/John D. Grampa
-------------------
John D. Grampa
Vice President Finance and Chief Financial Officer
FORWARD-LOOKING STATEMENTS
Portions of the narrative set forth in this document that are not
statements of historical or current facts are forward-looking statements. The
Company's actual future performance may materially differ from that contemplated
by the forward-looking statements as a result of a variety of factors. These
factors include, in addition to those mentioned elsewhere herein:
- The global economy;
- The condition of the markets the Company serves, whether
defined geographically or by segment, with the major market
segments being telecommunications and computer, automotive
electronics, optical media, industrial components, aerospace
and defense, and appliance;
- Changes in product mix and the financial condition of
customers;
- The Company's success in implementing its strategic plans and
the timely and successful completion of any capital projects;
- The availability of adequate lines of credit and the
associated interest rates;
- Other financial factors, including cost and availability of
materials, tax rates, exchange rates, pension costs, energy
costs and the cost and availability of insurance;
- The uncertainties related to the impact of war and terrorist
activities;
- Changes in government regulatory requirements and the
enactment of new legislation that impacts the Company's
obligations; and,
- The conclusion of pending litigation matters in accordance
with the Company's expectation that there will be no material
adverse effects.
29
Consolidated Statements of Income
Brush Engineered Materials Inc. and Subsidiaries, Years ended December 31, 2003,
2002 and 2001
(Dollars in thousands except per share amounts)
2003 2002 2001
---------- ----------- ----------
Net sales.......................................... $ 401,046 $ 372,829 $ 472,569
Cost of sales ................................. 328,008 324,932 404,574
---------- ----------- ----------
Gross profit ...................................... 73,038 47,897 67,995
Selling, general and administrative expense.... 68,834 61,293 75,315
Research and development expense............... 4,230 4,265 6,327
Other - net.................................... 9,314 5,184 422
---------- ----------- ----------
Operating loss..................................... (9,340) (22,845) (14,069)
Interest expense............................... 3,355 3,010 3,327
---------- ----------- ----------
LOSS BEFORE INCOME TAXES (12,695) (25,855) (17,396)
Minority interest.................................. (45) - -
Income taxes (benefit):
Currently payable............................... 855 (8,018) (755)
Deferred......................................... (279) 17,767 (6,367)
---------- ----------- ----------
576 9,749 (7,122)
---------- ----------- ----------
NET LOSS $ (13,226) $ (35,604) $ (10,274)
========== =========== ==========
Net loss per share of common
stock - basic and diluted.......................... $ (0.80) $ (2.15) $ (0.62)
========== =========== ==========
Weighted average number of shares of
common stock outstanding........................... 16,562,864 16,557,388 16,518,691
See Notes to Consolidated Financial Statements.
30
Consolidated Statements of Cash Flows
Brush Engineered Materials Inc. and Subsidiaries, Years ended December 31, 2003,
2002 and 2001
(Dollars in thousands)
2003 2002 2001
---------- ---------- --------
Cash flows from operating activities:
Net loss........................................................................ $ (13,226) $ (35,604) $(10,274)
Adjustments to reconcile net loss to net cash provided from operating activities:
Depreciation, depletion and amortization...................................... 19,503 20,356 20,944
Amortization of mine development.............................................. 1,228 284 665
Impairment from asset writedown............................................... - 4,393 -
Deferred tax (benefit) expense................................................ (279) 17,767 (6,367)
Derivative financial instruments ineffectiveness.............................. 5,054) (253) 555
Decrease (increase) in accounts receivable.................................... (6,590) 9,654 36,589
Decrease (increase) in inventory.............................................. 8,646 16,587 5,283
Decrease (increase) in prepaid and other current assets....................... 4,871 (1,387) 360
Increase (decrease) in accounts payable and accrued expenses.................. 2,308 (3,914) (29,534)
Increase (decrease) in interest and taxes payable............................. 1,221 (3,086) (1,951)
Increase (decrease) in other long-term liabilities............................ (443) (7,879) 2,747
Other - net................................................................... 4,019 (1,229) 3,458
---------- ---------- --------
NET CASH PROVIDED FROM OPERATING ACTIVITIES 26,312 15,689 22,475
Cash flows from investing activities:
Payments for purchase of property, plant and equipment........................ (6,162) (5,248) (23,130)
Payments for mine development................................................. (157) (166) (154)
Purchase of equipment previously held under operating lease................... (51,846) - -
Proceeds from sale of property, plant and equipment........................... 203 140 16
Other investments - net....................................................... - (57) -
---------- ---------- --------
NET CASH USED IN INVESTING ACTIVITIES (57,962) (5,331) (23,268)
Cash flows from financing activities:
Proceeds from issuance/(repayment) of short-term debt......................... (9,266) (1,941) 3,869
Proceeds from issuance of long-term debt...................................... 72,000 12,000 39,446
Repayment of long-term debt................................................... (26,034) (23,000) (35,500)
Debt issuance costs........................................................... (4,636) - -
Issuance of common stock under stock option plans............................. 25 - 1,760
Payments of dividends......................................................... - - (5,967)
---------- ---------- --------
NET CASH PROVIDED FROM (USED IN) FINANCING ACTIVITIES 32,089 (12,941) 3,608
Effects of exchange rate changes on cash and cash equivalents. . . . . . . . . . 266 (74) (115)
---------- ---------- --------
NET CHANGE IN CASH AND CASH EQUIVALENTS 705 (2,657) 2,700
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 4,357 7,014 4,314
---------- ---------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 5,062 $ 4,357 $ 7,014
========== ========== ========
See Notes to Consolidated Financial Statements.
31
Consolidated Balance Sheets
Brush Engineered Materials Inc. and Subsidiaries, Years ended December 31, 2003
and 2002
(Dollars in thousands)
2003 2002
--------- ---------
ASSETS
CURRENT ASSETS
Cash and cash equivalents............................................................ $ 5,062 $ 4,357
Accounts receivable (less allowance of $1,427 for 2003, and $1,317 for 2002)......... 55,102 47,543
Inventories.......................................................................... 87,396 94,324
Prepaid expenses..................................................................... 5,454 9,766
Deferred income taxes................................................................ 291 244
--------- ---------
TOTAL CURRENT ASSETS 153,305 156,234
OTHER ASSETS........................................................................... 26,761 25,629
LONG-TERM DEFERRED INCOME TAXES........................................................ 704 472
PROPERTY, PLANT, AND EQUIPMENT
Land................................................................................. 7,284 6,972
Buildings............................................................................ 98,576 97,184
Machinery and equipment.............................................................. 385,505 328,722
Software............................................................................. 20,008 19,983
Construction in progress............................................................. 4,691 4,222
Allowances for depreciation.......................................................... (329,328) (309,742)
--------- ---------
186,736 147,341
Mineral resources.................................................................... 5,029 5,029
Mine development..................................................................... 14,328 14,171
Allowances for amortization and depletion............................................ (15,247) (13,997)
--------- ---------
4,110 5,203
--------- ---------
PROPERTY, PLANT, AND EQUIPMENT-NET 190,846 152,544
--------- ---------
$ 371,616 $ 334,879
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Short-term debt...................................................................... $ 13,387 $ 27,235
Accounts payable..................................................................... 16,038 15,129
Salaries and wages................................................................... 17,443 12,043
Taxes other than income taxes........................................................ 2,379 2,883
Other liabilities and accrued items.................................................. 17,544 15,513
Income taxes......................................................................... 1,373 786
--------- ---------
TOTAL CURRENT LIABILITIES 68,164 73,589
OTHER LONG-TERM LIABILITIES............................................................ 14,739 17,459
RETIREMENT AND POST-EMPLOYMENT BENEFITS................................................ 49,358 48,518
LONG-TERM DEBT......................................................................... 85,756 36,219
MINORITY INTEREST IN SUBSIDIARY........................................................ 26 -
SHAREHOLDERS' EQUITY
Serial preferred stock, no par value; 5,000,000 shares authorized, none issued....... - -
Common stock, no par value; authorized 60,000,000 shares; 22,919,518 issued shares
(22,917,618 for 2002)................................................................ 93,336 93,311
Common stock warrants................................................................ 1,616 -
Retained income...................................................................... 181,156 194,382
--------- ---------
276,108 287,693
Common stock in treasury, 6,294,128 shares in 2003 (6,281,355 in 2002)................. (105,633) (105,245)
Other comprehensive income (loss)...................................................... (16,794) (22,859)
Other equity transactions.............................................................. (108) (495)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 153,573 159,094
--------- ---------
$ 371,616 $ 334,879
========= =========
See Notes to Consolidated Financial Statements.
32
Consolidated Statements of Shareholders' Equity
Brush Engineered Materials Inc. and Subsidiaries, Years ended December 31, 2003,
2002 and 2001
(Dollars in thousands except per share amounts)
Common Other
Common Retained Stock in Comprehensive
Stock Warrants Income Treasury Income (loss)
--------- -------- --------- ---------- --------------
BALANCES AT JANUARY 1, 2001 $ 90,743 $ - $ 244,221 $ (104,887) $ (1,205)
Net loss ............................................... - - (10,274) - -
Foreign currency translation adjustment ................ - - - - (1,084)
Derivative and hedging activity ........................ - - - - (2,061)
Comprehensive loss .....................................
Declared dividends $0.24 per share ..................... - - (3,961) - -
Proceeds from sale of 95,230 shares
under option plans .................................... 1,530 - - - -
Income tax benefit from employees' stock options ....... 230 - - - -
Other equity transactions .............................. 358 - - 277 -
Forfeiture of restricted stock ......................... - - - (431) -
--------- ------ --------- ---------- ----------
BALANCES AT DECEMBER 31, 2001 92,861 - 229,986 (105,041) (4,350)
Net loss ............................................... - - (35,604) - -
Foreign currency translation adjustment ................ - - - - 832
Derivative and hedging activity ........................ - - - - (5,778)
Minimum pension liability .............................. - - - - (13,563)
Comprehensive loss .....................................
Other equity transactions .............................. 450 - - (75) -
Forfeiture of restricted stock ......................... - - - (129) -
--------- ------ --------- ---------- ----------
BALANCES AT DECEMBER 31, 2002 93,311 - 194,382 (105,245) (22,859)
Net loss ............................................... - - (13,226) - -
Foreign currency translation adjustment ................ - - - - 475
Derivative and hedging activity ........................ - - - - 4,623
Minimum pension liability .............................. - - - - 967
Comprehensive loss .....................................
Proceeds from sale of 1,900 shares under option plans .. 21 - - - -
Income tax benefit from employees' stock options ....... 4 - - - -
Issuance of 115,000 warrants ........................... - 1,616 - - -
Other equity transactions .............................. - - - (229) -
Forfeiture of restricted stock ......................... - - - (159) -
--------- ------ --------- ---------- ----------
BALANCES AT DECEMBER 31, 2003 $ 93,336 $1,616 $ 181,156 $ (105,633) $ (16,794)
========= ====== ========= ========== ==========
Other Total
--------- ---------
BALANCES AT JANUARY 1, 2001 $ 1,035 $ 229,907
Net loss ............................................... - (10,274)
Foreign currency translation adjustment ................ - (1,084)
Derivative and hedging activity ........................ - (2,061)
---------
Comprehensive loss ..................................... (13,419)
Declared dividends $0.24 per share ..................... - (3,961)
Proceeds from sale of 95,230 shares
under option plans .................................... - 1,530
Income tax benefit from employees' stock options ....... - 230
Other equity transactions .............................. (273) 362
Forfeiture of restricted stock ......................... 132 (299)
--------- ---------
BALANCES AT DECEMBER 31, 2001 894 214,350
Net loss ............................................... - (35,604)
Foreign currency translation adjustment ................ - 832
Derivative and hedging activity ........................ - (5,778)
Minimum pension liability .............................. - (13,563)
---------
Comprehensive loss ..................................... (54,113)
Other equity transactions .............................. (1,392) (1,017)
Forfeiture of restricted stock ......................... 3 (126)
--------- ---------
BALANCES AT DECEMBER 31, 2002 (495) 159,094
Net loss ............................................... - (13,226)
Foreign currency translation adjustment ................ - 475
Derivative and hedging activity ........................ - 4,623
Minimum pension liability .............................. - 967
---------
Comprehensive loss ..................................... (7,161)
Proceeds from sale of 1,900 shares under option plans .. - 21
Income tax benefit from employees' stock options ....... - 4
Issuance of 115,000 warrants ........................... - 1,616
Other equity transactions .............................. 359 130
Forfeiture of restricted stock ......................... 28 (131)
--------- ---------
BALANCES AT DECEMBER 31, 2003 $ (108) $ 153,573
========= =========
See Notes to Consolidated Financial Statements.
33
Notes to Consolidated Financial Statements
Brush Engineered Materials Inc. and Subsidiaries, December 31, 2003
NOTE A - SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION: The Company is a holding company with subsidiaries that have
operations in the United States, Western Europe and Asia. These operations
manufacture engineered materials used in a variety of markets, including
telecommunications and computer electronics, automotive electronics, optical
media, data storage, decorative and performance film, industrial components,
aerospace and defense, and appliance. The Company's operations are aggregated
into two business segments - the Metal Systems Group and the Microelectronics
Group - based upon the commonalities of their products, manufacturing processes,
customers and other factors. The Metal Systems Group produces strip and bulk
alloys (primarily copper beryllium), beryllium metal products and engineered
material systems while the Microelectronics Group manufactures precious and
non-precious vapor deposition targets, frame lid assemblies, other precious and
non-precious metal products, ceramics, electronic packages and thick film
circuits. The Company is vertically integrated and distributes its products
through a combination of company-owned facilities and independent distributors
and agents.
USE OF ESTIMATES: The preparation of financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results may differ from
those estimates.
CONSOLIDATION: The Consolidated Financial Statements include the accounts
of Brush Engineered Materials Inc. and its subsidiaries. All of the Company's
subsidiaries are wholly owned except for an insignificant joint venture in
Taiwan established in 2003. Inter-company accounts and transactions are
eliminated in consolidation.
CASH EQUIVALENTS: All highly liquid investments with a put option or
maturity of three months or less when purchased are considered to be cash
equivalents.
ACCOUNTS RECEIVABLE: An allowance for doubtful accounts is maintained for
the estimated losses resulting from the inability of customers to pay the
amounts due.
INVENTORIES: Inventories are stated at the lower of cost or market. The
cost of domestic inventories except ore and supplies is principally determined
using the last-in, first-out (LIFO) method. The remaining inventories are stated
principally at average cost.
PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment is stated on
the basis of cost. Depreciation is computed principally by the straight-line
method, except certain facilities for which depreciation is computed by the
sum-of-the-years digits or units-of-production method. Depreciable lives that
are used in computing the annual provision for depreciation by class of asset
are as follows:
Years
---------------
Land improvements ............................................. 5 to 25
Buildings ..................................................... 10 to 40
Leasehold improvements ........................................ Life of lease
Machinery and equipment ....................................... 3 to 15
Furniture and fixtures ........................................ 4 to 15
Automobiles and trucks ........................................ 2 to 8
Research equipment ............................................ 6 to 12
Computer hardware ............................................. 3 to 10
Computer software ............................................. 3 to 10
Depreciation expense was $18.6 million in 2003, $19.8 million in 2002, and
$19.9 million in 2001. Repair and maintenance costs are expensed as incurred.
MINERAL RESOURCES AND MINE DEVELOPMENT: Property acquisition costs and
mining costs associated with waste rock removal are recorded at cost and are
depleted or amortized by the units-of-production method based on recoverable
proven beryllium reserves. Exploration and pre-production mine development
expenses are charged to operations in the period in which they are incurred.
INTANGIBLE ASSETS: The Company adopted Statement No. 142, "Goodwill and
Other Intangible Assets" as of January 1, 2002. Under this statement, goodwill
and other indefinite-lived intangible assets are no longer amortized, but
instead reviewed annually, or more frequently under certain circumstances, for
impairment. The Company determined that a goodwill impairment charge was not
required upon adoption of the statement or subsequently during 2002 and 2003.
The Company had goodwill of $7.9 million on its balance sheet as of December 31,
2003 and 2002. Goodwill amortization expense was $0.3 million in 2001, all of
which was recorded by the Microelectronics Group. Intangible assets with finite
lives will continue to be amortized. The cost of intangible assets is amortized
using the straight-line method over the periods estimated to be benefited, which
is generally 20 years or less.
ASSET IMPAIRMENT: In the event that facts and circumstances indicate that
the carrying value of long-lived and intangible assets may be impaired, an
evaluation of recoverability is performed. If an evaluation is required, the
estimated future undiscounted cash flow associated with the asset or asset group
would be compared to the carrying amount to determine if a write-down is
required. In August 2001, the FASB issued Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". The statement amends prior
pronouncements and prescribes a uniform approach to accounting for long-lived
assets to be held and used, long-lived assets to be disposed of by other than a
sale and long-lived assets to be disposed of by sale. The statement was
effective January 1, 2002 and had no effect on the Company upon adoption.
34
DERIVATIVES: The Company records the changes in the fair values of
derivative financial instruments in accordance with Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities". The Company
recognizes all derivatives on the balance sheet at their fair values. If the
derivative is a hedge, depending upon the nature of the hedge, changes in the
fair value of the derivative are either offset against the change in fair value
of the hedged asset, liability or firm commitment through earnings or recognized
in other comprehensive income (loss) until the hedged item is recognized in
earnings. The ineffective portion of a derivative's change in fair value, if
any, is recognized in earnings immediately. If a derivative is not a hedge,
changes in its fair value are adjusted through income.
ASSET REMOVAL OBLIGATION: The Company adopted Statement No. 143,
"Accounting for Asset Retirement Obligations" in the fourth quarter 2002. Under
this statement, a liability must be recorded to recognize the legal obligation
to remove an asset at the time the asset is acquired or when the legal liability
arises. The liability is recorded for the present value of the ultimate
obligation by discounting the estimated future cash flows using a
credit-adjusted risk-free interest rate. The liability is accreted over time,
with the accretion charged to expense. An asset equal to the fair value of the
liability is recorded concurrent with the liability. The asset is then
depreciated over the life of the asset. Adoption of this statement did not have
a material effect on the Company's results of operations or financial position.
REVENUE RECOGNITION: The Company recognizes revenue when the title to the
goods passes to the customer.
SHIPPING AND HANDLING COSTS: The Company records shipping and handling
costs for products sold to customers in cost of sales on the Consolidated
Statements of Income.
ADVERTISING COSTS: The Company expenses all advertising costs as incurred.
Advertising costs were immaterial for the years presented in the Consolidated
Financial Statements.
INCOME TAXES: The Company uses the liability method in measuring the
provision for income taxes and recognizing deferred tax assets and liabilities
on the balance sheet. The Company records a valuation allowance to reduce the
deferred tax assets to the amount that is more likely than not to be realized.
RECLASSIFICATION: Certain amounts in prior years have been reclassified to
conform to the 2003 consolidated financial statement presentation.
NET INCOME PER SHARE: Basic earnings per share (EPS) is computed by
dividing income available to common stockholders by the weighted average number
of common shares outstanding for the period. Diluted EPS reflects the assumed
conversion of all dilutive common stock equivalents as appropriate under the
treasury stock method.
STOCK OPTIONS: The Company provides a stock incentive plan for eligible
employees. See Note H to the Consolidated Financial Statements for further
details. The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock Based Compensation" and applies the intrinsic value method
in accordance with APB Opinion No. 25, "Accounting for Stock Issued to
Employees" and related interpretations in accounting for its stock incentive
plan. If the Company had elected to recognize compensation expense for its stock
incentive plan awards based on the estimated fair value of the awards on the
grant dates, consistent with the method proscribed by SFAS No. 123 by amortizing
the expense over the options' vesting period, the pro forma net loss and loss
per share (E.P.S.) would have been as noted below:
2003 2002 2001
(Dollars in thousands, except per share data) -------- -------- --------
Net loss - as reported ........................ $(13,226) $(35,604) $(10,274)
Pro forma stock option expense ................ (1,095) (1,494) (1,352)
-------- -------- --------
Net loss - pro forma .......................... $(14,321) $(37,098) $(11,626)
======== ======== ========
E.P.S. - as reported .......................... $ (0.80) $ (2.15) $ (0.62)
E.P.S. - pro forma ............................ $ (0.86) $ (2.24) $ (0.70)
Note: The pro forma disclosures shown are not representative of the effects on
net income and earnings per share in future years.
The weighted-average fair value of the Company's stock options used to
compute the pro forma net income and earnings per share disclosures is $2.79,
$6.40 and $9.10 for 2003, 2002 and 2001, respectively. The fair value is the
estimated present value at grant date using the Black-Scholes option-pricing
model with the following weighted-average assumptions for the various grants in
2003, 2002 and 2001:
2003 2002 2001
-------- -------- --------
Risk-free interest rate ................ 3.63% 4.52% 5.09%
Dividend yield ......................... 0% 0% 1.40%
Volatility of stock .................... 39.50% 39.60% 36.50%
Expected life of option ................ 8 YEARS 8 years 7 years
NEW PRONOUNCEMENT: The FASB issued FIN 46, "Consolidation of Variable
Interest Entities" in January 2003 effective for periods ending subsequent to
June 15, 2003 for variable entities for which an enterprise holds a variable
interest that it acquired prior to February 1, 2003. The release clarifies the
application of Accounting Research Bulletin No. 51, "Consolidated Financial
Statements" to certain entities in which the equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from others. The Company adopted FIN 46 as
proscribed and its adoption did not have a material impact on the Company's
results of operations or financial position.
35
Notes to Consolidated Financial Statements
Brush Engineered Materials Inc. and Subsidiaries, December 31, 2003
NOTE B - INVENTORIES
Inventories in the Consolidated Balance Sheets are summarized as follows:
December 31,
2003 2002
(Dollars in thousands) -------- --------
Principally average cost:
Raw materials and supplies ........................ $ 24,990 $ 22,572
Work in process ................................... 65,212 65,809
Finished goods .................................... 20,637 29,522
-------- --------
Gross inventories .............................. 110,839 117,903
Excess of average cost over LIFO inventory value ..... 23,443 23,579
-------- --------
Net inventories ................................ $ 87,396 $ 94,324
======== ========
Average cost approximates current cost. Gross inventories accounted for
using the LIFO method totaled $73.9 million at December 31, 2003 and $81.8
million at December 31, 2002. The liquidation of LIFO inventory layers in 2003
reduced cost of sales by $3.6 million.
NOTE C - IMPAIRMENT CHARGE
The Company recorded asset impairment charges of $4.4 million in the fourth
quarter 2002 in accordance with SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets". The impairment charges resulted from the assets'
undiscounted projected cash flows being less than their carrying values. The
Metal Systems Group wrote off $3.1 million of equipment and related facilities
formerly used in the production of beryllium. The equipment has been shut down
due to the use of alternate input materials and manufacturing processes.
Management does not believe these assets are salable. The Microelectronics Group
wrote down equipment and a building $1.3 million from its net book value of $1.9
million to its estimated fair market value of $0.6 million. The fair market
value was determined by an appraisal by an independent firm. The equipment was
shut down in 2003. The impairment charges were recorded in other-net on the
Company's 2002 Consolidated Statement of Income.
NOTE D - INTEREST
Interest expense associated with active construction and mine development
projects is capitalized and amortized over the future useful lives of the
related assets. The following chart summarizes the interest incurred,
capitalized and paid, as well as the amortization of capitalized interest for
2003, 2002 and 2001.
2003 2002 2001
(Dollars in thousands) ------- ------- -------
Interest incurred ....................... $ 3,269 $ 3,095 $ 3,918
Less capitalized interest ............... (86) 85 591
------- ------- -------
Total expense ........................... $ 3,355 $ 3,010 $ 3,327
======= ======= =======
Interest paid ........................... $ 2,558 $ 3,162 $ 4,092
======= ======= =======
Amortization, included principally
in cost of sales ...................... $ 623 $ 716 $ 742
======= ======= =======
In 1986, the Company purchased company-owned life insurance policies
insuring the lives of certain United States employees. The contracts are
recorded at cash surrender value, net of policy loans, in other assets. The net
contract (income) expense, including interest expense recorded in selling,
general and administrative expenses, was $1.4 million, ($0.5) million and ($0.3)
million in 2003, 2002 and 2001, respectively. The related interest expense was
$1.3 million, $1.5 million and $1.4 million, in 2003, 2002 and 2001,
respectively.
NOTE E - DEBT
A summary of long-term debt follows:
December 31,
2003 2002
(Dollars in thousands) -------- --------
Senior Credit Agreement:
Revolving credit agreement ..................... $ 20,000 $ -
Senior five-year term note payable
in installments beginning in 2004 .............. 12,000 -
Senior five-year term note payable
in installments beginning in 2004 ............. 8,000 -
Variable rate demand bonds payable
in installments beginning in 2005 ............. 3,000 3,000
Variable rate promissory note - Utah
land purchase payable in 20 annual
installments through 2021 ...................... 915 946
Variable rate industrial development
revenue bonds payable in 2016 ................. 8,305 8,305
Revolving credit agreement ....................... - 24,000
Subordinated five-year term note ................. 35,000 -
-------- --------
87,220 36,251
Current portion of long-term debt ................ (1,464) (32)
-------- --------
Total ............................................ $ 85,756 $ 36,219
======== ========
Maturities on long-term debt instruments as of December 31, 2003 are as
follows:
(Dollars in thousands)
2004 ..................................................... $ 1,464
2005 ..................................................... 3,493
2006 ..................................................... 3,493
2007 ..................................................... 3,493
2008 ..................................................... 65,644
Thereafter ............................................... 9,633
-------
Total .................................................... $87,220
=======
36
In December 2003, the Company refinanced its existing revolving credit
agreement and a synthetic operating lease with a new debt structure totaling
$147.5 million. The refinancing included a five-year $105.0 million senior
secured credit agreement, a five-year $35.0 million subordinated term loan and a
$7.5 million Exim line of credit.
The senior secured credit agreement is with six financial institutions and
provides a maximum availability of $105.0 million. It consists of an $85.0
million revolving credit line secured by a portion of the Company's working
capital, a $12.0 million term note secured by a portion of the Company's real
estate and an $8.0 million term note secured by the Company's machinery and
equipment. At December 31, 2003, there was $20.0 million in long-term borrowings
outstanding against the revolving credit portion of the agreement at an average
rate of 5.00% that is fixed through January 2004, at which time it will be reset
according to the terms and options available to the Company under the agreement.
The credit agreement allows the Company to borrow money at a premium over LIBOR
or prime rate and at varying maturities. Also at December 31, 2003, there was
$20.0 million outstanding on the two term loans at an average rate of 5.35%,
which is fixed through March 2004, at which time it will be reset according to
the terms and conditions available under the agreement. The term notes are
payable in quarterly installments beginning in July 2004 and include a balloon
payment upon maturity in 2008.
The $35.0 million subordinated term note is secured by a second lien on the
Company's working capital, real estate and machinery and equipment and is
payable in five years with the option to prepay $5.0 million prior to September
2004 without penalty. The interest rate is based on variable prime plus a
premium and resets quarterly. To hedge a portion of this variability, the
company entered into an interest rate swap that fixed the rate on a notional
value of $10.0 million over the life of the note. At December 2003, the Company
had $35.0 million in long-term borrowings outstanding on this note at an average
effective rate of 14.10%.
Both the credit agreement and the subordinated term note are subject to
restrictive covenants including leverage, fixed charges and capital
expenditures. The subordinated term loan restricts the issuance of dividends.
The senior credit agreement and the subordinated term note are also secured by a
first and second lien on the stock of certain of the Company's direct and
indirect subsidiaries.
The $7.5 million Exim facility is secured by certain foreign accounts
receivable of the Company. The interest rate is LIBOR-based plus a premium.
There were no outstanding borrowings against this facility at the end of 2003.
Proceeds from the December 2003 refinancing were used to retire the
existing revolving credit agreement and to terminate an off-balance sheet
operating lease by purchasing the assets being leased for $51.8 million. See
Note F to the Consolidated Financial Statements. Financing fees of $6.2 million
associated with the debt refinancing were deferred and are included in other
assets on the Consolidated Balance Sheet. The deferred costs are being amortized
using the effective interest method over the life of the underlying debt.
Included in the $6.2 million deferred financing cost was the fair value of
115,000 warrants for the purchase of the Company's common stock.
The following table summarizes the Company's short-term lines of credit.
Amounts shown as outstanding are included in short-term debt on the Consolidated
Balance Sheets.
DECEMBER 31, 2003
Total Outstanding Available
------- ----------- ---------
(Dollars in thousands)
Domestic .......................... $34,634 $ 2,049 $32,585
Foreign ........................... 4,439 142 4,297
Precious metal .................... 9,732 9,732 -
------- ------- -------
Total ........................... $48,805 $11,923 $36,882
======= ======= =======
December 31, 2002
Total Outstanding Available
------- ----------- ---------
(Dollars in thousands)
Domestic .......................... $16,669 $13,239 $ 3,430
Foreign ........................... 14,713 5,707 9,006
Precious metal .................... 8,257 8,257 -
------- ------- -------
Total ........................... $39,639 $27,203 $12,436
======= ======= =======
The domestic line is committed and included in the $85.0 million maximum
borrowing under the revolving credit agreement and the $7.5 million Exim
facility. The foreign lines are uncommitted, unsecured and renewed annually. The
precious metal facility (primarily gold) is secured and renewed annually. The
average interest rate on short-term debt was 5.50% and 4.50% as of December 31,
2003 and 2002, respectively.
In November 1996, the Company entered into an agreement with the Lorain
Port Authority, Ohio to issue $8.3 million in variable rate industrial revenue
bonds, maturing in 2016. The variable rate ranged from 0.85% to 1.81% in 2003
and 1.28% to 2.12% during 2002.
In 1994, the Company refunded its $3.0 million industrial development
revenue bonds. The 7.25% bonds were refunded into variable rate demand bonds.
The variable rate ranged from 0.78% to 1.65% during 2003 and from 1.15% to 1.95%
during 2002. In December 1995, the Company entered into an interest rate swap
agreement to manage its interest rate exposure on the bond. The Company
converted the variable rate to a fixed rate of 4.75% under the interest rate
swap agreement. This swap matured in 2002.
The prior revolving credit agreement, as amended, was terminated in
December 2003. A portion of the Company's domestic receivables and inventory up
to a maximum of $55.0 million secured the agreement. In January and March 2003,
this agreement was amended to waive and revise various covenants and to extend
the maturity until April 2004. At December 31, 2002, there was $24.0 million in
long-term borrowings outstanding at an average interest rate of 4.92%.
37
Notes to Consolidated Financial Statements
Brush Engineered Materials Inc. and Subsidiaries, December 31, 2003
NOTE F - LEASING ARRANGEMENTS
The Company leases warehouse and manufacturing space and manufacturing and
computer equipment under operating leases with terms ranging up to 14 years.
Rent expense amounted to $16.2 million, $17.3 million, and $13.1 million during
2003, 2002, and 2001, respectively. The future estimated minimum lease payments
under non-cancelable operating leases with initial lease terms in excess of one
year at December 31, 2003 are as follows: 2004 - $5.0 million; 2005 - $4.2
million; 2006 - $3.6 million; 2007 - $3.3 million; 2008 - $3.3 million and
thereafter - $9.7 million.
The Company has an operating lease for one of its major production
facilities. This facility is owned by a third party and cost approximately $20.3
million to build. Occupancy of the facility began in 1997. Lease payments for
the facility continue through 2011 with options for renewal. The estimated
minimum payments are included in the preceding paragraph. The facility lease is
subject to certain restrictive covenants including leverage, fixed charges and
annual capital expenditures.
In December 2003, the Company terminated an operating lease for certain
equipment located in Elmore, Ohio and purchased the assets for a residual value
of $51.8 million as part of the Company's refinancing. See Note E to the
Consolidated Financial Statements. This leasing arrangement, which began in
1996, was structured as a synthetic lease, which meant it was an operating lease
for financial reporting purposes and a capital lease for federal income tax
purposes. Lease payments for the related equipment began in 1999 and continued
through the initial lease term expiring in 2001. The Company then exercised its
option to renew the lease of the equipment annually for one-year periods and in
2003 purchased the equipment. The 2003 expense for this lease was $9.3 million
and is included in the amounts in the above paragraph.
NOTE G - DERIVATIVE FINANCIAL INSTRUMENTS AND FAIR VALUE INFORMATION
The Company is exposed to commodity price, interest rate and foreign
currency exchange rate differences and attempts to minimize the effects of these
exposures through a combination of natural hedges and the use of derivative
financial instruments. The Company has policies approved by the Board of
Directors that establish the parameters for the allowable types of derivative
instruments to be used, the maximum allowable contract periods, aggregate dollar
limitations and other hedging guidelines. The Company will only secure a
derivative if there is an identifiable underlying exposure that is not otherwise
covered by a natural hedge. In general, derivatives will be held until maturity.
The following table summarizes the fair value of the Company's outstanding
derivatives and debt as of December 31, 2003 and 2002.
DECEMBER 31, 2003 December 31, 2002
--------------------- ---------------------
Asset/(liability) Notional Carrying Notional Carrying
(Dollars in thousands) Amount Amount Amount Amount
-------- -------- -------- --------
FOREIGN CURRENCY CONTRACTS
Forward contracts
Yen ........................................................... $ 16,242 $ (677) $ 4,344 $ 276
Euro .......................................................... 13,697 (1,307) - -
Sterling ...................................................... 3,536 (155) 2,928 (98)
-------- -------- -------- --------
Total ....................................................... $ 33,475 $ (2,139) $ 7,272 $ 178
======== ======== ======== ========
Options
Yen ........................................................... $ - $ - $ 2,420 $ (38)
Euro .......................................................... 6,290 (749) 16,750 (1,025)
-------- -------- -------- --------
Total ....................................................... $ 6,290 $ (749) $ 19,170 $ (1,063)
======== ======== ======== ========
INTEREST RATE EXCHANGE CONTRACTS
Floating to fixed .............................................. $ 55,858 $ (5,314) $ 50,477 $ (6,665)
COMMODITY PRICE CONTRACTS
Floating to fixed .............................................. - - 1,813 69
SHORT- AND LONG-TERM DEBT ....................................... - (99,143) - (63,454)
38
The fair values equal the carrying amounts in the Company's Consolidated
Balance Sheets as of December 31, 2003 and 2002. SFAS No. 107 defines fair value
as the amount at which an instrument could be exchanged in a current transaction
between willing parties, other than in a forced or liquidation sale. The fair
value of the foreign currency forward contracts and options and the commodity
and interest rate contracts was calculated by third parties on behalf of the
Company using the applicable market rates at December 31, 2003 and December 31,
2002. The fair value of the Company's debt was estimated using a discounted cash
flow analysis based on the Company's current incremental borrowing rates for
similar types of borrowing arrangements.
The Company records derivatives in its financial statements in accordance
with SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" and SFAS No. 138, "Accounting for Certain Derivative Instruments and
Certain Hedging Activities", which amended SFAS No. 133. Each of the Company's
commodity swaps, interest rate swaps and foreign currency derivative contracts
have been designated as cash flow hedges as defined under these statements. SFAS
No. 133 requires the fair value of outstanding derivative instruments to be
recorded on the balance sheet. Accordingly, derivative fair values were included
in the balance sheet line items as follows:
December 31,
Debit/(credit) balance 2003 2002
(Dollars in thousands) ------- -------
Prepaid expenses .................................. $ - $ 306
Other liabilities and accrued items ............... (3,952) (2,147)
Other long-term liabilities ....................... (4,250) (5,640)
------- -------
Total ........................................... $(8,202) $(7,481)
======= =======
The balance sheet classification of the fair values is dependent upon the
Company's rights and obligations under each derivative and the remaining term to
maturity. Changes in fair values of derivatives are recorded in income or other
comprehensive income (loss) (hereafter "OCI") as appropriate under SFAS No. 133
guidelines. A reconciliation of the changes in fair values and other derivative
activity recorded in OCI for 2003 and 2002 is as follows:
2003 2002
(Dollars in thousands) ------- -------
Balance in other comprehensive income
(loss) at January 1 ............................ $(7,839) $(2,061)
Changes in fair values and other current
period activity ................................. (107) (6,569)
Matured derivatives - charged to expense .......... 95 797
Derivative ineffectiveness-
(credited)/charged to expense ................... 4,635 (6)
------- -------
Balance in other comprehensive income
(loss) at December 31 .......................... $(3,216) $(7,839)
======= =======
One of the Company's interest rate swaps has a notional value of $45.9
million and initially was designated as a hedge of the variable rate portion of
an operating lease. As a result of the refinancing in December 2003, as further
described in Notes E and F to the Consolidated Financial Statements, that lease
was terminated and the $4.6 million cumulative loss previously recorded in OCI
that was associated with the swap was charged to expense on the Consolidated
Statements of Income as the swap no longer qualified for hedge accounting
treatment. The swap remained in place after the refinancing as payments under
the swap serve as a hedge against the interest rate payments on the new variable
rate debt. However, changes in the fair value of the swap due to movements in
the market interest rates from the date of the refinancing going forward will be
charged to income or expense in the current period. The majority of the $6.6
million change in fair value and other current period hedging activity in 2002
was caused by a decline in the fair value (an increase to the loss) on this
interest rate swap as a result of a decline in interest rates during that year.
Hedge ineffectiveness, including amounts charged from OCI and other adjustments
to the fair values of derivatives that did not flow through OCI, was a $5.1
million expense in 2003 and a $0.3 million credit in 2002 and was included in
other-net expense on the Company's Consolidated Statements of Income. The
Company estimates that approximately $3.0 million of the balance in OCI at
December 31, 2003 will be charged to income during 2004 as a result of maturing
derivatives.
The Company hedged a portion of its net investment in its Japanese
subsidiary using yen-denominated debt until this loan was repaid in December
2003. A net loss of $0.6 million associated with translating this debt into
dollars was recorded in the cumulative translation adjustment as of December 31,
2003. This balance will remain in cumulative translation adjustment and will
only be charged to income should the Company ever liquidate its investment. The
comparable balance in cumulative translation adjustment as of December 31, 2002
was a net loss of $29,000.
FOREIGN EXCHANGE HEDGE CONTRACTS
The Company uses forward and option contracts to hedge anticipated foreign
currency transactions, primarily foreign sales. The purpose of the program is to
protect against the reduction in value of the foreign currency transactions from
adverse exchange rate movements. Should the dollar strengthen significantly, the
decrease in the translated value of the foreign currency transactions should be
partially offset by gains on the hedge contracts. Depending upon the method
used, the contract may limit the benefits from a weakening of the dollar. The
Company's policy limits contracts to maturities of two years or less from the
date of issuance. All of the contracts outstanding as of December 31, 2003 are
scheduled to mature
39
Notes to Consolidated Financial Statements
Brush Engineered Materials Inc. and Subsidiaries, December 31, 2003
during 2004. Realized gains and losses on foreign exchange contracts are
recorded in other-net on the Consolidated Statements of Income. The total
exchange gain/(loss), which includes realized and unrealized losses, was ($0.9)
million in 2003, $1.5 million in 2002 and $2.3 million in 2001.
INTEREST RATE HEDGE CONTRACTS
The Company attempts to minimize its exposure to interest rate variations
by using combinations of fixed and variable rate instruments with varying
lengths of maturities. Depending upon the interest rate yield curve, credit
spreads, projected borrowing requirements and rates, cash flow considerations
and other factors, the Company may elect to secure interest rate swaps, caps,
collars, options or other related derivative instruments. Both fixed-to-variable
and variable-to-fixed interest rate swaps may be used.
In December 2003, the Company entered into a five-year variable-to-fixed
interest rate swap with a $10.0 million notional value designated as a hedge of
a portion of its new variable rate debt.
The Company also has the previously discussed $45.9 million interest rate
swap that does not qualify for hedge accounting under the current regulations,
but cash payments made or received under this swap will tend to offset changes
in the interest payments made on portions of its outstanding variable rate debt
not otherwise hedged. The swap matures in 2008 and its notional value declines
over time. Gains and losses on this swap were charged to cost of sales over its
life until the underlying hedged item, an equipment operating lease, was
terminated in December 2003. Gains and losses from that point forward are
recorded as derivative ineffectiveness within other-net on the Consolidated
Statements of Income.
In December 1995, the Company entered into an interest rate swap,
converting to a fixed rate from a variable rate on a $3.0 million industrial
revenue development bond. Gains and losses on this swap were recorded in
interest expense on the Consolidated Statements of Income. This swap matured
during 2002.
COMMODITY PRICE CONTRACTS
The Company purchases and manufactures products containing copper.
Purchases are exposed to price fluctuations in the copper market. However, for
the majority of its copper-based products, the Company will adjust its selling
prices to customers to reflect the change in its copper purchase price. This
program is designed to be profit neutral; i.e., any changes in copper prices,
either up or down, will be directly passed on to the customer.
The Company may use commodity price contracts (i.e., swaps) to hedge the
copper purchase price for those volumes where price fluctuations cannot be
passed on to the customer. Under these swaps, which are purchased from financial
institutions, the Company makes or receives payments based on a difference
between a fixed price (as specified in each individual contract) and the market
price of copper. These payments will offset the change in prices of the
underlying purchases and effectively fix the price of copper at the swap rate
for the contracted volume. The Company's policy limits commodity hedge contracts
to maturities of 27 months or less from the original date of issuance. The
Company did not have any copper swaps outstanding as of December 31, 2003. While
various copper swaps that matured during 2002 were deemed to be effective as
defined by SFAS No. 133, all of the swaps outstanding as of December 31, 2002
were deemed to be ineffective. Realized gains and losses on copper swap
contracts are recorded in cost of sales on the Consolidated Statements of
Income.
NOTE H - CAPITAL STOCK
In connection with the Company's refinancing agreement dated December 4,
2003, 115,000 $0.01 common stock warrants were issued to the lenders as part of
their fee. Holders of the warrants are entitled to redeem them for an equal
number of shares of Company common stock. The warrants were recorded as a
component of shareholders' equity at their fair value at the time of issuance.
The warrants expire December 5, 2008.
The Company has 5 million shares of Serial Preferred Stock authorized (no
par value), none of which has been issued. Certain terms of the Serial Preferred
Stock, including dividends, redemption and conversion, will be determined by the
Board of Directors prior to issuance.
On January 27, 1998 the Company's Board of Directors adopted a new share
purchase rights plan and declared a dividend distribution of one right for each
share of common stock outstanding as of the close of business on February 9,
1998. The plan allows for new shares issued after February 9, 1998 to receive
one right subject to certain limitations and exceptions. Each right entitles the
shareholder to buy one one-hundredth of a share of Serial Preferred Stock,
Series A, at an initial exercise price of $110. A total of 450,000 unissued
shares of Serial Preferred Stock will be designated as Series A Preferred Stock.
Each share of Series A Preferred Stock will be entitled to participate in
dividends on an equivalent basis with 100 shares of common stock and will be
entitled to one vote. The rights will not be exercisable and will not be
evidenced by separate right certificates until a specified time after any
40
person or group acquires beneficial ownership of 20% or more (or announces a
tender offer for 20% or more) of common stock. The rights expire on January 27,
2008, and can be redeemed for 1 cent per right under certain circumstances.
The amended 1995 Stock Incentive Plan authorizes the granting of five
categories of incentive awards: option rights, performance restricted shares,
performance shares, performance units and restricted shares. As of December 31,
2003, no performance units have been granted.
Option rights entitle the optionee to purchase common shares at a price
equal to or greater than market value on the date of grant. Option rights
outstanding under the amended 1995 Stock Incentive Plan and previous plans
generally become exercisable over a four-year period and expire 10 years from
the date of the grant. In 1995, the Company's right to grant options on a total
of 228,565 shares (under the Company's 1979, 1984 and 1989 stock option plans)
was terminated upon shareholder approval of the amended 1995 Stock Incentive
Plan. No further stock awards will be made under the Company's 1979, 1984 and
1989 stock option plans except to the extent that shares become available for
grant under these plans by reason of termination of options previously granted.
The 1990 Stock Option Plan for Non-employee Directors (the "1990 Plan") was
terminated effective May 7, 1998. The 1997 Stock Incentive Plan for Non-employee
Directors replaced the 1990 Plan and provided for a one-time grant of 5,000
options to up to six new non-employee directors who have not yet received
options under the 1990 Plan at an option price equal to the fair market value of
the shares at the date of the grant. Options are non-qualified and become
exercisable six months after the date of grant. The options generally expire 10
years after the date they were granted. The 1997 Stock Incentive Plan for
Non-employee Directors was amended on May 1, 2001. The amendment added 100,000
shares to the Plan and established a grant of up to 2,000 options to each
Director annually.
Stock option, performance restricted share award, performance share award,
and restricted share award activities are summarized in the following table:
2003 2002 2001
-------------------- ------------------------ -----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- -------- --------- -------- --------- --------
STOCK OPTIONS
Outstanding at beginning of year ............. 1,394,688 $ 17.82 1,346,568 $ 18.83 1,214,488 $ 17.75
Granted ...................................... 262,800 5.62 256,750 12.17 277,650 22.31
Exercised .................................... (1,900) 12.89 - - (95,230) 15.11
Cancelled .................................... (180,645) 16.76 (208,630) 17.42 (50,340) 17.35
--------- ------- --------- ------- --------- -------
Outstanding at end of year ................... 1,474,943 15.78 1,394,688 17.82 1,346,568 18.83
========= ======= ========= ======= ========= =======
Exercisable at end of year ................... 1,231,103 16.78 1,166,908 18.18 1,108,763 18.63
========= ======= ========= ======= ========= =======
PERFORMANCE AWARDS
Allocated at beginning of year ............... - - 78,000
Forfeited .................................... - - (78,000)
--------- --------- ---------
Allocated at end of year ..................... - - -
========= ========= =========
RESTRICTED AWARDS
Awarded and restricted at beginning of year .. 77,845 60,745 88,183
Awarded during the year ...................... - 33,100 20,000
Vested ....................................... (26,845) (15,700) (37,160)
Forfeited .................................... (4,050) (300) (10,278)
--------- --------- ---------
Awarded and restricted at end of year ........ 46,950 77,845 60,745
========= ========= =========
41
Notes to Consolidated Financial Statements
Brush Engineered Materials Inc. and Subsidiaries, December 31, 2003
The market value of the performance restricted shares and the performance
shares adjusted for management's expectation of reaching the management
objectives as outlined in the Plan agreement, and the related dividends on the
performance restricted shares have been recorded as deferred
compensation-restricted stock and are a component of other equity transactions
of shareholders' equity. Deferred compensation is amortized over the vesting
period. Amounts recorded against selling, general and administrative expense on
the Consolidated Statements of Income totaled $0.3 million in 2003, $0.4 million
in 2002 and $0.4 million in 2001.
The following table provides additional information about stock options
outstanding as of December 31, 2003:
Options Outstanding Options Exercisable
------------------------------------- --------------------------
Weighted-
average Weighted- Weighted-
Remaining average average
Range of Number Contract Exercise Number Exercise
Option Prices Outstanding Life Price Exercisable Price
- --------------- ----------- --------- --------- ----------- ---------
$ 5.55 - $ 8.10 257,300 9.15 $ 5.62 131,000 $ 5.59
$12.15 - $15.06 361,150 6.96 13.15 301,120 13.34
$15.75 - $18.63 484,868 3.59 16.83 467,058 16.87
$20.64 - $23.78 231,050 6.97 22.33 191,350 22.31
$26.44 - $26.72 140,575 4.35 26.71 140,575 26.71
--------- ---- --------- --------- ---------
1,474,943 5.99 $ 15.78 1,231,103 $ 16.78
========= ==== ========= ========= =========
The weighted-average remaining contractual life of options outstanding at
December 31, 2002 and 2001 is 6.04 years and 6.22 years, respectively. The
number of shares available for future grants as of December 31, 2003, 2002 and
2001 is 472,331 shares, 550,986 shares and 631,906 shares, respectively.
NOTE I - INCOME TAXES
Income (loss) before income taxes and income taxes (benefit) are comprised
of the following components, respectively:
(Dollars in thousands) 2003 2002 2001
-------- -------- --------
Income (loss) before income taxes:
Domestic ............................... $(14,721) $(24,996) $(18,035)
Foreign ................................ 2,071 (859) 639
-------- -------- --------
Total before income taxes ............ $(12,650) $(25,855) $(17,396)
======== ======== ========
Income taxes (benefit):
Current income taxes:
Domestic ............................... $ 158 $ (8,311) $ (1,588)
Foreign ................................ 697 293 833
-------- -------- --------
Total current ........................ 855 (8,018) (755)
Deferred income taxes:
Domestic ............................... $ (5,291) $ (1,068) $ (5,785)
Foreign ................................ (279) (1,095) (582)
Valuation allowance .................... 5,291 19,930 -
-------- -------- --------
Total deferred ....................... (279) 17,767 (6,367)
Total income taxes (benefit) ......... $ 576 $ 9,749 $ (7,122)
======== ======== ========
The reconciliation of the federal statutory and effective income tax rates
follows:
2003 2002 2001
----- ----- -----
Federal statutory rate ............. (34.0)% (34.0)% (34.0)%
State and local income taxes, net
of federal tax effect ............ 0.9 0.5 1.0
Effect of excess of percentage
depletion over cost depletion ...... (7.6) (2.2) (3.4)
Company-owned life insurance ....... 3.6 (0.6) (0.4)
Taxes on foreign source income ..... (3.7) (4.1) (5.6)
Valuation allowance ................ 41.8 77.1 -
Other items ........................ 3.5 1.0 1.5
----- ----- -----
Effective tax rate ................. 4.5% 37.7% (40.9)%
===== ===== =====
In accordance with the provisions of SFAS No. 109, "Accounting for Income
Taxes," the Company recorded a valuation allowance of $5.3 million in 2003 and
$19.9 million in 2002 as part of tax expense. In addition, the Company recorded
a $1.9 million valuation allowance reduction to OCI in 2003 and $7.3 million in
2002 for deferred tax assets associated with the changes to OCI for the minimum
pension liability and derivative and hedging activities. No valuation allowance
was required on $1.0 million of net deferred tax assets associated with certain
foreign subsidiaries.
42
The Company intends to maintain a valuation allowance on the net deferred
tax assets until a realization event occurs to support reversal of all or a
portion of the reserve.
Included in current domestic income taxes, as shown in the Consolidated
Statements of Income, are $0.2 million, $0.2 million and $0.3 million of state
and local income taxes in 2003, 2002 and 2001, respectively.
The Company had domestic and foreign income tax payments (refunds), of
$(3.3) million, $(1.1) million and $0.6 million in 2003, 2002 and 2001,
respectively.
Deferred tax assets and liabilities are determined based on temporary
differences between the financial reporting bases and the tax bases of assets
and liabilities. Deferred tax assets and (liabilities) recorded in the
Consolidated Balance Sheets consist of the following at December 31, 2003 and
2002:
2003 2002
(Dollars in thousands) -------- --------
Post-retirement benefits other than pensions .... $ 12,072 $ 10,549
Alternative minimum tax credit .................. 10,629 10,629
Other reserves .................................. 2,518 3,018
Environmental reserves .......................... 2,311 2,604
Pensions ........................................ 2,416 1,958
Derivative instruments and hedging activities ... 2,051 2,592
Inventory ....................................... 495 1,741
Tax credit carryforward ......................... 1,851 1,851
Net operating loss carryforward ................. 32,232 27,892
Capitalized interest expense .................... 419 -
Miscellaneous ................................... 64 339
-------- --------
67,058 63,173
Valuation allowance ............................. (30,793) (27,207)
-------- --------
Total deferred tax assets ....................... 36,265 35,966
-------- --------
Depreciation .................................... (33,060) (31,545)
Mine development ................................ (2,210) (2,566)
Capitalized interest expense .................... - (1,139)
-------- --------
Total deferred tax liabilities .................. (35,270) (35,250)
-------- --------
Net deferred tax asset .......................... $ 995 $ 716
======== ========
At December 31, 2003, for income tax purposes, the Company had domestic net
operating loss carryforwards of $88.1 million, which are scheduled to expire in
calendar years 2019 through 2023. The Company also had foreign net operating
loss carryforwards for income tax purposes totaling $5.3 million, comprised of
$4.7 million that do not expire, and $0.6 million which are scheduled to expire
in calendar year 2007.
At December 31, 2003, the Company had research and experimentation tax
credit carryforwards of $1.9 million that are scheduled to expire in calendar
years 2008 through 2020.
A provision has not been made with respect to $8.5 million of unremitted
earnings at December 31, 2003 that have been invested by foreign subsidiaries.
It is not practical to estimate the amount of unrecognized deferred tax
liability for undistributed foreign earnings.
NOTE J - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted loss
per share (E.P.S.):
2003 2002 2001
(Dollars in thousands, except for share data) ------------ ------------ ------------
Numerator for basic and
diluted E.P.S.:
Net loss .................................. $ (13,226) $ (35,604) $ (10,274)
Denominator for basic and
diluted E.P.S.:
Weighted-average
shares outstanding ....................... 16,562,864 16,557,388 16,518,691
------------ ------------ ------------
Basic and diluted E.P.S ..................... $ (0.80) $ (2.15) $ (0.62)
============ ============ ============
Under SFAS No. 128, "Earnings per Share," no potential common shares are
included in the computation of diluted per-share amounts when a loss from
continuing operations exists. Accordingly, dilutive securities have been
excluded from the diluted E.P.S. calculation of 109,052 for 2003, 51,337 for
2002 and 131,896 for 2001.
Options to purchase common stock with exercise prices in excess of the
average share price totaling 1,217,643 at December 31, 2003; 1,394,688 at
December 31, 2002; and 749,488 at December 31, 2001 were excluded from the
diluted E.P.S. calculations as their effect would have been anti-dilutive.
43
Notes to Consolidated Financial Statements
Brush Engineered Materials Inc. and Subsidiaries, December 31, 2003
NOTE K - PENSIONS AND OTHER POST-RETIREMENT BENEFITS
The obligation and funded status of the Company's domestic defined
benefit pension plan, unfunded supplemental retirement plan and retiree medical
and life insurance plan are as follows:
Pension Benefits Other Benefits
---------------------- ----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
(Dollars in thousands)
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year ............................... $ 100,821 $ 92,878 $ 43,453 $ 40,220
Service cost .......................................................... 4,116 4,217 274 298
Interest cost ......................................................... 6,668 6,425 2,818 2,757
Amendments ............................................................ - 347 - -
Actuarial loss ........................................................ 4,312 3,920 2,336 3,447
Benefit payments ...................................................... (5,413) (6,174) (3,433) (3,269)
Settlements ........................................................... (35) (792) - -
--------- --------- --------- ---------
Benefit obligation at end of year ..................................... 110,469 100,821 45,449 43,453
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year ........................ 78,086 94,713 - -
Actual return on plan assets........................................... 13,058 (10,517) - -
Employer contributions ................................................ 72 64 3,433 3,269
Benefit payments ...................................................... (5,413) (6,174) (3,433) (3,269)
--------- --------- --------- ---------
Fair value of plan assets at end of year .............................. 85,803 78,086 - -
--------- --------- --------- ---------
Funded status ......................................................... (24,666) (22,735) (45,449) (43,453)
Unrecognized net actuarial loss ....................................... 26,831 26,179 10,826 8,821
Unrecognized prior service cost (benefit) ............................. 5,519 6,166 (909) (1,020)
Unrecognized initial net (asset) obligation ........................... (1) (362) - -
--------- --------- --------- ---------
Net amount recognized ................................................. $ 7,683 $ 9,248 $ (35,532) $ (35,652)
========= ========= ========= =========
AMOUNTS RECOGNIZED IN THE CONSOLIDATED BALANCE SHEETS CONSIST OF:
Accrued benefit liability ............................................. $ (10,395) $ (10,416) $ (35,532) $ (35,652)
Intangible asset ...................................................... 5,482 6,101 - -
Accumulated other comprehensive income ................................ 12,596 13,563 - -
--------- --------- --------- ---------
Net amount recognized ................................................. $ 7,683 $ 9,248 $ (35,532) $ (35,652)
========= ========= ========= =========
ADDITIONAL INFORMATION
Increase in minimum liability included in other comprehensive income.. $ (967) $ 13,563 N/A N/A
Accumulated benefit obligation for all pension plans ................. 96,023 88,280 N/A N/A
44
Pension Benefits Other Benefits
----------------------------------- -----------------------------------
2003 2002 2001 2003 2002 2001
--------- --------- --------- --------- --------- ---------
(Dollars in thousands)
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost .................................... $ 4,116 $ 4,217 $ 3,622 $ 274 $ 298 $ 303
Interest cost ................................... 6,668 6,425 6,244 2,818 2,757 2,596
Expected return on plan assets .................. (9,359) (10,597) (10,455) - - -
Amortization of prior service cost (benefit) .... 647 626 672 (112) (112) (112)
Amortization of initial net (asset) obligation... (361) (412) (412) - - -
Recognized net actuarial (gain) loss ............ (26) (113) (958) 332 105 -
Settlement (gain) ............................... (48) (993) - - - -
Curtailment loss ................................ - - 570 - - -
--------- --------- --------- --------- --------- ---------
Net periodic (benefit) cost ..................... $ 1,637 $ (847) $ (717) $ 3,313 $ 3,048 $ 2,787
========= ========= ========= ========= ========= =========
The Company recorded a plan curtailment in the fourth quarter 2001 in
accordance with SFAS No. 88, "Employers' Accounting for Settlement and
Curtailment of Defined Benefit Pension Plans and for Termination Benefits". The
curtailment was required because of the significant reduction in the number of
plan participants. The curtailment increased the pension expense in 2001 by $0.6
million and reduced the benefit obligation by $2.4 million at December 31, 2001.
Pension Benefits Other Benefits
----------------------------------- -----------------------------------
2003 2002 2001 2003 2002 2001
--------- --------- --------- --------- --------- ---------
ASSUMPTIONS
WEIGHTED-AVERAGE ASSUMPTIONS USED TO DETERMINE
BENEFIT OBLIGATIONS AT FISCAL YEAR END
Discount rate ................................ 6.375% 6.750% 6.375% 6.750%
Rate of compensation increase ................ 2.750% 2.000% 2.750% 2.000%
WEIGHTED-AVERAGE ASSUMPTIONS USED TO DETERMINE
NET COST FOR THE FISCAL YEAR
Discount rate ................................ 6.750% 7.125% 8.000% 6.750% 7.125% 8.00%
Expected long-term return on plan assets ..... 9.000% 10.000% 10.000% N/A N/A N/A
Rate of compensation increase ................ 2.000% 5.000% 5.000% 2.000% 5.000% 5.00%
The Company uses a December 31 measurement date for the above plans.
45
Notes to Consolidated Financial Statements
Brush Engineered Materials Inc. and Subsidiaries, December 31, 2003
In 2003, the Company revised the expected long-term rate of return
assumption used in calculating the annual expense for its domestic pension plan
in accordance with SFAS No. 87, "Employers' Accounting for Pensions". The
assumed expected rate of return was decreased to 9.0% from 10.0% with the impact
being accounted for as a change in estimate.
Management establishes the expected long-term rate of return assumption
by reviewing its historical trends and analyzing the current and projected
market conditions in relation to the plan's asset allocation and risk management
objectives. Management consults with outside investment advisors and actuaries
when establishing the rate and reviews their assumptions with the Retirement
Plan Review Committee of the Board of Directors. The actual return on plan
assets was 19.7% in 2003 and the 10-year average return as of year-end 2003 was
7.9%. While the current 10-year average is below the 9.0% assumption, primarily
due to the poor performance of the U.S. equity markets in the 2000 to 2002 time
frame, the 10-year rolling average return was over 10.0% in seven of the last
10 years. Management believes that the 9.0% expected long-term rate of return
assumption is achievable and reasonable given current market conditions and
forecasts.
The rate of compensation increase assumption was changed to use a
graded assumption beginning at 2% for the 2003 fiscal year and increasing 0.75%
per year until it reaches 5% for the 2007 fiscal year and later.
2003 2002
------ ------
ASSUMED HEALTH CARE TREND RATES AT
FISCAL YEAR END
Health care trend rate assumed for next year ...... 8.000% 9.000%
Rate that the trend rate gradually declines to
(ultimate trend rate) ........................... 6.000% 6.000%
Year that the rate reaches the ultimate
trend rate ...................................... 2008 2008
Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plans. A one-percentage-point change in
assumed health care cost trend rates would have the following effects:
1-Percentage-Point 1-Percentage-Point
Increase Decrease
---------------------- ----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
(Dollars in thousands)
Effect on total of service and
interest cost components ... $ 155 $ 149 $ (137) $ (131)
Effect on post-retirement
benefit obligation ......... 2,439 2,297 (2,147) (2,029)
On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 ("the Act") was signed into law. The Act expanded
Medicare to include, for the first time, coverage for prescription drugs. The
Company sponsors retiree medical programs for certain of its locations and
expects that this legislation may eventually reduce the Company's costs for some
of these programs. At present, no analysis of the potential reduction in the
Company's costs or obligations has been performed as the Company awaits guidance
from various governmental and regulatory agencies concerning the requirements
that must be met to obtain these cost reductions, as well as the manner in which
such savings should be measured. Because of various uncertainties related to the
Company's response to this legislation and the appropriate accounting
methodology for this event, the Company has elected to defer financial
recognition of this legislation until the Financial Accounting Standards Board
issues final accounting guidance. When issued, that final guidance could require
the Company to change previously reported information. This deferral election is
permitted under FSP No. FAS 106-1.
PLAN ASSETS
The Company's domestic defined benefit pension plan weighted-average
asset allocation at fiscal year-end 2003 and 2002 and target allocation are as
follows:
Percentage of Pension
Plan Assets at
Target Fiscal Year End
Allocation ------------------------
Range 2003 2002
---------- ---------- ----------
ASSET CATEGORY
Equity securities ......... 35-75% 73% 75%
Debt securities ........... 10-25% 20% 24%
Real estate ............... 0-5% 6% 0%
Other ..................... 0-10% 1% 1%
---------- ----------
Total ................... 100% 100%
The Company's pension plan investment strategy, as approved by the
Retirement Plan Review Committee, is to employ an allocation of investments that
will generate returns equal to or better than the projected long-term growth of
pension liabilities so that the plan will be self-funding. The return objective
is to earn a real return (i.e., the actual return less inflation) of 6.0% as
measured on a 10-year moving-average basis. The allocation of investments is
designed to maximize the advantages of diversification while mitigating the risk
to achieve the return objective. Risk is defined as the annual variability in
value and is measured in terms of the standard deviation of investment return.
Under the Company's investment policies, allowable investments include domestic
equities, international
46
equities, fixed income securities, alternative securities (which include real
estate and private venture capital investments) and tactical allocation (a mix
of equities and bonds). Ranges, in terms of a percentage of the total assets,
are established for each allowable class of security. The Company may vary the
actual asset mix based on the ratio of the plan assets and liabilities. The
investment policy prohibits the use of derivative financial instruments that
create or add leverage to an existing security position. Derivatives may be used
to hedge an existing security or as a risk reduction strategy. Management
reviews the asset allocation on an annual or more frequent basis and makes
revisions as deemed necessary.
None of the plan assets noted above are invested in the Company's
common stock.
CASH FLOWS - EMPLOYER CONTRIBUTIONS
The Company expects to contribute $1.7 million to its pension benefit
plans and $3.6 million to its other benefit plans in 2004.
OTHER BENEFIT PLANS
The Company also has accrued unfunded retirement arrangements for
certain directors. The projected benefit obligation was $0.1 million at December
31, 2003 and $0.2 million at December 31, 2002. A corresponding accumulated
benefit obligation of $0.1 million at December 31, 2003 and $0.2 million at
December 31, 2002 has been recognized as a liability and is included in
retirement and post-employment benefits. Certain foreign subsidiaries have
funded and accrued unfunded pension and other post-employment arrangements. The
liability for these plans was $4.7 million at December 31, 2003 and $3.6 million
at December 31, 2002 and was included in retirement and post-employment benefits
on the Consolidated Balance Sheet.
The Company also sponsors a defined contribution plan available to
substantially all U.S. employees. Company contributions to the plan are based on
matching a percentage of employee savings up to a specified savings level. The
Company's contributions were $1.0 million in 2003, $1.0 million in 2002 and $2.5
million in 2001. The Company reduced its matching percentage in half effective
with the beginning of the fourth quarter 2001.
NOTE L - CONTINGENCIES AND COMMITMENTS
CBD CLAIMS
The Company is a defendant in proceedings in various state and federal
courts by plaintiffs alleging that they have contracted chronic beryllium
disease (CBD) or related ailments as a result of exposure to beryllium.
Plaintiffs in CBD cases seek recovery under theories of intentional tort and
various other legal theories and seek compensatory and punitive damages, in many
cases of an unspecified sum. Spouses, if any, claim loss of consortium.
Additional CBD claims may arise.
Management believes the Company has substantial defenses in these cases
and intends to contest the suits vigorously. Employee cases, in which plaintiffs
have a high burden of proof, have historically involved relatively small losses
to the Company. Third-party plaintiffs (typically employees of customers) face a
lower burden of proof than do the Company's employees, but these cases are
generally covered by varying levels of insurance.
Although it is not possible to predict the outcome of the litigation
pending against the Company and its subsidiaries, the Company provides for costs
related to these matters when a loss is probable and the amount is reasonably
estimable. Litigation is subject to many uncertainties, and it is possible that
some of the actions could be decided unfavorably in amounts exceeding the
Company's reserves. An unfavorable outcome or settlement of a pending CBD case
or additional adverse media coverage could encourage the commencement of
additional similar litigation. The Company is unable to estimate its potential
exposure to unasserted claims. The Company recorded a reserve for CBD litigation
of $2.9 million at December 31, 2003 and $4.2 million at December 31, 2002. The
reserve was reduced in both 2003 and 2002 for settlement payments as well as for
changes in estimates for the outstanding claims as a result of favorable rulings
and agreements. An asset of $3.2 million was recorded at December 31, 2003 and
$4.9 million at December 31, 2002 for recoveries from insurance carriers for
outstanding claims that are insured and for prior settlements initially paid
directly by the Company to the plaintiff on insured claims. The reserve is
included in other long-term liabilities and the recovery is included in other
assets on the Consolidated Balance Sheets.
While the Company is unable to predict the outcome of the current or
future CBD proceedings based upon currently known facts and assuming
collectibility of insurance, the Company does not believe that resolution of
these proceedings will have a material adverse effect on the financial condition
or cash flow of the Company. However, the Company's results of operations could
be materially affected by unfavorable results in one or more of these cases.
47
Notes to Consolidated Financial Statements
Brush Engineered Materials Inc. and Subsidiaries, December 31, 2003
ENVIRONMENTAL PROCEEDINGS
The Company has an active program for environmental compliance that
includes the identification of environmental projects and estimating their
impact on the Company's financial performance and available resources.
Environmental expenditures that relate to current operations, such as wastewater
treatment and control of airborne emissions, are either expensed or capitalized
as appropriate. The Company records reserves for the probable costs for
environmental remediation projects. The Company's environmental engineers
perform routine ongoing analyses of the remediation sites. Accruals are based
upon their analyses and are established at either the best estimate or, absent a
best estimate, at the low end of the estimated range of costs. The accruals are
revised for the results of ongoing studies and for differences between actual
and projected costs. The accruals are also affected by rulings and negotiations
with regulatory agencies. The timing of payments often lags the accrual, as
environmental projects typically require a number of years to complete. The
Company established undiscounted reserves for environmental remediation projects
of $6.9 million at December 31, 2003 and $7.7 million at December 31, 2002. The
current portion of the reserve totaled $0.7 million at December 31, 2003 and was
included in other liabilities and accrued items while the remaining $6.2 million
of the reserve at December 31, 2003 is considered long-term and is included in
other long-term liabilities on the Consolidated Balance Sheet. These reserves
cover existing or currently foreseen projects. It is possible that additional
environmental losses may occur beyond the current reserve, the extent of which
cannot be estimated.
The environmental reserve was reduced by $0.6 million in 2003 as a
result of revised estimates of the required remediation work and related costs,
primarily for RCRA projects, SWMU closure and other projects at the Company's
Elmore, Ohio site. Payments against the reserve totaled $0.2 million in 2003.
The environmental expense was $0.6 million in 2002. The environmental reserve
was reduced by $1.0 million during 2001 as result of a revised cost estimate for
an established Voluntary Action Plan and the completion of another project for
less than the previously estimated cost. The reserve was increased by $0.7
million in 2001 for various projects at the Elmore site. These items combined
for a net credit of $0.3 million to income in 2001.
LONG-TERM OBLIGATION
The Company has a long-term supply arrangement with Ulba/Kazatomprom of
the Republic of Kazakhstan and their marketing representative, Nukem, Inc. of
Connecticut. The agreement was signed in 2000 and amended in 2001 and 2003.
Under the amended 2003 agreement, the purchase commitments for copper beryllium
master alloy have been significantly reduced from the previous levels. The 2003
amended agreement also added purchase commitments for beryllium vacuum cast
billets and extended the contract period to 2012. All materials under the
arrangement are sourced from Ulba/Kazatomprom. The annual base purchase
commitments total between $5.3 and $5.6 million for 2004 through 2007. The price
per pound escalates each year through 2007. A new price will be renegotiated for
the years 2008 through 2012. If a new price cannot be agreed to by December 31,
2007, then the material purchases will terminate with the 2008 delivery volumes.
The contract allows for the Company to purchase additional quantities of copper
beryllium master alloy up to an annual maximum of 150,000 pounds of beryllium
contained in the master alloy. The purchase of beryllium vacuum cast billets can
be plus or minus 10% of the annual base quantity. Purchases of
beryllium-containing materials from Nukem were $3.3 million in 2001 and
immaterial in both 2003 and 2002.
The Company has agreements to purchase stated quantities of beryl ore,
beryllium metal and copper beryllium master alloy from the Defense Logistics
Agency of the U.S. Government. The agreements expire in 2007. Annual purchase
commitments total approximately $6.4 million in 2004 through 2007. The beryllium
component of the contract price is adjusted quarterly from these stated totals
based upon fluctuations in the non-seasonally adjusted consumer price index. The
Company may elect to take delivery of the materials in advance of the commitment
dates. Purchases under these agreements totaled approximately $5.7 million in
2003, $3.9 million in 2002 and $6.4 million in 2001. The purchased material will
serve as raw material input for operations within Brush Wellman Inc. and Brush
Resources Inc.
OTHER
The Company has outstanding letters of credit totaling $7.1 million
related to workers' compensation, consigned precious metal guarantees and
environmental remediation issues that expire in 2004.
The Company is subject to various other legal or other proceedings that
relate to the ordinary course of its business. The Company believes that the
resolution of these other legal or other proceedings, individually or in the
aggregate, will not have a material adverse impact upon the Company's
Consolidated Financial Statements.
48
NOTE M - SEGMENT REPORTING AND GEOGRAPHIC INFORMATION
Selected financial data by business segment as proscribed by SFAS
No.131, "Disclosures about Segments of an Enterprise and Related Information,"
for 2003, 2002 and 2001 are as follows:
Metal Micro- Total
(Dollars in thousands) Systems electronics Segments All Other Total
--------- ----------- --------- --------- ---------
2003
Revenues from external customers ................. $ 239,404 $ 157,323 $ 396,727 $ 4,319 $ 401,046
Intersegment revenues ............................ 2,414 1,119 3,533 17,994 21,527
Depreciation, depletion and amortization ......... 11,250 4,020 15,270 5,461 20,731
Profit (loss) before interest and taxes .......... (16,590) 12,618 (3,972) (5,368) (9,340)
Assets ........................................... 258,958 74,137 333,095 38,521 371,616
Expenditures for long-lived assets ............... 2,830 2,930 5,760 559 6,319
2002
Revenues from external customers ................. $ 227,884 $ 139,180 $ 367,064 $ 5,765 $ 372,829
Intersegment revenues ............................ 3,118 1,566 4,684 12,171 16,855
Depreciation, depletion and amortization ......... 12,060 3,930 15,990 4,650 20,640
Profit (loss) before interest and taxes .......... (37,657) 3,845 (33,812) 10,967 (22,845)
Assets ........................................... 223,986 71,832 295,818 39,061 334,879
Expenditures for long-lived assets ............... 1,930 2,370 4,300 1,114 5,414
2001
Revenues from external customers ................. $ 295,690 $ 169,598 $ 465,288 $ 7,281 $ 472,569
Intersegment revenues ............................ 2,596 2,066 4,662 12,036 16,698
Depreciation, depletion and amortization ......... 12,560 3,780 16,340 5,269 21,609
Profit (loss) before interest and taxes .......... (20,117) 4,568 (15,549) 1,480 (14,069)
Assets ........................................... 265,371 68,401 333,772 69,881 403,653
Expenditures for long-lived assets ............... 13,031 6,841 19,872 3,412 23,284
49
Notes to Consolidated Financial Statements
Brush Engineered Materials Inc. and Subsidiaries, December 31, 2003
Segments are evaluated using earnings before interest and taxes. The
"All Other" column includes the operating results of BEM Services, Inc. and
Brush Resources Inc., two wholly owned subsidiaries of the Company, as well as
the parent company's and other corporate expenses. BEM Services charges a
management fee for the services provided to the other businesses within the
Company on a cost-plus basis. Brush Resources sells beryllium hydroxide,
produced from its mine and extraction mill in Utah, to external customers and to
businesses within the Metal Systems Group. Assets shown in All Other include
cash, computer hardware and software, deferred taxes, capitalized interest and
the operating assets for Brush Resources Inc. Inventories for Metal Systems and
Microelectronics are shown at their FIFO values with the LIFO reserve included
under the All Other column. Intersegment revenues are eliminated in
consolidation. The revenues from external customer totals are presented net of
the intersegment revenues. Assets for the Metals Systems Group include the $51.8
million of equipment purchased in 2003 that was previously held under an
operating lease.
The Company's sales from U.S. operations to external customers,
including exports, were $311.5 million in 2003, $301.1 million in 2002, and
$385.8 million in 2001. Revenues attributed to countries based upon the location
of customers and long-lived assets deployed by the Company by country are as
follows:
(Dollars in thousands) 2003 2002 2001
- ------------------------- --------- ----------- ---------
REVENUES
United States ......... $ 276,668 $ 268,548 $ 338,233
All other ............. 124,378 104,281 134,336
--------- ----------- ---------
Total ................. $ 401,046 $ 372,829 $ 472,569
========= =========== =========
LONG-LIVED ASSETS
United States ......... $ 185,168 $ 147,263 $ 166,126
All other ............. 5,678 5,281 5,170
--------- ----------- ---------
Total ................. $ 190,846 $ 152,544 $ 171,296
========= =========== =========
No individual country, other than the United States, or customer
accounted for 10% or more of the Company's revenues for the years presented.
Revenues from outside the U.S. are primarily from Europe and Asia.
NOTE N - RELATED PARTY TRANSACTIONS
The Company has outstanding loans of $0.4 million with six employees,
including two executive officers, as of December 31, 2003. The loan balance was
$0.4 million as of December 31, 2002 as well. The loans were made in the first
quarter 2002 pursuant to life insurance agreements between the Company and the
employees. The portion of the premium paid by the Company is treated as a loan
from the Company to the employee and the loans are secured by the insurance
policies, which are owned by the employees. The agreements require the employee
to maintain the insurance policy's cash surrender value in an amount at least
equal to the outstanding loan balance. The loan is payable from the insurance
proceeds upon the employee's death or at an earlier date due to the occurrence
of specified events. The loans bear an interest rate equal to the applicable
federal rate.
NOTE O - OTHER COMPREHENSIVE INCOME
The following table summarizes the net gain/(loss) by component within
other comprehensive income as of December 31, 2003, 2002 and 2001.
December 31,
2003 2002 2001
---------- ---------- --------
(Dollars in thousands)
Foreign currency translation
adjustment ......................... $ (982) $ (1,457) $ (2,289)
Change in the fair value of
derivative financial instruments ... (3,216) (7,839) (2,061)
Minimum pension liability ............ (12,596) (13,563) -
---------- ---------- --------
Total ................................ $ (16,794) $ (22,859) $ (4,350)
========== ========== ========
50
NOTE P - QUARTERLY DATA (UNAUDITED)
Years ended December 31, 2003 and 2002.
2003
----------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
-------- ---------- ---------- ---------- ----------
(Dollars in thousands except per share data)
Net sales ......................................... $ 99,518 $ 101,805 $ 94,156 $ 105,567 $ 401,046
Gross profit ...................................... 17,113 18,864 14,370 22,691 73,038
Percent of sales ................................ 17.2% 18.5% 15.3% 21.5% 18.2%
Net income (loss) ................................. (3,016) 37 (3,060) (7,187) (13,226)
Net income (loss) per share of common stock ....... (0.18) - (0.18) (0.43) (0.80)
Stock price range
High ............................................ 6.15 8.92 10.45 15.60
Low ............................................. 4.80 5.06 7.70 10.20
2002
----------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
-------- ---------- ---------- ---------- ----------
(Dollars in thousands except per share data)
Net sales ..................................... $ 89,582 $ 100,749 $ 93,481 $ 89,017 $ 372,829
Gross profit .................................. 10,254 15,070 12,015 10,558 47,897
Percent of sales ............................ 11.4% 15.0% 12.9% 11.9% 12.8%
Net loss ...................................... (3,834) (2,049) (2,906) (26,815) (35,604)
Net loss per share of common stock ............ (0.23) (0.12) (0.18) (1.62) (2.15)
Stock price range
High ........................................ 14.00 13.24 12.20 8.00
Low ......................................... 10.25 11.15 6.98 4.50
Fourth quarter 2003 results include a $6.0 million pre-tax charge to
write off deferred costs and recognize derivative ineffectiveness as a result of
the debt refinancing.
51
Selected Financial Data
Brush Engineered Materials Inc. and Subsidiaries
(Dollars in thousands except for share data)
2003 2002 2001 2000 1999
------------ ------------ ------------ ------------ ------------
FOR THE YEAR
Net sales ..................................... $ 401,046 $ 372,829 $ 472,569 $ 563,690 $ 455,707
Cost of sales ................................. 328,008 324,932 404,574 444,951 363,773
Gross profit .................................. 73,038 47,897 67,995 118,739 91,934
Operating profit (loss) ....................... (9,340) (22,845) (14,069) 22,986 10,558
Interest expense .............................. 3,355 3,010 3,327 4,652 4,173
Income (loss) from continuing operations
Before income taxes .......................... (12,695) (25,855) (17,396) 18,334 6,385
Income taxes (benefit) ........................ 576 9,749 (7,122) 4,169 (54)
Net income (loss) ............................. (13,226) (35,604) (10,274) 14,165 6,439
Earnings per share of common stock:
Basic net income (loss) ..................... (0.80) (2.15) (0.62) 0.87 0.40
Diluted net income (loss) ................... (0.80) (2.15) (0.62) 0.86 0.40
Dividends per share of common stock ........... -- -- 0.24 0.48 0.48
Depreciation and amortization ................. 20,731 20,640 21,609 22,664 27,037
Capital expenditures .......................... 6,162 5,248 23,130 21,306 16,758
Mine development expenditures ................. 157 166 154 332 288
YEAR-END POSITION
Working capital ............................... 85,141 82,645 110,894 143,387 124,831
Ratio of current assets to current liabilities 2.2 to 1 2.1 to 1 2.4 to 1 2.3 to 1 2.3 to 1
Property and equipment:
At cost ..................................... 535,421 476,283 469,663 449,697 440,234
Cost less depreciation and impairment ....... 190,846 152,544 171,296 170,460 170,939
Total assets .................................. 371,616 334,879 403,653 452,506 428,406
Other long-term liabilities ................... 64,097 65,977 62,473 55,454 53,837
Long-term debt ................................ 85,756 36,219 47,251 43,305 42,305
Shareholders' equity .......................... 153,573 159,094 214,350 229,907 220,638
Book value per share:
Basic ....................................... 9.27 9.61 12.98 14.11 13.62
Diluted ..................................... 9.21 9.58 12.87 13.98 13.55
Weighted number of shares of stock outstanding:
Basic ....................................... 16,562,864 16,557,388 16,518,691 16,292,431 16,198,885
Diluted ..................................... 16,671,916 16,608,725 16,650,587 16,448,667 16,279,591
Shareholders of record ........................ 1,791 1,864 1,981 2,101 2,330
Number of employees ........................... 1,833 1,862 1,946 2,500 2,257
Minority interest of $45,000 decreased the net loss for 2003.
In addition to the capital expenditures shown above, with the proceeds from the
debt refinancing in 2003, the Company purchased $51.8 million of assets
previously held under an operating lease that have been used by the Company
since 1998.
A deferred tax valuation allowance increased income tax expense by $5.3 million
and $19.9 million in 2003 and 2002, respectively.
A special charge reduced net income by $16.5 million in 1998.
See Notes to Consolidated Financial Statements.
52
1998 1997 1996 1995 1994 1993
- ------------ ----------- ----------- ----------- ----------- -----------
$ 409,892 $ 433,801 $ 376,279 $ 369,618 $ 345,878 $ 295,478
325,173 324,463 271,149 268,732 253,938 227,686
84,719 109,338 105,130 100,886 91,940 67,792
(10,313) 36,024 34,305 29,086 25,098 10,658
1,249 553 1,128 1,653 2,071 2,952
(11,562) 35,471 33,177 27,433 23,027 7,706
(4,430) 9,874 8,686 6,744 4,477 1,248
(7,132) 25,597 24,491 20,689 18,550 6,458
(0.44) 1.58 1.55 1.28 1.15 0.40
(0.44) 1.56 1.53 1.27 1.15 0.40
0.48 0.46 0.42 0.36 0.26 0.20
24,589 19,329 22,954 20,911 19,619 21,720
36,732 53,155 26,825 24,244 17,214 11,901
433 9,526 3,663 787 543 814
100,992 100,599 128,172 125,156 116,708 105,272
2.1 to 1 2.3 to 1 2.9 to 1 2.9 to 1 2.8 to 1 3.1 to 1
421,467 463,689 404,127 374,367 350,811 337,342
164,469 173,622 130,220 121,194 116,763 118,926
403,690 383,852 355,779 331,853 317,133 293,372
49,955 48,025 47,271 45,445 43,354 40,663
32,105 17,905 18,860 16,996 18,527 24,000
221,811 236,813 219,257 200,302 186,940 172,075
13.63 14.60 13.84 12.40 11.61 10.70
13.50 14.41 13.72 12.30 11.57 10.69
16,267,804 16,214,718 15,846,358 16,159,508 16,102,350 16,087,250
16,424,747 16,429,468 15,980,481 16,289,795 16,156,159 16,093,696
2,313 2,329 2,407 2,351 2,521 2,566
2,167 2,160 1,926 1,856 1,833 1,803
53
Brush Engineered Materials Inc. Directors, Officers, Facilities and Subsidiaries
BOARD OF DIRECTORS AND
COMMITTEES OF THE BOARD
ALBERT C. BERSTICKER (2), (3), (4)
Non-Executive Chairman
Oglebay Norton Company
Retired Chairman and CEO
Ferro Corporation
GORDON D. HARNETT (2)
Chairman, President and CEO
Brush Engineered Materials Inc.
DAVID H. HOAG (2), (3), (4), (5)
Retired Chairman and CEO
The LTV Corporation
JOSEPH P. KEITHLEY (2), (3), (4), (5)
Chairman, President and CEO
Keithley Instruments, Inc.
WILLIAM B. LAWRENCE (1), (4)
Former Executive Vice President,
General Counsel & Secretary
TRW, Inc.
WILLIAM P. MADAR (2), (3), (4)
Chairman and Former CEO
Nordson Corporation
WILLIAM G. PRYOR (4), (5)
Retired President
Van Dorn Demag Corporation
Former President and CEO
Van Dorn Corporation
N. MOHAN REDDY (1), (4)
Professor
The Weatherhead School of Management
Case Western Reserve University
WILLIAM R. ROBERTSON (1), (4), (5)
Managing Partner
Kirtland Capital Partners
JOHN SHERWIN, JR. (1), (2), (4), (5)
President
Mid-Continent Ventures, Inc.
1 Audit Committee
2 Executive Committee
3 Governance Committee
4 Organization and Compensation
Committee
5 Retirement Plan Review Committee
CHARLES F. BRUSH, III
Director Emeritus
CORPORATE AND
EXECUTIVE OFFICERS
GORDON D. HARNETT (1), (2)
Chairman, President and CEO
JOHN D. GRAMPA (1), (2)
Vice President Finance
and Chief Financial Officer
DANIEL A. SKOCH (1), (2)
Senior Vice President
Administration
MICHAEL C. HASYCHAK (1)
Vice President, Treasurer and Secretary
JAMES P. MARROTTE (1)
Vice President, Controller
JOHN J. PALLAM (1)
Vice President, General Counsel
GARY W. SCHIAVONI (1)
Assistant Treasurer and Assistant Secretary
1 Corporate Officers
2 Executive Officers
OPERATING GROUPS
Alloy Products
RICHARD J. HIPPLE, PRESIDENT
Beryllium Products
MICHAEL D. ANDERSON, PRESIDENT
Brush International, Inc.
STEPHEN FREEMAN, PRESIDENT
Brush Resources Inc.
ALEX C. BOULTON, PRESIDENT
Technical Materials, Inc.
ALFONSO T. LUBRANO, PRESIDENT
Williams Advanced Materials Inc.
RICHARD W. SAGER, PRESIDENT
Zentrix Technologies Inc.
RICHARD W. SAGER, PRESIDENT
OFFICES AND FACILITIES
MANUFACTURING FACILITIES
Brewster, New York
Buffalo, New York
Delta, Utah
Elmore, Ohio
Fremont, California
Lincoln, Rhode Island
Lorain, Ohio
Newburyport, Massachusetts
Oceanside, California
Reading, Pennsylvania
Santa Clara, California
Singapore
Subic Bay, Philippines
Taipei, Taiwan
Tucson, Arizona
Wheatfield, New York
CORPORATE OFFICES
Cleveland, Ohio
SERVICE CENTERS
Elmhurst, Illinois
Fairfield, New Jersey
Singapore
Stuttgart, Germany
Theale, England
Tokyo/Fukaya, Japan
Warren, Michigan
SUBSIDIARIES
BEM Services, Inc.
Cleveland, Ohio
Brush Wellman Inc.
Cleveland, Ohio
Brush Ceramic Products Inc.
Tucson, Arizona
Brush International, Inc.
Cleveland, Ohio
Brush Resources Inc.
Delta, Utah
Brush Wellman GmbH
Stuttgart, Germany
Brush Wellman (Japan), Ltd.
Tokyo, Japan
Brush Wellman Limited
Theale, England
Brush Wellman (Singapore) Pte Ltd
Singapore
Circuits Processing Technology, Inc.
Oceanside, California
Technical Materials, Inc.
Lincoln, Rhode Island
Williams Advanced Materials Inc.
Buffalo, New York
Williams Advanced Materials
Far East Pte Ltd.
Singapore
Zentrix Technologies Inc.
Tucson, Arizona
54
Corporate Data
ANNUAL MEETING
The Annual Meeting of Shareholders will be held on May 4, 2004 at 11:00
a.m. at The Forum, One Cleveland Center, 1375 East Ninth Street, Cleveland,
Ohio.
INVESTOR INFORMATION
Brush Engineered Materials Inc. maintains an active program of
communication with shareholders, securities analysts and other members of the
investment community. Management makes regular presentations in major financial
centers around the world. To obtain:
- additional copies of the annual report
- SEC Form 10K/10Q
Please contact:
Michael C. Hasychak
Vice President, Treasurer and Secretary
WEB SITE
Brush Engineered Materials Inc.'s web site on the Internet offers
financial and investor information, news and facts about the Company, its
businesses, markets and products. The Company has adopted Corporate Governance
Guidelines and a Code of Business Conduct and Ethics in compliance with
applicable New York Stock Exchange and Securities and Exchange Commission
requirements. These materials, along with the charters of the Audit, Governance,
Organization and Compensation, and Retirement Plan Review Committees of the
Company's Board of Directors, which also comply with applicable requirements,
are available on the Company's web site.
Visit the site at: HTTP://WWW.BEMINC.COM
AUDITORS
Ernst & Young LLP
925 Euclid Avenue, Suite 1300, Cleveland, Ohio 44115
TRANSFER AGENT AND REGISTRAR
National City Bank Corporate Trust Operations
P.O. Box 92301, Cleveland, OH 44193-0900
For shareholder inquiries, call: (800) 622-6757
STOCK LISTING
New York Stock Exchange/Symbol: BW
CORPORATE HEADQUARTERS
Brush Engineered Materials Inc.
17876 St. Clair Ave., Cleveland, Ohio 44110
(216) 486-4200 - Facsimile: (216) 383-4091
[BRUSH ENGINEERED MATERIALS LOGO]
17876 St. Clair Avenue - Cleveland, Ohio 44110 - 216.486.4200