FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
Commission file No. 000-22029
Special Metals Corporation
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(Exact name of registrant as specified in its charter)
Delaware 25-1445468
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4317 Middlesettlement Road
New Hartford, NY 13413
----------------------------------------
(Address of principal executive offices)
(Zip Code)
(315) 798-2900
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(Registrant's telephone number, including area code)
Not Applicable
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
As of November 2, 1998 there were 15,479,000 shares of the Issuer's common
stock, par value $.01 per share, outstanding.
<PAGE>
SPECIAL METALS CORPORATION
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
INDEX
Page
Part I. Financial Information
Item 1. Condensed Financial Statements (unaudited)
Condensed Balance Sheets as of December 31, 1997 and
September 30, 1998 2
Condensed Statements of Operations and Retained Earnings
for the three months and nine months ended September 30,
1997 and 1998 3
Condensed Statements of Cash Flows for the nine months ended
September 30, 1997 and 1998 4
Notes to Condensed Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk 17
Part II. Other Information
Item 1. Legal Proceedings 17
Item 2. Changes in Securities and Use of Proceeds 18
Item 3. Defaults Upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
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<PAGE>
Part I. Financial Information
Item 1. Financial Statements
SPECIAL METALS CORPORATION
CONDENSED BALANCE SHEETS
(Unaudited - In thousands)
<TABLE>
<CAPTION>
December 31, September 30,
1997 1998
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 12,237 $ 11,383
Restricted deposits 1,161 1,085
Accounts receivable, less allowance for doubtful accounts
of $168 for 1997 and $124 for 1998 30,212 30,287
Refundable income taxes - 1,004
Inventories 50,580 53,951
Prepaid expenses 216 360
Deferred income taxes 2,375 2,447
----- -----
Total current assets 96,781 100,517
Property, plant and equipment 39,727 45,278
Deferred income taxes 1,618 1,147
Other assets 3,624 4,970
----- -----
Total assets $ 141,750 $ 151,912
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities:
Accounts payable $ 15,688 $ 12,333
Accrued liabilities 11,459 10,428
Income taxes payable 493 -
Current obligation under capital leases 316 264
--- ---
Total current liabilities 27,956 23,025
Long-term obligation under capital leases 174 -
Other long-term liabilities 9,649 9,848
----- -----
Total liabilities 37,779 32,873
Commitments and contingencies
Shareholders' equity:
Preferred stock - -
Common stock 155 155
Paid-in surplus 75,678 75,711
Accumulated other comprehensive income (496) (496)
Retained earnings 28,634 43,669
------ ------
Total shareholders' equity 103,971 119,039
------- -------
Total liabilities and shareholders' equity $ 141,750 $ 151,912
======= =======
See accompanying notes to condensed financial statements.
</TABLE>
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<PAGE>
SPECIAL METALS CORPORATION
CONDENSED STATEMENTS OF OPERATIONS AND
RETAINED EARNINGS
(Unaudited - In thousands, except per share amounts)
<TABLE>
<CAPTION>
Three months ended Sept. 30, Nine months ended Sept. 30,
1997 1998 1997 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales $ 44,168 $ 41,645 $ 138,372 $ 134,688
Cost of goods sold 33,609 33,825 105,347 106,376
------- ------ ------- -------
10,559 7,820 33,025 28,312
Selling, general and
administrative expenses 1,874 1,785 5,344 5,554
----- ----- ----- -----
Operating income 8,685 6,035 27,681 22,758
Interest expense 48 34 617 98
Abandoned acquisition costs 11 - 553 -
Interest income (84) (133) (265) (464)
Other expense (income) (92) 25 (296) (20)
--- -- ---- ---
Income before income taxes 8,802 6,109 27,072 23,144
Income tax expense 3,177 2,020 9,766 8,109
----- ----- ----- -----
Net income 5,625 4,089 17,306 15,035
Retained earnings
Beginning of period 17,313 39,580 5,632 28,634
------ ------ ----- ------
End of period $22,938 $43,669 $22,938 $43,669
======= ======= ======= =======
Net income per share $0.36 $0.26 $1.16 $0.97
(Basic and Dilutive)
Weighted average shares outstanding 15,512 15,479 14,873 15,479
(Basic and Dilutive)
See accompanying notes to condensed financial statements.
</TABLE>
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<PAGE>
SPECIAL METALS CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited - In thousands)
<TABLE>
<CAPTION>
Nine months ended Sept. 30,
1997 1998
---- ----
<S> <C> <C>
Operating Activities:
Net income $ 17,306 $ 15,035
Depreciation and amortization 3,079 2,910
Other adjustments and changes in assets and liabilities (12,035) (8,842)
------- ------
Net cash provided by operating activities 8,350 9,103
Investing Activities:
Capital expenditures (7,508) (8,297)
Net change in restricted deposits - 76
Other - (1,510)
------- ------
Net cash used in investing activities (7,508) (9,731)
Financing Activities:
Proceeds from sale of common stock 45,957 -
Repayment of revolving credit facilities (26,000) -
Repayment of subordinated notes payable to affiliates (1,500) -
Repayments of term loans (20,000) -
Proceeds from equipment loans 531 -
Payments on capital lease obligations (228) (226)
Other (192) -
------- ------
Net cash used in financing activities (1,432) (226)
------- ------
Net increase (decrease) in cash and cash equivalents (590) (854)
Cash and cash equivalents at beginning of period 3,336 12,237
------- ------
Cash and cash equivalents at end of period $ 2,746 $ 11,383
======= ======
</TABLE>
See accompanying notes to condensed financial statements.
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<PAGE>
SPECIAL METALS CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(Unaudited)
NOTE 1 - ACCOUNTING POLICIES
The accompanying unaudited condensed financial statements of Special Metals
Corporation (the "Company") have been prepared in accordance with generally
accepted accounting principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting only of normal recurring accruals)
considered necessary for a fair presentation have been included. Results for the
period ended September 30, 1998 are not necessarily indicative of the results
that may be expected for the year ending December 31, 1998.
For further information, refer to the financial statements and footnotes thereto
included in the Company's annual report on Form 10-K for the year ended December
31, 1997.
NOTE 2 - INVENTORIES
Inventories consist of the following (in thousands):
December 31, September 30,
1997 1998
---- ----
Raw materials and supplies $ 13,007 $ 15,923
Work-in-process 37,573 38,028
------ ------
$ 50,580 $ 53,951
= ====== = ======
NOTE 3 - CONTINGENCIES
Environmental
The Company is subject to loss contingencies pursuant to various federal, state
and local environmental laws, and is currently involved in several actions
regarding the clean-up of disposal sites alleged to contain hazardous and/or
toxic wastes generated over a number of years including the following.
The Company, with contribution from other parties, performed remedial actions at
a site in Clayville, New York (the "Ludlow Landfill"). Except for adjoining
property known as the "North Gravel Pit," the New York State Department of
Environmental Conservation ("DEC") has advised the Company that all work
performed to date is acceptable. The Company is also responsible for operation
and maintenance
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<PAGE>
SPECIAL METALS CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
costs for a period of 30 years, which began in 1997. The costs for this are
estimated to be approximately $150,000 per year in years one and two, and
approximately $90,000 in the remaining years. The total estimated costs of
approximately $2.8 million have been discounted at an annual rate of 4% in the
accompanying financial statements. The Company may also be required to perform
contingent post-closure activities. It is not possible to determine which, if
any, of the contingent activities the Company will need to perform.
Contamination has also been discovered at the North Gravel Pit site. A study was
completed in 1997 to determine the extent of the contamination and to select an
appropriate remedial alternative. A report detailing the work and a recommended
remedial alternative was prepared by the Company's engineers and submitted to
the DEC on or around the end of January 1998. The recommended remedial
alternative has a total estimated capital cost for the remedy of approximately
$910,000 with a total estimated annual operation and maintenance cost of
approximately $39,000. The estimated 30 year present value for operation and
maintenance costs is approximately $600,000. However, the engineering cost
estimates are preliminary and, accordingly, may be subject to material
adjustment during the period of remedial design or as a result of future
negotiation with the DEC. In a June, 1998 letter the DEC informed the Company
that it is not prepared to accept the recommended remedial alternative. The
Company has been meeting with its engineers and the DEC to formulate a response
to the DEC.
The Company is also involved in a site in Utica, New York which is alleged to be
contaminated. In the mid 1980's, the owners/operators of Universal Waste in
Utica, New York (the "Universal Waste Site") were cited by the DEC in a formal
enforcement proceeding for cleanup of the site which was allegedly contaminated.
The owner of the Universal Waste Site requested by motion that the Company be
named as an indispensable party to that proceeding. The DEC, however, took the
position that the Company should not be named as an indispensable party. The
Company believes that at least four other potentially responsible parties have
been identified with respect to the contamination at the site. A consent order
was executed obligating the site operator to conduct a preliminary site
assessment on a portion of the property. The preliminary site assessment was
completed in 1996. The DEC conducted a separate preliminary site assessment
offsite, which also was completed in 1996. The Company is presently not involved
in investigating the alleged contamination. Based upon the limited information
available to its environmental engineers, the Company has established a reserve
of $575,000. However, because of the preliminary nature of the investigation, it
is not possible, at this time, to provide a reasonable estimate as to the
ultimate cost of any investigative or remedial work which will be required, or
the Company's share, if any, of such costs.
One outfall of four permitted under the Company's State Pollution Discharge
Elimination System permit at its New Hartford facility is occasionally out of
compliance with respect to PCB limits. The current limit for PCBs in the
Company's permit is non-detect. The DEC has notified the Company that sampling
aquatic organisms downstream from the Company's outfall revealed higher than
acceptable levels of PCBs. The Company has offered to install additional storm
water treatment equipment at an estimated cost of $360,000 in order to meet the
non-detect limit. The DEC has approved the Company's proposal. Although the
Company cannot at this time provide a reasonable estimate of any additional
costs that may be required, the Company does not believe it will incur any
material liability in connection with this matter.
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<PAGE>
The Company is on notice of, and involved in, certain other environmental
matters which have been settled or are at various stages of discussion,
negotiation or settlement which the Company does not believe to be material.
Although the Company believes that it is in substantial compliance with
applicable requirements of environmental laws and that its reserves for the
items noted above are adequate, there can be no assurance that some, or all, of
the risks noted previously will not result in liabilities that are material to
the Company's business, results of operations, financial positions, or cash
flows.
OTHER
From time to time, the Company is involved in legal proceedings relating to
claims arising out of its operations in the normal course of business. The
Company does not believe that it is a party to any proceedings at the present
time that could reasonably be expected to have a material adverse effect on the
business, financial condition, results of operations or cash flows of the
Company.
NOTE 4 - EARNINGS PER SHARE
Earnings per share ("EPS") are computed by dividing net income by the weighted
average number of shares of common stock outstanding during the period (basic
EPS) plus common stock equivalents, if the impact of common stock equivalents is
dilutive (diluted EPS). The Company's common stock equivalents, which consist of
stock options, were not considered in the calculations of earnings per share for
the periods presented herein because the impact of the common stock equivalents
was anti-dilutive.
NOTE 5 - COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income." Statement 130 establishes
new rules for the reporting and display of comprehensive income and its
components. The adoption of this Statement had no impact on the Company's net
income or shareholders' equity. Statement 130 requires the Company's pension
adjustment, which prior to adoption was reported separately in shareholders'
equity, to be included in other comprehensive income. Prior year financial
statements have been reclassified to conform with the requirements of Statement
130. During the three months and nine months ended September 30, 1998 and 1997,
total comprehensive income, which was comprised of net income and adjustments to
the pension adjustment account, equaled net income.
NOTE 6 - ACQUISITION OF INCO ALLOYS INTERNATIONAL
On October 28, 1998, Special Metals Corporation acquired the Inco Alloys
International high performance nickel alloys business unit ("IAI") of Inco
Limited ("Inco") and entered into a non-competition agreement with INCO for
aggregate consideration of $365 million, consisting of $348 million in cash and
$17 million liquidation value Series A Senior Convertible Preferred Stock. The
Company financed the cash portion of the consideration with funds drawn under a
new $375 million bank credit facility and with proceeds from the issuance of $80
million liquidation value Series A Senior Convertible Preferred Stock to TIMET
Finance Management Company ("TIMET"), a wholly-owned subsidiary of Titanium
Metals Corporation ("TMC"). The preferred stock issued to Inco and TIMET will
accrue dividends at the rate of 6.625% per annum, payable quarterly, and is
convertible into Special Metals common stock at a conversion price of
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<PAGE>
$16.50 per share. The preferred stock is mandatorily redeemable after seven and
one-half years and is subject to optional redemption by the Company commencing
October 28, 2001 at a redemption price of 103.975% of the liquidation amount
plus accumulated and unpaid dividends. The redemption price declines
incrementally on each subsequent October 28 until October 28, 2006, after which
the redemption price is 100.0% of the liquidation amount plus accumulated and
unpaid dividends. In connection with the preferred stock sale, Special Metals
and TMC signed an agreement in principle to form a strategic alliance with
respect to manufacturing, marketing, and product development in titanium and
high-performance nickel based alloys.
IAI is one of the world's leading manufacturers of high performance nickel
alloys intended for demanding applications. IAI produces alloys in various
forms, including sheet, strip, foil, plate, tubing, billet, bar, rod, extruded
shapes, wire rod and welding products. IAI products are used in the aerospace,
chemical process, environmental, off-shore drilling, industrial gas turbine, and
automotive markets.
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<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Certain statements contained in this item constitute "forward-looking
statements" within the meaning of Section 21E of the Securities Exchange Act of
1934. See Part II. Other Information, Item 5(b), "Forward-Looking Statements."
OVERVIEW
The Company manufactures superalloys and special alloys, which are highly
engineered metal alloys designed to withstand extreme heat, stress and
corrosion. Special Metals operates three divisions. The Superalloy Billet and
Bar Division manufactures a wide array of wrought superalloy and special alloy
products in billet, bar and cast form, which are used primarily in jet engines.
This division also produces "shape memory" alloys, such as Nitinol, which are
primarily used in medical and dental applications. The Powder Division produces
powder metallurgy-based superalloy products for military jet engines and the
latest generation of large commercial jet engines. The Dental Division produces
amalgamable dental alloys. For the nine months ended September 30, 1998, the
Superalloy Billet and Bar Division, the Powder Division and the Dental Division
accounted for 90%, 6% and 4%, respectively, of the Company's net sales of $134.7
million.
RECENT DEVELOPMENTS - IAI ACQUISITION. On October 28, 1998, Special Metals
completed the acquisition of the Inco Alloys International high performance
nickel alloys business unit ("IAI") from Inco Limited ("Inco") and entered into
a non-competition agreement with Inco for aggregate consideration of $365
million, consisting of $348 million in cash and $17 million liquidation value
Series A Senior Convertible Preferred Stock (the "Acquisition"). The Company
financed the cash portion of the consideration with proceeds from the issuance
of $80 million liquidation value Series A Senior Convertible Preferred Stock to
TIMET Finance Management Company ("TIMET") and with funds drawn under a new $375
million bank credit facility. See "- Liquidity and Capital Resources." The
preferred stock issued to Inco and TIMET will accrue dividends at the rate of
6.625% per annum, payable quarterly, and is convertible into Special Metals
common stock at a conversion price of $16.50 per share. The preferred stock is
mandatorily redeemable after seven and one-half years and is subject to optional
redemption commencing October 28, 2001. See Footnote 6 to the Condensed
Financial Statements in Part I. Item 1. "Condensed Financial Statements
(unaudited)." In connection with the preferred stock sale, Special Metals and
TMC also signed an agreement in principle to form a strategic alliance with
respect to manufacturing, marketing, and product development in titanium and
high-performance nickel based alloys. IAI is one of the world's leading
manufacturers of high performance nickel alloys intended for demanding
applications. IAI produces alloys in various forms, including sheet, strip,
foil, plate, tubing, billet, bar, rod, extruded shapes, wire rod and welding
products. IAI products are used in the aerospace, chemical process,
environmental, off-shore drilling, industrial gas turbine, and automotive
markets.
NET SALES. Net sales include sales of the Company's superalloy and special alloy
products and revenue earned from toll conversion. Sales of the Company's
products are made under conventional purchase orders, one-year supply contracts,
long-term firm price contracts, and indexed price contracts. A substantial
majority of the Company's net sales during the nine months ended September 30,
1998 were sold under conventional purchase orders, one-year supply contracts,
and indexed price contracts.
Export sales represent a significant portion of the Company's business. During
the nine months ended September 30, 1998, sales to purchasers outside of the
United States totaled 29% of the Company's net
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sales. Substantially all of the Company's export sales are conducted in U.S.
dollars.
COSTS OF GOODS SOLD. The superalloy industry is characterized by high capital
investment and high fixed costs, and profitability is therefore significantly
affected by changes in volume. Variable costs such as raw materials, labor,
supplies and energy (primarily electricity) generally account for over
three-fourths of the Company's costs of goods sold. Fixed costs, such as
indirect overhead and depreciation, constitute the remainder of the Company's
costs of goods sold.
A substantial portion of the Company's raw material used in production consists
of commodities, such as nickel, which are subject to wide price fluctuations.
The price that the Company pays for nickel is usually based upon quoted prices
on the London Metals Exchange (the "LME") plus a premium due to quality,
location, and volume purchased. Although the Company's long-term agreements
provide for certain price adjustments to reflect changes in the price of raw
materials, once a customer places an order, the price is fixed and is not
subject to further adjustment. In an attempt to mitigate the risks associated
with raw material price fluctuations and to match raw material purchases with
firm price product orders, the Company often enters into forward contracts to
manage its exposure to changes in nickel prices and also enters into contracts
for the purchase of scrap with customers. Nickel forward contracts obligate the
Company to make or receive payment equal to the net change in value of the
contract at its maturity. Substantially all contracts are designed as hedges of
the Company's firm sales commitments, are timed to correspond to the commitment
period, and are effective in hedging the Company's exposure to changes in nickel
prices during that cycle.
At September 30, 1998, the Company had open purchase contracts with a notional
principal value of approximately $7.4 million. The fair value of the material
covered by these contracts based on the September 30, 1998 price quoted on the
LME, was approximately $4.6 million. Unrealized gains and losses on the
contracts which have been designated, and are effective, as hedges for firm
sales commitments, totaling approximately $2.2 million, have been deferred.
Unrealized losses on forward contracts not designated or effective as hedges,
totaling approximately $.6 million, have been recognized in income.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses represent costs associated with sales and marketing,
research and development, legal services, and the office of the president.
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<PAGE>
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, statement of
operations data as a percentage of net sales.
<TABLE>
<CAPTION>
Three months ended Sept. 30, Nine months ended Sept. 30,
1997 1998 1997 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Costs of goods sold 76.1 81.2 76.1 79.0
---- ---- ---- ----
Gross profit 23.9 18.8 23.9 21.0
Selling, general and
administrative expenses 4.2 4.3 3.9 4.1
---- ---- ---- ----
Operating income 19.7 14.5 20.0 16.9
Interest expense .1 .1 .4 .1
Abandoned acquisition costs .1 - .4 -
Interest income (.2) (.3) (.2) (.3)
Other income (.2) .1 (.2) (.1)
---- ---- ---- ----
Income before income taxes 19.9 14.6 19.6 17.2
Income taxes expense 7.2 4.8 7.1 6.0
---- ---- ---- ----
Net income 12.7% 9.8% 12.5% 11.2%
==== ==== ==== ====
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED WITH THREE MONTHS ENDED SEPTEMBER
30, 1997.
NET SALES. Net sales decreased $2.5 million, or 5.7% from $44.1 million in the
three months ended September 30, 1997 to $41.6 million in the three months ended
September 30, 1998. This decrease was principally due to reduced shipments in
the core business as a result of customer inventory adjustments in response to
earlier order patterns which led to overstocking in customer plants.
COST OF GOODS SOLD. Cost of goods sold increased $.2 million, or .6% from $33.6
million in the three months ended September 30, 1997 to $33.8 million in the
three months ended September 30, 1998, primarily as a result of increased costs
associated with implementing new management information systems, unrealized
losses on nickel forward purchase contracts, offset, in part, by decreased
sales. As a percentage of net sales, cost of goods sold increased from 76.1% in
the three months ended September 30, 1997 to 81.2% in the three months ended
September 30, 1998.
GROSS PROFIT. Gross profit decreased $2.7 million, or 25.9% from $10.6 million
in the three months ended September 30, 1997 to $7.9 million in the three months
ended September 30, 1998.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expense decreased $.1 million, or 4.7% from $1.9 million in the
three months ended September 30, 1997 to $1.8 million in the three months ended
September 30, 1998. Selling, general and administrative expenses as a percentage
of net sales increased from 4.2% in the three months ended September 30, 1997 to
4.3% in the three months ended September 30, 1998.
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<PAGE>
OPERATING INCOME. Operating income decreased $2.7 million, or 30.5% from $8.7
million in the three months ended September 30, 1997 to $6.0 million in the
three months ended September 30, 1998. Operating income as a percentage of net
sales decreased from 19.7% in the three months ended September 30, 1997 to 14.5%
in the three months ended September 30, 1998.
INCOME TAXES. Income tax expense decreased $1.2 million, or 36.4% from $3.2
million in the three months ended September 30, 1997 to $2.0 million in the
three months ended September 30, 1998. The effective income tax rate decreased
from 36.1% in three months ended September 30, 1997 to 33.1% in the three months
ended September 30, 1998 as a result of a favorable adjustment based upon the
Company's actual 1997 income tax returns.
NET INCOME. Net income decreased 27.3% from $5.6 million in the three months
ended September 30, 1997 to $4.1 million in the three months ended September 30,
1998. Net income as a percentage of net sales decreased from 12.7% in the three
months ended September 30, 1997 to 9.8% in the three months ended September 30,
1998.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 1997.
NET SALES. Net sales decreased $3.7 million, or 2.7% from $138.4 million in the
nine months ended September 30, 1997 to $134.7 million in the nine months ended
September 30, 1998. This decrease was principally due to reduced shipments in
the core business as a result of customer inventory adjustments in response to
earlier order patterns which led to overstocking in customer plants.
COST OF GOODS SOLD. Cost of goods sold increased $1.0 million, or 1.0% from
$105.3 million in the nine months ended September 30, 1997 to $106.3 million in
the nine months ended September 30, 1998, primarily as a result of increased
costs associated with implementing new management information systems,
unrealized losses on nickel forward purchase contracts, offset, in part by
decreased sales. As a percentage of net sales, cost of goods sold increased from
76.1% in the nine months ended September 30,1997 to 79.0% in the nine months
ended September 30, 1998.
GROSS PROFIT. Gross profit decreased $4.7 million, or 14.3% from $33.0 million
in the nine months ended September 30, 1997 to $28.3 million in the nine months
ended September 30, 1998.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $.2 million, or 3.9% from $5.3 million in the
nine months ended September 30, 1997 to $5.5 million in the nine months ended
September 30, 1998. This increase was due to increased expenditures related to
the office of the president, Directors' insurance, and Board of Directors
expenses. Selling, general and administrative expenses as a percentage of net
sales increased from 3.9% in the nine months ended September 30, 1997 to 4.1% in
the nine months ended September 30, 1998.
OPERATING INCOME. Operating income decreased $4.9 million, or 17.8% from $27.7
million in the nine months ended September 30, 1997 to $22.8 million in the nine
months ended September 30, 1998. Operating income as a percentage of net sales
decreased from 20.0% in the nine months ended September 30, 1997 to 16.9% in the
nine months ended September 30, 1998.
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<PAGE>
INTEREST EXPENSE. Interest expense decreased $.5 million, or 84.2% from $.6
million in the nine months ended September 30, 1997 to $.1 million in the nine
months ended September 30, 1998. This decrease was due primarily to the
repayment of debt outstanding with proceeds from the Company's initial public
offering during the first quarter of 1997.
INCOME TAXES. Income tax expense decreased $1.7 million, or 17.0% from $9.8
million in the nine months ended September 30, 1997 to $8.1 million in the nine
months ended September 30, 1998. The effective income tax rate decreased from
36.1% in nine months ended September 30, 1997 to 35.0% in the nine months ended
September 30, 1998.
NET INCOME. Net income decreased 13.1% from $17.3 million in the nine months
ended September 30, 1997 to $15.0 million in the nine months ended September 30,
1998. Net income as a percentage of net sales decreased from 12.5% in the nine
months ended September 30, 1997 to 11.2% in the nine months ended September 30,
1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity needs arise primarily from capital investments, working
capital requirements, and principal and interest payments on indebtedness. The
Company has historically met these liquidity requirements with funds generated
from operations and from short-term and long-term debt financing (including
borrowings from its principal stockholders). The Company's business is capital
intensive and requires substantial expenditures for, among other things, the
purchase and maintenance of equipment used in the manufacturing process and
compliance with environmental laws.
Net cash provided by operating activities was $8.3 million and $9.1 million for
the nine months ended September 30, 1997 and 1998, respectively.
Capital expenditures were $7.5 million and $8.3 million for the nine months
ended September 30, 1997 and 1998, respectively.
The Company's principal sources of funds are (i) funds generated from operations
and (ii) borrowings under the Company's new Senior Secured Credit Agreement with
Credit Lyonnais, Merchant & Traders Trust Company, Mellon Bank, The Bank of Nova
Scotia and other financial institutions from time to time party thereto (the
"Credit Agreement"), which the Company entered into in connection with the
Acquisition. The Credit Agreement provides for a $125 million term loan (the
"Tranche A Term Loan"), a $100 million term loan (the "Tranche B Term Loan,"
and, together with the Tranche A Term Loan, the "Term Loans") and a $150 million
revolving credit and letter of credit facility (the "Revolving Credit
Facility"). Proceeds from the Term Loans were used to finance a portion of the
purchase price of the Acquisition.
Under the Revolving Credit Facility, the Company can borrow, repay and re-borrow
from time to time up to $150 million in the aggregate. The Revolving Credit
Facility terminates on October 28, 2003. Proceeds from a portion of the
Revolving Credit Facility were used to finance a portion of the purchase price
of the Acquisition and the balance can be used for working capital and general
corporate purposes and for permitted acquisitions and investments. The Company's
ability to borrow under the Credit Agreement is subject to the satisfaction of
various conditions, including compliance with certain
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<PAGE>
financial covenants. The amount the Company may borrow under the Credit
Agreement is reduced by the aggregate amount of any letters of credit issued for
the account of the Company. Interest on the Term Loans and amounts outstanding
under the Revolving Credit Facility bear interest at the Company's option at (i)
a base rate, which is the higher of the bank's short-term commercial reference
rate or the Federal Funds rate plus .50%, plus a margin of zero to 0.75%
depending on the Company's leverage ratio or (ii) the Eurodollar rate, which is
the reserve adjusted New York interbank offered rate, plus a margin of 0.75% to
2.00% depending on the Company's leverage ratio. A commitment fee of .375% to
.50% per annum, depending on the Company's leverage ratio, on the unused
available revolving credit commitment is due quarterly.
Principal on the Tranche A Term loan is scheduled to be repaid in quarterly
installments over five years as follows: $10 million in the first year, $15
million in the second year, $25 million in the third year, $35 million in the
fourth year and $40 million in the fifth year. Principal on the Tranche B Term
loan is scheduled to be repaid in quarterly installments over seven years as
follows: $1 million in each of the first five years and $47.5 million in each of
the sixth and seventh years. The Company is required to prepay amounts
outstanding under the Credit Agreement out of the excess cash flow of the
Company. Prepayments will be applied first to the Term Loans, pro rata, then to
amounts outstanding under the Revolving Credit Facility and finally as cash
collateral against outstanding letters of credit. So long as any amounts remain
outstanding under the Tranche A Term Loan, lenders under the Tranche B Term Loan
may elect not to have their portion of the Tranche B Term loan prepaid until the
Tranche A Term Loan is paid in full.
The Company's obligations under the Credit Agreement are secured by all of the
assets of the Company and its domestic subsidiaries and by a pledge of the
capital stock of certain subsidiaries. The Credit Agreement also contains
covenants restricting the ability of the Company to, among other things, make
certain restricted payments, create liens, guarantee indebtedness or enter into
transactions with affiliates. The Company is also subject to certain financial
tests relating to, among other things, its minimum cash flow, consolidated
leverage ratio, interest coverage ratio and fixed charge coverage ratio.
In connection with the Acquisition, the Company issued an aggregate of $97
million liquidation value Series A Senior convertible Preferred Stock. See "--
Overview -- Recent Developments-IAI Acquisition" and Footnote 6 to the Condensed
Financial Statements in Part I. Item 1. "Condensed Financial Statements
(unaudited)."
Over the next four years, the Company plans to invest up to $54 million in
capital expenditures to expand and modernize its melting, forging and finishing
equipment, install a state-of-the-art information system and make other
investments to maintain its position as a technical leader. In addition, the
Company has planned capital expenditures of $90 million related to the IAI
business. In addition to planned capital expenditures, the Company expects to
evaluate from time to time potential acquisitions. Potential acquisitions may
include investments in companies, technologies or products that complement the
Company's business or products. Sources of funds for such acquisitions could
include funds generated from operations or alternative sources of debt or equity
capital. Certain covenants in the Credit Agreement may restrict or limit the
Company's ability to enter into or complete an acquisition. Under such
circumstances, the Company would need to amend, obtain a waiver of or refinance
the Credit Agreement. See Part II. Other Information, Item 5(b),
"Forward-Looking Statements."
The Company does not expect the future costs of compliance with currently
enacted environmental
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<PAGE>
laws and adopted or proposed regulations to have a material impact on its
liquidity and capital resources. However, the imposition of more strict
standards or requirements under environmental laws and the possibility of
increased enforcement could result in expenditures with such a material impact.
See Footnote 3 to the Condensed Financial Statements in Part I. Item 1.
"Condensed Financial Statements (unaudited)." See also Part II. Other
information, Item 5(b), "Forward- Looking Statements."
The Company expects that its cash and cash equivalents on hand, cash flow from
operations and borrowing capacity under the New Credit Agreement will be
adequate to meet its anticipated operating requirements, and planned capital
expenditures over the next 12 months. See Part II. Other information, Item 5(b),
"Forward-Looking Statements."
IMPACT OF YEAR 2000
The Year 2000 computer issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Computer
programs in the Company's computer systems and plant equipment systems which
contain time-sensitive software may recognize a date using "00" as the year 1900
rather than the year 2000. This could result in system failures or
miscalculations resulting in disruptions in manufacturing operations or other
normal business activities.
The Company has undertaken a project aimed at replacing its current management
information systems with an enterprise-wide business/information system and a
related upgrade to the information technology infrastructure. However, the
Company also believes that modifications to certain of its process control
computers will be required so that they will function properly with respect to
dates in the year 2000 and thereafter. The Company presently believes that with
modifications to existing software and conversions to new software, the year
2000 issue will not pose significant operational problems for its information
technology systems and process control systems. However, if such modifications
and conversions are not made, or are not completed timely, a material impact on
the operations of the Company could result.
The Company's plan to resolve the Year 2000 issue involves the following four
phases: assessment, remediation, testing, and implementation. To date, the
Company has fully completed its assessment of all computer systems and programs
which could be significantly affected by the Year 2000. Appraisal costs were
expensed prior to the Company initiating a formal Year 2000 program. In addition
to assessing the Company's 2000 readiness, the Company has initiated formal
communications with its significant suppliers and large customers to determine
the extent to which the Company is vulnerable to those third parties' failure to
remediate their own year 2000 issues. Several of the Company's significant
suppliers and customers have responded and believe they will be Year 2000
compliant prior to December 31, 1999. The Company's estimate of the time to
complete its year 2000 project includes the estimated time associated with the
impact of third party year 2000 issues, and is based on presently available
information. However, there can be no guarantee that the systems of other
parties on which the Company's systems rely will be timely converted and would
not have an adverse effect on the Company's systems.
-15-
<PAGE>
The Company's overall Year 2000 project approach and status is as follows:
<TABLE>
<CAPTION>
($ millions)
Estimated Costs
Stage of Timetable for Total Incurred to
Description of Approach Completion Completion Budget Date
----------------------- ---------- ---------- ------ ----
<S> <C> <C> <C> <C>
COMPUTER SYSTEMS:
Assess systems for possible
Year 2000 impact 100% Completed -- --
Modify or replace non-
compliant systems and test
systems with system clocks
set at current date 65% July 1, 1999 $5.6 $4.1
PROCESS CONTROL SYSTEMS:
Computer-dependent
process control systems
assessment and compliance
procedures 45% June 30, 1999 $0.5 $0.1
</TABLE>
The Company has determined it has no exposure to contingencies related to the
year 2000 issue for the products it has sold. The Company expects to utilize
both internal and external resources to reprogram, or replace, and test the
software for year 2000 modifications. The Company anticipates completing the
year 2000 project in 1999, prior to any anticipated impact on its operating
systems. Maintenance or modification costs will be expensed as incurred, while
the costs of new information technology will be capitalized and amortized in
accordance with Company policy. The Company's current estimated cost of making
its computer-dependent plant equipment Year 2000 compliant is $.5 million. The
estimated cost of the Year 2000 computer project, including software
modifications, consultants, replacement costs for non-compliant systems, based
on presently available information is approximately $5.6 million.
The time frame during which the Company believes it will complete the year 2000
modifications is based on management's best estimates, which were derived
utilizing numerous assumptions of future events, including the continued
availability of certain resources, third party modification plans and other
factors. However, there can be no guarantee that the estimated time of
completion will be achieved and actual results could differ materially from
those anticipated. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in this area, the ability to locate and correct all relevant computer codes, and
similar uncertainties.
The Company currently has a no contingency plan in place in the event that it
does not complete
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<PAGE>
all phases of the Year 2000 program. The Company plans to evaluate the status of
completion in April 1999 to determine whether such a plan is necessary.
The Company believes it has an effective program in place to resolve the Year
2000 issue in a timely manner. As noted above, the Company has not yet completed
all necessary phases of the Year 2000 program. In the event that the Company
does not complete any additional phases, the Company's ability could be impaired
to take customer orders, manufacture and ship products, invoice customers or
collect payments. In addition, disruptions in the economy generally resulting
from Year 2000 issues could also materially adversely affect the Company. The
amount of potential liability and lost revenue cannot be reasonably estimated at
this time.
Based on its due diligence investigation in connection with the Acquisition, the
Company believes that actions will be required to resolve the Year 2000 issues
at IAI. The Company has retained an outside consultant to implement a Year 2000
program for the acquired assets. However, the Company is not at this time able
to estimate the timetable or cost of Year 2000 compliance at IAI.
BACKLOG
As of September 30, 1998, the Company's backlog orders aggregated approximately
$126.5 million, compared to approximately $150.7 million at September 30, 1997.
The decrease in backlog orders is primarily due to changes in customer order
patterns. The Company defines backlog as firm purchase orders, which are
generally subject to cancellation by the customer.
Substantially all orders in the backlog at September 30, 1998 are expected to be
shipped within the next 12 months. Due to the cyclical nature of order entry
experienced by the Company and its dependence on the aerospace industry, there
can be no assurance that order entry will continue at current levels or that
current firm purchase orders will not be canceled or delayed.
INFLATION
Although the Company's sales and results of operations are affected by the
prices of raw materials used to make its products and the cyclicality of the
aerospace industry, the Company does not believe that general economic inflation
has had a material effect on its results of operation for the periods presented.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
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<PAGE>
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
(A) EXPANSION OF BOARD OF DIRECTORS
Concurrent with the closing of the Acquisition, the Company expanded its board
of directors from seven to nine members and Francis J. Petro, President of Inco
Alloys International, Inc., was elected to fill one of the newly created
directorships as a Class II director with a term expiring at the next annual
meeting of the board of directors. An additional director, to be nominated by
TMC, is expected to be appointed at the Company's next regularly scheduled
meeting of the board of directors.
(B) PRESS RELEASE
The Company issued a press release dated October 28, 1998 disclosing its
acquisition of Inco Alloys International (IAI) high performance nickel alloys
business unit from Inco Limited.
The Company issued a press release dated October 22, 1998 disclosing certain
information, including certain results of operations and earnings for the fiscal
quarter ended September 30, 1998 and nine months ended September 30, 1998.
The Company issued a press release dated July 8, 1998, disclosing its definitive
agreement with Inco Limited to acquire the Inco Alloys International (IAI)
business unit of Inco Limited.
(C) FORWARD-LOOKING STATEMENTS
Certain statements in this Report and in future filings by the Company with the
Securities and Exchange Commission, in the Company's press releases and in oral
statements made by or with the approval of an authorized executive officer of
the Company constitute "forward-looking statements" within the meaning of
Section 21E of the Securities Exchange Act. Such forward-looking statements
involve known and unknown risks, uncertainties and other factors, which may
cause the actual results, performance or achievements of the Company to be
materially different from those expressed or
implied by such forward-looking statements. Such factors include economic
slowdowns and recessions (especially in the aerospace industry, in which most of
the Company's customers are concentrated); the availability and pricing of raw
materials used in the manufacture of the Company's products; the reliable
operation of the Company's manufacturing facilities and equipment; the Company's
ability to evaluate, finance and integrate acquired businesses, products and
companies into the Company's
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<PAGE>
existing business and operations; the Company's ability to effectively compete
in the industries in which it does business; the Company's ability to
successfully negotiate new labor agreements and otherwise maintain favorable
relations with its employees, a majority of whom are unionized; and the
Company's ability to comply with existing and future environmental laws and
regulations, the accuracy of its current estimates of existing environmental
liabilities and the possibility that currently unknown environmental liabilities
may be discovered.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS
3.1 Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 to the Company's
Registration Statement on Form S-1, File No. 333-18499).
3.1.1 Certificate of Designations for the Series A Preferred Stock,
filed on October 28, 1998, with the Secretary of State of
Delaware (incorporated by reference to Exhibit 4.5 to the
Company's Current Report on Form 8-K filed on November 12, 1998).
4.1 Agreement, dated October 28, 1998, among the Company, the Lenders
and Credit Lyonnais New York Branch as Issuing Bank and Agent
(incorporated by reference to Exhibit 4.1 to the Company's
Current Report on Form 8-K filed on November 12, 1998).
27.1 Financial Data Schedule.
(B) REPORTS ON FORM 8-K
The Company filed a report on Form 8-K dated July 10, 1998 in connection with
its agreement to acquire Inco Alloys International (IAI), a business unit of
Inco Limited.
The Company filed a report on Form 8-K dated November 12, 1998 in connection
with its acquisition of Inco Alloys International (IAI), a business unit of Inco
Limited.
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<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SPECIAL METALS CORPORATION
Date: November 12, 1998 By: /s/ Donald R. Muzuka
--------------------
Donald R. Muzyka
President and Chief Executive Officer
Date: November 12, 1998 By: /s/ Donald C. Darling
---------------------
Donald C. Darling
Chief Financial Officer and Chief
Accounting Officer
-20-
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Condensed Financial Statements contained in the Quarterly Report to which this
schedules relates and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<CIK> 0001028965
<NAME> SPECIAL METALS CORPORATION
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 12,468
<SECURITIES> 0
<RECEIVABLES> 30,411
<ALLOWANCES> (124)
<INVENTORY> 53,951
<CURRENT-ASSETS> 100,517
<PP&E> 88,539
<DEPRECIATION> (43,261)
<TOTAL-ASSETS> 151,912
<CURRENT-LIABILITIES> 23,025
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0
0
<COMMON> 155
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<TOTAL-LIABILITY-AND-EQUITY> 151,912
<SALES> 134,688
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<OTHER-EXPENSES> 0
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</TABLE>
