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 June 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
--------------------------
(Exact name of registrant as specified in its charter)
Delaware 25-1445468
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(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 July 31, 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 JUNE 30, 1998
INDEX
Page
Part I. Financial Information
Item 1. Condensed Financial Statements (unaudited)
Condensed Balance Sheets as of June 30, 1998 and December 31, 1997 2
Condensed Statements of Operations and Retained Earnings
for the three months and six months ended June 30, 1997 and 1998 3
Condensed Statements of Cash Flows for the three months and six
months ended June 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 16
Part II.Other Information
Item 1. Legal Proceedings 16
Item 2. Changes in Securities and Use of Proceeds 16
Item 3. Defaults Upon Senior Securities 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 18
Signatures 19
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Part I. Financial Information
Item 1. Financial Statements
SPECIAL METALS CORPORATION
CONDENSED BALANCE SHEETS
(Unaudited - In thousands)
<TABLE>
<CAPTION>
December 31, June 30,
1997 1998
-------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 12,237 $ 4,825
Restricted deposits 1,161 1,982
Accounts receivable, less allowance for doubtful accounts
of $168 for 1997 and $124 for 1998 30,212 32,485
Inventories 50,580 58,222
Prepaid expenses 216 541
Deferred income taxes 2,375 2,375
-------------- --------------
Total current assets 96,781 100,430
Property, plant and equipment 39,727 44,158
Deferred income taxes 1,618 1,279
Other assets 3,624 3,757
-------------- --------------
Total assets $ 141,750 $ 149,624
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 15,688 $ 15,587
Accrued liabilities 11,459 10,388
Income taxes payable 493 (1,436)
Current obligation under capital leases 316 319
-------------- --------------
Total current liabilities 27,956 24,858
Long-term obligation under capital leases 174 25
Other long-term liabilities 9,649 9,791
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Total liabilities 37,779 34,674
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 39,580
-------------- --------------
Total shareholders' equity 103,971 114,950
-------------- --------------
Total liabilities and shareholders' equity $ 141,750 $ 149,624
============== ==============
</TABLE>
See accompanying notes to condensed financial statements.
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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 June 30, Six Months ended June 30,
1997 1998 1997 1998
--------------------------------- --------------------------------
<S> <C> <C> <C> <C>
Net Sales $ 46,780 $ 43,852 $ 94,204 $ 93,043
Cost of goods sold 35,709 35,038 71,738 72,551
--------------------------------- --------------------------------
11,071 8,814 22,466 20,492
Selling, general and
administrative expenses 1,857 1,949 3,470 3,769
--------------------------------- --------------------------------
Operating income 9,214 6,865 18,996 16,723
Interest expense 48 31 569 64
Abandoned acquisition
costs 542 - 542 -
Interest income (160) (154) (181) (331)
Other income (185) (33) (204) (45)
--------------------------------- --------------------------------
Income before income
taxes 8,969 7,021 18,270 17,035
Income tax expense 2,885 2,410 6,589 6,089
--------------------------------- --------------------------------
Net income 6,084 4,611 11,681 10,946
Retained earnings
Beginning of period 11,229 34,969 5,632 28,634
--------------------------------- --------------------------------
End of period $ 17,313 $ 39,580 $ 17,313 $ 39,580
================================= ================================
Net income per share
(Basic and Diluted) $ 0.39 $ 0.30 $ 0.80 $ 0.71
Weighted average shares
outstanding
(Basic and Diluted) 15,475 15,479 14,524 15,478
</TABLE>
See accompanying notes to condensed financial statements.
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<PAGE>
SPECIAL METALS CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited - In thousands)
<TABLE>
<CAPTION>
Six months ended June 30,
1997 1998
------------------------------
<S> <C> <C>
Operating Activities:
Net income $ 11,681 $ 10,946
Depreciation and amortization 2,051 1,925
Other adjustments and changes in assets and liabilities (4,813) (12,826)
------------------------------
Net cash provided by operating activities 8,919 45
Investing Activities:
Capital expenditures (3,541) (6,244)
Net change in restricted deposits - (821)
Other - (246)
------------------------------
Net cash used in investing activities (3,541) (7,311)
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) -
Payments on capital lease obligations (170) (146)
Other (77) -
------------------------------
Net cash used in financing activities (1,790) (146)
------------------------------
Net increase (decrease) in cash and cash equivalents 3,588 (7,412)
Cash and cash equivalents at beginning of period 3,336 12,237
------------------------------
Cash and cash equivalents at end of period $ 6,924 $ 4,825
==============================
</TABLE>
See accompanying notes to condensed financial statements.
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<PAGE>
SPECIAL METALS CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
JUNE 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 June 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, June 30,
1997 1998
------------------------------
Raw materials and supplies $ 13,007 $ 14,495
Work-in-process 37,573 43,727
------------------------------
$ 50,580 $ 58,222
==============================
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 will be meeting with its engineers 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 not 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
The Company has adopted Statement of Financial Accounting Standards No. 128,
"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 six months ended June 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 - PENDING ACQUISITION
As of July 8, 1998, the Company entered into a definitive agreement with Inco
Limited and certain of its subsidiaries, to acquire the Inco Alloys
International high performance nickel alloys business unit for a cash purchase
price of $408 million, subject to certain adjustments (the "Acquisition"). The
Company intends to finance the Acquisition through the issuance of up to
$125,000,000 aggregate liquidation amount of shares of its 6-5/8% Series A
Senior Convertible Preferred Stock (the "Series A Preferred Stock") to a
subsidiary of Titanium Metals Corporation ("TIMET"), with the remaining balance
of the purchase price being financed through borrowings under a new credit
facility of $425 million, the terms
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<PAGE>
of which are currently being negotiated (the "New Credit Facility"). The
closings under the New Credit Facility and the TIMET investment are conditioned
upon the closing of the Acquisition. The Acquisition, which is subject to
various closing conditions and regulatory approvals, including antitrust
clearance, is expected to close in the third quarter of 1998. Reference is made
to the information included in the Company's Form 8-K dated July 10, 1998.
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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 six months ended June 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 $93.0
million.
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 six months ended June 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 six months ended June 30, 1998, sales to purchasers outside of the United
States totaled 29% of the Company's net 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
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<PAGE>
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 June 30, 1998, the Company had open purchase contracts with a notional
principal value of approximately $8.8 million. The fair value of the material
covered by these contracts based on the June 30, 1998 price quoted on the LME,
was approximately $5.3 million. Unrealized gains and losses on the contracts
which have been designated, and are effective, as hedges for firm sales
commitments, totaling approximately $2.6 million, have been deferred. Unrealized
losses on forward contracts not designated or effective as hedges, totaling
approximately $.9 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.
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 June 30, Six months ended June 30,
1997 1998 1997 1998
------------------------------ ----------------------------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Costs of goods sold 76.3 79.9 76.1 78.0
------------------------------ ----------------------------
Gross profit 23.7 20.1 23.9 22.0
Selling, general and
administrative expenses 4.0 4.4 3.7 4.0
------------------------------ ----------------------------
Operating income 19.7 15.7 20.2 18.0
Interest expense .1 .1 .6 .1
Abandoned acquisition costs 1.1 - .6 -
Interest income (.3) (.4) (.2) (.4)
Other income (.4) - (.2) -
------------------------------ ----------------------------
Income before income taxes 19.2 16.0 19.4 18.3
Income taxes expense 6.2 5.5 7.0 6.5
------------------------------ ----------------------------
Net income 13.0% 10.5% 12.4% 11.8%
============================== ============================
</TABLE>
THREE MONTHS ENDED JUNE 30, 1998 COMPARED WITH THREE MONTHS ENDED JUNE 30, 1997.
NET SALES. Net sales decreased $2.9 million, or 6.3% from $46.8 million in the
three months ended June 30, 1997 to $43.9 million in the three months ended June
30, 1998. This decrease was principally due to reduced shipments in the core
business as a result of customer inventory adjustments in response to changes in
commercial aircraft production rates.
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<PAGE>
COST OF GOODS SOLD. Cost of goods sold decreased $.7 million, or 1.9% from $35.7
million in the three months ended June 30, 1997 to $35.0 million in the three
months ended June 30, 1998, primarily as a result of decreased sales, offset, in
part, by increased costs associated with implementing the new management
information systems, and by unrealized losses on nickel forward purchase
contracts. As a percentage of net sales, cost of goods sold increased from 76.3%
in the three months ended June 30, 1997 to 79.9% in the three months ended June
30, 1998.
GROSS PROFIT. Gross profit decreased $2.3 million, or 20.4% from $11.1 million
in the three months ended June 30, 1997 to $8.8 million in the three months
ended June 30, 1998.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expense was $1.9 million in the three months ended June 30, 1997
and three months ended June 30, 1998. Selling, general and administrative
expenses as a percentage of net sales increased from 4.0% in the three months
ended June 30, 1997 to 4.4% in the three months ended June 30, 1998.
OPERATING INCOME. Operating income decreased $2.3 million, or 25.5% from $9.2
million in the three months ended June 30, 1997 to $6.9 million in the three
months ended June 30, 1998. Operating income as a percentage of net sales
decreased from 19.7% in the three months ended June 30, 1997 to 15.7% in the
three months ended June 30, 1998.
INCOME TAXES. Income tax expense decreased $.5 million, or 16.5% from $2.9
million in the three months ended June 30, 1997 to $2.4 million in the three
months ended June 30, 1998. The effective income tax rate increased from 32.2%
in three months ended June 30, 1997 to 34.3% in the three months ended June 30,
1998.
NET INCOME. Net income decreased 24.2% from $6.1 million in the three months
ended June 30, 1997 to $4.6 million in the three months ended June 30, 1998. Net
income as a percentage of net sales decreased from 13.0% in the three months
ended June 30, 1997 to 10.5% in the three months ended June 30, 1998.
SIX MONTHS ENDED JUNE 30, 1998 COMPARED WITH SIX MONTHS ENDED JUNE 30, 1997.
NET SALES. Net sales decreased $1.2 million, or 1.2% from $94.2 million in the
six months ended June 30, 1997 to $93.0 million in the six months ended June 30,
1998. This decrease was principally due to reduced shipments in the core
business as a result of customer inventory adjustments in response to changes in
commercial aircraft production rates.
COST OF GOODS SOLD. Cost of goods sold increased $.9 million, or 1.1% from $71.7
million in the six months ended June 30, 1997 to $72.6 million in the six months
ended June 30, 1998, primarily as a result of unrealized losses on nickel
forward purchase contracts and increased costs associated with implementing the
new management information systems, offset, in part by decreased sales. As a
percentage of net sales, cost of goods sold increased from 76.1% in the six
months ended June 30, 1997 to 78.0% in the six months ended June 30, 1998.
GROSS PROFIT. Gross profit decreased $1.9 million, or 8.8% from $22.4 million in
the six months ended June 30, 1997 to $20.5 million in the six months ended June
30, 1998.
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<PAGE>
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $.4 million, or 8.6% from $3.4 million in the
six months ended June 30, 1997 to $3.8 million in the six months ended June 30,
1998. This increase was due to increased expenditures related to the Board of
Directors and a planned increase in research and development activities.
Selling, general and administrative expenses as a percentage of net sales
increased from 3.7% in the six months ended June 30, 1997 to 4.0% in the six
months ended June 30, 1998.
OPERATING INCOME. Operating income decreased $2.3 million, or 12.0% from $19.0
million in the six months ended June 30, 1997 to $16.7 million in the six months
ended June 30, 1998. Operating income as a percentage of net sales decreased
from 20.2% in the six months ended June 30, 1997 to 18.0% in the six months
ended June 30, 1998.
INTEREST EXPENSE. Interest expense decreased $.5 million, or 88.7% from $.6
million in the six months ended June 30, 1997 to $.1 million in the six months
ended June 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 $.5 million, or 7.6% from $6.6
million in the six months ended June 30, 1997 to $6.1 million in the six months
ended June 30, 1998. The effective income tax rate decreased from 36.0% in six
months ended June 30, 1997 to 35.7% in the six months ended June 30, 1998.
NET INCOME. Net income decreased 6.3% from $11.7 million in the six months ended
June 30, 1997 to $10.9 million in the six months ended June 30, 1998. Net income
as a percentage of net sales decreased from 12.4% in the six months ended June
30, 1997 to 11.8% in the six months ended June 30, 1998.
IMPACT OF YEAR 2000
Based on a preliminary assessment, the Company believes it will be required to
modify or replace portions of its software so that its computer systems will
function properly with respect to dates in the year 2000 and thereafter. The
Company has undertaken a project aimed at replacing its current management
information systems with new management information systems which it believes
will function properly with respect to dates in the year 2000 and thereafter.
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
computer 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 is in the process of initiating 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. 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 companies on which the
Company's systems rely will be timely converted and would not have an adverse
effect on the Company's systems. The Company has determined it has no exposure
to
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<PAGE>
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. The Company is not able, at this
time, to estimate what the ultimate cost of its year 2000 project will be.
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 is currently in the process of reviewing the impact of the year 2000
issues on the assets to be acquired in connection with the Acquisition.
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<PAGE>
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 $8.9 million and zero for the six
months ended June 30, 1997 and 1998, respectively. The difference in cash flows
from operating activities is principally the result of increased working capital
requirements attributable to increases in accounts receivable and inventory.
Capital expenditures were $3.5 million and $6.2 million for the six months ended
June 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 Credit Agreement with Credit Lyonnais
and other financial institutions from time to time party thereto (the "Credit
Agreement"). Under the Credit Agreement, as amended, the Company may borrow,
repay, and re-borrow from time to time, the lesser of (a) $56 million, declining
$4 million per year from 1998 through 2001, at which time all remaining
outstanding amounts are due, or (b) the Company's borrowing base. The Credit
Agreement defines the Company's borrowing base as the sum of 85% of eligible
accounts receivable and 60% of eligible inventory. As of June 30, 1998, the
borrowing base was $56.3 million. The Company's ability to borrow under the
Credit Agreement is subject to the satisfaction of various conditions, including
compliance with certain 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. All advances under the Credit
Agreement 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 .25%, (ii) the Eurodollar rate, which is the New York interbank
offered rate, plus 1.25% or (iii) LIBOR plus 1.25%. A commitment fee of .20% per
annum on the unused available working capital commitment is due monthly. At June
30, 1998, there were no amounts outstanding under the Credit Agreement.
The Company's obligations under the Credit Agreement are secured by the
Company's receivables, inventory and general intangibles. The Credit Agreement
also contains covenants restricting the ability of the Company to 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 consolidated net worth, its
consolidated leverage ratio and the ratio of its senior debt to consolidated
earnings before interest, taxes, depreciation and amortization ("EBITDA"). The
Company may prepay amounts owing under the Credit Agreement at its option at any
time.
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. Capital expenditures
are expected to be significantly increased upon completion of the purchase of
the assets of the Inco Alloys International high performance nickel alloys
business unit pursuant to the Acquisition. In
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<PAGE>
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."
In July 1998, the Company entered into a definitive agreement with respect to
the Acquisition. The Company intends to finance the Acquisition through the
issuance of up to $125,000,000 aggregate liquidation amount of shares of its
Series A Preferred Stock to TIMET, with the remaining balance of the purchase
price being financed through borrowings under the New Credit Facility. The New
Credit Facility will replace the Credit Agreement. Reference is made to the
information included in the Company's Form 8-K dated July 10, 1998.
The Series A Preferred Stock will, subject to the favorable vote of a majority
of the stockholders of the Company, be convertible into shares of Common Stock
of the Company at a conversion price equal to approximately $18.94 (which
corresponds to 125% of the average closing price of Common Stock over the 40
consecutive trading day period ending 20 days following the announcement of the
transaction). The Series A Preferred Stock will be subject to mandatory
redemption in 2006.
The closings under the New Credit Facility and the TIMET investment are
conditioned upon the closing of the Acquisition. The Acquisition, which is
subject to various closing conditions and regulatory approvals, including
antitrust clearance, is expected to close in the third quarter of 1998.
The Company does not expect the future costs of compliance with currently
enacted environmental 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 Credit Agreement and 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."
BACKLOG
As of June 30, 1998, the Company's backlog orders aggregated approximately
$109.0 million, compared to approximately $151.3 million at June 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 June 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
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<PAGE>
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.
EFFECTS OF NEW ACCOUNTING PRONOUNCEMENTS
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 six months ended June 30, 1998 and 1997, total
comprehensive income, which was comprised of net income and adjustments to the
pension adjustment account, equaled net income.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
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
The annual meeting of stockholders of the Company was held on May 28, 1998 (the
"Annual Meeting"). Holders of Common Stock were entitled to elect three
directors. On all matters which came before the Annual Meeting, holders of
Common Stock were entitled to one vote for each share held. Proxies for
14,812,269 of the 15,479,000 shares of Common Stock entitled to vote were
received in connection with the Annual Meeting.
The following table sets forth the names of the three persons elected at the
Annual Meeting to serve as
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<PAGE>
directors until the first annual meeting of stockholders of the Company
following the end of the Company's fiscal year ending December 31, 2000 and the
number of votes cast for, against or withheld with respect to each person.
Name of Director For Against Withheld
- ---------------- --- ------- --------
Donald C. Darling 14,805,269 7,000 0
Raymond F. Decker 14,805,269 7,000 0
Robert F. Dropkin 14,805,269 7,000 0
The following table sets forth certain additional matters which were submitted
to the shareholders for approval at the Annual Meeting and the tabulation of the
votes with respect to each such matter.
Name of Director For Against Withheld
- ---------------- --- ------- --------
Approval of Ernst & Young LLP as 14,805,419 3,850 3,000
independent auditors for the Company
for the fiscal year ending
December 31, 1998.
ITEM 5. OTHER INFORMATION
(A) PRESS RELEASE
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.
The Company issued a press release dated July 16, 1998 disclosing certain
information, including certain results of operations and earnings for the fiscal
quarter ended June 30, 1998 and six months ended June 30, 1998.
(B) 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 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; 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
-17-
<PAGE>
environmental liabilities may be discovered.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
10.9 First Amendment to Amended and Restated Payment in Lieu of Taxes
Agreement, dated January 22, 1998, by and between the Oneida County
Industrial Development Agency and the Company.
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.
-18-
<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: August 11, 1998 By: /s/ Donald R. Muzyka
--------------------
Donald R. Muzyka
President and Chief Executive Officer
Date: August 11, 1998 By: /s/ Donald C. Darling
---------------------
Donald C. Darling
Chief Financial Officer and Chief
Accounting Officer
-19-
Exhibit 10.9
FIRST AMENDMENT TO AMENDED AND RESTATED
PAYMENT IN LIEU OF TAX AGREEMENT
This First Amendment, dated as of January 22, 1998, is by and between
ONEIDA COUNTY INDUSTRIAL DEVELOPMENT AGENCY, a New York public benefit
corporation having an office at 153 Brooks Road, Rome, New York 13441 (the
"Agency"), and SPECIAL METALS CORPORATION, a Delaware corporation having an
office at 4317 Middle Settlement Road, New Hartford, New York 13413 (the
"Company").
RECITALS
A. The Agency and the Company entered into a Payment in Lieu of Tax
Agreement dated as of February 1, 1994 (the "Original Agreement").
B. The Company requested that the Original Agreement be extended for a
term of 10 years and the Agency, by resolution adopted on October 3, 1996,
approved the extension of the Original Agreement for a term of ten years.
C. The extension was evidenced by an Amended and Restated Payment in
Lieu of Tax Agreement dated as of February 28, 1997 signed by the Agency and the
Company (the "Amended and Restated Agreement").
D. The Company and the Agency desired to amend the Amended and Restated
Agreement to clarify certain of its provisions.
NOW, THEREFORE, the Amended and Restated Agreement is hereby amended as
follows:
1. Section 2 of the Amended and Restated Agreement is amended in its
entirety to read as follows:
(a) The Company shall pay to each Authority as set forth on Exhibit B
attached hereto and made a part hereof, an amount in lieu of the Exempt
Taxes (the "Pilot Payments") during each Exemption Year equal to one
third (1/3) of such taxes that would be payable to each such Authority
as if the Company, and not the Agency, owned the Project Facility, for
each Exemption Year through the Exemption Year ending February 28,
2007; and one hundred (100%) percent of such taxes for each Exemption
Year thereafter. Pilot Payments at the level of one third (1/3) of such
taxes are hereafter referred to as "Reduced Pilot Payments"; Pilot
1
<PAGE>
Payments at the level of one hundred percent (100%) of such taxes are
referred to as "Full Pilot Payments".
(b) Anything herein to the contrary notwithstanding, if the Company (i)
fails to continue to maintain the operation of the Project Facility in
the County of Oneida, State of New York or (ii) fails to maintain
during any Exemption Year an average number of full-time equivalent
employees of not less than 390, then for each Exemption Year
thereafter, the Company shall pay to each Authority Full Pilot Payments
during each subsequent Exemption Year equal to one hundred percent
(100%) of such taxes that would be payable to each such Authority as if
the Company, and not the Agency, owned the Project Facility.
Notwithstanding the foregoing, if the Company can demonstrate to the
reasonable satisfaction of the Agency that the reduction in the number
of full-time equivalent employees below 390 during any Exemption Year
is primarily the result of adverse economic conditions and/or
efficiencies of operation, and not the transfer of production from the
Project Facility to other facilities operated by the Company, the
Company shall be entitled to continue to make Partial Pilot Payments
during each subsequent Exemption Year.
(c) If the Company is required by the terms hereof to make Full Pilot
Payments during an Exemption Year due to its failure to maintain an
average full-time employment level of 390 or more for the prior
Exemption Year, the Company shall be entitled to resume making Partial
Pilot Payments if, during any subsequent Exemption Year during the term
of this Agreement, the average number of full-time equivalent employees
at the Project Facility again equals or exceeds 390. In such event, the
Company's ability to make Partial Pilot Payments shall be restored as
of the first day of the Exemption Year immediately following the
Exemption Year in which the average number of full-time equivalent
employees once again equals or exceeds 390.
(d) Anything herein to the contrary notwithstanding, upon the failure
of the Company in making any payment when due hereunder and upon
failure to cure such default within thirty (30) days of receipt of
notice as herein provided, the Company shall henceforth pay Full Pilot
Payments equal to one hundred percent (100%) of the Exempt Taxes
together with interest at the rate of nine percent (9%) per annum on
all delinquent payments,
2
<PAGE>
together with expenses of collection, including but not limited to,
payment of attorneys fees; provided, however, nothing herein contained
shall be deemed to limit any other rights and remedies the Agency may
have hereunder or under the Lease.
(e) Anything herein to the contrary notwithstanding, this Agreement
shall terminate on the date on which the Lease shall terminate and the
Agency shall reconvey title to the Project Facility to the Company
pursuant to the Lease.
2. Except as amended as stated above, the Amended and Restated Pilot
Agreement shall remain in effect in accordance with its terms.
3. This Amendment shall be governed and construed in accordance with
the laws of the State of New York.
4. This Amendment shall be effective as of the date set forth above at
the beginning.
5. This Amendment may be executed in one or more counterparts, each of
which shall be an original and all of which together shall constitute but one
and the same instrument.
ONEIDA COUNTY
INDUSTRIAL DEVELOPMENT
AGENCY
By: /s/ Robert R. Calli
-----------------------
Robert R. Calli
Chairman
SPECIAL METALS
CORPORATION
By: /s/ Donald R. Muzyka
------------------------
Donald R. Muzyka
President
3
<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> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
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<RECEIVABLES> 32,609
<ALLOWANCES> (124)
<INVENTORY> 58,222
<CURRENT-ASSETS> 100,430
<PP&E> 86,486
<DEPRECIATION> (42,328)
<TOTAL-ASSETS> 149,624
<CURRENT-LIABILITIES> 24,858
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0
0
<COMMON> 155
<OTHER-SE> 114,795
<TOTAL-LIABILITY-AND-EQUITY> 149,624
<SALES> 93,043
<TOTAL-REVENUES> 93,043
<CGS> 72,551
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<NET-INCOME> 10,946
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<EPS-DILUTED> 0.71
</TABLE>
