|• CERADYNE, INC. - Q2 2012 FORM 10-Q • SECTION 301-CERTIFICATION OF PRINCIPAL EXECUTIVE OFCR • SECTION 302-CERTIFICATION OF PRINCIPAL FINANCIAL OFCR • SECTION 906-CERTIFICATION OF CEO • SECTION 906-CERTIFICATION OF CFO • INSTANCE DOCUMENT • XBRL TAXONOMY EXTENSION SCHEMA DOCUMENT • XBRL TAXONOMY EXTENSION CALCULATION LINKBASE DOCUMENT • XBRL TAXONOMY EXTENSION DEFINITION LINKBASE DOCUMENT • XBRL TAXONOMY EXTENSION LABEL LINKBASE DOCUMENT • XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE DOCUMENT|
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended June 30, 2012
For the transition period from to
Commission File No. 000-13059
(Exact name of Registrant as specified in its charter)
Registrant’s telephone number, including area code (714) 549-0421
(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 ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).
Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Exhibit Index on Page 32
FOR THE QUARTER ENDED
June 30, 2012
PART I. FINANCIAL INFORMATION
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
See accompanying condensed notes to Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share data)
See accompanying condensed notes to Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)
See accompanying condensed notes to Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
See accompanying condensed notes to Consolidated Financial Statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) 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 accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. The balance sheet at December 31, 2011 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. For further information, refer to the Consolidated Financial Statements and Notes to Financial Statements included in Ceradyne’s annual report on Form 10-K for the year ended December 31, 2011.
Share-based compensation expense for the three and six months ended June 30, 2012 was $1.0 million and $2.3 million, respectively, which was related to restricted stock units only as the Company did not have any share-based compensation expense for stock options. This compared to $1.1 million and $2.0 million for the three and six months ended June 30, 2011, respectively.
Share-based compensation expense is based on the value of the portion of share-based payment awards that is ultimately expected to vest. Forfeitures are estimated at the time of grant in order to estimate the amount of share-based awards that will ultimately vest. The forfeiture rate is based on historical rates. Share-based compensation expense recognized in the Company’s Consolidated Statements of Income for the three and six month periods ended June 30, 2012 includes compensation expense for share-based payment awards based on the estimated grant-date fair value. Since share-based compensation expense recognized in the Consolidated Statements of Income for the three and six month periods ended June 30, 2012 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures.
The Company maintains the 1994 Stock Incentive Plan and 2003 Stock Incentive Plan.
The Company was authorized to grant options for up to 2,362,500 shares under its 1994 Stock Incentive Plan. The Company has granted options for 2,691,225 shares and has had cancellations of 397,811 shares through June 30, 2012. There are no remaining stock options available to grant under this plan. The options granted under this plan generally became exercisable over a five-year period for incentive stock options and six months for nonqualified stock options and have a maximum term of ten years.
The 2003 Stock Incentive Plan was amended in 2005 to allow the issuance of Restricted Stock Units (the “Units”) to eligible employees and non-employee directors. The Units are payable in shares of the Company’s common stock upon vesting. For directors, the Units typically vest annually over three years following the date of their issuance. For officers and employees, Units typically vest annually over five years following the date of their issuance.
The Company may grant options and Units for up to 1,875,000 shares under the 2003 Stock Incentive Plan. The Company has granted options for 475,125 shares and Units for 1,003,869 shares under this plan through June 30, 2012. There have been cancellations of 135,393 shares associated with this plan through June 30, 2012. The options under this plan have a life of ten years.
During the three and six months ended June 30, 2012 and 2011, the Company issued Units to certain directors, officers and employees with weighted average grant date fair values and Units issued as indicated in the table below. The Company records compensation expense for the amount of the grant date fair value on a straight line basis over the vesting period.
Share-based compensation expense reduced the Company’s results of operations as follows (dollars in thousands):
As of June 30, 2012, all stock options were vested, consequently there was no unrecognized compensation cost related to them. The aggregate intrinsic value of stock options exercised was $1.1 million and $4.0 million for the six months ended June 30, 2012 and 2011, respectively.
As of June 30, 2012, there was approximately $9.6 million of total unrecognized compensation cost related to non-vested Units granted under the 2003 Stock Incentive Plan. That cost is expected to be recognized over a weighted average period of 3.3 years.
The following is a summary of stock option activity:
The following is a summary of Unit activity:
The following table summarizes information regarding options outstanding and options exercisable at June 30, 2012:
The following table summarizes information regarding Units outstanding at June 30, 2012:
Basic net income per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding. Diluted net income per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding plus the effect of any dilutive stock options and Units using the treasury stock method and the net share settlement method for the convertible debt. During the three and six months ended June 30, 2012 and 2011, the average trading price of the Company’s stock did not exceed the conversion price of the convertible debt, therefore there was no impact to the calculation of diluted shares.
The following is a summary of the number of shares entering into the computation of net income per common and potential common shares (in thousands):
The following are the number of shares not included in the fully diluted computation pertaining to restricted stock units as their impact would be anti-dilutive.
Inventories are valued at the lower of cost (first in, first out) or market. Inventory costs include the cost of material, labor and manufacturing overhead. The following is a summary of the inventory components as of June 30, 2012 and December 31, 2011 (in thousands):
Property, plant and equipment are recorded at cost and consist of the following (in thousands):
The components of intangible assets are as follows (in thousands):
The estimated useful lives for intangible assets are:
Amortization of definite-lived intangible assets will be approximately (in thousands): $5,689 for the balance of fiscal year 2012, $6,014 in fiscal year 2013, $8,213 in fiscal year 2014, $10,921 in fiscal year 2015 and $13,427 in fiscal year 2016.
The roll forward of the goodwill balance by segment during the six months ended June 30, 2012 is as follows (in thousands):
The Company is required to test annually whether the estimated fair value of its reporting units is sufficient to support the goodwill assigned to those reporting units; the Company performs the annual test in the fourth quarter. The Company is also required to test goodwill for impairment before the annual test if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount, such as a significant adverse change in the business climate. The Company determined that a test of goodwill for impairment was not required as of June 30, 2012.
During the six months ended June 30, 2012, the Company repurchased and retired 161,000 shares of its common stock at an aggregate cost of $4.0 million under a stock repurchase program authorized in 2011 by the Company’s Board of Directors. From the inception of this stock purchase program, the Company has repurchased and retired 161,000 shares of its common stock at an aggregate cost of $4.0 million. The Company is authorized to repurchase an additional $96.0 million for a total of $100.0 million.
The Company measures fair value and provides required disclosures about fair value measurements as it relates to financial and nonfinancial assets and liabilities in accordance with a framework specified by GAAP. This framework addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under GAAP. The framework also includes additional guidance to provide greater clarity about the credit and noncredit component of an other-than-temporary impairment event.
The fair value framework requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:
Level 1: quoted market prices in active markets for identical assets and liabilities
Level 2: observable market based inputs or unobservable inputs that are corroborated by market data
Level 3: unobservable inputs that are not corroborated by market data
The carrying value of cash and cash equivalents, accounts receivable and trade payables approximates the fair value due to their short-term maturities.
For recognition purposes, on a recurring basis, the Company measures available for sale short-term and long-term investments at fair value. Approximately $2.9 million of the unrealized losses in short term investments as of June 30, 2012 have been in a loss position for more than 12 months. The fair value of the following investments is determined using quoted prices in active markets (Level 1):
The fair value of long-term investments in auction rate securities is based on a Level 3 valuation technique that includes the present value of future cash flows (principal and interest payments), review of the underlying collateral, and considers relevant probability weighted and risk adjusted observable inputs and minimizes the use of unobservable inputs. The fair values of auction rate securities at June 30, 2012 and December 31, 2011 were $15.5 million and $15.0 million, respectively.
During the three months ended June 30, 2012 and 2011 there were no charges due to other-than-temporary reductions in the value of investments in auction rate securities. The Company also recognized pre-tax credits of $4,000 and $111,000 in other comprehensive income during the three months ended June 30, 2012 and 2011, respectively, due to temporary increases in the value of its investments in auction rate securities.
During the six months ended June 30, 2012 and 2011, there were no charges due to other-than-temporary reductions in the value of investments in auction rate securities. The Company also recognized a pre-tax credit of $457,000 and pre-tax reduction of $53,000 in other comprehensive income during the six months ended June 30, 2012 and 2011, respectively, due to temporary changes in the value of its investments in auction rate securities.
Cumulatively to date, the Company has incurred $4.7 million in pre-tax charges due to other-than-temporary reductions in the value of its investments in auction rate securities, realized losses of $8.8 million from sales of auction rate securities and pre-tax temporary impairment charges of $2.6 million reflected in other comprehensive income. As of June 30, 2012, the fair value of the Company’s investments in auction rate securities was below cost by approximately $7.3 million. The fair value of the auction rate securities has been below cost for more than one year.
For disclosure purposes, the Company is required to measure the fair value of outstanding debt on a recurring basis. The fair value of outstanding debt is determined using quoted prices in active markets. The fair value of short-term debt, based on quoted market prices, was $93.5 million at both June 30, 2012 and December 31, 2011.
In May 2011, the FASB issued new guidance which changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements to ensure consistency between U.S. GAAP and International Financial Reporting Standards (“IFRS”). This new guidance also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. The Company adopted this standard in the first quarter of 2012 which did not materially expand its consolidated financial statement footnote disclosures.
In June 2011, the FASB issued new guidance which eliminates the option to report other comprehensive income and its components in the statement of changes in equity. This new guidance requires that all nonowner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. The Company adopted this standard in the first quarter of 2012 which changed the presentation of its consolidated financial statements with the inclusion of a new separate statement labeled “Consolidated Statements of Comprehensive Income”.
During December 2005, the Company issued $121.0 million of 2.875% senior subordinated convertible notes (“Notes”) due December 15, 2035. The Company subsequently repurchased $27.9 million of the Notes during 2009 which reduced the outstanding principal amount to $93.1 million. Since the Notes are convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement), the Company separately accounts for the liability and equity components of the Notes in a manner that reflects the Company’s nonconvertible debt borrowing rate as interest cost is recognized.
As of June 30, 2012 and December 31, 2011, short-term debt and the equity component (recorded in additional paid in capital, net of income tax benefit), determined in accordance with the accounting guidance for convertible debt, comprised the following (in thousands):
The discount on the liability component of short-term debt is being amortized using the effective interest method based on an annual effective rate of 7.5%, which represented the market interest rate for similar debt without a conversion option on the issuance date, through December 2012, which coincides with the first date that holders of the Notes can exercise their put option as discussed below.
Interest expense on the Notes, excluding capitalized interest, for the three and six months ended June 30, 2012 and 2011 included the following (in thousands):
The Notes contain put options, which may require the Company to repurchase in cash all or a portion of the Notes on December 15, 2012, December 15, 2015, December 15, 2020, December 15, 2025, and December 15, 2030 at a repurchase price equal to 100% of the principal amount of the Notes to be repurchased plus accrued and unpaid interest, including contingent interest, if any, up to but excluding the repurchase date.
In December 2005, the Company established an unsecured $10.0 million line of credit (“2005 LOC”) which was closed in April 2012. In June 2011, the Company established an unsecured $5.0 million line of credit (“2011 LOC”) that was increased to $7.0 million on December 19, 2011 and will mature on April 1, 2013. The Company expects to renew the 2011 LOC at that time for multiple years. As of June 30, 2012, there were no outstanding amounts on the 2011 LOC. However, the available line of credit at June 30, 2012 has been reduced by outstanding letters of credit in the aggregate amount of $5.7 million. The interest rate on the 2011 LOC was 1.2% as of June 30, 2012 which was based on the LIBOR rate for a period of one month, plus a margin of 1.0% percent.
Pursuant to the bank line of credit, the Company is subject to certain covenants, which include, among other things, the maintenance of specified minimum amounts of net income and liquidity. The Company was in compliance with all covenants at June 30, 2012.
The Company serves its markets and manages its business through four operating segments, each of which has its own manufacturing facilities and administrative and selling functions.
The financial information for all segments is presented below (in thousands):
Foreign sales are determined by the country to which the shipment is delivered.
The following is revenue by market application for the Advanced Ceramic Operations segment (in thousands):
The Company provides pension benefits to its employees in Germany. These pension benefits are rendered for the time after the retirement of the employees by payments into legally independent pension and relief facilities. They are generally based on length of service, wage level and position in the company. The direct and indirect obligations comprise obligations for pensions that are already paid currently and expectations for those pensions payable in the future. The Company has four separate plans in Germany: a) Pensionskasse - Old; b) Pensionskasse - New; c) Additional Compensation Plan; and d) Deferred Compensation Plan. For financial accounting purposes, the Additional and Deferred Compensation Plans are accounted for as single-employer defined benefit plans, Pensionskasse - Old is a multiemployer defined benefit plan and the Pensionskasse - New is a defined contribution plan. The Company also provides pension benefits to its employees of Ceradyne Boron Products located in Quapaw, Oklahoma. There are two defined benefit retirement plans, one for eligible salaried employees and one for hourly employees. The benefits for the salaried employee plan are based on years of credited service and compensation. The benefits for the hourly employee plan are based on stated amounts per year of service.
Components of net periodic benefit costs under these defined benefit plans were as follows (in thousands):
The Company occasionally enters into foreign exchange forward contracts to reduce earnings and cash flow volatility associated with foreign exchange rate changes to allow management to focus its attention on its core business operations. Accordingly, the Company enters into contracts which change in value as foreign exchange rates change to economically offset the effect of changes in value of foreign currency assets and liabilities, commitments and anticipated foreign currency denominated sales and operating expenses. The Company enters into foreign exchange forward contracts in amounts between minimum and maximum anticipated foreign exchange exposures, generally for periods not to exceed one year. These derivative instruments are not designated as accounting hedges. The Company had outstanding foreign exchange forward contracts with a notional value of 55.0 million Euros at June 30, 2012.
The Company measures the financial statements of its foreign subsidiaries using the local currency as the functional currency. Assets and liabilities of these subsidiaries are translated at the exchange rate on the balance sheet date. Revenues, costs and expenses are translated at the rates of exchange prevailing during the year. Translation adjustments resulting from this process are included in stockholders’ equity. Gains and losses from foreign currency transactions are included in other income, miscellaneous.
The Company classifies accrued interest and penalties as part of the accrued liability for uncertain tax positions and records the corresponding expense in the provision for income taxes.
Components of the required reserve at June 30, 2012 and December 31, 2011 are as follows (in thousands):
It is anticipated that any change in the above UTBs will impact the effective tax rate. At June 30, 2012, the 2007 through 2011 years are open and subject to potential examination in one or more local jurisdictions and 2009 through 2011 years are open for federal income tax purposes. The Company does not anticipate any significant release of UTBs within the next twelve months.
Effective January 1, 2008, the Company was granted an income tax holiday for a manufacturing facility in China. The tax holiday allows for tax-free operations through December 31, 2009, followed by operations at a reduced income tax rate of 12.5% on the profits generated in 2010 through 2012, with a return to the full statutory rate of 25% for periods thereafter. This manufacturing facility in China incurred a pre-tax loss for the three and six months ended June 30, 2012, accordingly, there was no benefit from the tax holiday for this period. Income tax expense for the three and six months ended June 30, 2011 was reduced by $0.4 million and $1.3 million, respectively, from the tax holiday in China.
Income taxes are determined using an annual effective tax rate, which generally differs from the United States federal statutory rate, primarily because of state taxes, research and development tax credits and the income tax holiday in China. The Company recognizes deferred tax assets and liabilities for temporary differences between the financial and tax reporting of the Company's assets and liabilities, along with net operating loss and credit carry forwards.
A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The factors used to assess the likelihood of realization of the deferred tax assets are the reversal of deferred tax liabilities, the Company’s forecast of future taxable income, and available tax planning strategies that are prudent and feasible. The Company evaluated positive and negative evidence and, although realization is not assured, management determined that it is more likely than not that the net deferred tax asset will be realized through future taxable income and tax planning strategies. Failure to achieve the forecasted taxable income and successful implementation of tax planning strategies in the applicable taxing jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in the Company’s effective tax rate on future earnings.
The Company leases certain of its manufacturing facilities under noncancelable operating leases expiring at various dates through 2015. The Company incurred rental expense under these leases of $2.2 million and $1.8 million for the six months ended June 30, 2012 and 2011, respectively. The approximate minimum rental commitments required under existing noncancelable leases as of June 30, 2012 are as follows (in thousands):
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q contains statements which may constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934. One generally can identify forward-looking statements by the use of forward-looking terminology such as “believes,” “may,” “will,” “expects,” “intends,” “estimates,” “anticipates,” “plans,” “seeks,” or “continues,” or the negative thereof, or variations thereon, or similar terminology. Forward-looking statements regarding future events and the future performance of the Company involve risks and uncertainties that could cause actual results to differ materially. Reference is made to the risks and uncertainties which are described in this Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and in Part II, Item 1A under the caption “Risk Factors.” Reference is also made to the risks and uncertainties described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the Securities and Exchange Commission, in Item 1A under the caption “Risk Factors,” and in Item 7 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
We develop, manufacture and market advanced technical ceramic products, ceramic powders and components for defense, industrial, energy, automotive/diesel and commercial applications. Our products include:
Our customers include the U.S. government, prime government contractors, companies engaged in solar energy, oil and natural gas exploration and nuclear energy, and large industrial, automotive, diesel and commercial manufacturers in both domestic and international markets.
The tables below show, for each of our four operating segments, revenues and income (loss) from operations in the periods indicated.
Segment revenues (in millions):
Segment operating income (loss) (in millions):
* Not meaningful
We categorize our products into five market applications. The tables below show our sales by market application and the percentage contribution to our total sales of each market application in the different time periods.
Sales by Market Application (in millions):
The principal factor contributing to our growth in sales from 2002 through 2007 was increased demand by the U.S. military for ceramic body armor that protects soldiers, which was driven primarily by military conflicts such as those in Iraq and Afghanistan. This demand was driven by recognition of the performance and life saving benefits of utilizing advanced technical ceramics in lightweight body armor. Our sales declined in 2008 primarily because of a reduction in shipments of body armor. Our sales declined in 2009 primarily because of a continued reduction in shipments of body armor and also due to a decline in sales of our industrial, automotive/diesel and commercial market product lines due to the severe economic recession. In 2010, sales of body armor continued to decline. However, sales from energy related products grew by 61.6% in 2010 when compared to 2009. Most of this growth in energy sales was generated by sales of our ceramic crucibles used in the production of photovoltaic cells for solar panels. Additionally, sales of industrial and automotive/diesel products rebounded sharply in 2010, particularly at our ESK Ceramics subsidiary. In 2011, our sales increased due to higher shipments of body armor due to the increased demand for ESAPI body armor, an increase of sales to the nuclear industry, and continuing growth of sales at our ESK Ceramics subsidiary.
Commencing in 2004, several strategic acquisitions also have contributed to our sales growth. These include our acquisition of ESK Ceramics in August 2004, our acquisition of Minco, Inc. in July 2007, our acquisition of EaglePicher Boron, LLC in August 2007, which we renamed Boron Products, LLC and our acquisition of VIOX Corporation in January 2011.
To illustrate the impact of body armor, energy-related products, and our acquisitions, the following table shows our sales from body armor, energy-related products, from our acquisitions, and from all other sources for each of the years 2002 through 2011 (in millions).