|• FORM 10-Q • CERTIFICATION OF CEO PURSUANT TO RULE 13A-14(A), ADOPTED PURSUANT TO SECTION 302 • CERTIFICATION OF CFO PURSUANT TO RULE 13A-14(A), ADOPTED PURSUANT TO SECTION 302 • CERTIFICATION OF CEO AND CFO PURSUANT TO SECTION 906 • XBRL INSTANCE DOCUMENT • XBRL TAXONOMY EXTENSION SCHEMA • XBRL TAXONOMY EXTENSION CALCULATION LINKBASE • XBRL TAXONOMY EXTENSION DEFINITION LINKBASE • XBRL TAXONOMY EXTENSION LABEL LINKBASE • XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE|
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the quarterly period ended June 30, 2012
Commission file number 1-14368
Titanium Metals Corporation
(Exact name of registrant as specified in its charter)
5430 LBJ Freeway, Suite 1700, Dallas, Texas 75240-2697
(Address of principal executive offices) (Zip Code)
Registrants telephone number, including area code: (972) 233-1700
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, and (2) has been subject to such filing requirements for the past 90 days. Yes þ 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ 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 (as defined by Rule 12b-2 of the Exchange Act).
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
Number of shares of common stock outstanding on July 27, 2012: 175,061,774
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CONDENSED CONSOLIDATED BALANCE SHEETS
See accompanying Notes to Condensed Consolidated Financial Statements.
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TITANIUM METALS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
CONDENSED CONSOLIDATED BALANCE SHEETS
See accompanying Notes to Condensed Consolidated Financial Statements.
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CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In millions, except per share data)
See accompanying Notes to Condensed Consolidated Financial Statements.
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CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
See accompanying Notes to Condensed Consolidated Financial Statements.
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying Notes to Condensed Consolidated Financial Statements.
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CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2012
See accompanying Notes to Condensed Consolidated Financial Statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
Note 1 Basis of presentation and organization
Basis of presentation. The unaudited Condensed Consolidated Financial Statements contained in this Quarterly Report have been prepared on the same basis as the audited Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2011 that we filed with the Securities and Exchange Commission (SEC) on February 29, 2012 (2011 Annual Report). They include the accounts of Titanium Metals Corporation and its majority owned subsidiaries (collectively referred to as TIMET). Unless otherwise indicated, references in this report to we, us or our refer to TIMET and its subsidiaries, taken as a whole. All material intercompany transactions and balances with consolidated subsidiaries have been eliminated. In our opinion, we have made all necessary adjustments (which include only normal recurring adjustments) in order to state fairly, in all material respects, our consolidated financial position, results of operations and cash flows as of the dates and for the periods presented. We have condensed or omitted certain information and footnote disclosures (including those related to the Consolidated Balance Sheet at December 31, 2011) normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). Our results of operations for the interim periods ended June 30, 2012 may not be indicative of our operating results for the full year. The Condensed Consolidated Financial Statements contained in this Quarterly Report should be read in conjunction with the 2011 Consolidated Financial Statements contained in our 2011 Annual Report. Our first three fiscal quarters reported are the approximate 13-week periods ending on the Saturday generally nearest to March 31, June 30 and September 30. Our fourth fiscal quarter and fiscal year always end on December 31. For presentation purposes, our financial statements and the accompanying notes have been presented as ended on March 31, June 30, September 30 and December 31, as applicable.
Organization. At June 30, 2012, Contran Corporation and its subsidiaries held 29.5% of our outstanding common stock. Substantially all of Contrans outstanding voting stock is held by trusts established for the benefit of certain children and grandchildren of Harold C. Simmons, of which Mr. Simmons is sole trustee, or is held by Mr. Simmons or persons or other entities related to Mr. Simmons. At June 30, 2012, Mr. Simmons and his spouse owned an aggregate of 15.7% of our common stock, and the Combined Master Retirement Trust (CMRT), a trust sponsored by Contran to permit the collective investment by trusts that maintain the assets of certain employee benefit plans adopted by Contran and certain related companies, held an additional 8.8% of our common stock. Mr. Simmons is the sole trustee of the CMRT and a member of the trust investment committee for the CMRT. Consequently, Mr. Simmons may be deemed to control each of Contran and us.
Note 2 Fair value of financial instruments
Carrying amounts of certain of our financial instruments including, among others, cash and cash equivalents and accounts receivable, approximate fair value because of their short maturities. We carry our investments in marketable equity securities at fair value based upon quoted market prices, and the carrying values of our notes receivable from affiliates approximate fair value because the applicable interest rates are variable based upon stated market indices. The carrying value of our indebtedness approximates fair value because the applicable interest rates are variable based upon stated market indices, which represent Level 2 inputs within the fair value hierarchy.
Note 3 Notes receivable from affiliates
From time to time, companies related to Contran will have loans and advances outstanding between them and various related parties pursuant to term and demand notes. These loans and advances are generally entered into for specific transactions or cash management purposes.
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The following table summarizes the aggregate outstanding principal balances on our notes receivable from affiliates as of December 31, 2011 and June 30, 2012:
Following the establishment of our U.S. credit facility in February 2012, the terms of the Contran unsecured revolving demand promissory note were amended to increase the interest rate on outstanding borrowings on or after March 1, 2012 to prime plus 2.75%, which exceeds the prevailing interest rate under our U.S. credit facility.
Note 4 Inventories
Note 5 Marketable securities
Our marketable securities include investments in the publicly traded shares of related parties, including NL Industries, Inc., Kronos Worldwide, Inc. and Valhi, Inc., each a majority owned subsidiary of Contran, and certain mutual funds. All of our marketable securities are classified as available-for-sale, which are carried at fair value using quoted market prices in active markets for each marketable security, representing inputs from the highest level (level 1) within the fair value hierarchy. Because we have classified all of our marketable securities as available-for-sale, any unrealized gains or losses on the securities are recognized through other comprehensive income.
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The following table summarizes the market value of our marketable securities as of December 31, 2011 and June 30, 2012:
At June 30, 2012, we owned 6.4 million shares of Valhi common stock, which represents approximately 1.9% of Valhis outstanding shares. Such shares of Valhi common stock reflects a 3-for-1 split which Valhi implemented in May 2012. Valhis stock split had no impact on our financial statements or our ownership interest. Additionally, we held approximately 0.5% of NLs outstanding common stock and 0.3% of Kronos outstanding common stock at June 30, 2012.
From time to time during 2011 and 2012, we also held investments in various mutual funds which had a primary investment objective of holding corporate and government debt securities from U.S. and other markets. These funds have daily liquidity and were held for the temporary investment of cash available for our operations in order to generate a higher return than would be available if such funds were invested in an asset qualifying for classification as a cash equivalent, and accordingly, we have classified our investments in these mutual funds as a current asset.
Because we have classified all of our investments in marketable securities as available-for-sale, any unrealized gains or losses are recognized through other comprehensive income. With respect to our investment in Kronos, our cost basis exceeded its market value for a period of approximately one month at June 30, 2012. Based on Kronos closing market price as of August 1, 2012, the aggregate market value exceeded our cost basis, and therefore, such decline in market price was temporary at June 30, 2012.
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Note 6 Property and equipment
Note 7 Other noncurrent assets
Note 8 Accrued and other current liabilities
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Note 9 Long-term debt
Credit facilitiesAs of June 30, 2012, we had outstanding borrowings of $91.9 million under our U.S. credit facility. The average annualized interest rate on our U.S. credit facility was 3.2% as of June 30, 2012 and 3.5% for the six-month period ended June 30, 2012.
In June 2012, we replaced our credit facility in the U.K. with a £22.5 million credit facility that matures on March 31, 2015. Interest on outstanding borrowings generally accrues at a rate of LIBOR plus 1.6%, and all other terms are substantially similar to our previous U.K. credit facility. There were no outstanding borrowings under the U.K. credit facility at June 30, 2012 and our previous U.K., facility at December 31, 2011.
Restrictions and other Our credit facilities contain certain restrictive covenants customary in lending transactions of this type. In some cases, we are required to maintain certain financial ratios, such as a fixed charge coverage ratio. We are in compliance with all of our debt covenants at June 30, 2012. We believe we will be able to comply with the financial covenants contained in each of our credit facilities until maturity of such facilities; however, if future operating results differ materially from our expectations, we may be unable to maintain compliance.
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Note 10 Employee benefits
Defined benefit pension plans. The components of the net periodic pension expense are set forth below:
Postretirement benefits other than pensions ( OPEB). The components of net periodic OPEB expense are set forth below:
In the second quarter of 2011, we amended the benefit formula and the service requirements for certain of our U.S. employees as part of the ratification of a new collective bargaining agreement. Such amendment resulted in the immediate recognition of $2.1 million of previously unrecognized prior service credit due to the benefit curtailment which resulted in a curtailment gain included as a reduction to cost of sales.
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Note 11 Other income and expense
In August 2009, we filed a claim in the bankruptcy proceedings of Tronox Incorporated, which operates a manufacturing site adjacent to our Henderson, Nevada plant site. In our claim, we asserted that Tronoxs operations at its manufacturing site contribute to the groundwater contamination at our site discussed in Note 13, and that Tronox should therefore be responsible for reimbursing us for a portion of the cost of our remediation activities. In February 2011, Tronox emerged from bankruptcy upon the effectiveness of their plan of reorganization. As part of the Tronox plan of reorganization, in February 2011 we received (i) 49,963 shares of common stock of the reorganized Tronox and (ii) an additional 46,617 shares of such common stock that we purchased for an aggregate of $1.3 million in cash pursuant to the exercise of our right to participate in a Tronox common stock rights offering, in both cases in satisfaction of our claim. The aggregate fair value of the consideration we received in February 2011 upon Tronoxs emergence from bankruptcy, using the over-the-counter quoted market price of such common stock on the date Tronoxs plan of reorganization became effective (a level 2 input in the fair value hierarchy), in excess of our cost basis was $10.6 million ($0.04 per diluted share, net of income taxes) and is included in other operating income. Subsequently, in March 2011 we sold all of our shares of Tronox common stock in an over-the-counter market transaction and realized a gain of $1.3 million which is included in other non-operating expense.
In the second quarter of 2012, we received two payments on an insurance claim related to certain damaged property, resulting in other non-operating income of $1.6 million ($0.01 per diluted share, net of income taxes). We expect additional insurance recoveries during 2012 upon final resolution of our claim.
Note 12 Income taxes
Note 13 Commitments and contingencies
Environmental matters. As a result of Environmental Protection Agency (EPA) inspections, in April 2009 the EPA issued a Notice of Violation (Notice) to us alleging that we violated certain provisions of the Resource Conservation and Recovery Act and the Toxic Substances Control Act (TSCA) at our Henderson plant. We responded to the EPA and are currently in discussions with them concerning the nature and extent of required follow-up testing and potential remediation that may be required. In addition, we are currently performing work in accordance with an approved plan to address certain matters raised in the Notice.
In May 2010, the EPA notified us alleging two unrelated violations of the recordkeeping and reporting requirements of TSCA at our Henderson plant and initiated an investigation of our Morgantown plant under these provisions of TSCA. In June 2010, with EPA approval, we conducted a voluntary self-audit of TSCA compliance at all of our U.S. facilities and disclosed the results of the self-audit to the EPA, including our findings with respect to areas of non-compliance. We do not expect the consequences of such non-compliance to have a material effect on our results of operations, financial condition or liquidity.
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As part of our continuing environmental assessment with respect to our plant site in Henderson, in 2008 we completed and submitted to the Nevada Department of Environmental Protection (NDEP) a Remedial Alternative Study (RAS) with respect to the groundwater located beneath the plant site. The RAS, which was submitted pursuant to an existing agreement between the NDEP and us, addressed the presence of certain contaminants in the plant site groundwater that require remediation. The NDEP completed its review of the RAS and our proposed remedial alternatives, and the NDEP issued its record of decision in February 2009, which selected our preferred groundwater remedial alternative action plan. We commenced implementation of the plan in 2009. In connection with our implementation of the plan, which may be subject to change as remediation proceeds, we are undertaking soil remediation to address source areas associated with conveyance ditches previously used by several companies in the BMI complex, the cost of which is covered by insurance.
We had $2.2 million accrued at June 30, 2012 for remediation activities anticipated at our Henderson plant site, including amounts accrued at the lower end of the range of estimated costs for the groundwater remedial action plan selected by the NDEP in its record of decision and for additional soil remediation. We will continue evaluating alternative methods and timing for all of our remediation activities, and if necessary, we may revise our estimated costs in the future. We estimate the upper end of the range of reasonably possible costs related to all of our environmental matters, in excess of our existing accrual, to be approximately $2.4 million. We expect these estimated costs to be incurred over a remediation period of at least five years.
Legal proceedings. We record liabilities related to legal proceedings when estimated costs are probable and reasonably estimable. Such accruals are adjusted as further information becomes available or circumstances change. Estimated future costs are not discounted to their present value. It is not possible to estimate the range of costs for certain matters. No assurance can be given that actual costs will not exceed accrued amounts or that costs will not be incurred with respect to matters as to which no problem is currently known or where no estimate can presently be made. Further, additional legal proceedings may arise in the future.
In November 2011, a purported shareholder derivative lawsuit was filed in Delaware Chancery court by one of our stockholders (Louisiana Municipal Police Retirement System v. Harold C. Simmons, et al. (Delaware Chancery Court C.A. No. 7059-CS) (LAMPERS)) and names each of the current members of our Board of Directors as defendants and us as a nominal defendant. The lawsuit alleges Mr. Simmons, who is deemed to be a controlling shareholder, caused us to enter into related party transactions with affiliated companies for which Mr. Simmons is also deemed to control that are unfair to us. The lawsuit alleges each of the directors breached their fiduciary duties to us and the minority stockholders. The plaintiff seeks unspecified damages, costs and attorneys fees. The defendants have filed a motion to dismiss the lawsuit for plaintiffs failure to make demand upon our directors to consider the merits of plaintiffs claim. The plaintiff filed an amended complaint in the lawsuit, and the defendants refiled their motion to dismiss.
In December 2011, a similar purported shareholder derivative lawsuit was filed in federal court in the Northern District of Texas by another TIMET stockholder (Bert Bauman v. Harold C. Simmons, et al. (United States District Court, Northern District of Texas Case No. 3:11-CV-3607)) and names as defendants each of the current members of our Board of Directors, our current Chief Executive and Chief Financial Officers and Contran Corporation, and us as a nominal defendant. As with the LAMPERS action, the Bauman lawsuit alleges Mr. Simmons caused us to enter into related party transactions with affiliates that are unfair to us. The action brings claims for breach of fiduciary duty, unjust enrichment and waste of corporate assets. The action also claims the director defendants violated U.S. securities laws by failing to properly disclose the related party transactions in our proxy statement. Plaintiff seeks unspecified damages, costs and attorneys fees, disgorgement of profits or benefits, if any, obtained by defendants and various equitable measures, including additional corporate governance and oversight procedures. The defendants also have filed a motion to dismiss this lawsuit for plaintiffs failure to make demand upon our directors to consider the merits of plaintiffs claim.
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Note 14 Business segment information
Our production facilities are located in the United States, United Kingdom, France and Italy, and our products are sold throughout the world. Our President and Chief Executive Officer functions as our chief operating decision maker (CODM), and the CODM receives consolidated financial information about us. He makes decisions concerning resource utilization and performance analysis on a consolidated and global basis. We have one reportable segment, our worldwide Titanium melted and mill products segment. The following table provides supplemental information to our Condensed Consolidated Financial Statements:
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The statements contained in this Quarterly Report on Form 10-Q (Quarterly Report) that are not historical facts, including, but not limited to, statements found in the Notes to Condensed Consolidated Financial Statements and Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A), are forward-looking statements that represent managements beliefs and assumptions based on currently available information. Forward-looking statements can generally be identified by the use of words such as believes, intends, may, will, looks, should, could, anticipates, expects or comparable terminology or by discussions of strategies or trends. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we do not know if these expectations will prove to be correct. Such statements by their nature involve substantial risks and uncertainties that could significantly affect expected results. Actual future results could differ materially from those described in such forward-looking statements, and we disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Among the factors that could cause actual results to differ materially are the risks and uncertainties discussed in this Quarterly Report, including risks and uncertainties in those portions referenced above and those described from time to time in our other filings with the SEC which include, but are not limited to:
Should one or more of these risks materialize (or the consequences of such a development worsen), or should the underlying assumptions prove incorrect, actual results could differ materially from those forecasted or expected.
The following discussion and analysis should be read in conjunction with our Condensed Consolidated Financial Statements and related notes included elsewhere in this Quarterly Report and with our Consolidated Financial Statements and the information under the heading Managements Discussion and Analysis of Financial Condition and Results of Operations, which are included in our 2011 Annual Report.
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General overview. We are a vertically integrated producer of titanium sponge, melted products and a variety of mill products for commercial aerospace, military, industrial and other applications. We are one of the worlds leading producers of titanium melted products (ingot, electrode and slab) and mill products (billet, bar, plate, sheet and strip). We are the only producer with major titanium production facilities in both the United States and Europe, the worlds principal markets for titanium. The titanium metals industry is highly competitive on a worldwide basis. We compete primarily on the basis of price, quality of products, technical support and the availability of products to meet customers delivery schedules.
Our business is more dependent on commercial aerospace demand than is the overall titanium industry. Demand for titanium products within the commercial aerospace sector is derived from both jet engine components (e.g., blades, discs, rings and engine cases) and airframe components (e.g., bulkheads, tail sections, landing gear, wing supports and fasteners). Deliveries of titanium generally precede aircraft deliveries by about one year, and our business cycle generally correlates to this timeline, although the actual timeline can vary considerably depending on the titanium product.
The following factors have the most impact on our reported operating results and also represent our key performance indicators:
Financial overview. We reported net income attributable to TIMET stockholders of $30.2 million, or $0.17 per diluted share, in the second quarter of 2012 as compared to net income attributable to TIMET stockholders of $31.5 million, or $0.18 per diluted share, in the second quarter of 2011. We reported net income attributable to TIMET stockholders of $55.8 million, or $0.32 per diluted share, in the first half of 2012 as compared to net income attributable to TIMET stockholders of $60.4 million, or $0.34 per diluted share, in the first half of 2011. Our net income for the both 2012 periods is lower principally due to lower operating income resulting from the net effects of higher average selling prices and lower sales volumes of industrial-grade products in 2012. Additionally, operating income for the first half of 2011 was favorably impacted by a first quarter $10.6 million ($0.04 per diluted share, net of income taxes) gain on settlement of a claim to recover certain groundwater remediation costs attributable to a third-party manufacturing facility adjacent to our Henderson facility.
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RESULTS OF OPERATIONS
Quarter ended June 30, 2012 compared to quarter ended June 30, 2011
Summarized financial information. The following table summarizes certain information regarding our results of operations for the three months ended June 30, 2011 and 2012. Our reported average selling prices reflect actual selling prices after the effects of currency exchange rates, customer and product mix and other related factors throughout the periods presented.
Net sales. Our net sales were $281.7 million for the second quarter of 2012 compared to net sales of $272.0 million for the second quarter of 2011. The increase in net sales was principally the result of increased average selling prices, partially offset by reduced volumes. Average selling prices increased 9% for melted products and 8% for mill products driven by annual adjustments under certain of our long-term agreements and a higher mix of aerospace products during the 2012 period. Reduced volumes of industrial product sales, which generally have project-oriented demand and sell at lower prices than more complex aerospace-grade products, contributed to increased average selling prices and decreased volumes for our mill products during the second quarter of 2012. A continuation of strong demand for our mill products within the commercial aerospace sector largely offset the effects of reduced sales volume of our industrial-grade mill products.
Cost of sales and gross margin. For the second quarter of 2012, our cost of sales was $220.7 million compared to $209.1 million for the second quarter of 2011. Cost of sales for the quarter ended June 30, 2012 increased primarily due to higher manufacturing costs associated with a higher proportion of more complex products. During the second quarter of 2011, we amended our retiree medical benefit plan for certain U.S. employees, which resulted in a curtailment gain of $2.1 million included as a reduction to cost of sales. See Note 11 to our Condensed Consolidated Financial Statements.
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For the second quarter of 2012, our gross margin was $61.0 million compared to $62.9 million for the second quarter of 2011. Excluding the curtailment gain, the positive impacts of a favorable change in product mix substantially offset the impact of lower sales volumes in the current period.
Operating income. Operating income for the second quarter of 2012 was $43.7 million compared to $46.5 million for the same period of 2011, consistent with the decline in gross margin discussed above.
Income taxes. Our effective income tax rate was 33% for the second quarter of 2012 and 2011. We operate in multiple tax jurisdictions, and as a result, the geographic mix of our pre-tax income or loss can impact our overall effective tax rate. Our effective rates in the second quarter of 2011 and 2012 were lower than the U.S. statutory rate primarily due to the effects of (i) the positive impact of earnings being generated in lower tax rate jurisdictions and (ii) the positive impact of the domestic production activities deduction.
Six months ended June 30, 2012 compared to six months ended June 30, 2011
Summarized financial information. The following table summarizes certain information regarding our results of operations for the six months ended June 30, 2011 and 2012. Our reported average selling prices reflect actual selling prices after the effects of currency exchange rates, customer and product mix and other related factors throughout the periods presented.
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Net sales. Our net sales were $558.5 million for the first half of 2012 compared to net sales of $524.1 million for the first half of 2011. The increase in net sales was principally the result of increased average selling prices for melted and mill products, partially offset by reduced melted product volumes during the first half of 2012. Average selling prices increased 5% for melted products and 6% for mill products principally driven by annual adjustments under certain of our long-term agreements. Additionally, reduced volumes of industrial product sales, which generally have project-oriented demand and sell at lower prices than more complex aerospace-grade products, contributed to increased average selling prices and decreased volumes for our mill products during the first half of 2012. A continuation of strong demand for our mill products within the commercial aerospace sector largely offset the effects of reduced sales volume of our industrial-grade mill products.
Cost of sales and gross margin. For the first half of 2012, our cost of sales was $439.1 million compared to $412.9 million for the first half of 2011. Cost of sales for the six months ended June 30, 2012 increased primarily due to higher manufacturing costs associated with a higher proportion of more complex products. In addition, cost of sales in the first half of 2011 includes the favorable impact of the $2.1 million curtailment gain discussed above.
For the first half of 2012, our gross margin was $119.4 million compared to $111.2 million for the first half of 2011, reflecting the positive impacts of a favorable change in product mix, partially offset by the impact of lower sales volumes in the current period.
Operating income. Operating income for the first half of 2012 was $85.8 million compared to $91.6 million for the same period of 2011, reflecting the net effect of the higher gross margin during the 2012 period and lower other operating income due to a first quarter 2011 $10.6 million gain on settlement of a claim to recover certain groundwater remediation costs attributable to a third-party facility adjoining one of our plant sites.
Income taxes. Our effective income tax rate was 33% for the first half of 2012 and 2011. We operate in multiple tax jurisdictions, and as a result, the geographic mix of our pre-tax income or loss can impact our overall effective tax rate. Our effective rates in the first half of 2012 and 2011 were lower than the U.S. statutory rate primarily due to the effects of (i) the positive impact of earnings being generated in lower tax rate jurisdictions and (ii) the positive impact of the domestic production activities deduction.
We have substantial operations located in the United Kingdom, France and Italy. Approximately 43% of our sales originated in Europe for the six months ended June 30, 2012, a portion of which were denominated in foreign currency, principally the British pound sterling or the euro. Certain raw material costs, principally purchases of titanium sponge and alloys for our European operations, are denominated in U.S. dollars, while labor and other production costs are primarily denominated in local currencies. The functional currencies of our European subsidiaries are those of their respective countries. Our European operations may incur borrowings denominated in U.S. dollars or in their respective functional currencies. Our export sales from the U.S. are denominated in U.S. dollars and are not subject to currency exchange rate fluctuations. We do not use currency contracts to hedge our currency exposures.
The translated U.S. dollar value of our foreign sales and operating results are subject to currency exchange rate fluctuations which may favorably or adversely impact reported earnings and may affect the comparability of period-to-period operating results. By applying the exchange rates prevailing during the prior year period to our local currency results of operations for the current year period, the translation impact of currency rate fluctuations can be estimated. The U.S. dollar strengthened against the British pound and euro in the three and six months ended June 30, 2012 as compared to the corresponding periods in 2011. These fluctuations in foreign currency exchange rates had the following effects on our sales and operating income:
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Product deliveries for the first half of 2012 reflect continued strong sales to the commercial aerospace supply chain in support of the industrys estimated timelines for fleet replacement and commercial aircraft production. Reduced sales of industrial-use titanium mill and melted products contributed to overall volumes being lower than the first half of 2011. Average selling prices for the first half of 2012 were up 6% and 5% for mill and melted products, respectively, due to the relative mix of aerospace versus industrial sales and cost-based index pricing under certain long-term agreements.
The continued development and production of next generation aircraft, combined with the resurgence in orders for recently reintroduced legacy models with new, fuel-efficient engines and a strong original equipment manufacturer order backlog, are indicators that our industry has entered the sustained growth period forecasted by various industry experts. If the industrys estimated timelines for fleet replacement and commercial aircraft production are met, we anticipate production rates throughout the commercial aerospace supply chain will continue to be strong during the next year and accelerate over the next several years. Projected aircraft deliveries over a longer time horizon are also expected to remain strong as fuel efficiency and expansion of the global fleet in developing areas, such as Asia, the Middle East and South America, are expected to support future demand. Based on current industry dynamics and subject to temporary fluctuations resulting from adjustments of inventory levels within the supply chain, we expect continued strong commercial aerospace mill product deliveries for the remainder of the year and foreseeable future and believe that our manufacturing flexibility and efficiencies will allow us to largely mitigate the impact of increasing titanium feedstock costs for the rest of 2012. Demand growth in industrial markets may continue to be affected by generally weak global economic conditions, but we believe our customer supply agreements, which secure major positions on the engines and structures for key growth platforms, will bolster our core aerospace business for the foreseeable future.
We continue to enhance our ability to meet our current and prospective customers needs and strengthen our position as a trusted supplier in markets where technical ability and precision are critical. We have been successful over the past several years in establishing significant manufacturing and raw material flexibility and cost efficiencies throughout our manufacturing processes, and together with the benefit of our customer long-term agreements, we believe these core strengths will serve us well in the current environment of strong demand. Our fiscal discipline and industry expertise have allowed us to manage our production rates and costs effectively while investing capital conservatively and maintaining a strong balance sheet. We believe our financial strength and operating flexibility position us to take advantage of opportunities to strengthen and expand our presence in key markets.
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LIQUIDITY AND CAPITAL RESOURCES
Our consolidated cash flows for the six months ended June 30, 2011 and 2012 are presented below. The following should be read in conjunction with our Condensed Consolidated Financial Statements and notes thereto.
Operating activities. Cash flow from operations is a primary source of our liquidity. Changes in pricing, production volume and customer demand, among other things, could significantly affect our liquidity. Trends in cash flows from operating activities, excluding changes in assets and liabilities, have generally been similar to the trends in operating income. Changes in assets and liabilities result primarily from the timing of production, sales and purchases. Changes in assets and liabilities tend to even out over time. However, period to period relative changes in assets and liabilities can significantly affect the comparability of cash flows from operating activities. Our cash from operating activities decreased $52.1 million, from $25.7 million used during the first six months of 2011 to $77.8 million used in the first six months of 2012 primarily due to the net effects of the following factors:
Relative changes in working capital can have significant effects on cash flows from operating activities. As shown below, our average days sales outstanding (DSO) increased from December 31, 2011 to June 30, 2012. The increase in our DSO was the result of an increase in receivables relating to strong sales in the first half of 2012 and the timing of collection of those receivables.
As shown below, our average number of days sales in inventory (DSI) increased from December 31, 2011 to June 30, 2012. The overall increase in average DSI was primarily the result of the high production volumes, rising cost of raw materials and higher inventory levels. Based on our sales order backlog, outlook for inventory requirements and strategic stocking of certain raw materials, we expect to deploy additional working capital to maintain appropriate inventory levels in response to improving customer demand trends. As a result, we expect that our cash flows from operating activities will continue to consume cash for the remainder of 2012 with funding provided by cash on hand, short-term investments and borrowing availability under our existing credit facilities.
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For comparative purposes, we have also provided average DSO and DSI for the comparative prior year periods in the table below:
Investing activities. Cash flows used in our investing activities decreased from $108.6 million in the first six months of 2011 to $23.7 million in the first six months of 2012 primarily due to the net effects of the following factors:
Financing activities. We had the following significant items included in our cash flows from financing activities:
We expect to borrow additional amounts under our revolving credit facilities during the remainder of 2012, in part to finance the expected net use of cash from operating activities as discussed above and capital spending as discussed below.
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Debt Obligations. At June 30, 2012, there was approximately $91.9 million outstanding under our $200 million U.S. revolving credit facility that matures in February 2017.
Future cash requirements
Liquidity. Our primary sources of liquidity on an ongoing basis are our cash flow from operating activities and borrowings under various credit facilities. We generally use these amounts to (i) fund capital expenditures, (ii) repay indebtedness incurred primarily for working capital purposes and (iii) provide for the payment of dividends. From time-to-time we will incur indebtedness, generally to (i) fund short-term working capital needs, (ii) refinance existing indebtedness, (iii) make investments in marketable and other securities (including the acquisition of securities issued by our subsidiaries and affiliates) or (iv) fund major capital expenditures or the acquisition of other assets outside the ordinary course of business.
We routinely evaluate our liquidity requirements, capital needs and availability of resources in view of, among other things, our alternative uses of capital, debt service requirements, the cost of debt and equity capital and estimated future operating cash flows. As a result of this process, we have in the past, or in light of our current outlook, may in the future, seek to raise additional capital, modify our common and preferred dividend policies, restructure ownership interests, incur, refinance or restructure indebtedness, repurchase shares of common stock, sell assets, or take a combination of such steps or other steps to increase or manage our liquidity and capital resources. In the normal course of business, we investigate, evaluate, discuss and engage in acquisition, joint venture, strategic relationship and other business combination opportunities in the titanium, specialty metal and other industries. In the event of any future acquisition or joint venture opportunities, we may consider using then-available liquidity, issuing equity securities or incurring indebtedness.
At June 30, 2012, we had aggregate cash and cash equivalents and current marketable securities of $27.4 million, and we had borrowing availability under our existing credit facilities of $129.2 million, including $80.1 million under our U.S. revolving credit facility. We are in compliance with all of our debt covenants at June 30, 2012. Although our U.S. revolving credit facility has a remaining capacity of $105.1 million at June 30, 2012, only $80.1 million was available to borrow due to debt covenant restrictions. We currently expect the full capacity to be available on the U.S. revolving credit facility at the end of September 2012. We could borrow all available amounts under each of our European credit facilities without violating our existing debt covenants. Our non-U.S. subsidiaries held $10.7 million of our aggregate cash and cash equivalents and all of our current marketable securities at June 30, 2012. Based upon our expectations of our operating performance, the anticipated demands on our cash resources, borrowing availability under our U.S. and European credit facilities and anticipated borrowing capacity after the maturity of these credit facilities, we expect to have sufficient liquidity to meet our obligations for the short-term (defined as the next twelve-month period) and our long-term obligations.
Capital expenditures. We currently estimate we will invest a total of approximately $90 million to $100 million for capital expenditures during 2012. Our planned capital expenditures include projects to drive increased operating efficiency, properly maintain equipment and expand the productive capacity at our melting facilities, including a project we have commissioned at our facility in Morgantown, Pennsylvania, currently expected to be completed in 2013. As part of our expansion plans, we are implementing plasma melting technology to enhance our capabilities to meet the growing demand for complex, high-temperature alloys utilized more extensively in new generation aircraft engines. Capital spending for 2012 is expected to be funded by existing cash resources and available credit facilities.
We continue to evaluate additional opportunities to improve or augment productive assets including capital projects, acquisitions or other investments which, if consummated, any required funding would be provided by existing cash resources or borrowings under our U.S. and European credit facilities.
Contractual commitments. Except as noted above, there have been no other material changes to our contractual commitments discussed in our 2011 Annual Report.
Off-balance sheet arrangements. There have been no material changes to our off-balance sheet arrangements discussed in our 2011 Annual Report.
Recent accounting pronouncements. There have been no recent accounting pronouncements requiring disclosure.
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Critical accounting policies. For a discussion of our critical accounting policies, refer to Part I, Item 7 - Managements Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates in our 2011 Annual Report. There have been no changes in our critical accounting policies during the first six months of 2012.
Affiliate transactions. Corporations that may be deemed to be controlled by or affiliated with Mr. Simmons sometimes engage in (i) intercorporate transactions such as guarantees, management and expense sharing arrangements, shared fee arrangements, joint ventures, partnerships, loans, options, advances of funds on open account, and sales, leases and exchanges of assets, including securities issued by both related and unrelated parties, and (ii) common investment and acquisition strategies, business combinations, reorganizations, recapitalizations, securities repurchases, and purchases and sales (and other acquisitions and dispositions) of subsidiaries, divisions or other business units, which transactions have involved both related and unrelated parties and have included transactions which resulted in the acquisition by one related party of a publicly-held minority equity interest in another related party. We continuously consider, review and evaluate such transactions, and understand that Contran and related entities consider, review and evaluate such transactions. Depending upon the business, tax and other objectives then relevant, it is possible that we might be a party to one or more such transactions in the future. See Notes 3 and 5 to our Condensed Consolidated Financial Statements.
We are exposed to market risk, including foreign currency exchange rates, commodity prices and security prices. There have been no material changes in these market risks since we filed our 2011 Annual Report, and we refer you to the report for a complete description of these risks.
Evaluation of disclosure controls and procedures. We maintain a system of disclosure controls and procedures. The term disclosure controls and procedures, as defined by regulations of the SEC, means controls and other procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit to the SEC under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit to the SEC under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and our principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions to be made regarding required disclosure. Each of Bobby D. OBrien, our Chief Executive Officer, and James W. Brown, our Chief Financial Officer, have evaluated the design and operating effectiveness of our disclosure controls and procedures as of June 30, 2012. Based upon their evaluation, these executive officers have concluded that our disclosure controls and procedures were effective as of June 30, 2012.
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Scope of managements report on internal control over financial reporting. We also maintain internal control over financial reporting. The term internal control over financial reporting, as defined by regulations of the SEC, means a process designed by, or under the supervision of, our principal executive and principal financial officers, or persons performing similar functions, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP, and includes those policies and procedures that:
Changes in internal control over financial reporting. There have been no changes to our internal control over financial reporting during the quarter ended June 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Refer to our 2011 Annual Report and Note 13 to our Condensed Consolidated Financial Statements for descriptions of certain previously reported legal proceedings.
There have been no material changes in the first six months of 2012 with respect to our risk factors presented in Item 1A in our 2011 Annual Report on Form 10-K.
Prior to 2011, our board of directors authorized the repurchase of up to $100 million of our common stock in open market transactions or in privately negotiated transactions. In July 2011, our board of directors authorized the repurchase of up to an additional $100 million of our common stock in open market transactions or in privately negotiated transactions. Prior to 2012, we purchased 9.2 million shares of our common stock in open market transactions for an aggregate purchase price of $135.7 million. During the first six months of 2012, we purchased 0.1 million shares of our common stock in open market transactions for an aggregate purchase price of $1.4 million. All shares acquired under this authorization have been cancelled. The following table discloses certain information regarding the shares of our common stock we purchased during the second quarter of 2012 (we made no purchases during April or May of 2012).
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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.
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