10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 |
For the fiscal year ended October 31, 2006
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 |
Commission file number 1-5725
QUANEX CORPORATION
(Exact name of registrant as specified in its charter)
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| Delaware
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38-1872178 |
| (State or other jurisdiction of incorporation or organization)
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(I.R.S. Employer Identification No.) |
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| 1900 West Loop South, Suite 1500, Houston, Texas
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77027 |
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(Zip code) |
Registrant’s telephone number, including area code: (713) 961-4600
Securities registered pursuant to Section 12(b) of the Act:
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| Title of each class
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Name of each exchange on which registered |
| Common Stock, $.50 par value
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New York Stock Exchange, Inc. |
| Rights to Purchase Series A Junior Participating Preferred Stock
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New York Stock Exchange, Inc. |
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule
405 of the Securities Act. Yes þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section
13 or Section 15(d) of the Act. Yes o No þ
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 þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated
filer” in Rule 12b-2 of the Exchange Act. (Check one):
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| Large accelerated filer þ
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Accelerated filer o
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Non-accelerated filer o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Act). Yes o No þ
The aggregate market value of the voting common equity held by non-affiliates as of April 30,
2006, computed by reference to the closing price for the Common Stock on the New York Stock
Exchange, Inc. on that date, was $1,604,349,249. Such calculation assumes only the registrant’s
officers and directors were affiliates of the registrant.
At December 11, 2006, there were outstanding 37,031,301 shares of the registrant’s Common
Stock, $.50 par value.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s definitive Proxy Statement, to be filed with the Commission
within 120 days of October 31, 2006, for its Annual Meeting of Stockholders to be held on February
22, 2007, are incorporated herein by reference in Part III of this Annual Report.
PART I
Item 1. Business
General
Quanex was organized in 1927 as a Michigan corporation under the name Michigan Seamless Tube
Company. The Company reincorporated in Delaware in 1968 under the same name and then changed its
name to Quanex Corporation in 1977. The Company’s executive offices are located at 1900 West Loop
South, Suite 1500, Houston, Texas 77027. References made to the “Company” or “Quanex” include
Quanex Corporation and its subsidiaries unless the context indicates otherwise.
The Company’s businesses are focused on two end markets, vehicular products and building
products, and are managed on a decentralized basis. The businesses are presented as three
reportable segments: Vehicular Products, Engineered Building Products and Aluminum Sheet Building
Products. Each business has administrative, operating and marketing functions. The Company
measures each business’s return on investment and seeks to reward superior performance with
incentive compensation, which is a significant portion of total compensation for salaried
employees. Intercompany sales are conducted on an arms-length basis. Operational activities and
policies are managed by corporate officers and key division executives. Also, a small corporate
staff provides corporate accounting, financial and treasury management, tax, legal, internal audit,
information technology and human resource services to the operating divisions.
Quanex is a technological leader in the production of engineered carbon and alloy steel bars,
heat treated bars, aluminum flat-rolled products, flexible insulating glass spacer systems,
extruded profiles, and precision-formed metal and wood products which primarily serve the North
American vehicular products and building products markets. The Company uses state-of-the-art
manufacturing technologies, low-cost production processes, and engineering and metallurgical
expertise to provide customers with specialized products for specific applications. Quanex
believes these capabilities also provide the Company with unique competitive advantages. The
Company’s growth strategy is focused on the continued development of its two target markets,
vehicular products and building products, and protecting, nurturing and growing its core businesses
that serve those markets.
Business Developments
In the Company’s Vehicular Products segment, rotary centrifugal continuous casters are used at
two of the steel bar plants (Fort Smith, Arkansas and Jackson, Michigan), each with an in-line
manufacturing process to produce bearing grade quality, seam-free, engineered carbon and alloy
steel bars that enable Quanex to participate in higher margin niches of the vehicular products bar
market. Over the past ten years, the Company has invested approximately $340 million through
internal growth and an acquisition (MACSTEEL Monroe) to enhance its steel bar manufacturing and
refining processes, to improve rolling and finishing capability, and to expand shipping capacity
from 550 thousand tons to approximately 1.2 million tons per year. Approximately 75% of tonnage
shipped has some value-added operation performed to the bars. Phases I through VII and IX of the
MACSTEEL expansions have been completed.
The Phase VIII capital project announced in September 2004 is on schedule for completion in
December 2006. Phase VIII will increase the annual capacity of the Fort Smith, Arkansas facility
by approximately 40,000 tons, thereby increasing total engineered bar shipping capacity to close to
1.3 million tons. In addition to an increase in capacity, the Phase VIII modernization will
improve production flow and further enhance metallurgical quality. Specifically included in the
project are upgrades to the rotary continuous caster, direct rolling mill, and metallurgical
refining areas.
1
In February 2005, the Company announced the Phase IX capital project which called for the
construction of a value-added bar processing center at MACSTEEL Monroe to eliminate outside
processing for straightening, heat treating, testing, and bar turning services. The project
included the installation of two straightening and testing lines, two heat treat furnaces and a
MACPLUS bar turning line, all housed in a new building. The project was completed in September
2006.
On January 27, 2006, the Company completed the sale of Temroc Metals, Inc. (Temroc), located
in Hamel, Minnesota. The business produced aluminum extrusions and fabricated products primarily
for the recreational vehicle market.
Manufacturing Processes, Markets, and Product Sales by Business Segment
Quanex has 22 manufacturing facilities in 12 states in the United States. These facilities
feature efficient plant design and flexible manufacturing processes, enabling the Company to
produce a wide variety of custom engineered products and materials for the vehicular products and
building products markets. The Company is able to maintain minimal levels of finished goods
inventories at most locations because it typically manufactures products upon order to customer
specifications.
The majority of the Company’s products are sold into the vehicular products and building
products markets. The primary market drivers are North American light vehicle builds, heavy duty
truck builds, residential housing starts and remodeling expenditures.
For financial information regarding each of Quanex’s business segments, see “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” herein and Note 11 to the
Consolidated Financial Statements. For net sales of the Company by major product lines see Note 11
to the Consolidated Financial Statements. For the years ended October 31, 2006, 2005, and 2004, no
one customer accounted for 10% or more of the Company’s sales.
Vehicular Products Segment
The Vehicular Products segment includes engineered steel bar manufacturing, steel bar and tube
heat-treating services, and steel bar and tube corrosion and wear resistant finishing services.
The Company’s MACSTEEL engineered steel bar operations, which represent the majority of the
segment’s sales and operating income, include three plants, one located in Arkansas and two in
Michigan, which in aggregate are capable of shipping 1.2 million tons of hot rolled and cold
finished, engineered, carbon and alloy steel bars annually. The Company believes that it has the
only two bar plants in North America using rotary continuous casting technology. The highly
automated continuous casting and direct charge rolling at these plants substantially reduce labor
and energy costs by eliminating the intermittent steps that characterize manufacturing operations
at most other steel mills.
MACSTEEL produces various grades of customized, engineered steel bars by melting steel scrap
and casting it through both static and rotary continuous casters. Prior to casting, molten steel
benefits from secondary refining processes that include argon stirring, ladle refining, and vacuum
arc degassing. These processes enable the production of higher quality, “cleaner” steel. The
Company believes that it is the lowest cost producer of engineered carbon and alloy steel bars in
North America, in part because its average energy cost per produced ton are significantly lower
than those of its competitors; at the two plants that utilize continuous rotary casting technology,
bars move directly from the continuous caster to the rolling mill before cooling to ambient
temperature, thereby reducing the need for costly reheating. Its highly automated manufacturing
processes enable the Company to produce finished steel bars using approximately 1.5 man-hours of
labor per ton.
2
Bar products are custom manufactured primarily for customers within the vehicular product
markets serving the passenger car, light truck, sport utility vehicle, heavy truck, off-road and
farm equipment industries. These customers use engineered steel bars in critical applications such
as camshafts, crankshafts, gears, wheel spindles and hubs, bearing components, steering components,
hydraulic mechanisms and seamless tube production.
Vehicular Products also includes two additional, complementary value-added business units.
One is a heat-treating plant in Indiana that uses custom designed, in-line equipment to provide
tube and bar quench and tempering and related value-added processes such as complete metallurgical
testing and “cut-to-length” just-in-time delivery. This plant primarily serves customers in the
vehicular products and energy markets. The other, located in Wisconsin, treats steel bars and
tubes using the patented Nitrotec process to improve the metal’s corrosion and wear resistance
properties while providing a more environmentally friendly, non-toxic alternative to chrome
plating. Their primary end market is the mobile fluid power applications in the vehicular products
market.
Engineered Building Products Segment
The Engineered Building Products segment is comprised of six fabricated metal components
operations, two facilities producing wood fenestration (door and window) products, three vinyl
extrusion facilities, a flexible insulating glass spacer operation and a facility that produces
glass spacer installation equipment. The segment’s operations produce window and door components
and products for original equipment manufacturers (OEMs) that serve the building and remodeling
markets. Products include flexible insulating glass spacer systems, window and patio door screens,
window cladding frames, residential exterior products and engineered vinyl and composite door and
window frames and custom window grilles and trim in a variety of woods for the home improvement,
residential, and light commercial construction markets.
The extrusion operations use highly automated production facilities to manufacture vinyl
profiles and composites, the window and door structural frames used by high-end fenestration OEMs.
The value added capabilities include frame design, tooling design and fabrication, laser welding,
roll forming, poly laminating, stamping, and end-product assembly to produce a variety of
fenestration products. In addition, the insulating glass sealant business uses composite and
laminating technology to produce highly engineered window spacer products used to separate two
panes of glass in a window sash to improve its thermal performance. Engineered Products customers’
end-use applications include windows, window screens, sills, cladding, doors, exterior door
thresholds, astragals, patio door systems, and custom hardwood architectural moldings. Key success
factors range from design and development expertise to flexible, world class quality manufacturing
capability and just-in-time delivery.
Aluminum Sheet Building Products Segment
The Aluminum Sheet Building Products segment is comprised of an aluminum sheet casting
operation and three stand-alone aluminum sheet finishing operations. Aluminum sheet finishing
capabilities include reducing coil to specific gauge, annealing, slitting and custom coating.
Customer end-use applications include exterior housing trim, fascias, roof edgings, soffits,
downspouts, gutters, trim, and trim coils. The product is packaged and delivered just-in-time for
use by various customers in the building and construction markets, as well as other capital goods
and transportation markets.
3
The Company’s aluminum mini-mill uses an in-line casting process that can produce
approximately 400 million pounds of reroll (hot-rolled aluminum sheet) annually. The mini-mill
converts aluminum scrap to reroll through melting, continuous casting, and in-line hot rolling
processes. It also has shredding and blending
capabilities, including two rotary barrel furnaces and a dross recovery system that broaden
its use of raw materials, allowing it to melt lesser grades of scrap, while improving raw material
yields. Delacquering equipment improves the quality of the raw material before it reaches the
primary melt furnaces by burning off combustibles in the scrap. In addition, scrap is blended
using computerized processes to most economically achieve the desired molten aluminum alloy
composition. The Company believes its production capabilities result in a significant
manufacturing advantage and savings from reduced raw material costs, optimized scrap utilization,
reduced unit energy cost and lower labor costs.
Raw Materials and Supplies
The Vehicular Products segment’s operations purchase their principal raw material, steel
scrap, on the open market. Collection and transportation of raw materials to the Company’s plants
can be adversely affected by extreme weather conditions. Prices for the steel scrap also vary in
relation to the general business cycle and global demand.
The Engineered Building Products segment’s operations purchase a diverse range of raw
materials, which include coated and uncoated aluminum sheet, wood (both hardwood and softwood),
polyvinyl chloride and epoxy resin. In most cases the raw materials are available from several
suppliers at market prices. One exception is aluminum sheet which is purchased from the Aluminum
Sheet Building Products segment at prices based upon arms-length transactions. Sole sourcing
arrangements are entered into from time to time if beneficial savings can be realized and only when
it is determined that a vendor can reliably supply all of the Company’s raw material requirements.
The Aluminum Sheet Building Products segment’s most significant raw material is aluminum scrap
purchased on the open market, where availability and delivery can be adversely affected by, among
other things, extreme weather conditions. Firm fixed price forward purchases matched to firm fixed
price forward sales are used on a limited basis to hedge against fluctuations in the price of
aluminum scrap required to manufacture products for fixed-price sales contracts. To a lesser
extent, aluminum ingot futures contracts are bought and sold on the London Metal Exchange to hedge
aluminum scrap requirements.
Backlog
At October 31, 2006, Quanex’s backlog of orders to be shipped in the next twelve months was
approximately $298 million, comprised of $263 million for the Vehicular Products segment, $10
million for the Engineered Building Products segment, and $25 million for the Aluminum Sheet
Building Products segment. This compares to approximately $330 million at October 31, 2005,
comprised of $273 million for the Vehicular Products segment, $15 million for the Engineered
Building Products segment, and $42 million for the Aluminum Sheet Building Products segment. The
decrease from October 31, 2006 to October 31, 2005 is directly related to the reduced demand within
both the vehicular products and building products markets. Because many of the markets in which
Quanex operates have short lead times, the Company does not believe that backlog figures are
reliable indicators of annual sales volume or operating results.
Competition
The Company’s products are sold under highly competitive conditions. Quanex competes with a
number of companies, some of which have greater financial resources. Competitive factors include
product quality, price, delivery, and the ability to manufacture to customer specifications. The
amounts of engineered steel bars, aluminum mill sheet products, engineered products and extruded
products manufactured by the Company represent a small percentage of annual domestic production.
4
MACSTEEL’s operations compete with several large non-integrated steel producers. Although
these producers may be larger and have greater resources than the Company, Quanex believes that the
technology used at the Company’s facilities permits it to compete effectively in the markets it
serves.
The operations of the Engineered Building Products segment compete with a range of small and
midsize metal, vinyl and wood fabricators and wood molding facilities. The Company also competes
against sealant firms and insulated glass panel fabricators. Competition is primarily based on
regional presence, custom engineering, product development, quality, service and price. The
operations also compete with in-house operations of vertically integrated fenestration OEMs.
The Aluminum Sheet Building Products segment competes with small to large aluminum sheet
manufacturers, some of which are divisions or subsidiaries of major corporations with substantially
greater resources than the Company. The Company competes in coil-coated and mill finished
products, primarily on the basis of the breadth of product lines, the quality and responsiveness of
its services, and price.
Sales and Distribution
The Company has sales organizations with sales representatives in many parts of the United
States. Engineered steel bars are primarily sold to tier-one or tier-two suppliers through the
Company’s direct sales force and a limited number of manufacturers’ representatives. The
Engineered Building Products segment’s products are sold primarily to OEMs through company direct
sales force, along with the limited use of distributors to market wood moldings. The Aluminum
Sheet Building Products segment’s products are sold to both OEM and distribution customers through
both direct and indirect sales groups.
Seasonal Nature of Business
Sales for both the Engineered Building Products and Aluminum Sheet Building Products segment’s
products are seasonal. The winter weather typically reduces homebuilding and home improvement
activity. These segments typically experience their lowest sales during the Company’s first fiscal
quarter. Profits tend to be lower in quarters with lower sales because a high percentage of
manufacturing overhead and operating expense is due to labor and other costs that are generally
semi-variable throughout the year.
Sales for the Vehicular Products segment are generally not seasonal. However, due to the
number of holidays in the Company’s first fiscal quarter, sales have historically been lower in
this period as some customers reduce production schedules. As a result of reduced production days
combined with the effects of seasonality, the Company generally expects that, absent unusual
activity, its lowest sales will occur in the first fiscal quarter.
Service Marks, Trademarks, Trade Names, and Patents
The Company’s federally registered trademarks or service marks include QUANEX, QUANEX and
design, SEAM-FREE and design, NITROSTEEL, MACGOLD, MACSTEEL, MACSTEEL THE MIGHTY MITE and design,
MAC+, MACPLUS, ULTRA-BAR, TRUSEAL TECHNOLOGIES, EDGETHERM, INSULEDGE, COLONIAL CRAFT, MIKRON,
MIKRONWOOD, MIKRONWOOD A PAINTABLE COMPOSITE and design, M design, MIKRONBLEND, MIKRON BLEND and
design, SPECTUSBLEND, SPECTUS BLEND and design, K2 MIKRON and design, BUILDER & REMODELER
EXECUTIVE, WINDOW EXECUTIVE, HOMESHIELD, HOMESHIELD and design, STORM SEAL, MACPRIME, Seam-Free,
NITRO-100, NITROSTEEL, and “THE BEST ALLOY & SPECIALTY BARS” marks. The trade name Nichols
Aluminum is used in connection with the sale of the Company’s aluminum mill sheet products. The
HOMESHIELD, COLONIAL CRAFT, MACSTEEL, TRUSEAL TECHNOLOGIES, MIKRON and QUANEX word and design marks
and associated trade names are considered valuable in the conduct of the Company’s
business. The business conducted by the Company generally does not depend upon patent
protection other than at its vinyl extrusion and window sealant business units. Although the
Company holds numerous patents, the proprietary process technology that the Company has developed
is also the source of considerable competitive advantage.
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Research and Development
Expenditures for research and development of new products or services during the last three
years were not significant. Although not technically defined as research and development, a
significant amount of time, effort and expense is devoted to (a) custom engineering which qualifies
the Company’s products for specific customer applications and (b) developing superior, proprietary
process technology.
Environmental Matters
Quanex is subject to extensive laws and regulations concerning the discharge of materials into
the environment and the remediation of chemical contamination. To satisfy such requirements,
Quanex must make capital and other expenditures on an ongoing basis. The cost of environmental
matters has not had a material adverse effect on Quanex’s operations or financial condition in the
past, and management is not aware of any existing conditions that it currently believes are likely
to have a material adverse effect on Quanex’s operations, financial condition, or cash flow.
Remediation
Under applicable state and federal laws, the Company may be responsible for, among other
things, all or part of the costs required to remove or remediate wastes or hazardous substances at
locations Quanex has owned or operated at any time. The Company is currently participating in
environmental investigations or remediation at several such locations.
From time to time, Quanex also has been alleged to be liable for all or part of the costs
incurred to clean up third-party sites where it is alleged to have arranged for disposal of
hazardous substances. At present, the Company is involved at several such facilities.
Total environmental reserves and corresponding recoveries for Quanex’s current plants, former
operating locations, and disposal facilities were as follows:
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October 31, |
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2006 |
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2005 |
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(In thousands) |
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Current1 |
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2,591 |
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$ |
2,146 |
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Non-current |
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14,186 |
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17,784 |
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Total environmental reserves |
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16,777 |
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19,930 |
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Receivable for recovery of remediation costs2 |
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7,192 |
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11,052 |
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Approximately $3.6 million of the October 31, 2006 reserve represents administrative costs;
the balance represents estimated costs for investigation, studies, cleanup, and treatment. As
discussed below, the reserve
includes net present values for certain fixed and reliably determinable components of the
Company’s remediation liabilities. Without such discounting, the Company’s estimate of its
environmental liabilities as of October 31, 2006 would be $18.6 million. An associated $7.2
million undiscounted recovery from indemnitors of remediation costs at one plant site is recorded
as of October 31, 2006.
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Reported in Accrued liabilities on the
Consolidated Balance Sheets |
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Reported in Other current assets and Other
assets on the Consolidated Balance Sheets |
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The Company’s Nichols Aluminum-Alabama, Inc. (NAA) subsidiary operates a plant in Decatur,
Alabama that is subject to an Alabama Hazardous Wastes Management and Minimization Act Post-Closure
Permit. Among other things, the permit requires NAA to remediate, as directed by the state,
historical environmental releases of wastes and waste constituents. Consistent with the permit,
NAA has undertaken various studies of site conditions and, during the first quarter 2006, started a
phased program to treat in place free product petroleum that had been released to soil and
groundwater. Based on its studies to date, which remain ongoing, NAA currently expects remediation
costs at the Decatur plant to be $6.7 million or approximately 39% of the Company’s total
environmental reserve. NAA was acquired through a stock purchase in which the sellers agreed to
indemnify Quanex and NAA for environmental matters related to the business and based on conditions
initially created or events initially occurring prior to the acquisition. Environmental conditions
are presumed to relate to the period prior to the acquisition unless proved to relate to releases
occurring entirely after closing. The limit on indemnification is $21.5 million excluding legal
fees. In accordance with the indemnification, the indemnitors paid the first $1.5 million of
response costs and have been paying 90% of ongoing costs. Based on experience to date, estimated
cleanup costs going forward, and costs incurred to date as of October 31, 2006, the Company expects
to recover from the shareholders $7.2 million. Of that, $5.9 million is recorded in Other assets,
and the balance is reflected in Other current assets. As discussed in Note 1 under
Reclassifications, this obligation and associated receivable are reported separately on a gross
basis in the Company’s balance sheet; all prior periods have been reclassified to correspond to
the current period presentation.
During the fourth fiscal quarter of 2006, the Company increased the reserve for its MACSTEEL
plant in Jackson, Michigan $5.4 million to $5.9 million, so that it now represents 35% of the
Company’s total environmental reserve. The increase reflects completion of studies supporting
selection of an interim remedy to address the impact of a historical plant landfill and slag
cooling and sorting operation on groundwater. Based on those studies, the Company is proceeding
with preparation of design plans for submittal to the Michigan Department of Environmental Quality
of a hydraulic barrier (sheet pile wall) and groundwater extraction and treatment system to prevent
impacted groundwater migration. The primary component of the reserve is for the estimated cost of
operating the groundwater extraction and treatment system for the interim remedy over the next 10
years. The Company has estimated the annual cost of operating the system to be approximately $0.5
million. These operating costs and certain other components of the Jackson reserve have been
discounted utilizing a discount rate of 4.6% and an estimated inflation rate of 2.0%. Without
discounting, the Company’s estimate of its Jackson remediation liability as of October 31, 2006
would be $6.6 million. In addition to the $5.9 million reserve, the Company anticipates incurring
a capital cost of $4.4 million to construct the sheet pile wall and install the groundwater
extraction and treatment system. Depending on the effectiveness of the interim remedy, the results
of future operations, and regulatory concurrences, the Company may incur additional costs to
implement a final site remedy and may pay costs beyond the ten-year time period currently projected
for operation of the interim remedy.
Approximately 17% or $2.8 million of the Company’s total environmental reserve is currently
allocated to cleanup work related to Piper Impact. During the first quarter of 2005, the Company
sold the operating assets of the Piper Impact business, including its only active plant on Barkley
Drive in New Albany, Mississippi. In the fourth fiscal quarter of 2005, the Company sold the
location on Highway 15 in New Albany where Piper Impact previously had operated a plant (the
Highway 15 location), but as part of the sale retained environmental liability for pre-closing
contamination there. The Company voluntarily implemented a state-approved remedial action plan at
the Highway 15 location that includes natural attenuation together with a groundwater collection
and treatment system. The Company has estimated the annual cost of operating the existing system
to be
approximately $0.1 million and has assumed that the existing system will continue to be
effective. The primary component of the reserve is the estimated operational cost over the next 28
years, which was discounted to a net present value using a discount rate of 4.7% and an estimated
inflation rate of 2.0%. The aggregate undiscounted amount of the estimated Piper Impact
remediation costs as of October 31, 2006 is $3.9 million. The Company continues to monitor
conditions at the Highway 15 location and to evaluate performance of the remedy.
7
The final remediation costs and the timing of the expenditures at the NAA plant, Jackson
plant, Highway 15 location, and other sites for which the Company has remediation obligations will
depend upon such factors as the nature and extent of contamination, the cleanup technologies
employed, the effectiveness of the cleanup measures that are employed, and regulatory concurrences.
While actual remediation costs therefore may be more or less than amounts accrued, the Company
believes it has established adequate reserves for all probable and reasonably estimable remediation
liabilities. It is not possible at this point to reasonably estimate the amount of any obligation
for remediation in excess of current accruals because of uncertainties as to the extent of
environmental impact, cleanup technologies, and concurrence of governmental authorities. The
Company currently expects to pay the accrued remediation reserve through at least fiscal 2034,
although some of the same factors discussed earlier could accelerate or extend the timing.
During the third quarter of 2005, the United States Department of Justice filed a complaint
against the Company for recovery of cleanup costs incurred at the “Jepscor” Superfund site in
Dixon, Illinois. The United States Environmental Protection Agency indicated that it had incurred
approximately $2.6 million to remove processing residue and other materials from that former metal
recovery plant. Of the Jepscor site’s former owners, operators, and many customers, the government
asserted liability for cleanup only against the Company. During the fourth fiscal quarter of 2005,
the Company and the Department of Justice reached a tentative agreement to settle this matter. In
May 2006, the parties successfully finalized that settlement, pursuant to which the Company paid
$1.0 million of the government’s cleanup costs. Such amount had been reserved for during fiscal
2005.
Compliance
Quanex incurred expenses of approximately $3.0 million and capitalized an additional $1.0
million during fiscal 2006 in order to comply with existing environmental regulations. This
compares to $4.7 million of expense and $2.9 million of capital incurred during fiscal 2005. For
fiscal 2007, the Company estimates expenses at its facilities will be approximately $3.5 million
for continuing environmental compliance. In addition, the Company estimates that capital
expenditures for environmental compliance in fiscal 2007 will be approximately $4.6 million, which
includes $4.4 million for construction of the Jackson plant sheet pile wall and installation of the
groundwater extraction and treatment system. Future expenditures relating to environmental matters
will necessarily depend upon the application to Quanex and its facilities of future regulations and
government decisions. Quanex will continue to have expenditures beyond fiscal 2007 in connection
with environmental matters, including control of air emissions, control of water discharges and
plant decommissioning costs. It is not possible at this time to reasonably estimate the amount of
those expenditures, except as discussed above due to uncertainties about emission levels, control
technologies, the positions of governmental authorities, the application of requirements to Quanex,
and, as to decommissioning, settlement dates. Based upon its experience to date, Quanex does not
believe that its compliance with environmental requirements will have a material adverse effect on
its operations or financial condition.
8
Employees
The Company had 4,200 employees at October 31, 2006 and approximately 4,100 at December 11,
2006. Of the total employed, approximately 34% are covered by collective bargaining agreements.
The TruSeal
Technologies’ collective bargaining agreement expires on
December 16, 2006. A new agreement has not yet been ratified.
Following is a table of collective bargaining agreements currently in place.
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| |
|
|
|
|
|
Covered |
| |
|
|
|
|
|
Employees |
| Facility |
|
Expires |
|
Union |
|
at 10/31/06 |
TruSeal Technologies
|
|
Dec. 2006
|
|
United Steelworkers of America
|
|
|
200 |
|
Nichols
Aluminum—Davenport/Casting
|
|
Nov. 2007
|
|
International Brotherhood of
Teamsters
|
|
|
253 |
|
MACSTEEL Monroe
|
|
Dec. 2007
|
|
United Automobile Workers
International Union of
America
|
|
|
273 |
|
MACSTEEL Arkansas
|
|
Jan. 2008
|
|
United Steelworkers of America
|
|
|
282 |
|
MACSTEEL Jackson
|
|
Feb. 2008
|
|
United Steelworkers of America
|
|
|
230 |
|
Nichols Aluminum-Lincolnshire
|
|
Jan. 2009
|
|
International Association of
Machinists and Aerospace
Workers
|
|
|
94 |
|
Nichols Aluminum — Alabama
|
|
May 2011
|
|
United Steelworkers of America
|
|
|
93 |
|
Financial Information about Foreign and Domestic Operations
For financial information on the Company’s foreign and domestic operations, see Note 11 of the
Financial Statements contained in this Annual Report on Form 10-K.
Communication with the Company
The Company’s website is www.quanex.com. Quanex invites inquiries to the Company and its
Board of Directors. Interested persons may contact the appropriate individual or department by
choosing one of the options below.
General
Investor
Information:
For Investor Relations matters or to obtain a printed copy of the Company Code of Ethics,
Corporate Governance Guidelines or charters for the Audit, Compensation and Management Development,
and Nominating and Corporate Governance Committees of the Board of Directors, send a request to the
Company’s principal address below or inquiry@quanex.com. This material may also be obtained from
the Company website at www.quanex.com by following the “Corporate Governance” link.
The Company’s required Securities Exchange Act filings such as annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports are
available free of charge through the Company’s website, as soon as reasonably practicable after
they have been filed with or furnished to the Securities and Exchange Commission (SEC) pursuant to
Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 (the 1934 Act). Forms 3, 4 and 5
filed with respect to equity securities under Section 16(a) of the 1934 Act are also available on
the Company’s website. All of these materials are located at the “Financial Information” link.
They can also be obtained free of charge upon request to inquiry@quanex.com or to the Company’s
principal address: Quanex Corporation, 1900 West Loop South, Suite 1500, Houston, TX 77027.
Communications with the Company’s Board of Directors:
Persons wishing to communicate to the Company’s Board of Directors or specified individual
directors may do so by sending them in care of Raymond A. Jean, The Chairman of the Board of
Directors, at the Company’s principal address below or hotline@quanex.com.
9
Hotline
Accounting Issues:
Persons who have concerns or complaints regarding questionable accounting, internal accounting
controls or auditing matters may submit them to the Senior Vice President — Finance & Chief
Financial Officer at the Company’s principal address or hotline@quanex.com.
Such communications will be kept confidential to the fullest extent possible. If the
individual is not satisfied with the response, they may contact the Audit Committee of the Board of
Directors of the Company. If concerns or complaints require confidentiality, then this
confidentiality will be protected, subject to applicable laws.
Reporting Illegal or Unethical Behavior:
Employees, officers and directors who suspect or know of violations of the Company Code of
Business Conduct or Ethics, or illegal or unethical business or workplace conduct by employees,
officers or directors have an obligation to report it. If the individuals to whom such information
is conveyed are not responsive, or if there is reason to believe that reporting to such individuals
is inappropriate in particular cases, then the employee, officer or director may contact the Chief
Compliance Officer, Chief Financial Officer, Director of Internal Audit, or any corporate officer
in person, by telephone, letter to the Company’s principal address or e-mail below. Quanex also
encourages persons who are not affiliated with the Company to report any suspected illegal or
unethical behavior.
| |
1) |
|
By Letter
Quanex Corporation
1900 West Loop South, Suite 1500
Houston, Texas 77027 |
| |
| |
2) |
|
By Telephone
Direct Telephone
Toll Free Telephone
Toll Free HOTLINE |
(713) 877‑5349
(800) 231‑8176
(888) 704‑8222 |
| |
| |
3) |
|
By Electronic Mail HOTLINE
hotline@quanex.com |
Such communications will be kept confidential to the fullest extent possible. If the
individual is not satisfied with the response, they may contact the Nominating and Corporate
Governance Committee of the Board of Directors of the Company. If concerns or complaints require
confidentiality, then this confidentiality will be protected, subject to applicable laws.
Item 1A. Risk Factors
In addition to the factors discussed elsewhere in this report and in Management’s
Discussion and Analysis of Financial Condition and Results of Operations, the following are some of
the potential risk factors that could cause our actual results to differ materially from those
projected in any forward-looking statements. You should carefully consider these factors, as well
as the other information contained in this document, when evaluating your investment in our
securities. Any of the following risks could have material adverse effects on our financial
condition, operating results and cash flow. The below list of important factors is not
all-inclusive or necessarily in order of importance.
10
If the Company’s raw materials or energy were to become unavailable or to significantly increase in
price, the Company might not be able to timely produce products for our customers or maintain our
profit levels.
Quanex requires substantial amounts of raw materials, substantially all of which are purchased
from outside sources. The Company does not have long-term contracts for the supply of most of our
raw materials. The availability and prices of raw materials may be subject to curtailment or
change due to new laws or regulations, suppliers’ allocations to other purchasers or interruptions
in production by suppliers. For example, the Company experienced a steep increase in costs for
steel and aluminum scrap in fiscal 2004 due to a global rebound in manufacturing in addition to
increased demand from China and other consumers for scrap metal. In addition, the operation of the
Company’s facilities requires substantial amounts of electric power and natural gas. Any change in
the supply of, or price for, these raw materials could affect our ability to timely produce
products for the Company’s customers. Although the Company has contractual arrangements with many
of our customers that permit us to increase prices in response to increased raw material costs, in
times of rapidly rising raw material prices the adjustments will lag the current market price
creating material volatility in top and bottom line results.
Portions of our business are generally cyclical in nature. Lowered vehicle production, fewer
housing starts, reduced remodeling expenditures or weaknesses in the economy could significantly
reduce our revenue, net earnings and cash flow.
Demand for the Company’s products is cyclical in nature and sensitive to general economic
conditions. The Company’s business supports cyclical industries such as the automotive and
construction industries.
The demand for the Vehicular Products Segment’s products is largely dependent on the North
American production level of vehicles. The markets for these products have historically been
cyclical because new vehicle demand is dependent on, among other things, consumer spending and is
tied closely to the overall strength of the economy. Declines in vehicle production could
significantly reduce our net earnings. The segment’s sales are also impacted by retail inventory
levels and their customers’ production schedules. If its OEM customers significantly reduce their
inventory levels and reduce their orders from us, the segment’s performance could be impacted.
The primary drivers of the Engineered Building Products and Aluminum Sheet Building Products
segments are housing starts and remodeling expenditures. The building and construction industry is
cyclical and seasonal, and product demand is based on numerous factors such as interest rates,
general economic conditions, consumer confidence and other factors beyond our control. Declines in
housing starts and remodeling expenditures due to such factors could significantly reduce the
segments’ net earnings.
The Company is subject to various environmental requirements, and compliance with, or
liabilities under, existing or future environmental laws and regulations could significantly
increase the Company’s costs of doing business.
The Company is subject to extensive federal, state and local laws and regulations concerning
the discharge of materials into the environment and the remediation of chemical contamination. To
satisfy such requirements, the Company must make capital and other expenditures on an ongoing
basis. For example, environmental agencies continue to develop regulations implementing the
Federal Clean Air Act. Depending on the nature of the regulations adopted, the Company may be
required to incur additional capital and other expenditures in the next several years for air
pollution control equipment, to maintain or obtain operating permits and approvals, and to address
other air emission-related issues. Future expenditures relating to environmental matters will
necessarily depend upon the application to Quanex and its facilities of future regulations and
government decisions. It is likely that the Company will be subject to increasingly stringent
environmental standards and the additional expenditures related to compliance with such standards.
Furthermore, if the Company fails to comply with applicable environmental regulations, the Company
could be subject to substantial fines or penalties and to civil and criminal liability.
11
Under applicable state and federal laws, the Company also may be responsible for, among other
things, all or part of the costs required to remove or remediate wastes or hazardous substances at
locations the Company has owned or operated at any time. The Company is currently involved in
environmental investigations or remediation at several such locations. From time to time, the
Company also has been alleged to be liable for all or part of the costs incurred to clean up
third-party sites where it is alleged to have arranged for disposal of hazardous substances. While
the Company has established reserves for such liabilities, such reserves may not be adequate to
cover the ultimate cost of remedial measures required by environmental authorities. The discovery
of previously unknown contamination, inadequate performance of a remedy or the imposition of new
clean-up requirements at any site for which Quanex is responsible could require the Company to
incur additional costs or become subject to significant new or increased liabilities.
The Company may not be able to successfully identify, manage or integrate future acquisitions, and
if the Company is unable to do so, it is unlikely to sustain its historical growth rates and
profitability.
Historically, Quanex has grown through a combination of internal growth and external expansion
through acquisitions, such as its December 2003 acquisitions of TruSeal Technologies and MACSTEEL
Monroe and its December 2004 acquisition of Mikron Industries. Although Quanex is actively
pursuing its growth strategy both in its domestic target markets and overseas and expect to
continue doing so in the future, the Company cannot provide any assurance that it will be able to
identify appropriate acquisition candidates or, if it does, that it will be able to successfully
negotiate the terms of an acquisition, finance the acquisition or integrate the acquired business
effectively and profitably into its existing operations. Integration of future acquired businesses
could disrupt the Company’s business by diverting management’s attention away from day-to-day
operations. Further, failure to successfully integrate any acquisition may cause significant
operating inefficiencies and could adversely affect the Company’s profitability. Consummating an
acquisition could require the Company to raise additional funds through additional equity or debt
financing. Additional equity financing could depress the market price of Quanex common stock. In
addition, the Company’s ability to access the credit markets in the future to obtain additional
financing, if needed, could be influenced by the its ability to meet current covenant requirements
associated with its existing credit agreement, its credit rating, or other factors.
The Company operates in competitive markets, and the Company’s business will suffer if it is
unable to adequately address potential downward pricing pressures and other factors that may reduce
its operating margins.
The principal markets that Quanex serves are highly competitive. Competition is based
primarily on the precision and range of achievable tolerances, quality, price and the ability to
meet delivery schedules dictated by customers. The Company’s competition in the markets in which
it participates comes from companies of various sizes, some of which have greater financial and
other resources than Quanex does and some of which have more established brand names in the markets
Quanex serves. Any of these competitors may foresee the course of market development more
accurately than the Company, develop products that are superior to the Company’s products, have the
ability to produce similar products at a lower cost than the Company, or adapt more quickly than
the Company to new technologies or evolving customer requirements. Increased competition could
force the Company to lower its prices or to offer additional services at a higher cost to the
Company, which could reduce its gross profit and net income.
Original Equipment Manufacturers (OEMs) have significant pricing leverage over suppliers and may be
able to achieve price reductions over time, which will reduce the Company’s profits.
The Company’s products are sold primarily to OEMs, and to a much lesser extent, sold through
distributors. There is substantial and continuing pressure from OEMs in all industries to reduce
the prices they pay to suppliers.
Quanex attempts to manage such downward pricing pressure, while trying to preserve its
business relationships with its OEM customers, by seeking to reduce its production costs through
various measures, including purchasing raw materials and components at lower prices and
implementing cost-effective process improvements. However, the Company’s suppliers may resist
pressure to lower their prices and may seek to impose price increases. If the Company is unable to
offset OEM price reductions through these measures, its gross margins and profitability could be
adversely affected. In addition, OEMs have substantial leverage in setting purchasing and payment
terms, including the terms of accelerated payment programs under which payments are made prior to
the account due date in return for an early payment discount.
12
The Company could lose customers and the related revenues due to the transfer of manufacturing
capacity by its customers out of the United States to lower cost regions of the world.
Manufacturing activity in the United States has been on the decline over the past several
years. One of the reasons for this decline is the migration by U.S. manufacturers to other regions
of the world that offer lower cost labor forces. The combined effect is that U.S. manufacturers
can reduce product costs by manufacturing and assembling in other regions of the world and then
importing those products to the United States. Some of the Company’s customers have shifted
production to other regions of the world and there can be no assurance that this trend will not
continue. The Company will lose customers and revenues if its customers locate in areas that the
Company chooses not to serve or that it cannot economically serve.
If the Company’s relationship with its employees were to deteriorate, the Company could be faced
with labor shortages, disruptions or stoppages, which could shut down certain of its operations,
reducing its revenue, net earnings, and cash flows.
The Company’s operations rely heavily on its employees, and any labor shortage, disruption or
stoppage caused by poor relations with its employees and/or renegotiation of labor contracts could
shut down certain of its operations. Approximately 34% of the Company’s employees are covered by
collective bargaining agreements which expire between 2006 and 2011. It is possible that the
Company could become subject to additional work rules imposed by agreements with labor unions, or
that work stoppages or other labor disturbances could occur in the future, any of which could
impact financial results. Similarly, any failure to negotiate a new labor agreement when required
might result in a work stoppage that could reduce our operating margins and income.
In addition, many OEMs and their suppliers have unionized work forces. Work stoppages or
slowdowns experienced by OEMs or their suppliers could result in slowdowns or closures of assembly
plants where Quanex products are included in assembled vehicles. In the event that one or more of
the Company’s customers experiences a material work stoppage, such work stoppage could prevent the
customers from purchasing Quanex products.
Changes in regulatory requirements or new technologies may render the Company’s products obsolete
or less competitive.
Changes in legislative, regulatory or industry requirements or in competitive technologies may
render certain of the Company’s products obsolete or less competitive, preventing the Company from
selling them at profitable prices, or at all. The Company’s ability to anticipate changes in
technology and regulatory standards and to successfully develop and introduce new and enhanced
products on a timely and cost-efficient basis will be a significant factor in our ability to remain
competitive. The Company’s business may, therefore, require significant ongoing and recurring
additional capital expenditures and investments in research and development. The Company may not
be able to achieve the technological advances necessary for it to remain competitive or certain of
its products may become obsolete. The Company is also subject to the risks generally associated
with new product introductions and applications, including lack of market acceptance, delays in
product development and failure of products to operate properly.
13
Equipment failures, delays in deliveries or catastrophic loss at any of the Company’s manufacturing
facilities could lead to production curtailments or shutdowns that prevent the Company from
producing its products.
An interruption in production capabilities at any of the Company’s facilities as a result of
equipment failure or other reasons could result in the Company’s inability to produce its
products, which would reduce its sales and earnings for the affected period. In addition, Quanex
generally manufactures its products only after receiving the order from the customer and thus does
not hold large inventories. In the event of a stoppage in production at any of our manufacturing
facilities, even if only temporary, or if Quanex experiences delays as a result of events that are
beyond its control, delivery times could be severely affected. Any significant delay in deliveries
to the Company’s customers could lead to increased returns or cancellations and cause us to lose
future sales. The Company’s manufacturing facilities are also subject to the risk of catastrophic
loss due to unanticipated events such as fires, explosions or violent weather conditions. The
Company has in the past and may in the future experience plant shutdowns or periods of reduced
production as a result of equipment failure, delays in deliveries or catastrophic loss, which could
have a material adverse effect on our results of operations or financial condition. Although the
Company has obtained property damage and business interruption insurance, the Company may not have
adequate insurance to compensate it for all losses that result from any of these events.
The Company’s business involves complex manufacturing processes that may result in costly accidents
or other disruptions of its operations.
The Company’s business involves complex manufacturing processes. Some of these processes
involve high pressures, temperatures, hot metal and other hazards that present certain safety risks
to workers employed at its manufacturing facilities. Although the Company employs safety
procedures in the design and operation of its facilities, the potential exists for accidents
involving death or serious injury. The potential liability resulting from any such accident, to
the extent not covered by insurance, could cause the Company to incur unexpected cash expenditures,
thereby reducing the cash available to it to operate its business. Such an accident could disrupt
operations at any of the Company’s facilities, which could adversely affect its ability to deliver
product to its customers on a timely basis and to retain its current business.
Flaws in the design or manufacture of the Company’s products could cause future product liability
or warranty claims for which it does not have adequate insurance or affect its reputation among
customers.
The Company’s products are essential components in vehicles, buildings and other applications
where problems in the design or manufacture of our products could result in property damage,
personal injury or death. While the Company believes that its liability insurance is adequate to
protect it from future product liability and warranty liabilities, its insurance may not cover all
liabilities or be available in the future at a cost acceptable to the Company. In addition, if any
of the Company’s products prove to be defective, it may be required in the future to participate in
a recall involving such products. A successful claim brought against us in excess of available
insurance coverage, if any, or a requirement to participate in any product recall, could
significantly reduce the Company’s profits or negatively affect its reputation with customers.
The Company’s success depends upon its ability to develop new products and services, integrate
acquired products and services and enhance its existing products and services.
The Company has continuing programs designed to develop new products and to enhance and
improve its products. Quanex is expending resources for the development of new products in all of
its segments. The successful development of its products and product enhancements are subject to
numerous risks, both known and unknown, including: 1) unanticipated delays; 2) access to capital;
3) budget overruns; 4) technical problems; and 5)
other difficulties that could result in the abandonment or substantial change in the design,
development and commercialization of these new products.
14
Given the uncertainties inherent with product development and introduction, the Company cannot
provide assurance that any of its product development efforts will be successful on a timely basis
or within budget, if at all. Failure to develop new products and product enhancements on a timely
basis or within budget could harm the Company’s business and prospects.
The Company has a risk that its goodwill and indefinite-lived intangible assets may be impaired
and result in a charge to income.
The purchase method of accounting for business combinations requires the Company to make use
of estimates and judgments to allocate the purchase price paid for acquisitions to the fair value
of the net tangible and identifiable intangible assets. The Company performs a goodwill impairment
test annually as of August 31. In addition, goodwill would be tested more frequently if changes in
circumstances or the occurrence of events indicates that a potential impairment exists. The
Company tests for impairment of its goodwill using a two-step approach as prescribed in SFAS 142.
The first step of the Company’s goodwill impairment test compares the fair value of each reporting
unit with its carrying value including assigned goodwill. The second step of the Company’s
goodwill impairment test is required only in situations where the carrying value of the reporting
unit exceeds its fair value as determined in the first step. In such instances, the Company
compares the implied fair value of goodwill to its carrying value. The implied fair value of
goodwill is determined by allocating the fair value of a reporting unit to all of the assets and
liabilities of that unit as if the reporting unit had been acquired in a business combination and
the fair value of the reporting unit was the price paid to acquire the reporting unit. The excess
of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is
the implied fair value of goodwill. An impairment loss is recorded to the extent that the carrying
amount of the reporting unit goodwill exceeds the implied fair value of that goodwill. The Company
primarily uses the present value of future cash flows to determine fair value and validates the
result against the market approach. Future cash flows are typically based upon appropriate future
periods for the businesses and an estimated residual value. Management judgment is required in the
estimation of future operating results and to determine the appropriate residual values. The
residual values are determined by reference to an exchange transaction in an existing market for
that asset. Future operating results and residual values could reasonably differ from the
estimates and could require a provision for impairment in a future period which would result in a
charge to income from operations in the year of the impairment with a resulting decrease in our
recorded net worth.
The Company may not be able to protect its intellectual property.
A significant amount of time, effort and expense is devoted to (a) custom engineering which
qualifies our products for specific customer applications and (b) developing superior, proprietary
process technology. The Company relies on a combination of copyright, patent, trade secrets,
confidentiality procedures and contractual commitments to protect its proprietary information.
Despite the Company’s efforts, these measures can only provide limited protection. Unauthorized
third parties may try to copy or reverse engineer portions of the Company’s products or otherwise
obtain and use the Company’s intellectual property. Any patents owned by the Company may be
invalidated, circumvented or challenged. Any of the Company’s pending or future patent
applications, whether or not being currently challenged, may not be issued with the scope of the
claims the Company seeks, if at all. In addition, the laws of some countries do not provide the
same level of protection of the Company’s proprietary rights as do the laws of the United States.
If the Company cannot protect its proprietary information against unauthorized use, it may not
remain competitive.
15
The Company may not be able to repay or repurchase the principal amount of its debentures when
required.
At maturity, the entire outstanding principal amount of Convertible Senior Debentures due 2034
(the Debentures) will become due and payable by the Company. In addition, on May 15 of 2011, 2014,
2019, 2024 and 2029 or if certain designated events occur, holders of the Debentures may require
the Company to repurchase their Debentures for cash. If the holders require Quanex to repurchase
the Debentures or in the event a fundamental change occurs, the Company will be required to
purchase all or any part of the holder’s Debentures at a purchase price equal to 100% of their
principal amount, plus accrued and unpaid interest (including contingent interest and additional
interest, if any) to, but not including, the date of purchase. It is possible that Quanex will not
have sufficient funds at the time of repurchase to make the required repurchases of the Debentures
or that restrictions in its other indebtedness may not allow these repurchases. The Company’
failure to purchase the Debentures would be a default under the indenture that governs them.
The Company has the ability to issue additional equity securities, which would lead to dilution of
its issued and outstanding common stock.
The issuance of additional equity securities or securities convertible into equity securities,
as well as the conversion of the debentures or any other securities convertible into equity
securities, would result in dilution of existing stockholders’ equity interests in Quanex. The
Company is authorized to issue, without stockholder approval, 1,000,000 shares of preferred stock,
no par value per share, in one or more series, which may give other stockholders dividend,
conversion, voting, and liquidation rights, among other rights, which may be superior to the rights
of holders of our common stock. The Company’s board of directors has the authority to issue,
without vote or action of stockholders, shares of preferred stock in one or more series, and has
the ability to fix the rights, preferences, privileges and restrictions of any such series. Any
such series of preferred stock could contain dividend rights, conversion rights, voting rights,
terms of redemption, redemption prices, liquidation preferences or other rights superior to the
rights of holders of our common stock. The Company’s board of directors has no present intention
of issuing any such preferred series, but reserves the right to do so in the future. In addition,
the Company is authorized, by prior shareholder approval, to issue up to 50,000,000 shares of
common stock, $.50 par value per share, of which 37,031,301 shares were outstanding as of December
11, 2006. Quanex is authorized to issue, without stockholder approval, securities convertible into
either common stock or preferred stock.
Item 1B. Unresolved Staff Comments
None.
16
Item 2. Properties
The following table lists Quanex’s principal properties together with their locations, general
character and the industry segment which uses the facility. Listed facilities are owned by the
Company, unless indicated otherwise. See Item 1, “Business,” for discussion of the capacity of
various facilities.
| |
|
|
| Location |
|
Principal Products |
Vehicular Products Segment |
|
|
Fort Smith, Arkansas |
|
Special bar quality engineered steel |
Jackson, Michigan |
|
Special bar quality engineered steel |
Monroe, Michigan |
|
Special bar quality engineered steel |
Huntington, Indiana |
|
Heat treating |
Pleasant Prairie, Wisconsin |
|
Bar finishing |
Engineered Building Products Segment |
|
|
Rice Lake, Wisconsin |
|
Fenestration products |
Chatsworth, Illinois |
|
Fenestration products (two plants) |
Hood River, Oregon |
|
Fenestration products |
Richmond, Indiana |
|
Fenestration products |
Solon, Ohio |
|
Insulated flexible spacer research & sales |
Barbourville, Kentucky |
|
Insulated flexible spacer |
Luck, Wisconsin |
|
Fenestration products |
Richmond, Kentucky |
|
Vinyl extrusions |
Winnebago, Illinois |
|
Vinyl extrusions |
Mounds View, Minnesota |
|
Fenestration products |
Leased (expires 2008) |
|
|
Kent, Washington |
|
Vinyl extrusions (two plants) |
Leased (leases expiring 2007,
2008, 2010 and 2011) |
|
|
Dubuque, Iowa |
|
Fenestration products |
Leased (expires 2008) |
|
|
Cleveland, Ohio |
|
Insulated glass assembly equipment |
Leased (expires 2006) |
|
|
Aluminum Sheet Building Products Segment |
|
|
Lincolnshire, Illinois |
|
Aluminum sheet finishing |
Davenport, Iowa |
|
Aluminum sheet and finishing (two plants) |
Decatur, Alabama |
|
Aluminum sheet finishing |
Owned and leased (expires 2018) |
|
|
Executive Offices |
|
|
Houston, Texas |
|
Corporate Office |
Leased (expires 2010) |
|
|
The Company believes that its properties are generally in good condition, are well maintained,
and are generally suitable and adequate to carry on the Company’s business. In fiscal 2006, the
Company’s vehicular products focused facilities operated at approximately 90% of capacity, while
the building products focused facilities operated at approximately 75% of capacity.
17
Item 3. Legal Proceedings
On September 6, 2006, the Michigan Department of Environmental Quality sent to the Company a
proposed administrative consent order with respect to alleged past violations of air emission
requirements. The proposed order sought payment of a civil penalty in the amount of approximately
$162,000. The parties have reached an agreement in principle pursuant to which the penalty would
be reduced to $139,000. Quanex expects to finalize and execute the consent order in the first or
second quarter of fiscal 2007. For additional discussion of environmental issues, see Item 1 and
Item 8, Note 17 to the Consolidated Financial Statements. For additional discussion of the
Company’s pending tax case see Note 17 to the Consolidated Financial Statements.
Item 4. Submission of Matters to Vote of Security Holders
None.
PART II
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters
Quanex’s common stock, $.50 par value, is traded on the New York Stock Exchange, under the
ticker symbol NX. The following tables present the quarterly common stock cash dividends and the
high and low closing prices for the Company’s common stock during each fiscal quarter within the
two most recent fiscal years. Share amounts set forth below and elsewhere in this report have been
adjusted to reflect the results of the March 2006 and December 2004 three-for-two stock splits in
the form of a stock dividend.
Quarterly Common Stock Cash Dividends
| |
|
|
|
|
|
|
|
|
| Paid during the Quarter Ended |
|
2006 |
|
|
2005 |
|
January |
|
$ |
0.1033 |
|
|
$ |
0.0900 |
|
April |
|
|
0.1200 |
|
|
|
0.0900 |
|
July |
|
|
0.1200 |
|
|
|
0.0900 |
|
October |
|
|
0.1400 |
|
|
|
0.1033 |
|
|
|
|
|
|
|
|
Total |
|
$ |
0.4833 |
|
|
$ |
0.3733 |
|
|
|
|
|
|
|
|
Quarterly Common Stock Sales Price (High & Low Closing Price)
| |
|
|
|
|
|
|
|
|
| Quarter Ended |
|
2006 |
|
|
2005 |
|
January |
|
$ |
41.67 |
|
|
$ |
35.15 |
|
|
|
|
32.50 |
|
|
|
22.52 |
|
April |
|
|
47.28 |
|
|
|
41.33 |
|
|
|
|
38.83 |
|
|
|
31.46 |
|
July |
|
|
44.72 |
|
|
|
41.09 |
|
|
|
|
35.11 |
|
|
|
31.18 |
|
October |
|
|
36.90 |
|
|
|
44.15 |
|
|
|
|
29.25 |
|
|
|
36.26 |
|
The terms of Quanex’s revolving credit agreement do not specifically limit the total amount of
dividends or other distributions to its shareholders.
18
There were approximately 3,447 holders of Quanex common stock (excluding individual
participants in securities positions listings) on record as of December 11, 2006.
Issuer Purchases of Equity Securities
On August 26, 2004, the Company’s Board of Directors approved an increase in the number of
authorized shares in the Company’s existing stock buyback program, up to 2.25 million shares; and
on August 24, 2006 the Board of Directors approved an additional increase of 2.0 million shares to
the existing program. The Company purchased 1,573,950 treasury shares at an average price of
$37.06 during the year ended October 31, 2006; no purchases were made during the fourth quarter of
2006. As of October 31, 2006, the number of shares in treasury was reduced to 1,200,617 resulting
primarily from stock option exercises. No shares were purchased during fiscal 2005. At October
31, 2005 there were no shares of treasury stock.
Equity Compensation Plan Information
The following table summarizes as of October 31, 2006, certain information regarding equity
compensation to our employees, officers, directors and other persons under our equity compensation
plans.
Equity Compensation Plan Information
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Number of |
|
| |
|
|
|
|
|
|
|
|
|
securities remaining |
|
| |
|
Number of |
|
|
|
|
|
|
available for |
|
| |
|
securities to be |
|
|
|
|
|
|
future issuance |
|
| |
|
issued upon |
|
|
Weighted-average |
|
|
under equity |
|
| |
|
exercise of |
|
|
exercise price of |
|
|
compensation |
|
| |
|
outstanding |
|
|
outstanding |
|
|
plans (excluding |
|
| |
|
options, warrants |
|
|
options, warrants |
|
|
securities reflected |
|
| Plan Category |
|
and rights |
|
|
and rights |
|
|
in column (a)) |
|
| |
|
(a) |
|
|
(b) |
|
|
(c) |
|
Equity compensation plans approved
by security holders |
|
|
1,184,314 |
|
|
$ |
25.70 |
|
|
|
2,575,422 |
|
Equity compensation plans not
approved by security holders(1) |
|
|
141,647 |
|
|
|
14.28 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
1,325,961 |
|
|
$ |
24.48 |
|
|
|
2,575,422 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
The Quanex Corporation 1997 Key Employee Stock Plan was approved by the Company’s Board
of Directors in October 1997. This plan provides for the granting of stock options to
eligible persons employed by the Company who are not executive officers of the Company.
Under the plan, the total number of stock options which may be granted is 900,000 shares.
Stock options may be granted at not less than the fair market value (as defined in the
plan) on the date the options are granted and generally become exercisable over three years
in one-third annual increments. The options expire ten years after the date of grant. The
Board of Directors may amend, terminate or suspend the plan at any time. This plan was
terminated at the December 2005 Board of Directors’ meeting. |
19
Item 6. Selected Financial Data
The following selected consolidated financial data for the years ended October 31, 2002
through October 31, 2006 is derived from the Company’s audited consolidated financial statements.
The operating results data includes reclassifications to conform to current period presentations
with no impact on net income. All periods have been adjusted on a retroactive basis to give effect
for the Company’s March 2006 and December 2004 three-for-two stock splits in the form of a stock
dividend. The data set forth should be read in conjunction with the Company’s consolidated
financial statements and accompanying notes to the consolidated financial statements included in
Item 8 of this Form 10-K. The historical information is not necessarily indicative of the results
to be expected in the future.
Glossary of Terms
The exact definitions of commonly used financial terms and ratios vary somewhat among
different companies and investment analysts. The following list gives the definition of certain
financial terms that are used in this report:
Asset turnover: Net sales divided by the average of beginning of year and end of
year total assets.
Working capital: Current assets less current liabilities.
Current ratio: Current assets divided by current liabilities.
Return on common stockholders’ equity: Net income attributable to common stockholders
divided by the average of beginning of year and end of year common stockholders’
equity.
Return on investment: The sum of net income and the after-tax effect of interest expense
less capitalized interest divided by the sum of the beginning of year and end of year
averages for short and long-term debt and stockholders’ equity.
20
Selected Financial Data 2002 — 2006
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Fiscal years ended October 31, |
|
| |
|
2006 |
|
|
2005(1)(2) |
|
|
2004(1) |
|
|
2003(1) |
|
|
2002(1) |
|
| |
|
(thousands, except per share data) |
|
Selected Operating Results Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
2,032,572 |
|
|
$ |
1,969,007 |
|
|
$ |
1,437,897 |
|
|
$ |
878,409 |
|
|
$ |
831,569 |
|
Operating income(3) |
|
|
251,394 |
|
|
|
292,775 |
|
|
|
98,997 |
|
|
|
64,887 |
|
|
|
79,431 |
|
Income from continuing operations(4) |
|
|
160,313 |
|
|
|
177,233 |
|
|
|
57,428 |
|
|
|
43,646 |
|
|
|
53,276 |
|
Income (loss) from discontinued operations,
net of tax(5) |
|
|
(130 |
) |
|
|
(22,073 |
) |
|
|
(2,961 |
) |
|
|
(759 |
) |
|
|
2,206 |
|
Net income (3)(4)(5) |
|
$ |
160,183 |
|
|
$ |
155,160 |
|
|
$ |
54,467 |
|
|
$ |
42,887 |
|
|
$ |
55,482 |
|
Percent of net sales |
|
|
7.9 |
% |
|
|
7.9 |
% |
|
|
3.8 |
% |
|
|
4.9 |
% |
|
|
6.7 |
% |
Diluted Earnings Per Share Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations |
|
$ |
4.09 |
|
|
$ |
4.50 |
|
|
$ |
1.53 |
|
|
$ |
1.18 |
|
|
$ |
1.50 |
|
Net income |
|
$ |
4.08 |
|
|
$ |
3.95 |
|
|
$ |
1.45 |
|
|
$ |
1.16 |
|
|
$ |
1.56 |
|
Cash dividends declared |
|
$ |
0.4833 |
|
|
$ |
0.3733 |
|
|
$ |
0.3111 |
|
|
$ |
0.2978 |
|
|
$ |
0.2844 |
|
Financial Position—Year End: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
1,202,152 |
|
|
$ |
1,114,778 |
|
|
$ |
940,054 |
|
|
$ |
697,211 |
|
|
$ |
728,573 |
|
Asset turnover |
|
|
1.8 |
|
|
|
1.9 |
|
|
|
1.8 |
|
|
|
1.2 |
|
|
|
1.1 |
|
Working capital |
|
|
242,196 |
|
|
|
143,043 |
|
|
|
144,057 |
|
|
|
95,157 |
|
|
|
104,336 |
|
Current ratio |
|
|
2.2 to 1 |
|
|
|
1.7 to 1 |
|
|
|
1.7 to 1 |
|
|
|
1.7 to 1 |
|
|
|
1.8 to 1 |
|
Total debt |
|
$ |
133,401 |
|
|
$ |
135,921 |
|
|
$ |
128,926 |
|
|
$ |
17,542 |
|
|
$ |
73,140 |
|
Stockholders’ equity |
|
|
758,515 |
|
|
|
656,742 |
|
|
|
500,707 |
|
|
|
445,159 |
|
|
|
421,395 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total capitalization |
|
$ |
891,916 |
|
|
$ |
792,663 |
|
|
$ |
629,633 |
|
|
$ |
462,701 |
|
|
$ |
494,535 |
|
Cash provided by operating activities |
|
$ |
190,271 |
|
|
$ |
249,120 |
|
|
$ |
124,237 |
|
|
$ |
102,840 |
|
|
$ |
81,111 |
|
Cash provided by (used for) investing activities |
|
|
(65,539 |
) |
|
|
(240,737 |
) |
|
|
(213,090 |
) |
|
|
(22,500 |
) |
|
|
(29,808 |
) |
Cash provided by (used for) financing activities |
|
|
(68,716 |
) |
|
|
(462 |
) |
|
|
108,478 |
|
|
|
(76,515 |
) |
|
|
(3,765 |
) |
Depreciation and amortization |
|
|
71,657 |
|
|
|
65,987 |
|
|
|
49,921 |
|
|
|
40,647 |
|
|
|
38,635 |
|
Capital expenditures, net |
|
|
72,262 |
|
|
|
50,792 |
|
|
|
18,713 |
|
|
|
24,411 |
|
|
|
30,353 |
|
Other Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total debt as a percent of capitalization |
|
|
15.0 |
% |
|
|
17.1 |
% |
|
|
20.5 |
% |
|
|
3.8 |
% |
|
|
14.8 |
% |
Return on investment—percent |
|
|
19.4 |
% |
|
|
22.6 |
% |
|
|
10.6 |
% |
|
|
9.3 |
% |
|
|
12.9 |
% |
Return on common stockholders’ equity—percent |
|
|
22.6 |
% |
|
|
26.8 |
% |
|
|
11.5 |
% |
|
|
9.9 |
% |
|
|
15.8 |
% |
Average number of employees |
|
|
4,356 |
|
|
|
4,124 |
|
|
|
2,975 |
|
|
|
2,408 |
|
|
|
2,351 |
|
Net sales per average employee |
|
$ |
467 |
|
|
$ |
477 |
|
|
$ |
483 |
|
|
$ |
365 |
|
|
$ |
354 |
|
Backlog for shipment in next 12 months |
|
$ |
298,000 |
|
|
$ |
330,000 |
|
|
$ |
489,000 |
|
|
$ |
162,000 |
|
|
$ |
169,000 |
|
|
|
|
| (1) |
|
During the fourth quarter of 2005, the Company committed to a plan to sell its Temroc
business. In the first quarter of 2005, the Company sold its Piper Impact business and in
the fourth quarter of 2004 sold its Nichols Aluminum — Golden business. Accordingly, the
assets and liabilities of Temroc, Piper Impact and Nichols Aluminum — Golden are reported
as discontinued operations in the Consolidated Balance Sheets for all periods presented,
and their operating results are reported as discontinued operations in the Consolidated
Statements of Income for all periods presented (see Note 18). |
| |
| (2) |
|
In December 2004, the Company acquired Mikron and accounted for the acquisition under the
purchase method of accounting. Accordingly, Mikron’s estimated fair value of assets
acquired and liabilities assumed in the acquisition and the results of operations are
included in the Company’s consolidated financial statements as of the effective date of the
acquisition. For more
information see Note 2 of the consolidated financial statements in Item 8 of this Form 10-K. |
| |
| (3) |
|
Included in operating income are gains on sale of land of $0.5 million and $0.4 million in
fiscal 2004 and 2003, respectively. |
| |
| (4) |
|
Fiscal 2003 and 2002 include gains associated with retired executive life insurance
proceeds of $2.2 million and $9.0 million, respectively. This represents the excess of life
insurance proceeds over (a) the cash surrender value and (b) liabilities to beneficiaries
of deceased executives, on whom the Company held life insurance policies. |
| |
| (5) |
|
Includes effects in fiscal 2005 of Temroc’s $13.1 million (pretax and after-tax) asset
impairment charge in accordance with SFAS 142 and SFAS No. 144
“Accounting for the
Impairment or Disposal of Long-Lived Assets” (SFAS 144). |
21
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations
General
The discussion and analysis of the Company’s financial condition and results of operations
should be read in conjunction with the Selected Financial Data and the Consolidated Financial
Statements of the Company and the accompanying notes.
Private Securities Litigation Reform Act
Certain of the statements contained in this document and in documents incorporated by
reference herein, including those made under the caption “Management’s Discussion and Analysis of
Results of Operations and Financial Condition” are “forward-looking” statements as defined under
the Private Securities Litigation Reform Act of 1995. Generally, the words “expect,” “believe,”
“intend,” “estimate,” “anticipate,” “project,” “will” and similar expressions identify
forward-looking statements, which generally are not historical in nature. All statements which
address future operating performance, events or developments that we expect or anticipate will
occur in the future, including statements relating to volume, sales, operating income and earnings
per share, and statements expressing general optimism about future operating results, are
forward-looking statements. Forward-looking statements are subject to certain risks and
uncertainties that could cause actual results to differ materially from our Company’s historical
experience and our present projections or expectations. As and when made, management believes that
these forward-looking statements are reasonable. However, caution should be taken not to place
undue reliance on any such forward-looking statements since such statements speak only as of the
date when made and there can be no assurance that such forward-looking statements will occur. The
Company undertakes no obligation to publicly update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise.
Factors exist that could cause the Company’s actual results to differ materially from the
expected results described in or underlying the Company’s forward-looking statements. Such factors
include domestic and international economic activity, prevailing prices of steel and aluminum scrap
and other raw material costs, the rate of change in prices for steel and aluminum scrap, energy
costs, interest rates, construction delays, market conditions, particularly in the vehicular, home
building and remodeling markets, any material changes in purchases by the Company’s principal
customers, labor supply and relations, environmental regulations, changes in estimates of costs for
known environmental remediation projects and situations, world-wide political stability and
economic growth, the Company’s successful implementation of its internal operating plans,
acquisition strategies and integration, performance issues with key customers, suppliers and
subcontractors, and regulatory changes and legal proceedings. Accordingly, there can be no
assurance that the forward-looking statements contained herein will occur or that objectives will
be achieved. All written and verbal forward-looking statements attributable to the Company or
persons acting on its behalf are expressly qualified in their entirety by such factors. For more
information, please see Item 1A, “Risk Factors”.
22
Results of Operations
Summary Information as % of Sales
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Fiscal Year Ended October 31,* |
|
| |
|
2006 |
|
|
2005 |
|
|
2004 |
|
| |
|
Dollar |
|
|
% of |
|
|
Dollar |
|
|
% of |
|
|
Dollar |
|
|
% of |
|
| |
|
Amount |
|
|
Sales |
|
|
Amount |
|
|
Sales |
|
|
Amount |
|
|
Sales |
|
| |
|
(Dollars in millions) |
|
Net sales |
|
$ |
2,032.6 |
|
|
|
100 |
% |
|
$ |
1,969.0 |
|
|
|
100 |
% |
|
$ |
1,437.9 |
|
|
|
100 |
% |
Cost of sales |
|
|
1,617.4 |
|
|
|
80 |
|
|
|
1,513.0 |
|
|
|
77 |
|
|
|
1,225.8 |
|
|
|
85 |
|
Selling, general and administrative |
|
|
92.7 |
|
|
|
5 |
|
|
|
97.8 |
|
|
|
5 |
|
|
|
63.7 |
|
|
|
4 |
|
Depreciation and amortization |
|
|
71.1 |
|
|
|
3 |
|
|
|
65.4 |
|
|
|
3 |
|
|
|
49.4 |
|
|
|
4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
|
251.4 |
|
|
|
12 |
|
|
|
292.8 |
|
|
|
15 |
|
|
|
99.0 |
|
|
|
7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense |
|
|
(4.8 |
) |
|
|
— |
|
|
|
(9.3 |
) |
|
|
(1 |
) |
|
|
(6.0 |
) |
|
|
(1 |
) |
Other, net |
|
|
4.2 |
|
|
|
— |
|
|
|
0.1 |
|
|
|
— |
|
|
|
0.3 |
|
|
|
— |
|
Income tax expense |
|
|
(90.5 |
) |
|
|
(4 |
) |
|
|
(106.4 |
) |
|
|
(5 |
) |
|
|
(35.9 |
) |
|
|
(2 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations |
|
$ |
160.3 |
|
|
|
8 |
% |
|
$ |
177.2 |
|
|
|
9 |
% |
|
$ |
57.4 |
|
|
|
4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| * |
|
All periods presented exclude Nichols Aluminum — Golden, Piper Impact and Temroc, which are
included in discontinued operations. |
Overview
Fiscal 2006 was a record year with net sales exceeding $2.0 billion for the first time in the
Company’s history. Both of the primary markets on which the Company focuses, the vehicular
products and the building products markets, experienced difficulties over the course of fiscal 2006
when compared to the much stronger performance of those markets over the past few years.
Notwithstanding these difficulties, the Company managed to outperform its primary markets by
focusing on the controllable factors.
Fiscal 2006 was a year of declining demand while maintaining relatively strong spreads (sales
price less material costs) at the Company’s process businesses. Record net sales of $2.0 billion
were an increase of 3.2% over fiscal 2005’s record level, attributable to strong base metal prices
and the full year impact of the Mikron acquisition, offset by reduced demand. The 3.2% increase in
net sales resulted from a 12.5% increase in Mikron net sales and a 2.0% increase in net sales
across all of the other businesses.
Business Segments
Business segments are reported in accordance with Statement of Financial Accounting Standards
(SFAS) No. 131, “Disclosures about Segments of an Enterprise and Related Information” (SFAS 131).
SFAS 131 requires that the Company disclose certain information about its operating segments, where
operating segments are defined as “components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating decision maker (CODM)
in deciding how to allocate resources and in assessing performance”. Generally, financial
information is required to be reported on the basis that it is used internally for evaluating
segment performance and deciding how to allocate resources to segments.
23
Quanex has three reportable segments covering two customer-focused markets; the vehicular
products and building products markets. The Company’s reportable segments are Vehicular Products,
Engineered Building Products, and Aluminum Sheet Building Products. The Vehicular Products segment
produces engineered steel bars for the light vehicle, heavy duty truck, agricultural, defense, capital
goods, recreational and energy markets. The Vehicular Products segment’s primary market drivers
are North American light vehicle builds and, to a lesser extent, heavy duty truck builds. The
Engineered Building Products segment produces engineered products and components serving the window
and door industry, while the Aluminum Sheet Building Products segment produces mill finished and
coated aluminum sheet serving the broader building products markets and secondary markets such as
recreational vehicles and capital equipment. The main market drivers of the building products
focused segments are residential housing starts and remodeling expenditures.
During the fourth quarter of fiscal 2006, certain internal reporting relationships were
changed that resulted in the Company’s CODM assessing financial performance and allocating
resources at a level of the organization below the segments to include each of the operating
divisions. For financial reporting purposes three of the Company’s five operating divisions,
Homeshield, TruSeal and Mikron, have been aggregated into the Engineered Building Products
reportable segment. The remaining two divisions, MACSTEEL and Nichols Aluminum, are reported as
separate reportable segments with the Corporate & Other comprised of corporate office expenses and
certain inter-division eliminations. The sale of products between segments is recognized at market
prices. The financial performance of the operations is based upon operating income. The segments
follow the accounting principles described in the Summary of Significant Accounting Principles.
Note that the three reportable segments value inventory on a FIFO basis and the LIFO reserve
relating to those operations accounted for under the LIFO method of inventory valuation is computed
on a consolidated basis in a single pool and treated as a corporate expense. Prior periods have
been adjusted to reflect the current presentation.
Vehicular Products — Three Years Ended October 31, 2006
The Vehicular Products segment’s primary market drivers are North American light vehicle
production (approximately 65% of sales) and Class 8 heavy duty truck production (approximately 10%
of sales). Calendar 2006 North American vehicle builds are expected to be some 15.8 million, 3.1%
below the 16.3 million in calendar 2005. The segment’s addition of new programs helped it to
overcome the market decline, thereby resulting in flat volume compared to fiscal 2005. Fiscal 2005
was considered to have been a year of relatively strong demand, particularly in the first half of
the year, when demand for the segment’s engineered steel bar products outstripped our ability to
fully supply customers. While the segment benefited from higher base selling prices in fiscal
2006, steel scrap costs were much less volatile than the falling prices experienced in the previous
year.
The following table sets forth selected operating data for the Vehicular Products segment:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended October 31, |
|
|
% Change |
|
| |
|
(Dollars in millions) |
|
|
2006 vs. |
|
|
2005 vs. |
|
| |
|
2006 |
|
|
2005 |
|
|
2004(1) |
|
|
2005 |
|
|
2004 |
|
Net sales |
|
$ |
988.8 |
|
|
$ |
1,017.2 |
|
|
$ |
798.6 |
|
|
|
(2.8 |
)% |
|
|
27.4 |
% |
Cost of sales |
|
|
782.3 |
|
|
|
772.6 |
|
|
|
677.1 |
|
|
|
1.3 |
|
|
|
14.1 |
|
Selling, general and administrative |
|
|
17.8 |
|
|
|
21.2 |
|
|
|
16.6 |
|
|
|
(16.0 |
) |
|
|
27.7 |
|
Depreciation and amortization |
|
|
34.1 |
|
|
|
32.7 |
|
|
|
30.9 |
|
|
|
4.3 |
|
|
|
5.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
$ |
154.6 |
|
|
$ |
190.7 |
|
|
$ |
74.0 |
|
|
|
(18.9 |
)% |
|
|
157.7 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income margin |
|
|
15.6 |
% |
|
|
18.7 |
% |
|
|
9.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
Fiscal 2004 includes MACSTEEL Monroe’s operations beginning January 1, 2004 |
24
Net sales for fiscal 2006 were 2.8% lower than fiscal 2005 due to a 3.2% decline in the
average selling price, directly attributable to lower scrap surcharges, which was only partially
offset by a 0.5% increase in volume. Net sales for fiscal 2005 were higher than fiscal 2004 by
27.4% due to the combination of a 34.0% increase in
average selling prices (including surcharges), increased sales as a result of two additional
months of business at MACSTEEL Monroe during fiscal 2005 (acquired December 31, 2003), offset by a
10.6% decline in volume excluding MACSTEEL Monroe.
| |
• |
|
Fiscal 2006 volume was lower in the first half of the year versus the tough
comparison of 2005, but outpaced fiscal 2005 in the second half of the year largely as
a result of new programs. Fiscal 2005 volumes dropped from the strong levels that had
persisted for several years primarily as a result of reduced end-use demand in the
second half of the year and inventory draw-downs. Near-term volumes are anticipated to
be lower than recent comparative periods in light of production cutbacks announced by
several of the major automotive manufacturers. Over time, end-use demand is expected
to increase, influenced, in part, by the overall driver aged population growth. The
Company continues to focus on consistently improving productivity as well as enhancing
its value-added offerings in an effort to meet the anticipated higher demand over time.
Future volume increases will also be based upon the Company’s ability to increase
content per vehicle as well as continued sales growth with the New American
Manufacturers (NAMs) which continue to take share from the former Big 3 manufacturers. |
| |
| |
• |
|
Average selling prices decreased from 2005 to 2006 primarily due to the
reduction of steel scrap surcharges from fiscal 2005’s all time high surcharges.
Although surcharges were lower in 2006, base prices held steady from 2005 to 2006.
Leading up to fiscal 2006 average selling prices increased over the preceding three
years primarily as the result of three items. First, the Company is always focused on
continuing to increase sales of the segment’s value-added products. As the mix of
value-added sales increases, so does the average sales price. The second contributing
factor to the average selling price increases are underlying base price increases that
were realized in 2005. The largest contributing factor for the increase from fiscal
2004 to 2005 is the overall price increases resulting from higher steel scrap
surcharges. Steel scrap raw material prices increased dramatically over the last half
of calendar 2003 and into fiscal 2004. As a result of the steel scrap raw material
price increases, surcharges were triggered on January 1, 2004 and have been adjusted
since then (see further discussion of surcharge lag in “Commodity Price Risk” of Item
7A). Steel scrap price surcharges have been a component of the Company’s MACSTEEL
sales contracts for many years and will remain in effect as long as steel scrap prices
remain at current levels. |
The 18.9% decrease in operating income from fiscal 2005 to fiscal 2006 resulted from average
selling prices decreasing by more than the decrease in raw material costs coupled with a 28%
increase in utility costs that were only partially offset by the reduced selling, general and
administrative expenses. The 157.7% increase in operating income from fiscal 2004 to 2005 resulted
from the increases in average selling prices offset by higher raw material costs. At MACSTEEL,
average selling prices held as raw material costs fell during fiscal 2005. During fiscal 2005 raw
material costs steadily declined for the first three fiscal quarters followed by an increase during
the fiscal fourth quarter. Fiscal 2005 selling, general and administrative expenses were higher
than both fiscal 2004 and fiscal 2006 primarily due to increased incentives for the year coupled
with a $3.1 million increase in the reserve for doubtful accounts receivable due to Jernberg
Industries, Inc. and Delphi, which filed for bankruptcy during the year. The increased
depreciation expense in 2005 and again in 2006 relate to the capital spending that has occurred
over the past few years to increase the segment’s valued added capacity. Depreciation expense is
expected to increase in the next year, impacted by the MACSTEEL Phase VIII and Phase IX capital
expansions.
25
The operating income margin decrease from fiscal 2005 to 2006 resulted from the items that
impacted operating income discussed above. Note that in the 1st quarter of fiscal 2006
the Company converted approximately 85% of the accounts, representing approximately 70% of
shipments, to a monthly surcharge mechanism from a quarterly surcharge mechanism. The impact of
the surcharge change reduces the volatility created by the inherent lag built into the quarterly
surcharge mechanism. As examples, fiscal 2005 benefited from the surcharge lag in a period when
raw material prices were decreasing, whereas fiscal 2004 was hurt by the surcharge lag in a period
when raw material prices increased. Under the quarterly surcharge mechanism, as raw material
prices rise, the Company experiences short term compression of the operating margin since the
surcharges are adjusted on a quarterly basis based upon raw material indexes from the previous
three months. Declines in raw material costs will increase the margin in the short term as the
surcharge reductions lag behind. Based upon the inherent lag of surcharge pricing, the Company’s
margins were compressed during fiscal 2004 and expanded during fiscal 2005. The operating income
margins experienced in fiscal 2004 are therefore believed to be below normal levels and the
operating income margins realized during fiscal 2005 are not sustainable over the long-term. The
operating income margins realized in fiscal 2006 are closer to expected normal levels due in large
part to the change in the surcharge mechanism combined also with the lower volatility in raw
material scrap prices during the year.
Engineered Building Products & Aluminum Sheet Building Products — Three Years Ended October 31,
2006
Both the Engineered Building Products segment and Aluminum Sheet Building Products segment
reported record net sales and the Aluminum Sheet Building Products segment reported record
operating income in fiscal 2006. Both segments’ primary market drivers are North American new
housing starts and remodeling activity. The primary drivers were both down for 2006 compared to a
very strong 2005, with housing starts estimated to be down almost 12% calendar 2006 over 2005. The
Engineered Building Products segment is comprised of three divisions: Homeshield, TruSeal and
Mikron. The Engineered Building Products segment benefited from a full year of net sales from
Mikron, a leading supplier of vinyl window profiles, which was acquired in December 2004.
Homeshield and TruSeal net sales increased 3.4% in a down market. The operations were negatively
impacted over the latter half of the year as housing starts and remodeling expenditures declined
sharply. While the annual rate of housing starts is expected to end down 12% versus 2005, the rate
in the last couple of months of the Company’s fiscal year was down in the 20% range. The Aluminum
Sheet Building Products segment benefited from higher selling prices and increased spreads offset
partially by the drop in demand.
The following table sets forth selected operating data for the two reportable segments within
Building Products, Engineered Building Products (Engineered BP) and Aluminum Sheet Building
Products (Aluminum Sheet BP):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended October 31, |
|
|
% Change |
|
| |
|
(Dollars in millions) |
|
|
2006 vs. |
|
|
2005 vs. |
|
| |
|
2006 |
|
|
2005(1) |
|
|
2004(2) |
|
|
2005 |
|
|
2004 |
|
Engineered BP net sales |
|
$ |
524.6 |
|
|
$ |
487.6 |
|
|
$ |
240.2 |
|
|
|
7.6 |
% |
|
|
103.0 |
% |
Aluminum Sheet BP net sales |
|
|
539.8 |
|
|
|
484.1 |
|
|
|
419.7 |
|
|
|
11.5 |
|
|
|
15.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
|
1,064.4 |
|
|
|
971.7 |
|
|
|
659.9 |
|
|
|
9.5 |
|
|
|
47.2 |
|
Cost of sales |
|
|
842.5 |
|
|
|
759.3 |
|
|
|
548.1 |
|
|
|
11.0 |
|
|
|
38.5 |
|
Selling, general and administrative |
|
|
50.5 |
|
|
|
48.5 |
|
|
|
30.5 |
|
|
|
4.1 |
|
|
|
59.0 |
|
Depreciation and amortization |
|
|
36.7 |
|
|
|
32.5 |
|
|
|
18.2 |
|
|
|
12.9 |
|
|
|
78.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Engineered BP operating income |
|
|
52.5 |
|
|
|
59.2 |
|
|
|
39.7 |
|
|
|
(11.3 |
) |
|
|
49.1 |
|
Aluminum Sheet BP operating income |
|
|
82.2 |
|
|
|
72.2 |
|
|
|
23.4 |
|
|
|
13.9 |
|
|
|
208.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
$ |
134.7 |
|
|
$ |
131.4 |
|
|
$ |
63.1 |
|
|
|
2.5 |
% |
|
|
108.2 |
% |
Engineered BP operating income margin |
|
|
10.0 |
% |
|
|
12.1 |
% |
|
|
16.5 |
% |
|
|
|
|
|
|
|
|
Aluminum Sheet BP operating income margin |
|
|
15.2 |
% |
|
|
14.9 |
% |
|
|
5.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income margin |
|
|
12.7 |
% |
|
|
13.5 |
% |
|
|
9.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
Mikron’s results of operations have been included beginning December 10, 2004
(fiscal 2005). |
| |
| (2) |
|
TruSeal’s results of operations have been included beginning January 1, 2004
(fiscal 2004). |
26
The
Engineered Building Products segment’s increase in net sales from 2004 to 2005 and 2006
has been influenced by the acquisitions of TruSeal in January 2004 and Mikron in December 2004.
Homeshield’s net sales increased 3.4% in fiscal 2006 and 4.9% in fiscal 2005. These net sales
increases resulted from a continuous expansion of new products coupled with increased sales of
existing products. Fenestration component sales were robust in fiscal 2005 as a result of
increased housing starts as well as strong remodeling and renovation activity, whereas fiscal
2006’s increase was primarily a result of new product introductions.
The increased net sales at the Aluminum Sheet Building Products segment from 2004 to 2005 and
2006 resulted from a combination of higher average selling prices and lower volumes. Aluminum
sheet volume decreased 4.3% in fiscal 2006 as building and construction markets declined at a much
higher rate. Fiscal 2005 volumes declined slightly due to inventory draw-downs of aluminum sheet
that resulted from pre-buying that occurred early in the year in a period of allocation. The
increased aluminum sheet selling prices during fiscal 2005 and 2006 were a result of reduced
industry capacity which combined with strong demand during the first half of 2005 to put upward
pressure on pricing. Aluminum sheet selling prices are correlated with aluminum prices on the
London Metal Exchange (LME). During fiscal 2006, LME aluminum prices increased sharply in the
first part of the fiscal year and retreated to a lesser extent in the latter half of the fiscal
year which resulted in a similar trend of the Aluminum Sheet Building Products segment’s average
selling price. The Company continues to increase the mix of value-added products across the
segment which should mitigate the expected margin pressure due to moderation in demand.
Fiscal 2005 housing starts were fueled by relatively low mortgage rates. Mortgage rates
increased during fiscal 2006 as expected which contributed to the decline in housing starts along
with the housing affordability index becoming unfavorable. Mortgage rates are not expected to rise
noticeably in the next year and home sales and starts of new units are expected to stabilize
following the substantial correction which began in the second quarter of 2006. Additionally, the
building products focused businesses are expected to benefit from the less volatile demand from
remodeling and renovation activity which comprises an estimated 40% of these businesses’ sales.
The Company is focused on working closely with customers to be a part of their new product
development which is an important component to increasing revenue. Generally, demographics for
long-term housing demand are favorable when factoring the population increase, immigration and an
increase in vacation homes. These coupled with an increase in the average-sized home should
benefit the segment over the long-term. Furthermore, the Company’s presence in the vinyl and
composite window market, which represents the fastest growing window segment, should continue to
fuel growth over a long time frame.
Operating income declined at the Company’s Engineered Building Products segment in 2006 due to
a combination of factors. Material costs, particularly those having natural gas and oil as feed
stocks, increased coupled with increased energy and labor costs. The labor costs will be brought
in line in fiscal 2007, as the operations will be staffed to more closely match demand. This was
difficult during fiscal 2006 as the market was transitioning to lower levels. Contributing to the
decline in operating income for fiscal 2006 was a protracted labor organization effort at one of
the Mikron facilities which resulted in reduced productivity and margins. The effort recently
concluded in the Company’s favor and improvements in productivity and margins are expected. All of
the aforementioned factors led to the corresponding decreases in operating income margin.
Spread is a key determinant of profitability for the Aluminum Sheet Building Products segment.
The spread between the Company’s selling price and raw material price expanded in both fiscal 2005
and fiscal 2006 even with the rise in raw material costs. This increase in spread was the primary
contributor to the increase in operating income margin from 5.6% in fiscal 2004 to 15.2% in fiscal
2006. The increased spread was partially offset by a 39.3% increase in utility costs in fiscal
2006. While the spreads realized during fiscal 2006 are expected to moderate over time, the move
to higher energy costs has enhanced the segment’s competitive advantage because as a scrap based
producer of aluminum, recycling aluminum only consumes 5% of the energy required to produce primary
aluminum from bauxite, an aluminum containing ore.
27
Corporate and Other — Three Years Ended October 31, 2006
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended October 31, |
|
|
$ Change |
|
| |
|
(Dollars in millions) |
|
|
2006 vs. |
|
|
2005 vs. |
|
| |
|
2006 |
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Net sales |
|
$ |
(20.6 |
) |
|
$ |
(19.9 |
) |
|
$ |
(20.6 |
) |
|
$ |
(0.7 |
) |
|
$ |
0.7 |
|
Cost of sales |
|
|
(7.4 |
) |
|
|
(18.9 |
) |
|
|
0.6 |
|
|
|
11.5 |
|
|
|
(19.5 |
) |
Selling, general and administrative |
|
|
24.4 |
|
|
|
28.1 |
|
|
|
16.6 |
|
|
|
(3.7 |
) |
|
|
11.5 |
|
Depreciation and amortization |
|
|
0.3 |
|
|
|
0.2 |
|
|
|
0.3 |
|
|
|
0.1 |
|
|
|
(0.1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (expense) |
|
$ |
(37.9 |
) |
|
$ |
(29.3 |
) |
|
$ |
(38.1 |
) |
|
$ |
(8.6 |
) |
|
$ |
8.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate and other operating expenses, not included in the operating segments mentioned
above, include the consolidated LIFO inventory adjustments (calculated on a combined pool basis),
corporate office expenses and inter-segment eliminations. As a result of raw material cost
increases during fiscal 2004 and fiscal 2006, the Company incurred expense of $20.4 million and
$13.1 million, respectively, in the form of a LIFO inventory adjustment. The pool of average raw
material costs was only slightly lower at the end of fiscal 2005 compared to the end of fiscal 2004
and as a result the Company recognized $0.1 million of income due to the reduction of the LIFO
inventory adjustment. Fluctuations associated with the LIFO inventory adjustment tend to comprise
a majority of the change from year to year in corporate and other expenses. For the year ended
October 31, 2005, the Company incurred $8.2 million of external consulting fees and external audit
fees associated with the implementation of the Sarbanes-Oxley Act. Comparatively little external
consulting fees were incurred in fiscal 2006 related to the company’s ongoing compliance with the
Sarbanes-Oxley Act. Offsetting the reduction in consultant fees was $4.0 million of stock option
expense in fiscal 2006 which was not required to be recorded in prior years; in prior years
potential stock option expense was disclosed in a footnote to the financial statements.
Other Items — Three Years Ended October 31, 2006
Interest expense for fiscal 2006 was $4.8 million compared to $9.3 million in fiscal 2005 and
$6.0 million in fiscal 2004. The increase from 2004 to 2005 is a result of a full year of interest
on the Company’s 2.5% Convertible Senior Debentures combined with higher interest rates incurred
during fiscal 2005. The pattern of borrowings and subsequent repayments against the revolving
credit agreement were similar in both fiscal 2004 and 2005 as funds were borrowed in the first
quarter of each year to fund acquisitions and paid off during the year. The decrease from 2005 to
2006 resulted from the fact that the borrowings against the Company’s revolving credit agreement
used to fund the Mikron acquisition had been repaid by the end of fiscal 2005. No amounts were
borrowed against the revolving credit facility during fiscal 2006, thereby reducing the amount of
interest expense.
Other, net (on the income statement) for fiscal 2006 was income of $4.2 million compared to
income of $0.1 million in fiscal 2005 and income of $0.3 million in fiscal 2004. Other, net
includes interest income and changes associated with the cash surrender value of life insurance.
The increase in fiscal 2006 partly relates to interest income earned on the cash and equivalents
balance that accumulated during 2006.
Income (loss) from discontinued operations, net of taxes for fiscal 2006 was a loss of $0.1
million compared to a loss of $22.1 million in fiscal 2005 compared to a loss of $3.0 million for
fiscal 2004. During fiscal 2005, the Company recorded a goodwill impairment charge for Temroc of
$13.1 million. The Temroc impairment combined with an additional loss on the sale of Piper Impact
comprised the difference between fiscal 2004 and fiscal 2005. See Note 18 for further information
regarding the composition of discontinued operations.
28
Outlook
The first quarter is historically the Company’s least profitable quarter as there are fewer
production days due to the holidays and there is reduced home building activity during the winter
period. Net sales for the first fiscal quarter of 2007 are expected to be down approximately 10%
from first quarter 2006 sales, and the Company expects its market drivers to be down appreciably
from the year ago period.
Vehicular Products fiscal first quarter 2007 steel bar ton shipments are estimated to be down
approximately 10% compared to the first quarter 2006, a result of cutbacks made by the Company’s
Tier 1 and Tier 2 customers, principally in response to the Big Three’s estimated 10% light vehicle
build rate reduction. Total light vehicle builds in the fiscal first quarter are projected to be
down 5% from the year ago quarter. The Vehicular Products segment is expected to outperform the
market for fiscal 2007 with new programs at both the “Big Three” and transplant automotive
companies.
At Engineered Building Products, 2007 fiscal first quarter net sales are expected to be down
approximately 20% compared to the first quarter of 2006, as the segment experiences lower demand
for window and door components in the face of declining housing starts and reduced remodeling
expenditures. Total housing starts are expected to be down 20% in the quarter.
Aluminum Sheet shipments are expected to be down approximately 10% compared to year ago first
quarter shipments, with momentum expected to return in January. LME aluminum ingot prices are
expected to remain high through the first quarter, which should allow for continued healthy
material spreads at Nichols Aluminum.
Taken together, the Company expects fiscal first quarter 2007 earnings from continuing
operations to be in a range of $0.35 to $0.45 per share.
For fiscal 2007, the Company expects to build momentum in all of its businesses as the year
progresses. Quanex cautions that it expects financial performance in the first half of 2007 to lag
the first half of 2006. Light vehicle builds and housing starts in the first half of 2007 are
forecasted to be down approximately 6% and 22%, respectively, from the first half of 2006. In the
second half of 2007, the Company expects its market drivers to improve over the second half of
2006. Accordingly, fiscal 2007 earnings per share from continuing operations are expected to be in
a range of $3.10 to $3.60 per share.
Liquidity and Capital Resources
Sources of Funds
The Company’s principal sources of funds are cash on hand, cash flow from operations, and
borrowings under its unsecured $350.0 million Senior Unsecured Revolving Credit Facility (the
Credit Facility). The Credit Facility was executed on September 29, 2006 and replaced the
Company’s $310.0 million Revolving Credit Agreement. Proceeds from the Credit Facility may be used
to provide availability for working capital, capital expenditures, permitted acquisitions and
general corporate purposes. The Credit Facility has a five-year term and may be increased by an
additional $100.0 million in the aggregate prior to maturity, subject to the receipt of additional
commitments and the absence of any continuing defaults.
At October 31, 2006, the Company had no borrowings under the Credit Facility and $125.0
million outstanding 2.50% Senior Convertible Debentures due May 15, 2034 (the Debentures).
This represents no change from October 31, 2005, borrowing levels. The aggregate availability
under the Credit Facility was $336.1 million at October 31, 2006, which is net of $13.9 million of
outstanding letters of credit.
29
The Company believes that it has sufficient funds and adequate financial resources available
to meet its anticipated liquidity needs. The Company also believes that cash flow from operations,
cash balances and available borrowings will be sufficient in the foreseeable future to finance
anticipated working capital requirements, capital expenditures, debt service requirements,
environmental expenditures, dividends and the stock buyback program.
The Company’s working capital was $242.2 million on October 31, 2006 compared to $143.0
million on October 31, 2005, a $99.2 million increase. Included in the $99.2 million working
capital increase is a $56.0 million increase in the cash and equivalents balance. The $43.2
million remaining increase is a result of a $32.2 million increase in accounts receivable coupled
with a $9.5 million decrease in accrued liabilities. The accounts receivable increase is related
to higher net sales in the fourth quarter of fiscal 2006 than in the fourth quarter of fiscal 2005
coupled with higher number of days sales outstanding. Net sales for the fourth quarter of fiscal
2006 were $44.4 million higher than the same period of fiscal 2005, which would equate to an
increase in accounts receivable of approximately $15.8 million. An additional increase in accounts
receivable of approximately $8.8 million is due to the fact that the average days outstanding at
the Company’s Vehicular Products segment increased 3 days from October 31, 2005 to October 31,
2006.
Operating Activities
Cash provided by operating activities during the year ended October 31, 2006 was $190.3
million compared to $249.1 million and $124.2 million for 2005 and 2004, respectively. The $58.8
million reduction in operating cash flows from fiscal 2005 to fiscal 2006 is primarily attributable
to the $32.2 million increase in accounts receivable discussed in the sources of funds section
above coupled with an increased contribution to the pension plans of approximately $13.2 million
during fiscal 2006. The $124.9 million increase in operating cash flows from fiscal 2004 to 2005
is primarily attributable to the $119.8 million increase in income from continuing operations. The
Company continues to focus on working capital consistent with improving its business processes.
Investment Activities
Net cash used for investment activities during the year ended October 31, 2006 was $65.5
million compared to $240.7 million and $213.1 million for fiscal 2005 and 2004, respectively.
Investment activities for the year ended October 31, 2006 included $72.3 million of capital
expenditures, $21.5 million higher than fiscal 2005, and $5.7 million of proceeds from the sale of
Temroc. Investment activities for the year ended October 31, 2005 included the acquisition of
Mikron and Besten for $200.6 million. The cost of the acquisitions was partially offset by the
$11.7 million received from the sale of Piper Impact as well as proceeds received as a working
capital adjustment from the sale of Nichols Aluminum — Golden.
Capital expenditures increased $21.5 million and $32.1 million in fiscal 2006 and fiscal 2005,
respectively. The increases are attributable to the expansion of value added capabilities and
caster upgrades within the Company’s Vehicular Products segment (Phase VIII and Phase IX expansions
at MACSTEEL) coupled with Mikron’s capital spending for capacity expansion. The Company expects
2007 capital expenditures to decrease to approximately $40 million to $50 million as the MACSTEEL
capital expansion projects are completed by the end of the first quarter and Mikron’s spending is
reduced. At October 31, 2006, the Company had commitments of approximately $35.3 million for the
purchase or construction of capital assets. The Company plans to fund these capital expenditures
through cash flow from operations.
30
Financing Activities
Cash from financing activities was a $68.7 million use of cash, $0.5 million use of cash and a
$108.5 million source of cash for the years ended October 31, 2006, 2005 and 2004, respectively.
During fiscal 2006, the Company purchased $58.3 million of Quanex common stock and paid out $18.4
million in dividends. During fiscal 2005, the Company borrowed approximately $200.0 million to
fund the acquisition of Mikron. By the end of fiscal 2005, all $200.0 million had been repaid.
The amount of dividends paid was offset by the amount of cash received and related tax benefits
realized associated with the issuance of stock upon exercise of stock options. During fiscal 2004,
the primary reason for the source was the issuance of the Debentures.
Debt Structure and Activity
Refer to Item 8, Note 9 “Long-Term Debt and Financing Arrangements” for a discussion of the
Company’s debt structure.
Stock Purchase Program
On August 26, 2004, the Board of Directors authorized the Company to reload its stock buyback
program, increasing the existing authorization up to 2.25 million shares; and on August 24, 2006
the Board of Directors approved an additional increase of 2.0 million shares to the existing
program. The Company purchased 1,573,950 treasury shares for $58.3 million during the year ended
October 31, 2006. As of October 31, 2006, the remaining shares authorized for repurchase was
2,676,050. See Note 13 “Stock Repurchase Program and Treasury Stock” for further information.
During fiscal 2007, the Company may purchase shares, from time to time, on the open market or in
negotiated transactions, as circumstances warrant, depending upon market conditions and other
factors.
Contractual Obligations and Commercial Commitments
Contractual Cash Obligations
The following tables set forth certain information concerning the Company’s unconditional
obligations and commitments to make future payments under contracts with remaining terms in excess
of one year, such as debt and lease agreements, and under contingent commitments.
Payments Due by Period
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Less than |
|
|
1-3 |
|
|
4-5 |
|
|
More Than |
|
| Contractual Cash Obligations |
|
Total |
|
|
1 Year |
|
|
Years |
|
|
Years |
|
|
5 Years |
|
| |
|
(In thousands) |
|
Long-term debt, including interest(1) |
|
$ |
220,495 |
|
|
$ |
6,150 |
|
|
$ |
8,462 |
|
|
$ |
8,782 |
|
|
$ |
197,101 |
|
Operating leases(2) |
|
|
26,630 |
|
|
|
7,026 |
|
|
|
9,100 |
|
|
|
3,694 |
|
|
|
6,810 |
|
Unconditional purchase obligations(3) |
|
|
19,438 |
|
|
|
17,258 |
|
|
|
2,180 |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total contractual cash obligations |
|
$ |
266,563 |
|
|
$ |
30,434 |
|
|
$ |
19,742 |
|
|
$ |
12,476 |
|
|
$ |
203,911 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
The long-term debt is primarily comprised of the $125.0 million of Debentures due in
2034 and $8.3 million of various revenue bonds. The Debenture obligation is based on
the stated maturity, and the debt interest amounts are based on rates as of October 31,
2006. |
| |
| (2) |
|
Operating leases cover a range of items from facilities, fork trucks and cars to fax
machines and other miscellaneous equipment. |
31
|
|
|
| (3) |
|
The unconditional purchase obligations are made up of $7.2 million of natural gas
contracts and $7.3 million of aluminum scrap contracts along with other miscellaneous
repair and maintenance items. |
The Company expects to contribute $0.4 million to the pension plan and approximately $0.6
million to the postretirement benefit plan to fund current benefit payment requirements during
fiscal 2007. Pension and other postretirement plan contributions beyond 2007 are not determinable
since the amount of any contribution is heavily dependent on the future economic environment and
investment returns on pension plan assets. Obligations to these plans are based on current and
projected obligations of the plans, performance of the plan assets, if applicable, and any
participant contributions. Refer to Note 10 of Item 8 to the consolidated financial statements for
further information on these plans. Management believes the effect of the plans on liquidity is
not significant to the Corporation’s overall financial condition.
The timing of payments related to the Company’s Supplemental Benefit Plan and Deferred
Compensation Plan cannot be readily determined due to their uncertainty. The Supplemental Benefit
Plan liability of $4.7 million at October 31, 2006 was recorded as part of Other (non-current)
liabilities as no payments are anticipated for fiscal 2007. The Company intends to fund these
benefits with life insurance policies valued at $29.1 million as of October 31, 2006. Based on the
$6.1 million market value of the Company’s Deferred Compensation Plan, payments for fiscal 2007 are
estimated to be approximately $310 thousand.
Other Commercial Commitments
The following table reflects other commercial commitments or potential cash outflows that may
result from a contingent event, such as a need to borrow short-term funds for liquidity purposes.
Amount of Commitment Expiration per Period
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Total Amounts |
|
|
Less than |
|
|
1-3 |
|
|
4-5 |
|
|
More Than |
|
| Other Commercial Commitments |
|
Committed |
|
|
1 Year |
|
|
Years |
|
|
Years |
|
|
5 Years |
|
| |
|
(In thousands) |
|
Standby letters of credit |
|
$ |
15,479 |
|
|
$ |
10,405 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
5,074 |
|
Guarantees |
|
|
1,000 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
1,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total commercial commitments |
|
$ |
16,479 |
|
|
$ |
10,405 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
6,074 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements, as such term is defined in the
rules promulgated by the Securities and Exchange Commission, that have or are reasonably likely to
have a current or future effect on the Company’s financial condition, changes in financial
condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital
resources that are material to investors.
Effects of Inflation
Inflation has not had a significant effect on earnings and other financial statement items.
Critical Accounting Estimates
The preparation of these financial statements requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and accompanying
footnotes. Estimates and
assumptions about future events and their effects cannot be perceived with certainty.
Estimates may change as new events occur, as more experience is acquired, as additional information
becomes available and as the Company’s operating environment changes. Actual results could differ
from estimates.
32
The Company believes the following are the most critical accounting policies used in the
preparation of the Company’s consolidated financial statements as well as the significant judgments
and uncertainties affecting the application of these policies.
Revenue Recognition and Allowance for Doubtful Accounts
The Company recognizes revenue when the products are shipped and the title and risk of
ownership pass to the customer. Selling prices are fixed based on purchase orders or contractual
agreements. Inherent in the Company’s revenue recognition policy is the determination of
collectibility. This requires management to make frequent judgments and estimates in order to
determine the appropriate amount of allowance needed for doubtful accounts. The Company’s
allowance for doubtful accounts is estimated to cover the risk of loss related to accounts
receivable. This allowance is maintained at a level the Company considers appropriate based on
historical and other factors that affect collectibility. These factors include historical trends
of write-offs, recoveries and credit losses, the careful monitoring of portfolio credit quality,
and projected economic and market conditions. Different assumptions or changes in economic
circumstances could result in changes to the allowance.
Inventory
The Company records inventory valued at the lower of cost or market value. Inventories are
valued using both the first-in first-out (FIFO) and last in, first out (LIFO) methods. The Company
adopted the link chain LIFO method in fiscal 1973. Since then, acquisitions were integrated into
the Company’s operations with some valuing inventories on a LIFO basis and others on a FIFO basis.
Inventory quantities are regularly reviewed and provisions for excess or obsolete inventory are
recorded primarily based on the Company’s forecast of future demand and market conditions.
Significant unanticipated changes to the Company’s forecasts could require a change in the
provision for excess or obsolete inventory.
Environmental Contingencies
Quanex is subject to extensive laws and regulations concerning the discharge of materials into
the environment and the remediation of chemical contamination. To satisfy such requirements,
Quanex must make capital and other expenditures on an ongoing basis. The Company accrues its best
estimates of its remediation obligations and adjusts such accruals as further information and
circumstances develop. Those estimates may change substantially depending on information about the
nature and extent of contamination, appropriate remediation technologies, and regulatory approvals.
In accruing for environmental liabilities, costs of future expenditures for environmental
remediation are not discounted to their present value, unless the amount and timing of the
expenditures are fixed or reliably determinable. When environmental laws might be deemed to impose
joint and several liability for the costs of responding to contamination, the Company accrues its
allocable share of liability taking into account the number of parties participating, their ability
to pay their shares, the volumes and nature of the wastes involved, the nature of anticipated
response actions, and the nature of the Company’s alleged connections. Recoveries of environmental
remediation costs from other parties are recorded as assets when their receipt is deemed probable.
Unanticipated changes in circumstances and/or legal requirements could result in expenses being
incurred in future periods in addition to an increase in actual cash required to remediate
contamination for which the Company is responsible.
33
Impairment or Disposal of Long-Lived Assets
Property, Plant and Equipment and Intangibles
The Company makes judgments and estimates in conjunction with the carrying value of property,
plant and equipment, other intangibles, and other assets, including amounts to be capitalized,
depreciation and amortization methods and useful lives. Additionally, carrying values of these
assets are reviewed for impairment whenever events or changes in circumstances indicate that
carrying value may not be recoverable. The Company determines that the carrying amount is not
recoverable if the carrying amount exceeds the sum of the undiscounted cash flows expected to
result from the use and eventual disposition of the asset. If the carrying value exceeds the sum
of the undiscounted cash flows, an impairment charge is recorded in the period in which such review
is performed. The Company measures the impairment loss as the amount by which the carrying amount
of the long-lived asset exceeds its fair value as determined by quoted market prices in active
markets or by discounted cash flows. This requires the Company to make long-term forecasts of its
future revenues and costs related to the assets subject to review. Forecasts require assumptions
about demand for the Company’s products and future market conditions. Future events and
unanticipated changes to assumptions could require a provision for impairment in a future period.
Goodwill
The purchase method of accounting for business combinations requires the Company to make use
of estimates and judgments to allocate the purchase price paid for acquisitions to the fair value
of the net tangible and identifiable intangible assets. The Company performs a goodwill impairment
test annually as of August 31. In addition, goodwill would be tested more frequently if changes in
circumstances or the occurrence of events indicates that a potential impairment exists. The
Company tests for impairment of its goodwill using a two-step approach as prescribed in SFAS 142.
The first step of the Company’s goodwill impairment test compares the fair value of each reporting
unit with its carrying value including assigned goodwill. The second step of the Company’s
goodwill impairment test is required only in situations where the carrying value of the reporting
unit exceeds its fair value as determined in the first step. In such instances, the Company
compares the implied fair value of goodwill to its carrying value. The implied fair value of
goodwill is determined by allocating the fair value of a reporting unit to all of the assets and
liabilities of that unit as if the reporting unit had been acquired in a business combination and
the fair value of the reporting unit was the price paid to acquire the reporting unit. The excess
of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is
the implied fair value of goodwill. An impairment loss is recorded to the extent that the carrying
amount of the reporting unit goodwill exceeds the implied fair value of that goodwill. The Company
primarily uses the present value of future cash flows to determine fair value and validates the
result against the market approach. Future cash flows are typically based upon appropriate future
periods for the businesses and an estimated residual value. Management judgment is required in the
estimation of future operating results and to determine the appropriate residual values. The
residual values are determined by reference to an exchange transaction in an existing market for
that asset. Future operating results and residual values could reasonably differ from the
estimates and could require a provision for impairment in a future period.
Disposal
In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived
Assets,” (SFAS 144) the Company presents the results of operations, financial position and cash
flows of operations that have either been sold or that meet the criteria for “held for sale
accounting” as discontinued operations. At the time an operation qualifies for held for sale
accounting, the operation is evaluated to determine whether or not the carrying value exceeds its
fair value less cost to sell. Any loss as a result of carrying value in excess of fair value less
cost to sell is recorded in the period the operation meets held for sale accounting. Management
judgment is
required to (1) assess the criteria required to meet held for sale accounting, and (2)
estimate fair value. Changes to the operation could cause it to no longer qualify for held for
sale accounting and changes to fair value could result in an increase or decrease to previously
recognized losses.
34
Income Taxes
The Company records the estimated future tax effects of temporary differences between the tax
basis of assets and liabilities and the amounts reported in the Company’s consolidated balance
sheet, as well as operating loss and tax credit carry forwards. The carrying value of the net
deferred tax liability reflects the Company’s assumption that the Company will be able to generate
sufficient future taxable income in certain jurisdictions to realize its deferred tax assets. If
the estimates and assumptions change in the future, the Company may be required to record a
valuation allowance against a portion of its deferred tax assets. This could result in additional
income tax expense in a future period in the consolidated statement of income.
Retirement and Pension Plans
The Company sponsors a number of defined benefit pension plans and an unfunded postretirement
plan that provides health care and life insurance benefits for eligible retirees and dependents.
The measurement of liabilities related to these plans is based on management’s assumptions related
to future events, including expected return on plan assets, rate of compensation increases and
health care cost trend rates. The discount rate, which is determined using a model that matches
corporate bond securities, is applied against the projected pension and postretirement
disbursements. Actual pension plan asset investment performance will either reduce or increase
unamortized pension losses at the end of any fiscal year, which ultimately affects future pension
costs.
The effects of the decrease in selected assumptions, assuming no changes in benefit levels and
no amortization of gains or losses for the pension plans in fiscal 2006, is shown below:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Effect on all Defined Benefit Pension Plans |
|
| |
|
October 31, 2006 |
|
| |
|
|
|
|
|
Increase |
|
|
|
|
| |
|
|
|
|
|
(Decrease) in |
|
|
Increase |
|
| |
|
Percentage |
|
|
Projected Benefit |
|
|
(Decrease) in 2006 |
|
| Assumption |
|
Point Change |
|
|
Obligation |
|
|
Pension Expense |
|
| |
|
(In thousands) |
|
Discount rate |
|
-0.5 pts |
|
$ |
6,166 |
|
|
$ |
830 |
|
Assumed return on plan assets |
|
-0.5 pts |
|
|
N/A |
|
|
|
261 |
|
Accounting guidance applicable to pensions does not require immediate recognition of the
effects of a deviation between actual and assumed experience and the revision of an estimate. This
approach allows the favorable and unfavorable effects that fall within an acceptable range to be
netted and disclosed as an unrecognized gain or loss in the footnotes. At October 31, 2006 and
2005, there were unrecognized losses of $13.0 million and $18.8 million, respectively. A portion
of the loss will be amortized in fiscal year 2007. The effect on fiscal years after 2007 will
depend on the actual experience of the plans.
35
Postretirement plan assumptions reflect our historical experience and our best judgments
regarding future expectations. Assumed health care cost trend rates could have an effect on the
amounts reported for post retirement benefit plans. A one-percentage point change in assumed
health care cost trend rates would have the following effects:
| |
|
|
|
|
|
|
|
|
| |
|
One |
|
|
One |
|
| |
|
Percent |
|
|
Percent |
|
| |
|
Increase |
|
|
Decrease |
|
| |
|
(In thousands) |
|
Effect on total service and interest cost components |
|
$ |
9 |
|
|
$ |
(8 |
) |
Effect on postretirement benefit obligation |
|
|
180 |
|
|
|
(163 |
) |
Mortality assumptions used to determine the obligations for our pension and other
postretirement benefit plans are related to the experience of the plans and to our third-party
actuary’s best estimate of expected plan mortality. The mortality assumptions for fiscal 2006
valuation purposes were updated to the RP-2000 tables. The change of this assumption increased the
projected benefit obligation and pension expense for fiscal 2006 by $2.9 million and $0.6 million,
respectively.
New Accounting Pronouncements
Stock—Based Compensation
On November 1, 2005, the Company adopted SFAS No. 123 (revised 2004), “Share-Based Payment”
(SFAS 123R) issued by the Financial Accounting Standards Board (FASB) in December 2004. SFAS 123R
requires companies to measure all employee stock-based compensation awards using a fair value
method and record such expense in the consolidated financial statements. Prior to November 1,
2005, under the disclosure only provisions of SFAS No. 123, “Accounting for Stock-Based
Compensation” (SFAS 123), the Company applied Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees” (APB 25), and related Interpretations in accounting for
its stock option plans. Accordingly, prior to fiscal 2006, the Company recognized zero stock-based
compensation expense in its income statement for non-qualified stock options, as the exercise price
was equal to the closing market price of the Company’s stock on the date of grant. However, the
Company did recognize stock-based compensation expense for its restricted stock plans for the
fiscal year ended October 31, 2005. In March 2005, the Securities and Exchange Commission issued
Staff Accounting Bulletin No. 107 (SAB 107) relating to SFAS 123R. The Company has applied the
provisions of SAB 107 in its adoption of SFAS 123R.
The Company elected the modified prospective transition method as permitted by the adoption of
SFAS 123R. Under this transition method, stock-based compensation expense beginning as of November
1, 2005 includes (i) compensation expense for all stock-based compensation awards granted prior to,
but not yet vested as of October 31, 2005, based on the grant-date fair value estimated in
accordance with the original proforma provisions of SFAS 123; and (ii) compensation expense for all
stock-based compensation awards granted subsequent to October 31, 2005, based on the grant-date
fair value estimated in accordance with the provisions of SFAS 123R. Prior to the adoption of SFAS
123R, unearned compensation was shown as a reduction of stockholders’ equity. The November 1, 2005
unearned compensation balance of $1.4 million was reclassified against additional paid-in-capital
upon adoption of SFAS 123R. In fiscal 2006 and future periods, common stock par value will be
recorded when the restricted stock is issued and additional paid-in-capital will be increased as
the restricted stock compensation cost is recognized for financial reporting purposes. In
accordance with the modified prospective transition method, the Company’s Consolidated Financial
Statements for prior periods have not been restated to reflect, and do not include, the impact of
SFAS 123R.
The Company recognizes compensation expense on a straight-line basis over the requisite
service period of the award. As stock-based compensation expense recognized in the income
statement beginning November 1, 2005 is based on awards ultimately expected to vest, it has been
reduced for estimated forfeitures. SFAS 123R requires forfeitures to be estimated at the time of
grant and revised, when necessary, in subsequent periods if actual
forfeitures differ from those estimates. Forfeitures were estimated based on historical
experience. In the Company’s proforma information required under SFAS 123 for the periods prior to
fiscal 2006, the Company accounted for forfeitures as they occurred. Prior to the implementation
of SFAS 123R, the Company computed stock-based compensation cost for employees eligible to retire
over the standard vesting period of the grants. Upon adoption of SFAS 123R, the Company amortizes
new option grants to such retirement-eligible employees immediately upon grant, consistent with the
retirement vesting acceleration provisions of these grants. For employees near retirement age, the
Company amortizes such grants over the period from the grant date to the retirement date if such
period is shorter than the standard vesting schedule.
36
The following is the effect for the year ended October 31, 2006 of adopting SFAS 123R (in
thousands except per share amounts):
| |
|
|
|
|
Decrease in operating income and income from continuing
operations |
|
$ |
4,024 |
|
Related deferred income tax benefit |
|
|
(1,489 |
) |
|
|
|
|
Decrease in net income |
|
$ |
2,535 |
|
|
|
|
|
Decrease in basic earnings per common share |
|
$ |
(0.07 |
) |
Decrease in diluted earnings per common share |
|
$ |
(0.06 |
) |
The amounts above relate to the impact of recognizing compensation expense for stock options
only, as compensation expense related to restricted stock was recognized by the Company before
implementation of SFAS 123R under previous accounting standards.
In accordance with SFAS 123R, the consolidated statements of cash flow report the excess tax
benefits from the stock-based compensation as financing cash inflows. For the year ended October
31, 2006, $4.4 million of excess tax benefits were reported as financing cash inflows.
Under SFAS 123R, the Company continues to use the Black-Scholes-Merton option-pricing model to
estimate the fair value of its stock options. However, the Company has applied the expanded
guidance under SFAS 123R and SAB 107 for the development of the assumptions used as inputs for the
Black-Scholes-Merton option pricing model for grants beginning November 1, 2005. The Company’s
fair value determination of stock-based payment awards on the date of grant using an option-pricing
model is affected by the Company’s stock price as well as assumptions regarding a number of highly
complex and subjective variables. These variables include, but are not limited to, the Company’s
expected stock price volatility over the term of the awards and actual and projected employee stock
option exercise behavior. Option-pricing models were developed for use in estimating the value of
traded options that have no vesting or hedging restrictions and are fully transferable. Because
the Company’s employee stock options have certain characteristics that are significantly different
from traded options, and because changes in the subjective assumptions can materially affect the
estimated value, in management’s opinion, the existing valuation models may not provide an accurate
measure of the fair value of the Company’s employee stock options. Although the fair value of
employee stock options is determined in accordance with SFAS 123R and SAB 107 using an
option-pricing model, that value may not be indicative of the fair value observed in a willing
buyer/willing seller market transaction.
On November 10, 2005, the FASB issued FASB Staff Position No. SFAS 123(R)-3, “Transition
Election Related to Accounting for Tax Effects of Share-Based Payment Awards” (FSP 123R-3). The
alternative transition method includes simplified methods to establish the beginning balance of the
additional paid-in capital pool (APIC pool) related to the tax effects of employee stock-based
compensation, and to determine the subsequent
impact on the APIC pool and Consolidated Statements of Cash Flows of the tax effects of
employee stock-based compensation awards that are outstanding upon adoption of SFAS 123R. The
Company had until November 2006 to make this one-time election, but adopted FSP 123R-3 early and
upon adoption elected the alternative transition method for its fiscal 2006 reporting.
Additionally, the Company is utilizing a one pool approach, grouping employee and non-employee
awards together. The election of the alternative transition method decreased operating cash flows
and equally increased financing cash flows by $0.4 million for fiscal year 2006, but did not affect
operating income or net income.
See Note 14 of Item 8 for additional stock-based compensation disclosures.
37
Other
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit
Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and
132(R)” (SFAS 158), which requires recognition of the funded status of a benefit plan in the
balance sheet. SFAS 158 also requires recognition, in other comprehensive income, of certain gains
and losses that arise during the period but which are deferred under pension accounting rules. SFAS
158 also requires defined benefit plan assets and obligations to be measured as of the date of the
employer’s fiscal year-end. SFAS 158 provides recognition and disclosure elements that will be
effective for fiscal years ending after December 15, 2006 (as of October 31, 2007 for the Company)
and measurement date elements that will be effective for fiscal years ending after December 15,
2008 (as of October 31, 2009 for the Company). The Company is currently evaluating the
recognition element of adopting SFAS 158; such adoption will be impacted by plan returns during
fiscal 2007. The measurement date element will not have an impact on the Company as the Company
already measures the plan assets and obligations as of the end of its fiscal year.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS 157), which
defines fair value, establishes a framework for measuring fair value in accordance with generally
accepted accounting principles, and expands disclosures about fair value measurements. The
provisions of SFAS 157 are effective for fiscal years beginning after November 15, 2007 (as of
November 1, 2008 for the Company). The Company is currently evaluating the impact of adopting SFAS
157 on its consolidated financial statements.
In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income
Taxes” (FIN 48) which is effective for fiscal years beginning after December 15, 2006 (as of
November 1, 2007 for the Company) and is an interpretation of FASB Statement No. 109, “Accounting
for Income Taxes”. FIN 48 prescribes a recognition threshold and measurement attribute for
recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN
48 also provides guidance on derecognition and expanded disclosure requirements. The Company is
currently assessing the impact, if any, that the adoption of FIN 48 will have on the Company’s
financial statements.
In October 2004, the President signed into law the American Jobs Creation Act (the AJC Act).
The AJC Act allows for a federal income tax deduction for a percentage of income earned from
certain domestic production activities. The Company’s U.S. production activities qualify for the
deduction. Based on the effective date of this provision of the AJC Act, the Company is eligible
for this deduction beginning in fiscal 2006. Additionally, in December 2004, the FASB issued FASB
Staff Position 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes (SFAS
109), to the Tax Deduction on Qualified Production Activities Provided by the American Jobs
Creation Act of 2004” (FSP 109-1). FSP 109-1, which was effective upon issuance, requires the
Company to treat the tax deduction as a special deduction instead of a change in tax rate that
would have impacted the existing deferred tax balances. This special deduction reduced the
Company’s effective tax rate in fiscal 2006 by approximately 1%.
38
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The following discussion of the Company and its subsidiaries’ exposure to various market risks
contains “forward looking statements” that involve risks and uncertainties. These projected results
have been prepared utilizing certain assumptions considered reasonable in light of information
currently available to the Company. Nevertheless, because of the inherent unpredictability of
interest rates, foreign currency rates and metal commodity prices as well as other factors, actual
results could differ materially from those projected in such forward looking information. The
Company does not use derivative financial instruments for speculative or trading purposes. For a
description of the Company’s significant accounting policies associated with these activities, see
Note 1 to the Consolidated Financial Statements.
Interest Rate Risk
The Company and its subsidiaries have a Credit Facility and other long-term debt which subject
the Company to the risk of loss associated with movements in market interest rates. At October 31,
2006 and 2005, the Company had fixed-rate debt totaling $126.8 million and $126.9 million,
respectively. This debt is fixed-rate and, therefore, does not expose the Company to the risk of
earnings loss due to changes in market interest rates.
The Company and certain of its subsidiaries’ floating-rate obligations totaled $6.6 million
and $9.0 million at October 31, 2006 and 2005, respectively. Based on the floating-rate
obligations outstanding at October 31, 2005, a one percent increase or decrease in the average
interest rate would result in a change to pre-tax interest expense of approximately $66 thousand.
Commodity Price Risk
The Vehicular Products segment has a scrap surcharge program in place, which is a practice
that is well established within the engineered steel bar industry. The scrap surcharge is based on
a three city, three- or one- month trailing average of #1 bundle scrap prices.. The Company’s
long-term exposure to changes in scrap costs is significantly reduced because of the surcharge
program. Over time, the Company recovers the majority of its scrap cost increases, though there is
a level of exposure to short-term volatility because of this lag. Historically, the segment’s
scrap surcharge has been based on a three-month trailing average. However, during the first
quarter of 2006, Quanex has moved approximately 85% of the accounts, representing about 70% of
shipments, to a one-month cycle. Reducing the adjustment period from three months to one month is
expected to reduce the segment’s margin volatility in the future.
Within the Aluminum Sheet Building Products segment, the Company uses various grades of
aluminum scrap as well as minimal amounts of prime aluminum ingot as raw materials for its
manufacturing processes. The price of this aluminum raw material is subject to fluctuations due to
many factors in the aluminum market. In the normal course of business, Nichols Aluminum enters
into firm price sales commitments with its customers. In an effort to reduce the risk of
fluctuating raw material prices, Nichols Aluminum enters into firm price raw material purchase
commitments (which are designated as “normal purchases” under SFAS No. 133, “Accounting for
Derivative Instruments and Hedging Activities”) as well as option contracts on the LME. The
Company’s risk management policy as it relates to these LME contracts is to enter into contracts to
cover the raw material needs of the Company’s committed sales orders, to the extent not covered by
fixed price purchase commitments.
39
Through the use of firm price raw material purchase commitments and LME contracts, the Company
intends to protect cost of sales from the effects of changing prices of aluminum. To the extent
that the raw material costs factored into the firm price sales commitments are matched with firm
price raw material purchase commitments, changes in aluminum prices should have no effect. During
fiscal 2006 and 2005, the Company
primarily relied upon firm price raw material purchase commitments to protect cost of sales
tied to firm price sales commitments. There were no outstanding LME hedges as of October 31, 2006
and October 31, 2005.
Within the Engineered Building Products segment, polyvinyl resin (PVC) is the significant raw
material consumed during the manufacture of vinyl extrusions. The Company has a monthly resin
adjustor in place with its customers that is adjusted based upon published industry resin prices.
This adjuster effectively shares the base pass-through price changes of PVC with its customers
commensurate with the market at large. The Company’s long-term exposure to changes in PVC prices
is thus significantly reduced due to the contractual component of the resin adjustor program.
40
Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Quanex Corporation
Houston, TX
We have audited the accompanying consolidated balance sheets of Quanex Corporation and subsidiaries
(the “Company”) as of October 31, 2006 and 2005, and the related consolidated statements of income,
stockholders’ equity, and cash flows for each of the three years in the period ended October 31,
2006. Our audits also included the financial statement schedule listed in the Index at Item
15(a)2. These financial statements and financial statement schedule are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these financial statements
based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects,
the financial position of the Company as of October 31, 2006 and 2005, and the results of its
operations and its cash flows for each of the three years in the period ended October 31, 2006, in
conformity with accounting principles generally accepted in the United States of America. Also, in
our opinion, such financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the effectiveness of the Company’s internal control over financial reporting
as of October 31, 2006, based on the criteria established in Internal Control—Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated
December 15, 2006 expressed an unqualified opinion on management’s assessment of the effectiveness
of the Company’s internal control over financial reporting and an unqualified opinion on the
effectiveness of the Company’s internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
Houston, TX
December 15, 2006
41
QUANEX CORPORATION
CONSOLIDATED BALANCE SHEETS
| |
|
|
|
|
|
|
|
|
| |
|
October 31, |
|
| |
|
2006 |
|
|
2005 |
|
| |
|
(In thousands, except share data) |
|
ASSETS |
|
|
|
|
|
|
|
|
Current assets: |
|
|
|
|
|
|
|
|
Cash and equivalents |
|
$ |
105,708 |
|
|
$ |
49,681 |
|
Accounts and notes receivable, net of allowance of $4,180 and $7,609 |
|
|
184,311 |
|
|
|
152,072 |
|
Inventories |
|
|
142,788 |
|
|
|
133,003 |
|
Deferred income taxes |
|
|
12,218 |
|
|
|
12,864 |
|
Other current assets |
|
|
5,584 |
|
|
|
4,669 |
|
Current assets of discontinued operations |
|
|
— |
|
|
|
5,504 |
|
|
|
|
|
|
|
|
Total current assets |
|
|
450,609 |
|
|
|
357,793 |
|
|
|
|
|
|
|
|
Property, plant and equipment, net |
|
|
432,058 |
|
|
|
423,942 |
|
Goodwill |
|
|
196,350 |
|
|
|
196,341 |
|
Cash surrender value insurance policies |
|
|
29,108 |
|
|
|
28,442 |
|
Intangible assets, net |
|
|
75,285 |
|
|
|
82,360 |
|
Other assets |
|
|
18,742 |
|
|
|
20,054 |
|
Assets of discontinued operations |
|
|
— |
|
|
|
5,846 |
|
|
|
|
|
|
|
|
Total assets |
|
$ |
1,202,152 |
|
|
$ |
1,114,778 |
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ EQUITY |
|
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
|
Accounts payable |
|
$ |
137,564 |
|
|
$ |
129,152 |
|
Accrued liabilities |
|
|
54,943 |
|
|
|
64,466 |
|
Income taxes payable |
|
|
13,185 |
|
|
|
14,465 |
|
Current maturities of long-term debt |
|
|
2,721 |
|
|
|
2,459 |
|
Current liabilities of discontinued operations |
|
|
— |
|
|
|
4,208 |
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
208,413 |
|
|
|
214,750 |
|
|
|
|
|
|
|
|
Long-term debt |
|
|
130,680 |
|
|
|
133,462 |
|
Deferred pension credits |
|
|
1,115 |
|
|
|
8,158 |
|
Deferred postretirement welfare benefits |
|
|
7,300 |
|
|
|
7,519 |
|
Deferred income taxes |
|
|
66,189 |
|
|
|
58,836 |
|
Non-current environmental reserves |
|
|
14,186 |
|
|
|
17,784 |
|
Other liabilities |
|
|
15,754 |
|
|
|
15,407 |
|
Liabilities of discontinued operations |
|
|
— |
|
|
|
2,120 |
|
|
|
|
|
|
|
|
Total liabilities |
|
|
443,637 |
|
|
|
458,036 |
|
|
|
|
|
|
|
|
Commitments and contingencies (Note 17) |
|
|
|
|
|
|
|
|
Stockholders’ equity: |
|
|
|
|
|
|
|
|
Preferred stock, no par value, shares authorized 1,000,000; issued and
outstanding—none |
|
|
— |
|
|
|
— |
|
Common stock, $0.50 par value, shares authorized 50,000,000; issued 38,319,960
and 38,198,199 |
|
|
19,160 |
|
|
|
19,092 |
|
Additional paid-in-capital |
|
|
208,714 |
|
|
|
198,333 |
|
Retained earnings |
|
|
579,753 |
|
|
|
445,670 |
|
Unearned compensation |
|
|
— |
|
|
|
(1,388 |
) |
Accumulated other comprehensive income (loss) |
|
|
(1,736 |
) |
|
|
(3,217 |
) |
|
|
|
|
|
|
|
|
|
|
805,891 |
|
|
|
658,490 |
|
Less treasury stock, at cost, 1,200,617 and 0 shares |
|
|
(45,628 |
) |
|
|
— |
|
Less common stock held by Rabbi Trust - 130,329 shares |
|
|
(1,748 |
) |
|
|
(1,748 |
) |
|
|
|
|
|
|
|
Total stockholders’ equity |
|
|
758,515 |
|
|
|
656,742 |
|
|
|
|
|
|
|
|
Total liabilities and stockholders’ equity |
|
$ |
1,202,152 |
|
|
$ |
1,114,778 |
|
|
|
|
|
|
|
|
See notes to consolidated financial statements.
42
QUANEX CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years ended October 31, |
|
| |
|
2006 |
|
|
2005 |
|
|
2004 |
|
| |
|
(In thousands, except per share amounts) |
|
Net sales |
|
$ |
2,032,572 |
|
|
$ |
1,969,007 |
|
|
$ |
1,437,897 |
|
Cost and expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales (exclusive of items shown separately below) |
|
|
1,617,399 |
|
|
|
1,512,980 |
|
|
|
1,225,784 |
|
Selling, general and administrative |
|
|
92,705 |
|
|
|
97,851 |
|
|
|
63,735 |
|
Depreciation and amortization |
|
|
71,074 |
|
|
|
65,401 |
|
|
|
49,381 |
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
|
251,394 |
|
|
|
292,775 |
|
|
|
98,997 |
|
Interest expense |
|
|
(4,818 |
) |
|
|
(9,300 |
) |
|
|
(5,967 |
) |
Other, net |
|
|
4,240 |
|
|
|
151 |
|
|
|
335 |
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations before income taxes |
|
|
250,816 |
|
|
|
283,626 |
|
|
|
93,365 |
|
Income tax expense |
|
|
(90,503 |
) |
|
|
(106,393 |
) |
|
|
(35,937 |
) |
|
|
|
|
|
|
|
|
|
|
Income from continuing operations |
|
|
160,313 |
|
|
|
177,233 |
|
|
|
57,428 |
|
Income (loss) from discontinued operations, net of taxes |
|
|
(130 |
) |
|
|
(22,073 |
) |
|
|
(2,961 |
) |
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
160,183 |
|
|
$ |
155,160 |
|
|
$ |
54,467 |
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from continuing operations |
|
$ |
4.28 |
|
|
$ |
4.69 |
|
|
$ |
1.55 |
|
Income (loss) from discontinued operations |
|
|
(0.01 |
) |
|
|
(0.58 |
) |
|
|
(0.08 |
) |
|
|
|
|
|
|
|
|
|
|
Basic earnings per share |
|
$ |
4.27 |
|
|
$ |
4.11 |
|
|
$ |
1.47 |
|
|
|
|
|
|
|
|
|
|
|
Diluted earning per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from continuing operations |
|
$ |
4.09 |
|
|
$ |
4.50 |
|
|
$ |
1.53 |
|
Income (loss) from discontinued operations |
|
|
(0.01 |
) |
|
|
(0.55 |
) |
|
|
(0.08 |
) |
|
|
|
|
|
|
|
|
|
|
Diluted earnings per share |
|
$ |
4.08 |
|
|
$ |
3.95 |
|
|
$ |
1.45 |
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding: |
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
37,479 |
|
|
|
37,772 |
|
|
|
36,981 |
|
Diluted |
|
|
39,708 |
|
|
|
39,809 |
|
|
|
37,571 |
|
See notes to consolidated financial statements.
43
QUANEX CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
Other |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
Income |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Additional |
|
|
|
|
|
|
Minimum |
|
|
|
|
|
|
Treasury |
|
|
Total |
|
| |
|
Comprehensive |
|
|
Common |
|
|
Paid-in |
|
|
Retained |
|
|
Pension |
|
|
|
|
|
|
Stock & |
|
|
Stockholders’ |
|
| Years Ended October 31, 2006, 2005 and 2004 |
|
Income |
|
|
Stock |
|
|
Capital |
|
|
Earnings |
|
|
Liability |
|
|
Other |
|
|
Other |
|
|
Equity |
|
| |
|
|
|
|
(In thousands, except share data) |
|
Balance at October 31, 2003 |
|
|
|
|
|
$ |
18,586 |
|
|
$ |
176,788 |
|
|
$ |
264,067 |
|
|
$ |
(3,639 |
) |
|
$ |
(2 |
) |
|
$ |
(10,641 |
) |
|
$ |
445,159 |
|
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
54,467 |
|
|
|
|
|
|
|
|
|
|
|
54,467 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
54,467 |
|
Adjustment for minimum pension
liability (net of taxes of $563) |
|
|
(880 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(880 |
) |
|
|
|
|
|
|
|
|
|
|
(880 |
) |
Foreign currency translation
adjustment |
|
|
56 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
56 |
|
|
|
|
|
|
|
56 |
|
Derivative transaction, reclassifications
into earnings (net of taxes of $1) |
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income |
|
$ |
53,645 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common dividends ($0.31 per share) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(11,530 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(11,530 |
) |
Common stock held by Rabbi Trust |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(442 |
) |
|
|
(442 |
) |
Cost of common stock in treasury |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,160 |
|
|
|
9,160 |
|
Other |
|
|
|
|
|
|
144 |
|
|
|
4,481 |
|
|
|
750 |
|
|
|
|
|
|
|
|
|
|
|
(660 |
) |
|
|
4,715 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at October 31, 2004 |
|
|
|
|
|
$ |
18,730 |
|
|
$ |
181,269 |
|
|
$ |
307,754 |
|
|
$ |
(4,519 |
) |
|
$ |
56 |
|
|
$ |
(2,583 |
) |
|
$ |
500,707 |
|
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
155,160 |
|
|
|
|
|
|
|
|
|
|
|
155,160 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
155,160 |
|
Adjustment for minimum pension
liability (net of taxes of $778) |
|
|
1,218 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,218 |
|
|
|
|
|
|
|
|
|
|
|
1,218 |
|
Foreign currency translation adjustment |
|
|
28 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
28 |
|
|
|
|
|
|
|
28 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income |
|
$ |
156,406 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common dividends ($0.37 per share) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(14,296 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(14,296 |
) |
Stock options exercised |
|
|
|
|
|
|
337 |
|
|
|
8,171 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,508 |
|
Stock-based compensation tax benefit |
|
|
|
|
|
|
|
|
|
|
5,787 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,787 |
|
Other |
|
|
|
|
|
|
25 |
|
|
|
3,106 |
|
|
|
(2,948 |
) |
|
|
|
|
|
|
|
|
|
|
(553 |
) |
|
|
(370 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at October 31, 2005 |
|
|
|
|
|
$ |
19,092 |
|
|
$ |
198,333 |
|
|
$ |
445,670 |
|
|
$ |
(3,301 |
) |
|
$ |
84 |
|
|
$ |
(3,136 |
) |
|
$ |
656,742 |
|
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
160,183 |
|
|
|
|
|
|
|
|
|
|
|
160,183 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
160,183 |
|
Adjustment for minimum pension
liability (net of taxes of $913) |
|
|
1,428 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,428 |
|
|
|
|
|
|
|
|
|
|
|
1,428 |
|
Foreign currency translation adjustment |
|
|
53 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
53 |
|
|
|
|
|
|
|
53 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income |
|
$ |
161,664 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common dividends ($0.48 per share) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(18,362 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(18,362 |
) |
Treasury shares purchased, at cost |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(58,326 |
) |
|
|
(58,326 |
) |
Stock -based compensation activity: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation earned |
|
|
|
|
|
|
(9 |
) |
|
|
5,157 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,148 |
|
Stock options exercised |
|
|
|
|
|
|
54 |
|
|
|
1,785 |
|
|
|
(7,742 |
) |
|
|
|
|
|
|
|
|
|
|
12,597 |
|
|
|
6,694 |
|
Restricted stock awards |
|
|
|
|
|
|
15 |
|
|
|
(116 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
101 |
|
|
|
— |
|
Stock-based compensation tax benefit |
|
|
|
|
|
|
|
|
|
|
4,955 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,955 |
|
Reclassification of unearned
compensation for restricted stock |
|
|
|
|
|
|
|
|
|
|
(1,388 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,388 |
|
|
|
— |
|
Other |
|
|
|
|
|
|
8 |
|
|
|
(12 |
) |
|
|
4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at October 31, 2006 |
|
|
|
|
|
$ |
19,160 |
|
|
$ |
208,714 |
|
|
$ |
579,753 |
|
|
$ |
(1,873 |
) |
|
$ |
137 |
|
|
$ |
(47,376 |
) |
|
$ |
758,515 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See notes to consolidated financial statements.
44
QUANEX CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (continued)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended October 31, 2006, 2005 and 2004 |
|
| |
|
|
|
|
|
Common Shares |
|
| |
|
Preferred |
|
|
|
|
|
|
|
|
|
|
Rabbi |
|
|
Net |
|
| |
|
Shares Issued |
|
|
Issued |
|
|
Treasury |
|
|
Trust |
|
|
Outstanding |
|
Balance at October 31, 2003 |
|
|
— |
|
|
|
37,168,360 |
|
|
|
(663,306 |
) |
|
|
(106,891 |
) |
|
|
36,398,163 |
|
Stock issued—options exercised (net of trade-ins) |
|
|
|
|
|
|
256,010 |
|
|
|
604,530 |
|
|
|
— |
|
|
|
860,540 |
|
Stock issued—compensation plans |
|
|
|
|
|
|
21,375 |
|
|
|
53,550 |
|
|
|
— |
|
|
|
74,925 |
|
Rabbi Trust |
|
|
|
|
|
|
18,696 |
|
|
|
5,226 |
|
|
|
(23,922 |
) |
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at October 31, 2004 |
|
|
— |
|
|
|
37,464,441 |
|
|
|
— |
|
|
|
(130,813 |
) |
|
|
37,333,628 |
|
Stock options exercised |
|
|
|
|
|
|
688,354 |
|
|
|
|
|
|
|
— |
|
|
|
688,354 |
|
Stock issued—compensation plans |
|
|
|
|
|
|
47,687 |
|
|
|
|
|
|
|
— |
|
|
|
47,687 |
|
Stock — other |
|
|
|
|
|
|
(1,799 |
) |
|
|
|
|
|
|
— |
|
|
|
(1,799 |
) |
Rabbi Trust |
|
|
|
|
|
|
(484 |
) |
|
|
|
|
|
|
484 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at October 31, 2005 |
|
|
— |
|
|
|
38,198,199 |
|
|
|
— |
|
|
|
(130,329 |
) |
|
|
38,067,870 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Treasury shares purchased |
|
|
|
|
|
|
— |
|
|
|
(1,573,950 |
) |
|
|
— |
|
|
|
(1,573,950 |
) |
Stock options exercised |
|
|
|
|
|
|
110,589 |
|
|
|
370,333 |
|
|
|
— |
|
|
|
480,922 |
|
Restricted stock awards |
|
|
|
|
|
|
30,885 |
|
|
|
3,000 |
|
|
|
— |
|
|
|
33,885 |
|
Forfeiture of restricted stock |
|
|
|
|
|
|
(18,000 |
) |
|
|
— |
|
|
|
— |
|
|
|
(18,000 |
) |
Other |
|
|
|
|
|
|
(1,713 |
) |
|
|
— |
|
|
|
— |
|
|
|
(1,713 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at October 31, 2006 |
|
|
— |
|
|
|
38,319,960 |
|
|
|
(1,200,617 |
) |
|
|
(130,329 |
) |
|
|
36,989,014 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See notes to consolidated financial statements.
45
QUANEX CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOW
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended October 31, |
|
| |
|
2006 |
|
|
2005 |
|
|
2004 |
|
| |
|
(In thousands) |
|
Operating Activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
160,183 |
|
|
$ |
155,160 |
|
|
$ |
54,467 |
|
Loss (income) from discontinued operations |
|
|
130 |
|
|
|
22,073 |
|
|
|
2,961 |
|
Adjustments to reconcile net income to cash provided by operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
71,657 |
|
|
|
65,987 |
|
|
|
49,921 |
|
Gain on sale of land |
|
|
— |
|
|
|
— |
|
|
|
(454 |
) |
Deferred income taxes |
|
|
7,084 |
|
|
|
(438 |
) |
|
|
30 |
|
Stock-based compensation |
|
|
5,298 |
|
|
|
946 |
|
|
|
603 |
|
Changes in assets and liabilities, net of effects from acquisitions and
dispositions: |
|
|
|
|
|
|
|
|
|
|
|
|
Decrease (increase) in accounts and notes receivable |
|
|
(32,229 |
) |
|
|
32,165 |
|
|
|
(45,932 |
) |
Decrease (increase) in inventory |
|
|
(9,753 |
) |
|
|
(8,847 |
) |
|
|
(6,722 |
) |
Increase (decrease) in accounts payable |
|
|
8,326 |
|
|
|
(43,696 |
) |
|
|
57,160 |
|
Increase (decrease) in accrued liabilities |
|
|
(8,059 |
) |
|
|
(419 |
) |
|
|
9,212 |
|
Increase (decrease) in income taxes payable |
|
|
(736 |
) |
|
|
19,624 |
|
|
|
(5,820 |
) |
Increase (decrease) in deferred pension and postretirement benefits |
|
|
(10,524 |
) |
|
|
3,015 |
|
|
|
(2,211 |
) |
Other, net |
|
|
(390 |
) |
|
|
4,825 |
|
|
|
2,873 |
|
|
|
|
|
|
|
|
|
|
|
Cash provided by (used for) operating activities from continuing operations |
|
|
190,987 |
|
|
|
250,395 |
|
|
|
116,088 |
|
Cash provided by (used for) operating activities from discontinued operations |
|
|
(716 |
) |
|
|
(1,275 |
) |
|
|
8,149 |
|
|
|
|
|
|
|
|
|
|
|
Cash provided by (used for) operating activities |
|
|
190,271 |
|
|
|
249,120 |
|
|
|
124,237 |
|
|
|
|
|
|
|
|
|
|
|
Investing Activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Acquisitions, net of cash acquired |
|
|
— |
|
|
|
(200,550 |
) |
|
|
(214,618 |
) |
Proceeds from sale of discontinued operations |
|
|
5,683 |
|
|
|
11,710 |
|
|
|
23,310 |
|
Capital expenditures, net of retirements |
|
|
(72,262 |
) |
|
|
(50,792 |
) |
|
|
(18,713 |
) |
Proceeds from sale of land |
|
|
— |
|
|
|
— |
|
|
|
637 |
|
Retired executive life insurance proceeds |
|
|
461 |
|
|
|
— |
|
|
|
— |
|
Other, net |
|
|
593 |
|
|
|
(46 |
) |
|
|
(877 |
) |
|
|
|
|
|
|
|
|
|
|
Cash provided by (used for) investing activities from continuing operations |
|
|
(65,525 |
) |
|
|
(239,678 |
) |
|
|
(210,261 |
) |
Cash provided by (used for) investing activities from discontinued operations |
|
|
(14 |
) |
|
|
(1,059 |
) |
|
|
(2,829 |
) |
|
|
|
|
|
|
|
|
|
|
Cash provided by (used for) investing activities |
|
|
(65,539 |
) |
|
|
(240,737 |
) |
|
|
(213,090 |
) |
|
|
|
|
|
|
|
|
|
|
Financing Activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Bank borrowings (repayments), net |
|
|
(2,519 |
) |
|
|
(180 |
) |
|
|
(10,000 |
) |
Issuance (purchase) of debentures |
|
|
— |
|
|
|
— |
|
|
|
125,000 |
|
Common stock dividends paid |
|
|
(18,362 |
) |
|
|
(14,296 |
) |
|
|
(11,530 |
) |
Issuance of common stock from option exercises, including related tax benefits |
|
|
11,094 |
|
|
|
14,295 |
|
|
|
11,665 |
|
Purchase of treasury stock |
|
|
(58,326 |
) |
|
|
— |
|
|
|
— |
|
Other, net |
|
|
(547 |
) |
|
|
(70 |
) |
|
|
(6,456 |
) |
|
|
|
|
|
|
|
|
|
|
Cash provided by (used for) financing activities from continuing operations |
|
|
(68,660 |
) |
|
|
(251 |
) |
|
|
108,679 |
|
Cash provided by (used for) financing activities from discontinued operations |
|
|
(56 |
) |
|
|
(211 |
) |
|
|
(201 |
) |
|
|
|
|
|
|
|
|
|
|
Cash provided by (used for) financing activities |
|
|
(68,716 |
) |
|
|
(462 |
) |
|
|
108,478 |
|
|
|
|
|
|
|
|
|
|
|
Effect of exchange rate changes on cash and equivalents |
|
|
11 |
|
|
|
17 |
|
|
|
10 |
|
Increase (decrease) in cash and equivalents |
|
|
56,027 |
|
|
|
7,938 |
|
|
|
19,635 |
|
Cash and equivalents at beginning of period |
|
|
49,681 |
|
|
|
41,743 |
|
|
|
22,108 |
|
|
|
|
|
|
|
|
|
|
|
Cash and equivalents at end of period |
|
$ |
105,708 |
|
|
$ |
49,681 |
|
|
$ |
41,743 |
|
|
|
|
|
|
|
|
|
|
|
See notes to consolidated financial statements.
46
QUANEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Significant Accounting Policies
The preparation of these financial statements requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and accompanying
footnotes. Estimates and assumptions about future events and their effects cannot be perceived
with certainty. Estimates may change as new events occur, as more experience is acquired, as
additional information becomes available and as the Company’s operating environment changes.
Actual results could differ from estimates.
The Company believes the following are the most critical accounting policies used in the
preparation of the Company’s consolidated financial statements as well as the significant judgments
and uncertainties affecting the application of these policies.
Nature and Scope of Operations
Quanex has three reportable segments covering two customer-focused markets; the vehicular
products and building products markets. The Company manufactures engineered carbon and alloy steel
bars, aluminum flat-rolled products, flexible insulating glass spacer systems, extruded profiles
and precision-formed metal and wood products which primarily serve the North American vehicular
products and building products markets. The Company’s manufacturing operations are conducted in
the United States. See Note 11, Industry Segment Information.
Revenue Recognition and Allowance for Doubtful Accounts
The Company recognizes revenue when the products are shipped and the title and risk of
ownership pass to the customer. Selling prices are fixed based on purchase orders or contractual
agreements. Inherent in the Company’s revenue recognition policy is the determination of
collectbility. This requires management to make frequent judgments and estimates in order to
determine the appropriate amount of allowance needed for doubtful accounts. The Company’s
allowance for doubtful accounts is estimated to cover the risk of loss related to accounts
receivable. This allowance is maintained at a level the Company considers appropriate based on
historical and other factors that affect collectibility. These factors include historical trends
of write-offs, recoveries and credit losses, the careful monitoring of portfolio credit quality,
and projected economic and market conditions. Different assumptions or changes in economic
circumstances could result in changes to the allowance.
Inventory
The Company records inventory valued at the lower of cost or market value. Inventories are
valued using both the first-in first-out (FIFO) and last in, first out (LIFO) methods. The Company
adopted the dollar-value link chain LIFO method in fiscal 1973 and the LIFO reserve is calculated
on a consolidated basis in a single consolidated pool. Since then, acquisitions were integrated
into the Company’s operations with some valuing inventories on a LIFO basis and others on a FIFO
basis. Inventory quantities are regularly reviewed and provisions for excess or obsolete inventory
are recorded primarily based on the Company’s forecast of future demand and market conditions.
Significant unanticipated changes to the Company’s forecasts could require a change in the
provision for excess or obsolete inventory.
47
QUANEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Environmental Contingencies
Quanex is subject to extensive laws and regulations concerning the discharge of materials into
the environment and the remediation of chemical contamination. To satisfy such requirements, Quanex
must make capital and other expenditures on an ongoing basis. The Company accrues its best
estimates of its remediation obligations and adjusts such accruals as further information and
circumstances develop. Those estimates may change substantially depending on information about the
nature and extent of contamination, appropriate remediation technologies, and regulatory approvals.
In accruing for environmental remediation liabilities, costs of future expenditures for
environmental remediation are not discounted to their present value, unless the amount and timing
of the expenditures are fixed or reliably determinable. When environmental laws might be deemed to
impose joint and several liability for the costs of responding to contamination, the Company
accrues its allocable share of liability taking into account the number of parties participating,
their ability to pay their shares, the volumes and nature of the wastes involved, the nature of
anticipated response actions, and the nature of the Company’s alleged connections. Recoveries of
environmental remediation costs from other parties are recorded as assets when their receipt is
deemed probable. Unanticipated changes in circumstances and/or legal requirements could result in
expenses being incurred in future periods in addition to an increase in actual cash required to
remediate contamination for which the Company is responsible.
Asset Retirement Obligations
Asset retirement obligations represent legal obligations associated with the retirement of
tangible long-lived assets that result from the normal operation of the long-lived asset. The
costs associated with such legal obligations are accounted for under the provisions of SFAS No.
143, “Accounting for Asset Retirement Obligations” (SFAS 143) and FASB Interpretation No. 47,
“Accounting for Conditional Asset Retirement Obligations” (FIN 47). The fair value of a liability
for an asset retirement obligation is recognized in the period in which it is incurred and
capitalized as part of the carrying amount of the long-lived asset. The fair value of such
obligations is based upon the present value of the future cash flows expected to be incurred to
satisfy the obligation. Over time, the liability is accreted to its settlement value and the
capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the
liability, the Company will recognize a gain or loss for any difference between the settlement
amount and the liability recorded. When certain legal obligations are identified with
indeterminate settlement dates, the fair value of these obligations can not be reasonably estimated
and accordingly a liability is not recognized. When a date or range of dates can reasonably be
estimated for the retirement of that asset, the Company will estimate the cost of performing the
retirement activities and record a liability for the fair value of that cost using established
present value techniques.
Long-Lived Assets
Property, Plant and Equipment and Intangibles
The Company makes judgments and estimates in conjunction with the carrying value of property,
plant and equipment, other intangibles, and other assets, including amounts to be capitalized,
depreciation and amortization methods and useful lives. Additionally, carrying values of these
assets are reviewed for impairment whenever events or changes in circumstances indicate that
carrying value may not be recoverable. The Company determines that the carrying amount is not
recoverable if the carrying amount exceeds the sum of the undiscounted cash flows expected to
result from the use and eventual disposition of the asset. If the carrying value exceeds the sum
of the undiscounted cash flows, an impairment charge is recorded in the period in which such review
is performed. The Company measures the impairment loss as the amount by which the carrying amount
of the long-lived asset exceeds its fair value as determined by quoted market prices in active
markets or by discounted cash flows. This requires the Company to make long-term forecasts of its
future revenues and costs related to the assets subject to review. Forecasts require assumptions about demand for the Company’s
products and future market conditions. Future events and unanticipated changes to assumptions
could require a provision for impairment in a future period.
48
QUANEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Property, plant and equipment is stated at cost and is depreciated using the straight-line
method over the estimated useful lives of the assets. The estimated useful lives of certain
categories are as follows:
| |
|
|
| |
|
Years |
Land improvements |
|
10 to 20 |
Buildings |
|
25 to 40 |
Building improvements |
|
10 |
Machinery and equipment |
|
3 to 12 |
Goodwill
The purchase method of accounting for business combinations requires the Company to make use
of estimates and judgments to allocate the purchase price paid for acquisitions to the fair value
of the net tangible and identifiable intangible assets. The Company performs a goodwill impairment
test annually as of August 31. In addition, goodwill would be tested more frequently if changes in
circumstances or the occurrence of events indicates that a potential impairment exists. The
Company tests for impairment of its goodwill using a two-step approach as prescribed in SFAS 142.
The first step of the Company’s goodwill impairment test compares the fair value of each reporting
unit with its carrying value including assigned goodwill. The second step of the Company’s
goodwill impairment test is required only in situations where the carrying value of the reporting
unit exceeds its fair value as determined in the first step. In such instances, the Company
compares the implied fair value of goodwill to its carrying value. The implied fair value of
goodwill is determined by allocating the fair value of a reporting unit to all of the assets and
liabilities of that unit as if the reporting unit had been acquired in a business combination and
the fair value of the reporting unit was the price paid to acquire the reporting unit. The excess
of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is
the implied fair value of goodwill. An impairment loss is recorded to the extent that the carrying
amount of the reporting unit goodwill exceeds the implied fair value of that goodwill. The Company
primarily uses the present value of future cash flows to determine fair value and validates the
result against the market approach. Future cash flows are typically based upon appropriate future
periods for the businesses and an estimated residual value. Management judgment is required in the
estimation of future operating results and to determine the appropriate residual values. The
residual values are determined by reference to an exchange transaction in an existing market for
that asset. Future operating results and residual values could reasonably differ from the
estimates and could require a provision for impairment in a future period.
Income Taxes
The Company records the estimated future tax effects of temporary differences between the tax
basis of assets and liabilities and the amounts reported in the Company’s consolidated balance
sheet, as well as operating loss and tax credit carry forwards. The carrying value of the net
deferred tax liability reflects the Company’s assumption that the Company will be able to generate
sufficient future taxable income in certain jurisdictions to realize its deferred tax assets. If
the estimates and assumptions change in the future, the Company may be required to record a
valuation allowance against a portion of its deferred tax assets. This could result in additional
income tax expense in a future period in the consolidated statement of income.
49
QUANEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Insurance
The Company manages its costs of group medical, property, casualty and other liability
exposures through a combination of retentions and insurance coverage with third party carriers.
Liabilities associated with the Company’s portion of these exposures are estimated in part by
considering historical claims experience, severity factors and other assumptions. Projections of
future loss expenses are inherently uncertain because of the random nature of insurance claims
occurrences and could be significantly affected if future occurrences and claims differ from these
assumptions and historical trends.
Retirement and Pension Plans
The Company sponsors a number of defined benefit pension plans and an unfunded postretirement
plan that provides health care and life insurance benefits for eligible retirees and dependents.
The measurement of liabilities related to these plans is based on management’s assumptions related
to future events, including expected return on plan assets, rate of compensation increases and
health care cost trend rates. The discount rate, which is determined using a model that matches
corporate bond securities, is applied against the projected pension and postretirement
disbursements. Actual pension plan asset investment performance will either reduce or increase
unamortized pension losses at the end of any fiscal year, which ultimately affects future pension
costs.
Treasury Stock
The Company records treasury stock purchases under the cost method whereby the entire cost of
the acquired stock is recorded as treasury stock. The Company uses a moving average method on the
subsequent reissuance of shares, and any resulting proceeds in excess of cost are credited to
additional paid in capital while any deficiency is charged to
retained earnings.
Discontinued Operations
The Company presents the results of operations, financial position and cash flows of
operations that have either been sold or that meet the criteria for “held for sale accounting” as
discontinued operations. At the time an operation qualifies for held for sale accounting, the
operation is evaluated to determine whether or not the carrying value exceeds its fair value less
cost to sell. Any loss as a result of carrying value in excess of fair value less cost to sell is
recorded in the period the operation meets held for sale accounting. Management judgment is
required to (1) assess the criteria required to meet held for sale accounting, and (2) estimate
fair value. Changes to the operation could cause it to no longer qualify for held for sale
accounting and changes to fair value could result in an increase or decrease to previously
recognized losses.
Principles of Consolidation
The consolidated financial statements include the accounts of Quanex and its subsidiaries, all
of which are wholly owned. All intercompany balances and transactions have been eliminated in
consolidation.
Earnings per Share Data
Basic earnings per share excludes dilution and is computed by dividing net income available to
common stockholders by the weighted average number of common shares outstanding for the period.
Diluted earnings per share reflects the potential dilution that could occur if securities or other
contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of common stock that then
shared in the earnings of the entity.
50
QUANEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Statements of Cash Flows
The Company generally considers all highly liquid debt instruments purchased with a maturity
of three months or less to be cash equivalents. Similar investments with original maturities
beyond three months are considered short-term investments.
Supplemental cash flow information is as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended October 31, |
|
| |
|
2006 |
|
|
2005 |
|
|
2004 |
|
| |
|
(In thousands) |
|
Cash paid for interest |
|
$ |
4,458 |
|
|
$ |
8,848 |
|
|
$ |
4,022 |
|
Cash paid for income taxes |
|
|
79,796 |
|
|
|
77,248 |
|
|
|
35,694 |
|
Cash received for income tax refunds |
|
$ |
— |
|
|
$ |
219 |
|
|
$ |
448 |
|
Reclassification
Certain reclassifications, none of which affected net income, have been made to prior period
amounts to conform to the presentation of fiscal year 2006. In March 2006, the company effected a
three-for-two stock split in the form of a stock dividend. All prior periods have been adjusted on
a retroactive basis after giving effect to such stock split. Also, the obligation for the
Company’s supplemental retirement plan for certain current and former officers and key employees
(SERP) is reported on a gross basis and reclassified to a liability instead of netting the
obligation with the associated cash surrender value of certain life insurance polices. See Note 10
for additional information. Additionally, the anticipated recovery from prior owners as a result
of an environmental indemnification agreement is reported on a gross basis and reclassified as an
asset instead of netting the recovery with the associated environmental remediation liability. See
Note 17 for additional information. Finally, certain compensation related liabilities have been
reclassified from accrued liabilities (current) to other liabilities (non-current) to better
reflect the timing of their expected settlement.
New Accounting Pronouncements
Stock—Based Compensation
On November 1, 2005, the Company adopted Statement of Financial Accounting Standards (SFAS)
No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R) issued by the Financial Accounting
Standards Board (FASB) in December 2004. SFAS 123R requires companies to measure all employee
stock-based compensation awards using a fair value method and record such expense in the
consolidated financial statements. Prior to November 1, 2005, under the disclosure only provisions
of SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS 123), the Company applied
Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” (APB
25), and related Interpretations in accounting for its stock option plans. Accordingly, prior to
fiscal 2006, the Company recognized zero stock-based compensation expense in its income statement
for non-qualified stock options, as the exercise price was equal to the closing market price of the
Company’s stock on the date of grant. However, the Company did recognize stock-based compensation
expense for its restricted stock plans for the fiscal year ended October 31, 2005. In March 2005,
the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (SAB 107) relating
to SFAS 123R. The Company has applied the provisions of SAB 107 in its adoption of SFAS 123R.
51
The changes in the carrying amount of goodwill for the two years ended October 31, 2006 are as
follows (in thousands):
The $75.2 million of goodwill during fiscal 2005 activity includes $9.9 million related to the
2004 acquisition of TruSeal. This increase to goodwill is attributable to a TruSeal deferred tax
liability recorded in the fourth quarter of 2005.