ITEM 1. BUSINESS
Overview
AGY Holding Corp. is a Delaware corporation, incorporated in 2004 following emergence from Chapter 11 bankruptcy protection, with its headquarters in South Carolina. The core business has been in existence for over 50 years. AGY Holding Corp. and its subsidiaries are referred to herein as “AGY” or the “Company”. AGY is a leading manufacturer of advanced glass fibers that are used as reinforcing materials in numerous diverse, high-value applications, including aircraft laminates, ballistic armor, pressure vessels, roofing membranes, mattress protection and architectural fabrics, and specialty electronics. AGY is focused on serving end-markets that require glass fibers for applications with demanding performance criteria, such as the aerospace, defense, construction, electronics, automotive, and industrial end-markets. We are able to leverage our flexible manufacturing capabilities to target new specialty end-use applications and to shift production rapidly to meet changing market demand.
Our Company was acquired by KAGY Holding Company, Inc. (“Holdings”) on April 7, 2006 pursuant to the terms of an agreement of merger dated February 23, 2006. In October 2006, we repaid all outstanding borrowings under our then-existing senior secured credit facilities as part of the refinancing of our indebtedness through our new $40 million credit facility, the issuance of $175 million in aggregate principal amount of 11% senior second lien notes due 2014 (the “Notes”) and our cash on hand.
We have three manufacturing facilities, two located in the United States and one located in China that we acquired a 70% interest in on June 10, 2009. This acquisition, which is described more fully in Note 3 to the Consolidated Financial Statements, expanded AGY’s manufacturing and servicing capabilities in the Asia-Pacific region relative to the electronics and industrial markets.
The following table summarizes our net sales by geographic region. Customer sales are attributed to geographic region based upon the location to which the product is shipped to the external customer.
Our Products
Glass Fiber Products. We are a leader in the design, development, manufacturing, and marketing of precision glass fibers used in diverse, high value applications. We produce high-quality fine filament glass fibers, which provide customers with enhanced strength-to-weight ratios and improved fabric quality and flexibility properties. Glass fibers are differentiated from one another in three ways: (i) glass chemistry, (ii) diameter of the filaments and (iii) sizing chemistry (a coating applied to the filament). Glass fiber is produced by passing molten glass through bushings, producing thin glass filaments, which are spooled and then twisted into fibers or bundled into untwisted heavy weight fibers called rovings. We produce hundreds of different glass fiber types. Glass fiber types are broadly segmented into two categories: E Glass and advanced materials, including S-2 Glass.
E Glass is a natural, lustrous, white continuous fiber made of highly stable and durable glass filaments. Within E Glass, we focus on both “semi-technical” and “technical” fibers. We differentiate between semi-technical and technical E Glass fibers based on their technical complexity and difficulty in manufacturing, and our technical fibers include filaments with a diameter of eight microns or less and fibers with specialized and proprietary sizing compositions. As a result of their complexity, technical fibers are manufactured by only a few suppliers. We generally compete with one or two alternative suppliers for the vast majority of our
technical products. Where our technical fibers are specified-in and offer significant value to our customers, we are able to command a price and margin premium compared to most semi-technical E Glass fibers. We plan to continue to produce semi-technical E Glass fibers to enable us to offer our customers a full suite of products.
S-2 Glass is a proprietary product that is technically more complex than conventional E Glass fibers, providing it with advanced performance characteristics. Compared to other alternatives such as carbon fiber, aramid fibers and steel, S-2 Glass delivers a better ratio of performance to cost in many applications. S-2 Glass has more than three times the percentage strain to failure of carbon fiber and performs three times better than aramid fibers in fire tests. S-2 Glass is also approximately one-third the weight of steel.
We differentiate our S-2 Glass advanced materials from E Glass by its different glass chemistry, which yields a proprietary product with superior performance characteristics making it suitable for applications with demanding performance criteria, such as ballistic armor, aircraft flooring and exterior skins, helicopter blades, firefighter oxygen tanks, automotive timing belts and ceramic appliance insulation. Historically, we have demonstrated our ability to increase S-2 Glass capacity significantly due to the nature of our manufacturing platform. In addition, we have introduced other unique advanced material product line extensions to targeted applications that have different performance characteristics and price points within multiple end markets, including wind energy, electronics and thermoplastics.
CFM Products. Continuous Filament Mat, or CFM, is a unique glass fiber reinforcement product used as an input in the production of flat sheet laminates, marine parts and accessories, and other products where its strength and durability make it the most cost-effective material to use. CFM increases the mechanical performance of products, such as stiffness and strength, as well as improves their resistance to chemicals. In CFM, AGY has a capacity of 12,000 metric tons over three manufacturing lines in Huntingdon, Pennsylvania, capable of producing many differentiated products from 0.6 oz. to 3.0 oz. weight serving a wide variety of markets and applications, such as ladder rails, electrical insulation, heavy truck bodies and oil rig decking.
All of our manufacturing processes require the use of bushings made of platinum-rhodium alloy. As a result, our ability to fully utilize or increase our production capacity for glass fiber and CFM products is subject to our ability to obtain and maintain sufficient amounts of alloy metals to support our operations through outright purchase, leasing or through technology improvements that reduce the alloy intensity of our manufacturing processes.
Segment Information
Since the acquisition of a 70% controlling interest in Main Union Industrial Ltd. and its subsidiary (which are collectively referred to herein as “AGY Asia”) on June 10, 2009, the Company operates its business as two reportable units, each a separate operating segment: AGY US and AGY Asia. The Company’s operating segments are managed separately based on differences in their manufacturing and technology capabilities, products and services and their end-markets as well as their distinct financing agreements. For financial information with respect to our business segments, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Note 23 to our Consolidated Financial Statements.
AGY US
The AGY US segment includes our US manufacturing operations and sale of advanced glass fibers that are used worldwide as reinforcing materials in numerous high-value applications through AGY and its wholly-owned domestic and French subsidiaries. The AGY US segment manufactures and sells the full suite of the products described above but is heavily focused on serving end-markets that require glass fibers for applications with demanding performance criteria. The respective share of end-market sales for the year ended December 31, 2011 for this segment are as follows:
The AGY US segment serves over 250 direct customers worldwide, including most major global weavers and a diverse group of other domestic and international commercial and industrial users of fibers. While supply chains vary by product, application and end-user, there are generally multiple links in the value chain between our fibers and corresponding end-products. Direct customers weave our fibers into glass fiber fabric. Through our working relationships with downstream contacts, we are often able to have our fibers specified-in end-products and, therefore, influence end-user demand and increase leverage with our direct customers.
Our direct customer relationships generally are stable and long-term. In order to qualify a new supplier, a customer may need to modify its own weaving loom set-ups and fabric specifications and also qualify the new fiber suppliers with downstream manufacturers and original equipment manufacturers, or OEM’s. Although glass fibers are only a portion of the final end-product’s overall manufacturing cost, defects can be costly and can have a major impact throughout the value chain. Consequently, customers demand high-quality, reliable fibers from their suppliers, and we have established a reputation with our customers for meeting these demands. We believe these factors have allowed us to maintain strong relationships with each of our key customers. The average length of the relationships with our top ten customers is more than 20 years.
Depending on the end-application, we compete with glass yarn manufacturers or other composite fiber producers worldwide. We compete in the areas of technology innovation, quality, ratio of performance to cost and customer service for our specialty advanced glass fibers and technical fibers. For our semi-technical E Glass fibers we compete primarily on the basis of cost, quality and price.
AGY Asia
The AGY Asia segment includes the manufacturing operations of the Company’s 70% controlling ownership of AGY Asia and its sale of E Glass fibers that at present are used primarily in the Asian electronics market. AGY Asia serves a smaller base of less than 20 customers, who are primarily weavers for the Asia Pacific electronics markets. Significant competitors include other global glass yarn producers primarily based in China, but such competitors are usually vertically integrated and therefore also compete within the weaver segment of the industry supply chain. AGY Asia is one of a limited number of independent non-integrated yarn producers in Asia, and we stress this independence in our efforts to secure supply positions with our weaving customers.
Our AGY US and AGY Asia segments accounted for approximately 85% and 15% of our total net sales, respectively, in 2011.
Our AGY US and AGY Asia segments accounted for approximately 74% and 26% of our total assets, respectively, in 2011.
Summary of our End-Markets and Key Applications by Segment
End-market and key application
Served Product
Segment
Aerospace end-market
Leading edge of helicopter blades
S-2 Glass
AGY US
Aircraft interior floors
S-2 Glass
AGY US
Aircraft interior panels
Technical E Glass
AGY US
Defense end-market
Ballistic armor
S-2 Glass
AGY US
Electronics end-market
Multi-layer printed circuit boards
All E Glass
AGY US - AGY Asia
Electrical insulation panels for transformers & generators
E Glass, CFM
AGY US
Construction end-market
Architectural roofing/tented structures fabric
Technical E Glass
AGY US
Insect and pool/patio screening
Technical E Glass
AGY US
Ladder rails for composite ladders
E Glass, CFM
AGY US
Industrial end-market
Pressure vessels
S-2 Glass
AGY US
Reinforcement tape
Semi-Technical E Glass
AGY US
Protective gear
Technical E Glass
AGY US
PTFE coated fabrics (for example, Teflon) used in industrial and food processing equipment
Technical E Glass
AGY US
Automotive high strength timing belts
S-2 Glass
AGY US
High temperature application sewing thread (industrial emissions filtration bags)
Technical E Glass
AGY US
Cooling tower infrastructure
E Glass, CFM
AGY US
Automotive interior door /seat panels
E Glass, CFM
AGY US
Mattress Protection
E Glass
AGY US
Industry Overview
We supply glass fibers (i) to the global composites industry and (ii) to other applications where glass fibers, sometimes coated, largely constitute a complete fabric system. Examples of composites applications include thermoplastic-glass fiber reinforced composites for ballistic armor, aluminum-glass fiber reinforced composites for aircraft interior and exterior panels and specialty electronics printed circuit boards. Sales into other applications, principally in the construction and selected industrial end-markets, represented the remainder of our sales for the year ended December 31, 2011. Examples of these applications include architectural roofing and mattress protection fabrics.
Customers
We sell to a majority of our customers on open account after an extensive credit review and approval process. For those customers that do not qualify for credit terms, we require cash in advance or a letter of credit. We provide consigned inventory at the customer’s location on a limited basis.
Due to the proximity of our manufacturing plants in relation to many of our top customers, we are able to provide strong customer service. This proximity allows same-day trucking and responsive technical service which enables our customers to manage their inventory more efficiently. Our three largest customers, Porcher Industries Group, Glotech Industrial Corp. and JPS Glass accounted for approximately 17%, 8% and 6%, respectively, of our consolidated net sales for 2011. AGY Asia’s customer concentration is high. Approximately 69% of the AGY Asia segment’s net sales in 2011 were generated from two customers, Glotech Industrial Corp. and Grace Fabric, a subsidiary of AGY Asia’s predecessor owner; however, customer concentration is expected to decrease in future years as we diversify the product lines and geographic sales of AGY Asia.
Backlog
Contracted backlog is not material to the Company’s business taken as a whole and, on average, is less than one month of sales.
Intellectual Property
As part of the transaction when we were spun out of Owens Corning in 1998, Owens Corning assigned to us various patents, know-how, trademarks and other business information. Owens Corning also licensed additional intellectual property assets and rights to us. Under this agreement, Owens Corning granted us a worldwide, paid-up and royalty-free license to make, have made, use, sell, offer to sell and import glass yarn fiber products and S-2 Glass. The agreement covers the life of the licensed patents and is perpetual for know-how. In connection with our purchase of Owens Corning’s CFM business in October 2007, Owens Corning assigned and licensed to us additional intellectual property and rights related to the CFM business.
AGY aggressively manages its patent portfolio, both in terms of seeking patent protection for new technologies and also in pruning patents that no longer have business value. We have a valuable portfolio of U.S. patents and related foreign patents as well as pending U.S. and foreign applications. This portfolio covers a wide spectrum from glass composition to fiber and mat process technology to sizing and binder chemistry to product design. Management does not believe the expiration of any of our patents will have a material impact on our operations or financial performance. In addition to patents, we also have know-how, in particular related to manufacturing extra fine denier filaments, S-2 Glass fiber products and CFM products, which we protect as trade secrets.
Science and Technology
Our science and technology (“S&T”) organization is responsible for creating new products and new applications for existing products. The team is composed of 15 glass technology professionals who have over 200 years of combined experience in translating customer requirements into specifications for new products and tailoring existing products to more rigorous end-user specifications. Our scientists collaborate with our sales, marketing and new business development people to drive growth through new application development and partnership with key customers and end-users.
Through this collaboration, over the last three years we have successfully introduced new products into existing as well as new applications and end-markets. In addition, we have identified a number of additional growth opportunities in applications such as ballistic protection against new threats, high-output wind-turbines, high-speed and high performance circuit boards, and thermoplastic composite reinforcement.
Environmental Matters
We are subject to a wide range of federal, state and local and general and industry-specific environmental, health and safety laws and regulations, including those relating to air emissions, wastewater discharges, solid and hazardous waste management and disposal and site remediation. Certain of our operations require environmental permits or other approvals from governmental authorities, and certain of these permits and approvals are subject to expiration, denial, revocation or modification under various circumstances. We are also subject to inspections and monitoring by government enforcement authorities.
As part of the transaction when we were spun out of Owens Corning, Owens Corning agreed to retain all liability, if any, resulting from the presence of potentially hazardous substances at or migrating from our then-existing sites as well as all liabilities resulting from the transportation or arrangements made by Owens Corning for the treatment, storage or disposal of hazardous substances to any off-site location prior to September 30, 1998. In addition, Owens Corning agreed to indemnify us against any losses and damages, if any, arising out of the environmental liabilities retained by Owens Corning.
There may be insignificant levels of asbestos in certain manufacturing facilities, however, we do not expect to incur costs (which are undeterminable) in the foreseeable future to remediate any such asbestos.
Suppliers
The major raw materials used in the production of glass fibers are pre-melted glass marbles or a range of minerals including silica and borates. We utilize our own marble making process in the Aiken, SC facility to supply a significant portion of the raw material marbles necessary to satisfy our indirect melting processes for yarn and CFM production. In addition, we have developed a secure supply agreement with an outside supplier to fulfill additional marble demand as required. We believe that the cost of producing marbles in Aiken is not materially different from the cost of sourcing marbles from other sources we have identified. Silica is readily available and is provided by a number of local suppliers. Borates are sourced from a supplier in Turkey.
We use bushings, heat-resistant trays made of platinum-rhodium alloy with holes through which molten glass is extruded into filaments, as part of our manufacturing process. We have bushing fabrication capabilities in our alloy shop facility located in Aiken, SC. In addition, AGY US continues to use a single external supplier to fabricate bushings in order to protect confidentiality due to the proprietary nature of our bushing designs (although other sources of supply are available).
Natural gas and electricity are a significant portion of our cost of production due to the amount of energy needed to melt raw materials for manufacturing into glass fibers. Energy costs represented approximately 14.5% of total cost of goods sold for each of the years ended December 31, 2011 and 2010.
In addition, we purchase bobbins, forming tubes and other packaging materials. These materials are reusable and are replaced if damaged during manufacturing or shipping.
Employees
As of December 31, 2011, we employed approximately 1,148 people throughout our operations, all of which are full-time employees and of which 741 are subject to collective bargaining agreements.
Available Information
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available on our website at http://www.agy.com/investor/index.htm, as soon as reasonably practicable after AGY electronically files such reports with, or furnishes those reports to, the Securities and Exchange Commission. The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE., Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.
ITEM 1A.
ITEM 1A. RISK FACTORS
Set forth below and elsewhere in this Annual Report and in other documents we have filed and will file with the SEC are risks and uncertainties that could cause our actual results to differ materially from the results contemplated by the forward-looking statements contained in this Annual Report. The risks described below are not the only risks facing us. Additional risks and uncertainties not currently known to us or those we currently view to be immaterial may also materially and adversely affect our business, financial condition or results of operations. Any of the following risks could materially and adversely affect our business, financial condition or results of operations.
Risks Related to Our Business
We face competition from other suppliers of glass fibers, as well as from suppliers of competing products that have resources far in excess of ours, which may harm our financial performance and growth prospects.
In the semi-technical fiber segment, we generally compete with two or more alternate suppliers for each application. For technical fibers and continuous filament mat products, we generally compete with one to two alternate suppliers for each application. Although we are the sole supplier of S-2 Glass, we compete with companies that produce alternative products including other high strength glasses, carbon fiber and aramid fiber products that we do not offer. In addition, today other competitors are manufacturing or developing high strength glasses in an effort to compete with S-2 Glass. We compete principally on the basis of fiber performance, breadth of product offering, product quality, product innovation, customer service, price and availability. Many of our competitors are large, well-established companies with financial and other resources far in excess of ours. As a result of the foregoing factors, there can be no assurance that we will be able to compete successfully against our competitors and we may lose customers or be forced to reduce prices, which could have a material adverse effect on our business, financial condition, operating results and cash flows.
Most of our major competitors focus on high-volume commodity or semi-technical products. We focus on the supply of highly technical glass fibers to specialty niche markets. Only one of our major competitors currently targets some of the same niche markets. Additional competitors may shift their focus to the highly technical products required by these niche markets. Also, our competitors may elect to produce and supply a competing product to S-2 Glass, as the process for producing this product has been off patent since the mid-1990’s. There can be no assurance that we will be able to compete successfully against competitors that elect to move into the end-markets we currently supply and, as a result, we may lose customers or be forced to reduce prices, which could have a material adverse effect on our business, financial condition, operating results and cash flows.
We face pricing pressures from competitors, creating potentially substantial price fluctuations for our products, which could have a material adverse effect on our business, financial condition, operating results and cash flows.
Although a significant amount of our business is specified at the end-user, especially in the Aerospace industry, we participate in some highly competitive markets and applications that can be subject to the risk of declining average selling prices (“ASPs”), and shifts in market share, both of which could impact our pricing leverage. The prices for our products may fluctuate substantially in the future, and any competitive pressures or downturns in market conditions could have a material adverse effect on our business, financial condition, operating results and cash flows.
Adverse macroeconomic and business conditions, as well as continued disruption in credit markets and government policy changes may significantly and negatively affect our revenues, profitability and financial condition.
Deterioration in economic conditions in the United States and in foreign markets in which we operate could substantially affect our sales and profitability. Volatility and disruption in credit and capital markets may impede access to business credit and tighten liquidity.
Changes in governmental banking, monetary and fiscal policies to restore liquidity and increase credit availability may not be effective. It is difficult to determine the extent of the economic and financial market problems and the many ways in which they may affect our suppliers, customers and our business in general. Continuation or further deterioration of these financial and macroeconomic conditions could have a significant adverse effect on our business, financial condition, operating results and cash flows including as follows:
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Some of our suppliers, customers and counterparties could face adverse liquidity issues, which could result in lower sales or in additional bad debts for the Company or non-performance by supplier;
•
One or more of the financial institutions syndicated under our senior secured revolving credit facility in the US or our non-recourse financing arrangements with the Bank of Shanghai may cease to be able to fulfill their funding obligations, which could adversely impact our liquidity;
•
it may become more costly or difficult to obtain financing or refinance the Company’s debt in the future;
•
it may become more costly or difficult to lease a portion of our alloy metals in the future;
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the Company’s assets may be impaired or subject to write down or write off.
The cyclical and uncertain nature of the end-use markets for our products could have a material adverse effect on our business, financial condition, operating results and cash flows.
Many of the end-markets for our products, including aerospace, defense, electronics and construction, are cyclical and sensitive to changes in general business conditions, industry capacity, consumer preferences, technology advances and other factors and have historically experienced downturns. We have no control over these factors and they can heavily influence our financial performance. For example, the global economic downturn that began in 2009 prompted many customers in our supply chain to move to leaner inventory holdings, which contributed to weaker demand for our products.
In addition, the demand for new commercial aircraft and aerospace refurbishment activity is cyclical and any reduction could result in reduced sales for our commercial aerospace products and could reduce our profit margins. Approximately 25% of our AGY US sales for the year ended December 31, 2011 were derived from sales to the aerospace end-market. Reductions in demand for commercial aircraft, or a delay in deliveries could result from many factors, including a terrorist attack similar to that which occurred on September 11, 2001 and any subsequent military response, changes in the propensity for the general public to travel by air, the rise in the cost of aviation fuel, consolidation and liquidation of airlines and slower macroeconomic growth. A downturn in the aerospace end-market could occur at any time, and in the event of a downturn, we have no way of knowing if, when and to what extent there might be a recovery.
Further, the production level of military equipment and vehicles that has occurred in recent years has not been sustained due to reduced military budgets and spending. The production level of military equipment and vehicles depends upon the U.S. and other non-U.S. defense budgets and the related demand for defense and related equipment. Advanced glass fibers are not always the preferred reinforcement material for certain defense applications depending on threat levels and cost performance criteria. We have not been awarded certain defense contracts we had sought to obtain in 2009 and as a result the defense end-market contribution to the AGY US sales declined materially between 2008 and 2010. The U.S. government prepares its budget on an annual basis under significant cost pressures and budgetary approval can be subject to the unpredictability of the political process.
Also, delays in the initiation of construction projects and in the roll out of new or modified products by our customers may result in reductions in sales or delays in the receipt of revenue, contributing to volatility in our quarter-to-quarter financial results.
If we are unable to develop product innovations and improve our production technology and expertise, we could lose customers or market share.
The end-markets for our products are subject to technological change and our success may depend on our ability to adapt to such technological changes and to continue to introduce new products and applications. In some of the end-markets to which we sell our glass fiber, such as electronics, products become obsolete rapidly. In addition, our customers may pursue alternative technology that could eliminate the need for our products. If we are unable to timely develop and introduce new products, or enhance existing products, in response to changing market conditions or customer requirements or demands then we could lose customers or market share, which could have a material adverse effect on our business, financial condition, operating results and cash flows.
We are dependent upon continued demand from our large customers.
Sales to our three largest customers represented approximately 17%, 8% and 6%, respectively, of our consolidated net sales for the year ended December 31, 2011. Approximately 69% of the AGY Asia segment’s net sales in 2011 were generated from two customers, including Glotech Industrial Corp. and Grace Fabric, a subsidiary of AGY Asia’s predecessor owner; however, customer concentration is expected to decrease in future years as we diversify the product lines and geographic sales of AGY Asia. The level of purchases by our customers is often affected by events beyond their control, including general economic conditions, demand for their products, business disruptions, disruptions in deliveries, strikes and other factors. The loss or significant reduction of orders from any of our large customers could result in us having excess capacity and reduced sales if we are unable to replace that customer. As a result, our business, financial condition, operating results and cash flow could suffer.
The decision by an end-user to modify or discontinue the production of an end-product that has our product specified-in could have a material adverse effect on our business, financial condition, operating results and cash flows.
A significant portion of our sales and gross profit is related to end-products in which our products are specified-in by the end-users. The majority of these sales were to applications in the aerospace and defense end-markets. For example, E Glass and S-2 Glass are specified-in to most Boeing commercial aircraft. However, changing market conditions and related changes to end-products may result in our products no longer being specified-in the applicable end-product. Such decisions by end-users to modify or terminate the production of certain end-products that have our products specified-in could have a material adverse effect on our business, financial condition, operating results and cash flows.
Our intellectual property rights may not provide meaningful commercial protection for our products or brands, which could adversely impact our business.
We rely upon a combination of trade secrets and contractual arrangements, and, to a lesser extent, patent and trademark laws to protect our intellectual property rights. The steps we take in this regard may not be adequate to prevent or deter the duplication of our technology, and we may not be able to detect unauthorized use of our technology or take appropriate and timely steps to enforce our intellectual property rights. In addition, we cannot be certain that our processes and products do not or will not infringe or otherwise violate the intellectual property rights of others. Infringement or other violation of intellectual property rights could cause us to incur significant costs and prevent us from selling our products and could have a material adverse effect on our business, financial condition, operating results and cash flows.
We may be liable for damages based on product liability claims brought against us and our customers.
The sale of our products involves the risk of product liability claims. Certain of our products provide critical performance functions to our customers’ end-products. Some of our products are used in and around aerospace applications, construction sites and industrial locations, among others, where personal injury or property damage may occur. There can be no assurance that our products will not be the subject of product liability claims or suits. In addition, if a person brings a product liability claim or suit against one of our customers, this customer may attempt to seek a contribution from us. A successful product liability claim or series of claims against us in excess of our insurance coverage for payments for which we are not otherwise indemnified could have a material adverse effect on our business, financial condition, operating results and cash flows.
Our business and financial performance may be harmed by future increases in the cost of certain alloy metals or our inability to access these metals.
Our business requires the use of bushings as part of the manufacturing process. Bushings are trays made with a heat-resistant platinum-rhodium alloy. As of December 31, 2011, platinum and rhodium together represented the largest asset on our balance sheet. Additionally, we are currently leasing a significant portion of the alloy metals needed to support our manufacturing operations in the United States under a master lease three-year agreement that we entered into with DB Energy Trading LLC in October 2009. The agreement allows AGY to enter into leases for up to 51,057 ounces of platinum and up to 3,308 ounces of rhodium, with terms of one to twelve months. At December 31, 2011, we leased approximately 49,800 ounces of platinum and 3,300 ounces of rhodium under the lease. Lease costs are determined by the quantity of metal leased, multiplied by a benchmark value of the applicable precious metal and a margin above the lease rate index.
The costs of the precious metals and the related alloy lease costs are subject to market fluctuations that are beyond our control. Although increases in platinum and rhodium prices favorably impact the Company’s ability to borrow money, pursuant to the Amended Credit Facility, which is tied to a borrowing base calculation supported in part by the market price of our owned alloy metals, it also unfavorably impacts our alloy lease costs reported in our financial results. We generally seek to offset the impact of rising material costs through selling price increases; however future market conditions and the terms of our contracts with customers may prevent us from passing material cost increases to our customers. In addition, we may not be able to achieve manufacturing productivity gains or other cost reductions to offset the impact of cost increases. As a result, higher platinum and rhodium alloy costs may have a material adverse effect on our business, financial condition, operating results and cash flows.
Based on the mix of products that we produced and the alloy metals consumed during the year ended December 31, 2011, approximately 3.8% of total alloy metals in use were depleted in the manufacturing process during that period. As a result of these on-going metal losses and of our historical alloy sales, our owned metal in ounces has declined as a percentage of our total metal pool. If we are unable to replenish depleted metal in the future through outright purchase, leasing or improvements in overall metal usage, we may have insufficient alloy metals for our manufacturing operation which could adversely affect our business, financial performance and operating results.
Our inability to obtain certain necessary raw materials and key components or an increase in cost of raw materials could disrupt the manufacture of our products and result in a material decline in our profitability.
Certain raw materials, including glass marbles and a range of minerals including silica and borates, and other key components necessary for the manufacture of our products, are obtained from a limited group of, or occasionally single, suppliers. Any restrictions on the supply, or an increase in the cost, of our raw materials could significantly reduce our profit margins. If we are unable to procure necessary raw materials and key components from our suppliers, we may not have readily available alternatives. As a result, our ability to manufacture products could be disrupted, and our business, financial condition, operating results and cash flows may be materially adversely affected. Efforts to mitigate restrictions on the supply or price increases of these raw materials by long-term purchase agreements, productivity improvements or by passing cost increases to our customers may not be successful.
Our energy costs may be higher than we anticipated.
Energy costs, including electricity and natural gas, represented approximately 14.5% of our total cost of goods sold for the years ended December 31, 2011 and 2010. Accurately predicting trends in energy costs is difficult to achieve as energy costs are, to a large extent, subject to factors beyond our control, such as political conditions in oil producing regions. If future energy costs are greater than anticipated, and we are unable to offset these cost increases with higher prices to our customers, our business, financial condition, operating results and cash flows may be materially adversely affected.
Our hedging activities to address energy price fluctuations may not be successful in offsetting increases in those costs or may reduce or eliminate the benefits of any decreases in those costs.
In order to mitigate short-term variation in our operating results due to commodity price fluctuations, we hedge a portion of our near-term exposure to the cost of natural gas and electricity. The results of our hedging practices could be positive, neutral or negative in any period depending on price changes of the hedged exposures.
Our hedging activities are not designed to mitigate long-term commodity price fluctuations and will not protect us from long-term commodity price increases. In addition, in the future our hedging positions may not correlate to our actual energy costs, which would cause acceleration in the recognition of unrealized gains and losses on our hedging positions in our operating results.
We are required to file tax returns on which we may be challenged in the future for tax calculations, valuations or positions taken.
We are subject to income, sales and property taxes in the U.S. and foreign jurisdictions. In the ordinary course of our business, there may be transactions, calculations or valuations where the ultimate tax determination is uncertain. It is possible that a taxing authority may not agree with our calculation, valuation or position taken. The results of an audit or litigation could have an adverse effect on our cash flow or on our financial statements in the period or periods for which that determination is made.
Labor disputes or increased labor costs could have a material adverse effect on our business, financial condition, operating results and cash flows.
Production, maintenance, warehouse and shipping employees at our Aiken, South Carolina manufacturing facility are represented by the Teamsters union. Our manufacturing footprint optimization program has resulted in all US manufacturing, except for continuous filament mat production, to be concentrated in our Aiken location. We renegotiated the current labor agreement with the Teamsters union in the second quarter of 2010, reaching a three-year agreement with a one-year optional extension with our Aiken employees, which expires on May 1, 2013. The production, maintenance, warehouse and shipping employees at our Huntingdon, Pennsylvania manufacturing facility, where we manufacture our continuous filament mat product, are represented by the Workers Unite union. We negotiated a three-year labor agreement with our Huntingdon employees in 2011, which expires in October 2014.
If we experience a work stoppage at the Aiken facility, we have no alternative production capability for our technical and advanced materials product lines. Our failure to offset increases in labor costs with continued efficiency gains and cost reduction, or any significant work stoppage in the future could have a material adverse effect on our business, financial condition, operating results and cash flows.
Our operations could expose us to significant regulations and compliance expenditures as a result of environmental, health and safety laws.
Our business is subject to a wide range of federal, state and local and general and industry-specific environmental, health and safety laws and regulations, including those relating to air emissions, wastewater discharges, solid and hazardous waste management and disposal and site remediation. Certain of our operations require environmental permits or other approvals from governmental authorities, and certain of these permits and approvals are subject to expiration, denial, revocation or modification under various circumstances. We are also subject to inspections and monitoring by government enforcement authorities. Our failure to comply with applicable environmental laws and regulations or permit or approval requirements could result in substantial civil or criminal fines or penalties or enforcement actions, including regulatory or judicial orders enjoining or curtailing operations or requiring remedial or corrective measures, installation of pollution control equipment or other actions, which could have a material adverse effect on our business, financial condition, operating results and cash flows.
In addition, as an owner and operator of real estate, we may be responsible under environmental laws and regulations for the investigation, remediation and monitoring, as well as associated costs, expenses and third-party damages, including tort liability and natural resource damages, relating to past or present releases of hazardous substances on or from our properties. Liability under these laws may be imposed without regard to whether we knew of or were responsible for the presence of those substances on our property, may be joint and several, meaning that the entire liability may be imposed on each party without regard to contribution, and retroactive and may not be limited to the value of the property. In addition, we or others may discover new material environmental liabilities, including liabilities related to third-party owned properties that we or our predecessors formerly owned or operated, or at which we or our predecessors have disposed of, or arranged for the disposal of, certain materials. We may be involved in administrative or judicial proceedings and inquiries in the future relating to such environmental matters, which could have a material adverse effect on our business, financial condition, operating results and cash flows.
New environmental laws or regulations (or changes in existing laws or regulations or their enforcement) may be enacted that require significant expenditures by us. If the resulting expenses significantly exceed our expectations, our business, financial condition, operating results and cash flows could be materially adversely affected.
There may be asbestos in certain manufacturing facilities; however, we do not expect to incur costs (which are undeterminable) in the foreseeable future to remediate any such asbestos, which may be present in the facilities.
We are also subject to various federal, state and local requirements concerning safety and health conditions at our manufacturing facilities. We may also be subject to material financial penalties or liabilities for noncompliance with those safety and health requirements, as well as potential business disruption, if any of our manufacturing facilities or a portion of any manufacturing facility is required to be temporarily closed as a result of any noncompliance with those requirements.
Owens Corning may fail to comply with its indemnification and other obligations related to our spin off from Owens Corning.
As part of the transaction in which we were spun out of Owens Corning, Owens Corning agreed to retain all liability, if any, resulting from the potential presence of hazardous substances at or migrating from our sites as well as all liabilities resulting from the transportation or arrangements made by Owens Corning for the treatment, storage or disposal of hazardous substances to any off-site location prior to September 30, 1998. In addition, Owens Corning agreed to indemnify us against any losses and damages, if any, arising out of the environmental liabilities retained by Owens Corning.
If the potential matters for which we are entitled to receive indemnification from Owens Corning result in significant liabilities for us, and for any reason Owens Corning and/or its affiliates are unable or unwilling to honor these indemnification obligations, we could be required to pay for these liabilities ourselves, which could have a material adverse effect on our business, financial condition, operating results and cash flows, our ability to fund or expand our operations and our ability to repay our existing and future indebtedness.
We rely on Owens Corning for the provision of certain products and services.
We have an agreement with Owens Corning regarding bushings fabrication that expires in December 2013. If for any reason Owens Corning is unable or unwilling to renew the bushing fabrication agreement, is unable or unwilling to honor its obligations under this agreement (or its renewal), or this agreement (or its renewal) is terminated, we may not be able to enter into a new agreement on comparable terms, if at all. Although we believe this risk has been partially mitigated by the establishment of our own alloy shop facilities, our business, financial condition, operating results and cash flows may be materially adversely affected if we are not able to enter into a new agreement on comparable terms with Owens Corning.
We have incurred net losses and filed for Chapter 11 protection under prior ownership in the past, have a limited history of profitability and may incur net losses in the future.
Beginning in 2000, a global economic downturn and inventory correction in the electronics end-market, a migration of commodity heavy yarn production for the electronics end-market to Asia, a key customer loss in the construction end-market and a number of other factors culminated in our filing for Chapter 11 protection on December 10, 2002. Since our emergence from Chapter 11 protection on April 2, 2004, we repositioned ourselves as a supplier of highly technical fibers to specialty high-margin applications.
As a result of a global economic downturn, which was prevalent through 2009, lower inventory levels held by several of our customers, and the conclusion of some defense programs, we experienced in 2009 a sharp decline in sales and in profitability resulting in the write off of the goodwill associated with our AGY US segment.
We cannot assure you that we will operate profitably in the future. In addition, we may experience significant quarter-to-quarter variations in operating results and cash flows.
If we are unable to successfully implement our cost reduction initiatives, our business, financial condition, operating results and cash flows could be materially adversely affected.
We are focused on cost reduction initiatives that relate to the optimization of our manufacturing footprint, as well as efficiency, throughput and process technology developments. Efficiency initiatives include managing assets to reduce lost machine time and focusing on quality assurance. Throughput initiatives involve reducing the frequency and duration of filament breaks, minimizing retooling duration and optimizing fiber manufacturing performance. Process technology developments involve lowering energy costs and capital intensity, reducing the need for platinum and rhodium alloy and developing the ability to quickly change glass compositions. We may be unable to successfully implement our cost reduction initiatives within expected time frames, which could have a material adverse effect on our business, financial condition, operating results and cash flows.
If Selling, general and administrative costs rise significantly from their current level, our business, financial condition, operating results and cash flows could be materially adversely affected.
We are actively managing our Selling, general and administrative expense by offsetting increasing costs, including restructuring costs, with a reduction in discretionary and other administrative expenses. If we are unable to continue managing Selling, general and administrative costs to their current level and Selling, general and administrative costs increase significantly, it could have a material adverse effect on our business, financial condition, operating results and cash flows.
Our business operates with a high degree of operating leverage, resulting from substantial capital requirements in our manufacturing operations, leading to high levels of fixed costs that will be incurred regardless of our level of business activity.
Our business is capital intensive, and regularly requires capital expenditures to maintain equipment, expand operations, increase operating efficiency and comply with environmental laws. A substantial capital requirement in our business is related to the fundamental nature of our manufacturing process which utilizes glass melting furnaces, which have a finite useful life, and which require regularly scheduled rebuilding and refurbishment.
Our capital intensity leads to high fixed costs, including depreciation expense, and results in a high degree of operating leverage, which magnifies the financial impact of volume changes in our business. In response to reduced demand for our products, we may experience negative leverage effects in that we are limited in our ability to reduce fixed costs quickly and these fixed costs may not be fully absorbed, resulting in higher average unit costs and lower gross margins if we are not able to offset this higher unit cost with price increases. Alternatively, in response to increased demand for our products, provided that we have readily available capacity to produce, we may experience positive operating leverage effects in that our fixed cost levels may not increase significantly, thus lowering our unit costs. However, in response to unanticipated increased demand for our products, for which we do not have readily available capacity to produce, we may be limited in our ability to quickly respond due to longer lead times for capital equipment, alloy, and labor requirements to increase output, which could result in an inability to satisfy demand for our products and loss of market share.
The useful life of the furnace at our AGY Asia subsidiary expires in 2012, requiring a rebuild. The rebuild is expected to require an investment of approximately $10 million. If we are unable to fund the furnace rebuild through operating cash flow and external financing, our Asian operations could be materially adversely affected. In addition, if AGY Asia is unable to meet the terms of the Asia credit facility and experience a default, it could result in a loss of the furnace, which secures the credit facility as collateral. Please refer to “Risk Factors - Risks Related to our Indebtedness” for discussion regarding our ability to remain in compliance.
A significant disruption or disaster at one of our three manufacturing facilities could have a material adverse effect on our business, financial condition, operating results and cash flows.
We own and operate three manufacturing facilities located in Aiken, South Carolina, Huntingdon, Pennsylvania and Shanghai, China. Each facility contains complex and sophisticated machines that are used in the respective manufacturing processes. Each manufacturing process could be affected by operational problems that could impair our production capability. Disruptions or shut downs at our facilities could be caused by:
•
maintenance outages, to conduct maintenance activities that cannot be performed safely during operations;
•
power failures or reductions, including the effect of lightning strikes on our electrical supply;
•
breakdown, failure or substandard performance of a significant portion of our equipment;
•
noncompliance with material environmental requirements or permits;
•
disruptions in the transportation infrastructure, including railroad tracks, bridges, tunnels or roads; or
•
other operational problems.
We are dependent upon the continued safe operation of these manufacturing facilities. Physical damage at any facility, such as damage caused by fires, floods, earthquakes or other catastrophic disasters, may also disrupt the manufacturing process and/or cause a facility shut down. Such damage may not be covered by, or may be in excess of, our industry standard insurance coverage. Any prolonged or permanent disruption in operations at our facilities could cause significant lost production, which would have a material adverse effect on our business, financial condition, operating results and cash flows.
Exposure to foreign currency exchange rate volatility could affect our operating results.
Fluctuations in foreign currency exchange rates may influence the profitability and cash flows of our business. For example, the sales of our AGY Asia subsidiary are denominated primarily in the U.S. dollar, while its costs are primarily denominated in local currency, the Chinese renminbi (“RMB”). As a result, the local currency margins of goods manufactured with costs denominated in local currency, yet sold in U.S. dollars, will vary with fluctuations in currency exchange rates, reducing when the U.S. dollar weakens against the RMB. In addition, the reported U.S. dollar value of the local currency financial statements of our AGY Asia subsidiary will vary with fluctuations in currency exchange rates. In addition, a significant percentage, approximately 38% for the year ended December 31, 2011, of the sales of AGY US are to customers in foreign countries. Accordingly, we may be adversely affected by unfavorable fluctuations in foreign currency exchange rates. As of December 31, 2011, we did not have any foreign currency hedging agreements in place. While we may enter hedging agreements from time to time to mitigate these types of fluctuations, we cannot remove all fluctuations or hedge all exposures, and our earnings may be impacted by changes in currency exchange rates.
An adverse change in the interest rates for our borrowings could adversely affect our financial condition.
We pay interest on outstanding borrowings under our revolving credit facilities and certain other long term debt obligations at interest rates that fluctuate based upon changes in various base interest rates. An adverse change in the base rates upon which our interest rates are determined could have a material adverse effect on our financial position, results of operations and cash flows.
We conduct a significant amount of our sales activities outside of the U.S., which subjects us to additional business risks that may cause our profitability to decline.
Because we operate and sell our products in a number of foreign countries, we are subject to risks associated with doing business internationally. Sales outside of the United States accounted for approximately 48% of our total consolidated sales for the year ended December 31, 2011, and will continue to account for a material portion of our sales for the foreseeable future. We may continue to pursue international growth opportunities, which could increase our exposure to risks associated with international sales and operations.
Our international operations are, and will continue to be subject to numerous risks, including:
•
unfavorable fluctuations in foreign currency exchange rates;
•
adverse changes in foreign tax, legal and regulatory requirements;
•
trade protection measures and import or export licensing requirements;
•
difficulty in protecting intellectual property;
•
differing labor regulations;
•
difficulty of enforcing agreements and collecting receivables through some foreign legal systems;
•
foreign customers may have longer payment cycles than customers in the U.S.;
•
political and economic instability; or
•
acts of hostility, terror or war.
Any one of the above could have a material adverse effect on our business, financial condition, operating results and cash flows.
Our business may suffer if we are unable to attract and retain key personnel.
We depend on the members of our senior management team and other key personnel. These employees have industry experience and relationships that we rely on to successfully implement our business plan. The loss of the services of our senior management team and other key personnel or the lack of success in attracting and retaining new and/or replacement management personnel could have a material adverse effect on our business, financial condition, operating results and cash flows.
Our Sponsor controls us and may have conflicts of interest with other holders of our securities.
On April 7, 2006, all of the outstanding stock of AGY was acquired by Holdings, which we refer to in this Annual Report as the Acquisition. Investment funds associated with Kohlberg & Company, L.L.C. (our “Sponsor”), control us through their ownership of substantially all of the equity of Holdings. As a result, our Sponsor, which controls substantially all of the voting power of Holdings, is able to control the voting power with respect to all matters and has significant influence on our overall operations and strategy. The interests of Holdings, our Sponsor or any of their affiliates may not in all cases coincide with the interests of other holders of our securities, including our “Notes”. To the extent that conflicts of interest arise, Holdings, our Sponsor or any of their affiliates may resolve those conflicts in a manner adverse to us or to other holders of our securities. For example, our Sponsor and its affiliates could cause us to make acquisitions that increase the amount of the indebtedness that is secured or sell revenue-generating assets, impairing our ability to make payments under our securities. Additionally, our Sponsor and its affiliates are in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us. Accordingly, our Sponsor and its affiliates may also pursue acquisition opportunities that may be complementary to our business, and as a result, those acquisition opportunities may not be available to us. In addition, our Sponsor and its affiliates may have an interest in pursuing acquisitions, divestitures and other transactions that, in their judgment, could enhance their equity investment, even though such transactions might involve risks to other holders of our securities.
Risks Related to Our Indebtedness
Our significant indebtedness and the restrictive covenants under the indenture governing our Notes could affect our financial health and may limit our ability to expand or pursue our business strategy.
We have a significant amount of debt. At December 31, 2011, excluding the indebtedness related to AGY Asia, which is non-recourse to AGY or any other domestic subsidiary of AGY, our total debt was $197.0 million (consisting of $25.0 million of senior secured borrowings and $172.0 million of the Notes) and we had approximately $12.8 million of additional secured borrowing capacity under our senior secured revolving credit facility for our North America operations. Our level of indebtedness could:
•
make it more difficult for us to satisfy our obligations with respect to the Notes;
•
increase our vulnerability to general adverse economic and industry conditions;
•
require us to dedicate a significant portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, research and development efforts and other general corporate purposes;
•
limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
•
place us at a competitive disadvantage compared to our competitors that have less debt; and
•
limit our ability to borrow additional funds.
In addition, the indenture governing our Notes contains restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests. Our failure to comply with those covenants could result in an event of default, which, if not cured or waived, could result in the acceleration of all of our debts. The covenants restrict our ability to take certain actions to some extent, including our ability to:
•
incur additional indebtedness;
•
pay dividends and make distributions in respect of our capital stock;
•
repurchase our capital stock;
•
make investments;
•
create or permit restrictions on the ability of our restricted subsidiaries to pay dividends or make other distributions to us;
•
engage in transactions with shareholders and affiliates;
•
create or permit certain liens;
•
use the proceeds from sales of assets and subsidiary stock;
•
sell or otherwise dispose of assets; and
•
engage in mergers and acquisitions.
There can be no assurance that our leverage and such restrictions will not adversely affect our ability to finance our future operations or capital needs or to engage in other business activities. In 2012, interest payments of $19.0 million will be due under the Notes. We may be unable to make the interest payments without one or more of the following occurrences: an amendment to our Amended Credit Facility, sale of assets, or other financing arrangements. Our ability to pay principal and interest on our indebtedness and to satisfy our other debt obligations will depend upon our future operating performance, which will be affected by prevailing economic conditions and financial, business and other factors, certain of which are beyond our control.
We may be unable to pay the AGY Asia 2012 mandatory term loan payments or to refinance the working capital loan.
AGY Asia has mandatory term loan repayment obligations of $11.0 million in 2012, of which $5.1 million is due in April, and $5.9 million is due in October. We have an agreement in principle with the AGY Asia lender to defer the April 2012 required principal payment for three months, to July 2012; however, such deferral is subject to execution of definitive documents which we expect to complete shortly. Notwithstanding the expected deferral, AGY Asia may be unable to make the mandatory $5.1 million principal payment in July 2012. Furthermore, if AGY Asia is unable to reach agreement with its lender to modify the term loan amortization schedule beyond July 2012, then AGY Asia may default under its loan agreement and the total outstanding debt of $27.6 million may be accelerated. As a result, all the outstanding borrowings under the term loan were classified as current liabilities as of December 31, 2011.
In addition, the working capital loan of AGY Asia in the aggregate amount of approximately $12.5 million matures in June 2012. If AGY Asia is unable to obtain an extension of the commitment or refinance the working capital loan prior to maturity, or if the commitment amount of any refinancing should be decreased, AGY Asia’s ability to finance its current operations and meet its short-term obligations could be adversely affected.
While the loans to AGY Asia are non-recourse to AGY US, any default by AGY Asia could impact our ability to raise additional capital or refinance our indebtedness at AGY US or operate with a global footprint, any of which could have an adverse effect on our business, financial condition, operating results and cash flows.
We may be unable to finance the consideration to be paid pursuant to the put/call agreement for the 30% noncontrolling interest in AGY Asia, which would trigger an event of default under our financing agreements.
In connection with the acquisition of a 70% controlling interest in AGY Asia, we entered into an option agreement with Grace, which expires in December 2013, pursuant to which Grace granted us a call option, and we granted Grace a put option, in respect of the 30% interest held by Grace in AGY Asia. Grace can exercise the put option after the one-year anniversary of the execution of the AGY Asia acquisition on June 10, 2009 at a stipulated multiple of earnings before interest, taxes, depreciation and amortization.
As of December 31, 2011, the redemption amount of the put option was nil compared to an initial carrying value of $12.4 million. Based on these provisions, we believe that neither the call option nor the put option will be exercised in 2012. If the acquisition of the noncontrolling interest is consummated, we intend, but cannot guarantee that we will be able, to finance the consideration to be paid pursuant to this agreement through our revolving credit agreement financing, the sale of additional equity to our Sponsor or through other sources of capital.
If AGY were to default in satisfying the put obligation it would be an event of default under AGY’s senior secured revolving credit agreement. Further, if the option is exercised on or before June 30, 2012, or after June 30, 2012, we are required pursuant to the revolving credit agreement to have excess availability under the revolver of at least $10.0 million and $8.75 million, respectively, for 60 days prior to consummation of the put option and to meet a fixed charge coverage ratio of 0.5:1.0 and of 1.0:1.0, respectively, in order to fund the option purchase price. Failure to consummate the put obligation as required, or failure to have sufficient excess availability or meet the fixed charge coverage ratio at consummation of the put option would trigger an event of default under the revolving credit agreement. An event of default, if not cured or waived, under our revolving credit facility could result in the acceleration of all of our debt thereunder. Additionally, since there are cross-default provisions in our Notes indenture and our Deutsche Bank alloy lease agreement, such failure could trigger defaults under those agreements, as well. There can be no assurance that we will meet the revolving credit agreement requirements to finance the obligation or that our Sponsor will contribute additional equity, or that we will be able to raise additional capital to enable us to consummate the put obligation.
We may be unable to refinance our alloy metals lease facility, which may result in default under our other loan agreements and an inability to access critical precious metals for our manufacturing requirements.
Our alloy metals lease facility expires in October 2012. Although we are currently in discussions with our metals lessor to extend the facility, there is no assurance that we will be able to obtain replacement financing on terms acceptable to us or at all. If we are unable to refinance the facility by June 15, 2012, in a manner acceptable to our senior secured revolving lenders, then we will be in default under that agreement and the lenders may accelerate amounts due under that facility, which could then trigger a default under our senior second lien notes.
Our borrowing capacity is directly tied, in part, to fluctuations in the market price of alloy metals that secure the Amended Credit Facility. Declines in these asset values could significantly reduce our borrowing base, further impair our liquidity, and could have a material adverse effect on our business and financial condition.
The Company’s ability to borrow money, under to the Amended Credit Facility is tied to a borrowing base calculation which is supported by the market price of our owned alloy metals, the book value of eligible accounts receivable, and the book value of eligible inventory. Fluctuations in the market prices of these alloy metals causes borrowing base volatility, which could adversely affect our borrowing capacity. At December 31, 2011, the market price per ounce of Platinum and Rhodium was $1,400. For every $100 reduction in the market price per ounce of Platinum and Rhodium, our ability to borrow under the Amended Credit Facility would be reduced by approximately $2.0 million. In addition, deterioration in our operating performance could reduce the amount of our eligible accounts receivable and inventory, which would reduce our ability to borrow. Further, our lender has the right, using its permitted discretion, to increase the required reserves specified in the borrowing base formula. Any such reserve modifications would have an adverse effect on our borrowing base and liquidity, and secondarily, may result in the application of the springing financial maintenance covenant under the Amended Credit Facility, either of which could materially and adversely affect our business and financial condition.
If our available borrowing capacity declines below $6.25 million, a springing financial covenant would be triggered under our Amended Credit Facility which would result in an event of default under the Amended Credit Facility and, if the amounts due under the Amended Credit Facility are accelerated as a result, could trigger defaults under our Notes and our alloy metals lease agreement, which would have a material adverse effect on our business and financial condition.
Pursuant to the Amended Credit Facility, the Company is required to maintain an available borrowing capacity of greater than $6.25 million. Although our undrawn availability as of December 31, 2011 was approximately $12.8 million, declines in the market price of the alloy metals securing the Amended Credit Facility or reductions in our eligible accounts receivable or inventory, or an increase in the required borrowing base reserves (as determined by the lender in its permitted discretion) could cause our available borrowing capacity to fall below $6.25 million. While we do not currently expect to borrow additional amounts under the Amended Credit Facility that would result in our available borrowing capacity falling below $6.25 million, we cannot be certain that these and other factors will not result in a reduction in our available borrowing capacity below $6.25 million.
If our available borrowing capacity falls below $6.25 million, we would become subject to the springing financial maintenance covenant, which requires a minimum fixed charge coverage ratio of 1.0 to 1.0. Based on our current financial condition, we would not satisfy this covenant as this ratio, as of December 31, 2011, was 0.4 to 1.0. Our inability to satisfy this covenant would result in an event of default under the Amended Credit Facility, which could result in all of the amounts coming due under the Amended Credit Facility. Any acceleration actions taken by our lenders as a result of this or any other event of default could result in cross-acceleration default triggers under the Notes and the Master Lease Agreement, ultimately causing both to immediately become due and payable. If the acceleration of any of our Amended Credit Facility, Notes, or the New Master Lease Agreement were to occur, we would not be able to repay such amounts when due, which would have a material adverse effect on our business, liquidity and financial condition, and there is no assurance that we would be able to obtain replacement financing on terms acceptable to us or at all.
If our available borrowing capacity under the Amended Credit Facility falls below $10 million, we will be required to calculate our borrowing base on a weekly, rather than monthly, basis, which could subject us to increased exposure to short term swings in our borrowing base and adversely affect our liquidity as well as our business and financial condition.
If our available borrowing capacity under the Amended Credit Facility falls below $10 million, we will be required to calculate our borrowing base on a weekly, rather than monthly, basis. If this occurs, we could be subject to increased exposure caused by short term fluctuations in the market price of the alloy metals securing the Amended Credit Facility and used to calculate our borrowing base. We could similarly be subject to increased risks associated with short term fluctuations in our eligible accounts receivable and eligible inventory. Any short term reduction in any of these amounts would reduce our borrowing base, which would adversely affect our liquidity and could result in the application of the springing financial maintenance covenant if our available borrowing capacity was reduced below $6.25 million. See the risk factor entitled “If our available borrowing capacity declines below $6.25 million, a springing financial covenant would be triggered under our Amended Credit Facility which could result in an event of default under both the Amended Credit Facility and our alloy metals lease agreement, either of which would have a material adverse effect on our business and financial condition.”
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
We are headquartered in Aiken, South Carolina and have three primary manufacturing facilities in two states within the U.S. and one in China. The following table outlines the location, type of facility and business segment of our administrative and manufacturing facilities, along with whether we own or lease each, as of December 31, 2011:
Name and Type of Facility
City
State/
Country
Owned/
Leased
Business
Segment
U.S.
Aiken worldwide corporate headquarters and manufacturing plant
Aiken
SC
Owned
AGY US
Huntingdon manufacturing plant
Huntingdon
PA
Owned
AGY US
Foreign
Lyon sales office
<>Lyon
France
Leased
AGY US
Shanghai, administrative office and manufacturing plant
Shanghai
China
Owned
AGY Asia
Hong Kong administrative office
Hong Kong
China
Leased
AGY Asia
All owned property in the U.S. is subject to a security interest under our AGY US senior secured revolving credit agreement and our Notes. The owned property in Shanghai is subject to a security interest under our AGY Asia term loan agreement. We believe that our existing properties are in good condition and are suitable for the conduct of our business.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are subject to various claims and legal actions that arise in the ordinary course of our business. We do not believe that we are currently party to any proceeding that, if determined adversely, would have a material adverse effect on our financial condition, results of operations or cash flows.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURE
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Not applicable.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain selected historical condensed consolidated financial information derived from our audited financial statements for the five-year period ended December 31, 2011 at the dates and for the periods indicated.
The selected historical financial information should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Consolidated Financial Statements and the accompanying notes thereto included in Item 8, “Financial Statements and Supplementary Data,” which are included elsewhere in this Annual Report on Form 10-K. Historical results are not necessarily indicative of results to be expected for future periods. All amounts are presented in thousands.
(1) We define working capital as our current assets (excluding unrestricted cash) minus our current liabilities, which includes the current portion of long-term debt and accrued interest thereon.
(2) Capital expenditures are presented net of proceeds of sales of assets, which were $1,326, $15,939, $14,146 and $6,090 for the years ended December 31, 2008, 2009, 2010 and 2011, respectively and related primarily to alloy sales.
(3) Investing activities include in 2009 a $18,200 payment for the 70% controlling interest in AGY Asia, net of cash acquired, which was funded by a $20,000 capital contribution from the Company’s equity sponsor recorded in financing activities.
(4) Financing activities in 2009 include a $20,000 capital contribution from the Company’s equity sponsor to fund the acquisition of the 70% controlling interest in AGY Asia in part offset by the $1.8 million cash outflow for the repurchase of $3.0 million of Notes, a $2.8 million increase in AGY US revolver borrowings and a $8.7 million decrease in AGY Asia borrowings since the acquisition.
(5) The deficiency for the years ended December 31, 2009, 2010 and 2011 was $106,591, $20,923 and $66,670, respectively.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
You should read the following discussion of our financial condition and results of operations with “Selected Financial Data” and the audited historical Consolidated Financial Statements and related notes included elsewhere in this Annual Report. This discussion contains forward-looking statements about our markets, the demand for our products and services and our future results. We based these statements on assumptions that we consider reasonable. Actual results may differ materially from those suggested by our forward-looking statements for various reasons including those discussed in the “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements” sections of this Annual Report. Those sections expressly qualify all subsequent oral and written forward-looking statements attributable to us or persons acting on our behalf. We do not have any intention or obligation to update forward-looking statements included in this Annual Report.
OVERVIEW
We are a leading manufacturer of advanced glass fibers that are used as reinforcing materials in numerous diverse high-value applications, including aircraft laminates, ballistic armor, pressure vessels, roofing membranes, mattress protection and architectural fabrics, and specialty electronics. We are focused on serving end-markets that require glass fibers for applications with demanding performance criteria, such as the aerospace, defense, construction, electronics, automotive and industrial end-markets.
Since the acquisition of AGY Asia on June 10, 2009 as discussed further below, the Company has two reportable segments, each a separate operating segment. The AGY US segment includes the U.S. manufacturing operations and its sale of advanced glass fibers that are used worldwide as reinforcing materials in numerous high-value applications and end-markets through AGY, its wholly owned domestic and French subsidiaries. The AGY Asia segment includes the manufacturing operations of the Company’s 70% controlling ownership interest of AGY Hong Kong Limited and its sale of advanced glass fibers that are used primarily in the Asian electronics markets. The Company’s operating segments are managed separately based on differences in their manufacturing and technology capabilities, products and services and their end-markets as well as their distinct financing agreements.
We believe we are making progress to improve operating efficiency, to expand our product offerings, our markets, and our customer base and to effectively manage our liquidity. We believe that the acquisition of AGY Asia contributes to the geographic expansion of our key businesses and the optimization of our manufacturing footprint. However, in the current economic environment, we have seen modest increases in demand in some of our key end markets but we do not anticipate a rapid return to pre-recession demand levels. Demand recovery in certain end markets has been offset by restrictions on defense-related demand due to general reductions of US and foreign government military vehicle and equipment procurements. In the midst of slower growth markets we continue to focus on new application development, as well as further optimization of our manufacturing footprint, efficiency and cost reduction initiatives, free cash flow generation and maintaining adequate liquidity necessary for our operations.
AGY Holding Corp. is a Delaware corporation and is a wholly owned subsidiary of KAGY Holding Company, Inc. (“Holdings”). Holdings acquired all of our outstanding stock in April 2006 (the “Acquisition”). Our principal executive office is located at 2556 Wagener Road, Aiken, South Carolina 29801 and our telephone number is (888) 434-0945. Our website address is http://www.agy.com.
Basis of Presentation
The accompanying financial data has been prepared by us pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) and is in conformity with U.S. generally accepted accounting principles (“GAAP”). Our fiscal year end is December 31. Unless otherwise stated, all years and dates refer to our fiscal year.
Management is responsible for the fair presentation of the accompanying Consolidated Financial Statements, prepared in accordance with GAAP, and has full responsibility for their integrity and accuracy. In the opinion of management, the accompanying Consolidated Financial Statements contain all adjustments necessary to present fairly our consolidated balance sheet, statement of operations, statement of cash flows and statement of changes in shareholder’s equity for all periods presented.
The Acquisition
On April 7, 2006, our Company was acquired by Holdings pursuant to the terms of an agreement of merger dated February 23, 2006 (the “Acquisition”). In the Acquisition, all issued and outstanding shares of our common stock were converted into the right to receive cash. Total merger consideration was approximately $271 million (approximately $275.5 million including acquisition related costs and adjustments).
2007 Continuous Filament Mat Business Combination
In October 2007, the Company acquired the North American Continuous Filament Mat business (“CFM”) of Owens Corning North America (“OC”) for an initial price of approximately $7.3 million (including acquisition-related costs of $0.8 million). The acquired assets included certain inventories and equipment located in AGY’s Huntingdon, PA facility and marble furnace assets located in Anderson, SC. Subsequently, under the terms of the acquisition agreement, OC paid AGY $2.3 million in July 2008 as a
result of the termination of the Anderson, SC land and building lease and of AGY vacating the premises in June 2008. The amount paid to the Company by OC reduced the CFM acquisition cost, first eliminating the goodwill and then reducing the value of the acquired property, plant, and equipment.
The CFM business is operated and managed as part of the AGY US segment.
2009 Chinese Business Combination
On June 10, 2009, pursuant to the terms of the Sale and Purchase Agreement dated March 12, 2009, by and among AGY Cayman, Grace Technology Investment Co., Ltd., and Grace THW Holding Limited (together, “Grace”), AGY Cayman, a company incorporated in the Cayman Islands and a wholly-owned subsidiary of the Company, completed its acquisition of 70% of the outstanding shares of Main Union Industrial Ltd. (renamed AGY Hong Kong Ltd.), a company incorporated in the People’s Republic of China (“PRC” or “China”) and previously a wholly-owned subsidiary of Grace Technology Investment Co., Ltd., a company incorporated in the British Virgin Islands and a wholly-owned subsidiary of Grace THW Holding Limited. AGY Hong Kong Ltd. owns 100% controlling interest in Shanghai Grace Technology Co., Ltd. (renamed AGY Shanghai Technology Co., Ltd.), a company incorporated in China, which is also a glassfiber yarns manufacturer. The acquired business is operated and managed as part of the AGY Asia segment and expands AGY’s geographic, manufacturing, and servicing capabilities in the Asia-Pacific region relative to the electronics and industrial end-markets.
The Company paid $20 million in cash for a 70% controlling interest in Main Union Industrial Ltd. and its subsidiaries (“AGY Asia”) and financed this consideration through the investment of additional equity by the Company’s private equity sponsors.
The details of this business combination, accounted for under the purchase method of accounting, the allocation of the purchase price that resulted in the recognition of a $20.4 million of gain on bargain purchase and the impact of AGY Asia, which has been included in our Consolidated Financial Statements since its June 10, 2009 acquisition, and the related put/call option agreement in respect of the 30% noncontrolling interest are presented in Note 3 to the accompanying Consolidated Financial Statements for the year ended December 31, 2011.
2011 AGY Asia Long-lived assets impairment
As a result of various factors in the AGY Asia reporting segment, including (a) continued losses due to operational performance challenges, (b) decreased liquidity, (c) pending debt service requirements, and (d) significant capital needs for the rebuilding of the furnace during 2012, the Company believes that a triggering event for evaluating the possible impairment of the long-lived assets in the AGY Asia segment occurred. With assistance of independent valuation experts, the Company initially determined that the carrying amounts of long-lived assets of AGY Asia were not recoverable as they exceeded the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the assets. Next, the Company determined the fair value of the AGY Asia long-lived assets and recognized an impairment loss of $37.9 million for the amount by which the carrying amounts of certain long-lived assets exceeded their fair values at December 31, 2011. Please refer to Note 5 to the accompanying Consolidated Financial Statements for the year ended December 31, 2011 for additional discussion on the calculation of the impairment loss, and the adjustments by major category of long-lived assets.
CRITICAL ACCOUNTING POLICIES
Our Consolidated Financial Statements have been prepared in accordance with GAAP. In preparing our financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses included in the financial statements. Estimates are based on historical experience and other information then currently available, the results of which form the basis of such estimates. While we believe our estimation processes are reasonable, actual results could differ from our estimates. The following describes the estimates considered most critical to our operating performance and involve the most subjective and complex assumptions and assessments.
Revenue recognition. We recognize revenue when title and risk of loss pass to the customer. Most of our revenues are recognized upon shipment to customers or upon usage notification for customers on consignment. Provisions for discounts and rebates to customers, returns and other adjustments are provided in the same period that the related sales are recorded and are based on historical experience, current conditions and contractual obligations, as applicable. We perform ongoing credit evaluations of our customers’ financial condition and establish an allowance for losses on trade receivables based upon factors surrounding the credit risk of specific customers, historical trends and other information.
Alloy metals. Alloy metals are the primary component of the heat-resistant, glass-forming bushings in our glass-melting furnaces. Molten glass is passed through the bushings to form glass filaments. In addition, alloy metals are an integral part of our installed glass-melting furnaces and therefore are classified as property, plant and equipment on the balance sheet. During the manufacturing process, a small portion of the alloy metal is physically consumed. The portion of the alloy metal physically consumed is measured at the time a bushing is reconditioned and is charged to income. This expense is recorded net of the metal that is recovered periodically after some special treatment. The amount of metal loss and the service life of the bushings are dependent upon a number of factors, including the type of furnace and the product being produced. Our alloy depletion expense net of the recoveries is disclosed in “Selected Financial Data” and as a component of “Cost of Good Sold” in the Consolidated Financial Statements.
Use of Estimates. The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The Company’s most significant estimates include assessment of intangible and long-lived assets for impairment, estimates used in determining pension and postretirement medical obligations, estimates used in determining stock-based compensation, determination of the allowance for sales discounts and rebates and establishing the valuation allowance on deferred tax assets. Actual results could differ from those estimates.
Goodwill and intangible assets with indefinite lives. We account for goodwill and other intangible assets in accordance with the provisions of ASC 350, Intangibles - Goodwill and Others. Goodwill and intangible assets with indefinite lives are not amortized, but instead are subject to annual impairment testing conducted each year as of October 31. The goodwill asset impairment test involves comparing the fair value of a reporting unit to its carrying amount. If the carrying amount of a reporting unit exceeds its fair value, a second step comparing the implied fair value of the reporting unit’s goodwill to the carrying amount of that goodwill is required to measure the potential goodwill impairment loss. Interim tests may be required if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. As defined in ASC 350-20-35, a reporting unit is an operating segment, or one level below an operating segment. Until our Chinese business combination in June 2009, we determined that we operated as one operating segment and one reporting unit. Since our Chinese business combination in June 2009, we determined that our Company operates as two reportable units consisting of AGY US and AGY Asia, each a separate operating segment, as discussed in the Segment Information footnote to the Consolidated Financial Statements. As there are no reporting units below the operating segment level, the reportable units are the level at which the Company tests for goodwill impairment.
All of our goodwill and other intangible assets with indefinite lives relate to AGY US, and accordingly, the test for impairment is based on the fair value of the AGY US reporting unit. To determine the estimated fair value of the reportable segment, the Company, with the assistance of a third-party specialist, uses both a market valuation and income valuation approach. The market valuation approach uses prices and other relevant information generated by market transactions involving comparable businesses. The income valuation approach uses valuation techniques such as discounted future cash flows analysis. Specific assumptions are updated at the date of each test to consider current industry and Company-specific performance and risk factors from the perspective of a market participant. While the Company believes it has made reasonable estimates and assumptions to calculate the fair value of the reporting unit, it is possible a material change could occur.
As discussed in Note 7 to the accompanying Consolidated Financial Statements for the year ended December 31, 2011, the Company performed its impairment testing of goodwill during 2009. The Company concluded with the assistance of independent third-party valuation specialists that the goodwill associated with the AGY US segment was fully impaired as of October 31, 2009. As a result, we recognized a non-cash, pre-tax goodwill impairment charge of approximately $85.0 million, classified as a “loss from operations” for the year ended December 31, 2009.
Our intangibles with indefinite lives (trademarks) are subject to at least annual impairment testing, which compares their fair value with their carrying amount. The results of these assessments did not indicate any impairment to these intangible assets for the years presented. As of December 31, 2011 the fair value of the trademarks exceeded their carrying value of $5.6 million by 4%.
We continually monitor and evaluate current business performance and our business outlook in determining whether there are events or circumstances requiring us to re-evaluate intangible assets with indefinite lives for impairment. Significant changes in demand levels within the Company’s respective markets, changes in production costs including raw materials, metal alloy, energy and direct labor, may have a material impact on the results of future valuations, and if adverse, could cause us to recognize additional impairment.
Impairment of long-lived assets, including definite-lived intangible assets. Pursuant to ASC 360-10, we evaluate our long-lived assets, including our tangible assets consisting of property plant, and equipment, and alloy metals (which are an integral part of our installed glass-melting furnaces) and our definite-lived intangible assets, for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. A significant decrease in the spot market price of alloy precious metals is one of the factors we consider in determining the need to test this asset group for recoverability. However, we also take into account that the market price of the precious metals may be volatile over short periods of time. Accordingly, changes in the market price of alloy precious metals may not trigger impairment assessment because such changes may not significantly impact future cash flows expected from the use of the alloy metals on an ongoing basis.
An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset, plus net proceeds expected from the disposition of the asset (if any), are less than the related asset’s carrying amount. Estimating future cash flows requires us to make judgments regarding future economic conditions, product demand, and pricing. Although we believe our estimates are appropriate, significant differences in the actual performance of the asset or group of assets may materially affect the Company’s asset values and results of operations.
As a result of the first step of the annual goodwill impairment evaluation on October 31, 2009 for the AGY US reporting segment, we tested for impairment the remaining long-lived assets of this reporting segment. Based on our analysis, the total estimated cash flows of the long-lived assets group exceeded substantially its carrying value, and no impairment charge was recognized in 2009.
During the fourth quarter of 2011, our US reporting segment continued to incur losses due to operational performance challenges, experienced a decrease in liquidity and there was a significant decline in precious metal market prices. Accordingly, management evaluated for impairment the long-lived assets of this reporting segment at December 31, 2011. Based on the analysis performed by management, the total recoverable cash flows of the long-lived assets group substantially exceeded its carrying value. No impairment charge was recognized for the US reporting segment.
As discussed in the Impairment Disclosure on page 19 and further discussed in Note 5 to the accompanying Consolidated Financial Statements for the year ended December 31, 2011, the Company performed a similar evaluation on the AGY Asia reporting segment, and recorded an impairment of $37.9 million as of December 31, 2011.
Income taxes. We account for income taxes under the asset and liability method approach established by ASC 740, Income Taxes. Deferred income tax assets and liabilities reflect tax net operating loss and credit carry-forwards and the tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. Deferred tax assets require a valuation allowance when it is more likely than not, based on the evaluation of positive and negative evidence, that some portion of the deferred tax assets may not be realized. When events and circumstances so dictate, we evaluate whether our deferred tax assets are realizable and the need for a valuation allowance considering objective evidence such as reversal of our existing deferred tax liabilities, and forecasts of future taxable income. Accounting standards require that uncertain tax positions be sustainable under regulatory review by tax authorities assumed to have all relevant information. We recognize the largest amount of benefit that is more likely than not realizable upon settlement with tax authorities.
We consider our foreign earnings in AGY Europe SARL and in AGY Asia to be permanently invested and, accordingly, we did not provide for U.S. income taxes on the undistributed earnings of our foreign subsidiaries.
Pension and Other Postretirement benefits. As discussed in Note 13 to the accompanying Consolidated Financial Statements for the year ended December 31, 2011, we have a reimbursement obligation to OC under OC’s defined benefit pension plan covering certain of our employees. We also have a postretirement benefit plan that covers substantially all of our domestic employees. Accounting for pensions and other postretirement benefits involves estimating the cost of benefits to be provided well into the future and attributing that cost over the time period each employee works. To accomplish this, we make extensive use of assumptions about discount rates, inflation, mortality, turnover and medical costs.
RESULTS OF OPERATIONS
The following tables illustrate our results of operations in dollars and as a percentage of net sales for the years ended December 31, 2011, 2010 and 2009 (dollars in thousands):
As further discussed below, we use EBITDA and Adjusted EBITDA, which are non-GAAP financial measures, to measure our financial performance.
EBITDA and Adjusted EBITDA (which are defined below) are reconciled from net income (loss) determined under GAAP as follows (dollars in thousands):
(a) We purchase or lease alloy metals that are used in our manufacturing process. During the manufacturing process a small portion of the alloy metal is physically consumed. When the metal is actually consumed we recognize a non-cash charge. This expense is recorded net of the amount of metal that can be recovered after some specific treatment and net of charges associated which such recovery treatment.
(b) Reflects the non-cash compensation expenses related to awards under Holdings’ 2006 Stock Option Plan and Holdings’ Restricted Stock granted to certain members of management.
(c) Reflects the elimination of the transactional costs associated with AGY Asia business combination that was consummated on June 10, 2009. Costs incurred and deferred at December 31, 2008 of $1,098 were expensed in 2009 as a result of adopting the provisions of ASC 805; the remainder of $1,627 constitutes incremental acquisition-related costs incurred and expensed in 2009.
(d) Reflects the elimination of the net gain on early extinguishment of debt associated with the $3,000 (face value) 11% senior second lien notes due 2014 (the “Notes”) repurchase made by the Company in February 2009.
(e) Reflects the elimination of the restructuring charges associated with (i) reductions in our salaried workforce in 2009, (ii), the relocation of some manufacturing equipment in 2010 to reduce our cost structure, streamline processes and optimize the AGY US manufacturing footprint and (iii) reduction in our salaried force in 2011 and the engagement of a global professional services firm to lead rapid operational improvement opportunities and provide interim senior management services in 2011.
(f) Reflects the elimination of the annual management fee and expenses payable to our Sponsor, Kohlberg & Company, LLC, pursuant to the management agreement entered into in connection with the Acquisition.
(g) Reflects the elimination of the charges associated with (i) the impairment of AGY Asia long-lived assets, which was recognized in 2011, and (ii) the impairment of the goodwill related to the AGY US segment, which was recognized in 2009.
(h) Reflects the elimination of the gain on bargain purchase associated with AGY Asia business combination.
(i) Reflects the elimination of the gain from contract termination associated with the termination for breaches of covenants of a supply agreement entered into by AGY Asia in 2009 at the time of the acquisition.
(j) Reflects primarily the elimination of the gain (loss) recorded versus historical book value on the sale or exchange of some non-operating assets.
EBITDA is defined as earnings before interest, taxes, depreciation and amortization. EBITDA is a measure used by management to measure operating performance. EBITDA is not a recognized term under GAAP and does not purport to be an alternative (a) to net income as a measure of operating performance or (b) to cash flows from operating activities as a measure of liquidity. Additionally, EBITDA is not intended to be a measure of free cash flow available for management’s discretionary use, as it does not consider certain cash requirements such as interest payments, tax payments and debt service requirements. Management believes EBITDA is helpful in highlighting trends because EBITDA excludes the results of decisions that are outside the control of operating management and can differ significantly from company to company depending on long-term strategic decisions regarding capital structure, the tax jurisdictions in which companies operate and capital investments. In addition, management believes that EBITDA provides more comparability between our historical results and our recent results that reflect purchase accounting and changes in our capital structure. Management compensates for the limitations of using non-GAAP financial measures by using them to supplement GAAP results to provide a more complete understanding of the factors and trends affecting the business than GAAP results alone. Because not all companies use identical calculations, these presentations of EBITDA may not be comparable to other similarly titled measures of other companies.
Adjusted EBITDA is a non-GAAP financial measure which is defined as EBITDA further adjusted to exclude unusual items and other adjustments permitted in calculating covenant compliance and calculated in the same manner as “Consolidated Cash Flow” under the indenture governing our Notes, which is used by management in calculating our fixed charge coverage ratio under the indenture governing our Notes. We believe that the inclusion of supplementary adjustments to EBITDA applied in presenting Adjusted EBITDA is appropriate to provide additional information to investors.
Year ended December 31, 2011 compared to year ended December 31, 2010
Net sales. Net sales remained flat at $183.7 million for the years ended December 31, 2010 and 2011. AGY Asia contributed $3.2 million of additional revenue (after accounting for the elimination of $1.3 million and $3.0 million of intercompany sales in 2011 and 2010, respectively) due primarily to the stronger Asian electronics market and pricing momentum through the first half of 2011. The $3.2 million, or 2.0%, net decrease in sales generated by AGY US for the year ended December 31, 2011, compared to the same period of 2010 was primarily due to $22.8 million of lower sales volumes, while a favorable product mix and pricing increases accounted for an increase in sales of $19.6 million. Aerospace and defense revenues were $49.9 million, or globally up 10% when compared to the prior year. This increase reflects a record sales level for aerospace, which increased by 18% compared to the year ended December 31, 2010 as a result of continued robust demand for aircraft retrofit, new build activity and pricing actions, while defense sales were negatively impacted by delays in certain major international programs. The electronics market revenues increased to $31.5 million, or 12%, compared to the same period in 2010 reflecting pricing actions, plus increased demand for specialty electronics fibers, which also drove mix enrichment within this market during the year. The G&I market revenues decreased globally to $73.9 million, or 13%. This $11.0 decrease was largely caused by our CFM business, which decreased $6.9 million, or 30%, to $16.4 million, when compared to the prior year as a result of market share loss at key accounts following late 2010 pricing actions. In addition, G&I revenues were negatively impacted by lower construction market revenues, which decreased $7.1 million, or 34%, to $14.0 million for the year ended December 31, 2011, reflecting some capacity-constrained sales only in part offset by 2011 pricing actions. These decreases were partly offset by a $3.1 million increase in other industrial and automotive market revenues driven by pricing actions and mix enrichment compared to the prior year.
Gross profit/ loss. We reported a consolidated gross profit of $12.0 million, or 7% of net sales for the year ended December 31, 2011, compared to $14.7 million, or 8% of net sales for the year ended December 31, 2010. AGY Asia segment profitability contribution decreased $1.6 million as increased margin from sales was more than offset by increased production costs due primarily to inflation in raw material, labor and energy costs and the appreciation of the Chinese currency compared to the U.S. dollar. AGY US’s contribution to the total gross profit decreased $1.1 million during the year, when compared to 2010. The profitability of our AGY US segment benefited from $20.4 million of margin from a more favorable product mix and pricing actions executed over the last five quarters, but was negatively impacted by $8.8 million of lower shipments due to constrained sales and reduced demand in certain markets. The $11.6 million net gain resulting from sales, however, was offset by increased manufacturing costs and challenges
we faced in operations where we experienced larger than expected manufacturing efficiency losses from the destabilizing effect of major capacity scale up in our Aiken, SC plant during the first half of 2011. In 2010, the AGY US segment results were also negatively impacted by $4.1 million of accelerated depreciation expenses related to the 2010 restructuring initiatives to optimize the U.S. manufacturing footprint, which totaled only $0.2 million in 2011.
Selling, general and administrative expenses. Selling, general and administrative costs remained flat at $15.8 million, or 8.6% of net sales for the year ended December 31, 2011 and 2010.The AGY US segment offset the negative impact of merit increases and payroll tax adjustments by reducing discretionary expenses and headcount, primarily during the fourth quarter of 2011.
Restructuring charges. In conjunction with the restructuring actions we initiated in our AGY US segment to improve our cost structure and mitigate the adverse impact of the decline in precious metals markets on our borrowings availability, we recorded $1.4 million in restructuring charges in the year ended December 31, 2011 that related primarily to severance and professional fees. For the year ended December 31, 2010, we recorded $2.7 million in restructuring charges in the AGY US segment, primarily related to the relocation of manufacturing equipment in conjunction with the structural cost reduction initiative to optimize the AGY US manufacturing footprint. See further disclosures in Note 8 to the accompanying Consolidated Financial Statements for the year ended December 31, 2011.
Long-lived assets impairment charge. Various factors in the AGY Asia reporting segment including (a) lower than expected operating profit and cash flows, (b) pending debt service requirements and (c) significant capital needs for the rebuilding of the furnace during 2012, triggered management to evaluate the potential impairment of the long-lived assets of this reporting segment at December 31, 2011. Accordingly, the Company concluded that certain of the long-lived assets were impaired and recorded an impairment charge of $37.9 million, classified in “loss from operations” in 2011. See further disclosures in Note 5 to the accompanying Consolidated Financial Statements for the year ended December 31, 2011.
Other operating income. During the year ended December 31, 2011, other operating income of $1.1 million consisted primarily of a $1.3 million gain recognized on sale of some precious metals. During the year ended December 31, 2010, other operating income of $6.4 million consisted primarily of a $6.3 million gain from the termination by AGY Asia, for breaches of covenants, of a supply agreement entered into in 2009 at the time of the acquisition.
Other non-operating income. During the years ended December 31, 2010 and 2011, other non-operating income of $0.19 million and $0.08 million, respectively, was not significant.
Interest expense. Interest expense increased $0.9 million from $22.8 million for the year ended December 31, 2010 to $23.7 million for the year ended December 31, 2011. The increase was primarily due to incremental interest expense associated with higher borrowings by AGY US and to the increase of the weighted average interest rate for AGY Asia.
Income tax benefit (expense). Income tax benefit/(expense) changed from $6.3 million tax benefit for the year ended December 31, 2010 to a $0.1 million tax expense for the year ended December 31, 2011 due to the limitation on recording tax benefits from net operating losses. During the year ended December 31, 2011, our effective tax rate was an expense of (0.14%). This rate varied from the statutory rate of 34% due primarily to the change in the valuation allowance for domestic deferred tax assets, which are not more-likely-than-not to be realized, change in foreign valuation allowance, losses on domestic and foreign subsidiaries with no tax benefit, and foreign rate differential, which benefits were partially offset by state taxes. Generally, the Company can recognize deferred tax assets for the losses incurred until such time that the aggregate deferred tax assets exceed aggregate deferred tax liabilities that do not relate to assets with an indefinite useful life. During the year ended December 31, 2010, our effective tax rate was a benefit of 30.3%. This rate varied from the statutory rate of 34% due primarily to establishment of valuation allowance during 2010 for domestic deferred tax assets, which are not more-likely-than-not to be realized, change in foreign valuation allowance, losses on domestic and foreign subsidiaries with no tax benefit, and foreign rate differential, which benefits were partially offset by state taxes.
Net income (loss). As a result of the aforementioned factors including primarily (a) higher than expected manufacturing efficiency losses in AGY US, (b) higher production costs in AGY Asia and additional restructuring and impairment charges in 2011, (c) accelerated depreciation and restructuring charges for the AGY US segment and (d) gain on contract termination related to AGY Asia in 2010, we reported a net loss attributable to AGY of $54.5 million for the year ended December 31, 2011, compared to a net loss of $16.1 million for the year ended December 31, 2010. The net loss attributable to the 30% noncontrolling interest in AGY Asia for the year ended December 31, 2011 was $12.2 million compared to net income of $1.5 million for the year ended December 31, 2010.
Year ended December 31, 2010 compared to year ended December 31, 2009
Net sales. Net sales increased $29.8 million, or 19.3%, to $183.7 million for the year ended December 31, 2010, compared to $153.9 million during the comparable period of 2009. AGY Asia, which was acquired in June 2009, contributed $12.4 million of additional revenue (after accounting for the elimination of $2.8 million of increased intercompany sales) of which approximately $3.6 million is due to the stronger Asian electronics demand and favorable pricing in 2010. The remaining $17.4 million, or 12.4%, net increase in sales generated by AGY US for the year ended December 31, 2010, compared to the same period of 2009 was primarily due to $22.9 million of higher sales volumes, while an unfavorable product mix and competitive pricing pressures accounted for a decrease in sales of $5.5 million. We experienced increased demand in all the markets that we serve except defense. These increases resulted primarily
from the return to more normal historical inventory levels for several of our customers. Market and global economic conditions stabilized and steadily improved over the bottom experienced during the second quarter of 2009. Aerospace sales increased by $8.6 million compared to the year ended December 31, 2009 and returned to 2008 average demand levels, reflecting increases in both aircraft retrofit and new build activity and some inventory restocking in the supply chain in early 2010. The electronics, industrial and construction market revenues of the U.S operating segment increased approximately $0.8 million, $14.3 million and $3.5 million, respectively, compared to the same period in 2009. Defense revenue decreased $9.8 million during the year ended December 31, 2010, compared to the same period of 2009 as the result of the conclusion of the Mine Resistant Ambush Protected (“MRAP”) program during the first quarter of 2009 and competitive pricing pressures.
Gross profit/ loss. We reported a consolidated gross profit of $14.7 million, or 8% of net sales for the year ended December 31, 2010, compared to a negative gross margin of $2.7 million for the year ended December 31, 2009. While AGY Asia contributed $4.6 million of the improvement, our AGY US segment drove the remaining increase in profitability of $12.8 million for the year ended December 31, 2010. The profitability of our AGY US segment benefited from $9.1 million of margin on increased sales but was negatively impacted $4.0 million from competitive pricing pressure in certain markets. Additionally, the AGY US segment results were positively impacted in 2010 by improved manufacturing efficiencies, cost reduction initiatives and higher absorption of overhead costs, partially offset by $4.1 million of accelerated depreciation related to the optimization of our U.S. manufacturing footprint. In 2009, the AGY US segment results were negatively impacted by expenses associated with management’s decision to curtail production capacity and lower inventory levels in order to improve liquidity.
Selling, general and administrative expenses. Selling, general and administrative costs decreased $0.2 million from $16.0 million for the year ended December 31, 2009 to $15.8 million for the year ended December 31, 2010. The $1.0 million of incremental expenses associated with the AGY Asia acquisition in 2010 compared to 2009 were offset by $1.2 million of lower expenses for our AGY US operating segment including a reduction in salaried workforce during 2009 and lower stock compensation charges during 2010. Selling, general and administrative costs decreased from 10.4% of net sales for the year ended December 31, 2009 to 8.6% of net sales for the year ended December 31, 2010.
Restructuring charges. In conjunction with additional actions taken in 2010 to further optimize the AGY US manufacturing footprint and improve profitability, we recorded $2.7 million in restructuring charges in the year ended December 31, 2010 that related primarily to the relocation of manufacturing equipment. For the year ended December 31, 2009, we recorded $0.8 million in restructuring charges in the AGY US segment, primarily related to severance and outplacement costs for headcount reductions in connection with our structural cost-reduction initiatives. See further disclosures in Note 8 to the accompanying Consolidated Financial Statements for the year ended December 31, 2010.
Other operating income. During the year ended December 31, 2010, other operating income of $6.4 million consisted primarily of a $6.3 million gain from the termination by AGY Asia, for breaches of covenants, of a supply agreement entered into in 2009 at the time of the acquisition. During the year ended December 31, 2009, other operating expense of $0.8 million was primarily due to $2.6 million of AGY Asia acquisition-related costs, including $1.1 million of costs incurred and deferred at December 31, 2008 that were subsequently expensed on January 1, 2009 as a result of adopting ASC 805. These costs were partially offset by a $1.2 million gain recognized on the sale of alloy metals in 2009.
Goodwill impairment charge. During 2009,the Company concluded that all goodwill was fully impaired and recognized non-cash, pre-tax goodwill impairment charges of $85.0 million, classified in “loss from operations”. See further disclosures in Note 7 to the Consolidated Financial Statements for the year ended December 31, 2009 in our Annual Report on Form 10-K for the year ended December 31, 2009 (our “2009 Form 10-K”).
Gain on bargain purchase. Management concluded, with the assistance of an independent third-party valuation specialist, that the fair value of the acquired assets exceeded the liabilities assumed associated with the AGY Asia acquisition, and that a bargain purchase of approximately $20.4 million resulted at the June 10, 2009 acquisition date. See further disclosures in Note 3 to the accompanying Consolidated Financial Statements for the year ended December 31, 2010.
Other non-operating income. During the year ended December 31, 2010, other non-operating income of $0.15 million was not significant. During the year ended December 31, 2009, other non-operating income of $1.5 million consisted primarily of the net $1.1 million gain on the early extinguishment of debt associated with the purchase of $3 million (face value) of our Notes.
Interest expense. Interest expense increased $0.6 million from $22.2 million for the year ended December 31, 2009 to $22.8 million for the year ended December 31, 2010. The increase was primarily due to incremental interest expense associated with the AGY Asia acquisition.
Income tax benefit (expense). Income tax benefit decreased $6.8 million from $13.1 million tax benefit for the year ended December 31, 2009 to a $6.3 million tax benefit for the year ended December 31, 2010. During the year ended December 31, 2010, our effective tax rate was a benefit of 30.3%. This rate varied from the statutory rate of 34% due primarily to establishment of valuation allowance during 2010 for domestic deferred tax assets, which are not more-likely-than-not to be realized. Other notable effects were the change in foreign valuation allowance, losses on domestic and foreign subsidiaries with no tax benefit, and foreign rate differential, which benefits were partially offset by state taxes. Generally, the Company can recognize deferred tax assets for the losses incurred until such time that the aggregate deferred tax assets exceed aggregate deferred tax liabilities that do not relate to assets with an indefinite
useful life. During the year ended December 31, 2009, our effective tax rate was a benefit of 12.3%. This rate varied from the statutory rate of 34% due primarily to the goodwill impairment charge not deductible for tax, a nontaxable gain in connection with the bargain purchase related to the AGY Asia acquisition, and transactional costs associated with the AGY Asia acquisition that were expensed during 2009 but not deductible for tax, which benefits were partially offset by state taxes.
Net income (loss). As a result of the aforementioned factors including primarily restructuring and accelerated depreciation charges for the AGY US segment and a gain on contract termination related to AGY Asia in 2010 and significant non-recurring non cash net charges (goodwill impairment charge; gain on bargain purchase) in 2009, we reported a net loss attributable to AGY of $16.1 million for the year ended December 31, 2010, compared to a net loss of $92.4 million for the year ended December 31, 2009. The net loss attributable to the 30% noncontrolling interest in AGY Asia from the acquisition date in June 2009 to December 31, 2009 was $1.1 million compared to net income of $1.5 million for the year ended December 31, 2010.
LIQUIDITY AND CAPITAL RESOURCES
AGY Holding Corp. and its Domestic Subsidiaries’ Liquidity
Cash requirements for, but not limited to, interest payments, working capital, capital expenditures, strategic initiatives, and normal recurring operating expenses have been funded from cash balances on hand, revolver borrowings, and sales of alloy metals.
As of December 31, 2011, AGY US had total liquidity of $13.3 million, consisting of $0.5 million in unrestricted cash and approximately $12.8 million of borrowing availability under the Amended Credit Facility. If our borrowing availability under the Amended Credit Facility falls below $6.25 million, we will be subject to a springing financial maintenance covenant under which we would likely be in default. In 2012, interest payments of $19.0 million will be due under AGY’s Senior Second Lien Notes, which we expect to be able to meet with our current and projected sources of liquidity and precious metal prices. In the event we are not able to meet those payments, we will seek one or more options to strengthen our liquidity, including: amendment to our Amended Credit Facility, sale of assets, or other financing arrangements. Please refer to “Risk Factors - Risks Related to our Indebtedness” for additional discussion regarding our liquidity.
There are no mandatory payments of principal on the Amended Credit Facility or on the Notes scheduled prior to their earliest maturity in August 2014 and November 2014, respectively.
AGY Asia’s Liquidity
AGY Asia’s cash requirements stem primarily from interest and principal payment, capital expenditures, alloy metals, strategic initiatives, normal recurring operating expenses and working capital requirements and have been funded by cash on hand, cash from operations and borrowings under the AGY Asia Credit Facility.
As of December 31, 2011, AGY Asia had total liquidity of $4.3 million, consisting of $1.8 million of unrestricted cash and approximately $2.5 million of borrowing availability under the AGY Asia Credit Facility. In 2012, semi-annual mandatory principal repayments of $11.0 million are due under the AGY Asia Credit Facility. We have an agreement in principle with the AGY Asia lender to defer the April 2012 required principal payment for three months, to July 2012. However, such deferral is subject to execution of definitive documents, which we expect to complete shortly. Notwithstanding the expected deferral, there is no assurance that we will be able to permanently revise the term loan amortization schedule on terms acceptable to us or at all. We may be unable to make the principal payments without one or more of the following occurrences: a refinancing of our AGY Asia Credit Facility, an amendment to our AGY Asia Credit Facility, sale of assets, or other financing arrangements. Please refer to “Risk Factors - Risks Related to our Indebtedness” for additional discussion regarding the liquidity of AGY Asia.
Working Capital
We define working capital as total current assets, excluding unrestricted cash, less total current liabilities, including short-term borrowings and current portion of long-term debt. We reported a working capital deficiency of $13.3 million on December 31, 2011 compared to working capital of $14.9 million and December 31, 2010. The $28.2 million decrease relates to (a) a $22.3 million decrease in the working capital of AGY Asia due to increases in short-term borrowings and current maturities of long term debt, and (b) a $5.5 million decrease in the working capital of AGY US. This decrease was due to a $3.4 million increase in trade payables primarily due to extending payment terms with suppliers, a $0.8 million increase in accrued liabilities primarily due to the increase of accrued restructuring expenses and of the amount due for pension and retiree medical reimbursement to Owens Corning and a $1.2 million decrease in deferred taxes due to increases in the valuation allowance.
Contractual Obligations
In the ordinary course of business, the Company enters into contractual obligations to make cash payments to third parties. The Company’s known contractual obligations as of December 31, 2011 were as follows (in thousands):
(1) Includes the classification of all the outstanding borrowings under the term loan of AGY Asia as current liabilities due to the uncertainty to satisfactorily revise the term loan amortization schedule with the lender beyond July 2012.
(2) Includes those leases, which have non-cancellable terms in excess of one year.
(3) Purchase obligations are commitments to suppliers to purchase goods or services, and include take-or-pay arrangements, capital expenditures, and contractual commitments to purchase equipment. We did not include ordinary course of business purchase orders in this amount as the majority of such purchase orders may be canceled and are reflected in historical operating cash flow trends. We do not believe such purchase orders will adversely affect our liquidity position.
(4) Includes future minimum rentals of leased alloy metals.
(5) Interest on variable rate debt is calculated using the weighted-average interest rate in effect as of December 31, 2011 for all future periods.
The table also does not include future estimated benefits payments for pension and other post-retirement benefit obligations and the put obligation related to the noncontrolling interest in AGY Asia, which are included in Notes 13 and 20, respectively, to the 2011 Consolidated Financial Statements.
Year ended December 31, 2011 compared to year ended December 31, 2010
Cash flows from operating activities
Cash used by operating activities was $2.3 million for the year ended December 31, 2011, compared to cash used by operating activities of $4.1 million for the year ended December 31, 2010. The $1.8 million decrease in cash used by operating activities is attributed to a global $2.9 million decrease in operating working capital in 2011 as compared to a $6.0 million increase during 2010. In addition to the decrease in cash used by working capital components, in 2011 we recognized a $5.4 million loss (as adjusted for non-cash items) compared to income of $1.9 million (as adjusted for non-cash items) recognized in 2010.
Cash flows from investing activities
Cash provided by investing activities was nil for the year ended December 31, 2011, compared to cash provided by investing activities of $4.3 million for the year ended December 31, 2010. The $4.3 million decrease was primarily due to $6.1 million in net proceeds from alloy sales recognized in 2011 as compared to $14.1 million in 2010, offset by a $3.7 million decrease in capital spending primarily attributable to AGY Asia for the year ended December 31, 2011 compared to 2010.
Cash flows from financing activities
Cash provided by financing activities was $1.4 million for the year ended December 31, 2011, compared to $0.4 million used for the year ended December 31, 2010. The $1.8 million increase was attributable to an $8.3 million increase in cash provided by revolver loans to AGY US, partly reduced by $0.9 million in cash used for debt issuance costs related to our amended revolving facility and a $5.7 million increase in cash used from loan repayments of AGY Asia.
Year ended December 31, 2010 compared to year ended December 31, 2009
Cash flows from operating activities
Cash used by operating activities was $4.1 million for the year ended December 31, 2010, compared to cash used by operating activities of $11.1 million for the year ended December 31, 2009. The $7.0 million decrease in cash used by operating activities during the year ended December 31, 2010 as compared to the prior year is attributed to a $23.5 million reduction in net loss (as adjusted for non-cash items) during the comparable periods. This loss reduction was offset in part by a global $16.5 million decrease of operating cash provided by working capital, primarily from a $14.3 million reduction in cash provided by inventory reductions and a $3.6 million increase in cash used by the change in accounts payable.
Cash flows from investing activities
Cash provided by investing activities was $4.3 million for the year ended December 31, 2010, compared to cash used in investing activities of $2.5 million for the year ended December 31, 2009. The $6.8 million increase was primarily due to (i) $9.8 million of capital expenditures for the year ended December 31, 2010 compared to $13.3 million for 2009, (ii) the sale of $14.1 million of alloy metals for the year ended December 31, 2010 compared to $15.9 million for the year ended December 31, 2009, (iii) a nonrecurring $13.1 million decrease in restricted cash in 2009 associated with the refinancing of AGY Asia in July 2009, and (iv) the $18.2 million payment for the majority interest of AGY Asia, net of cash acquired, in June 2009.
Cash flows from financing activities
Cash used in financing activities was $0.4 million for the year ended December 31, 2010, compared to $12.3 million provided for the year ended December 31, 2009. The $12.7 million decrease was attributable to the AGY Asia investment in 2009 consisting of a $20.0 million equity infusion by Kohlberg & Company, LLC to fund the acquisition, partly offset by a $12.3 million shareholder loan repayment, which were not recurring in 2010, as well as a $4.2 million decrease in US revolver borrowings and a $2.6 million decrease in AGY Asia bank loans. These were partly offset by the $1.8 million cash outflow for the repurchase of $3.0 million of Notes (face value) in the year ended December 31, 2009 that was not recurring in the comparable period of 2010.
Indebtedness
AGY US
Senior Secured Revolving Credit Facility. In March 2011, the Company expanded its $40 million senior secured credit facility to $50 million (“the Amended Credit Facility”), including a $20 million sub-limit for letters of credit. The Amended Credit Facility matures on August 15, 2014, unless, prior to that date, the Notes are refinanced or paid in full, in which case the facility matures on March 8, 2015. Availability under the facility is determined by a borrowing base equal to the sum of: (i) an advance rate against eligible accounts receivable of up to 85%, plus (ii) the lesser of (A) 65% of the book value of eligible inventory (valued at the lower of cost or market) and (B) 85% of the net orderly liquidation value for eligible inventory, plus (iii) up to $40,000 of eligible alloy inventory, minus (iv) 100% of mark-to-market risk on certain interest hedging arrangements, minus (v) a reserve of $7,500, and minus (vi) other reserves as the lender may determine in its permitted discretion.
The interest rate for borrowings is LIBOR plus 3.0% or Base Rate plus 2.0%. Depending on our fixed charge coverage ratio, the interest rate may be adjusted downward to LIBOR plus 2.5% or Base Rate plus 1.5%. In addition, there are customary commitment and letter of credit fees under the Amended Credit Facility.
All obligations under the Amended Credit Facility are guaranteed by Holdings. The Company’s obligations under the Amended Credit Facility are secured, subject to permitted liens and other agreed upon exceptions, by a first-priority security interest in substantially all of the Company’s assets.
The Amended Credit Facility contains customary representations and warranties and customary affirmative and negative covenants, including, among other things, restrictions on indebtedness, liens, investments, mergers and consolidations, dividends and other payments in respect to capital stock, transactions with affiliates, and optional payments and modifications of subordinated and other debt instruments. In addition, the agreement contains a “springing financial maintenance covenant,” which would not be effective until a default or an event of default occurs, or unless the availability under the facility were to fall below the greater of $6.25 million and 12.5% of the Borrowing Base (as defined) as of the last day of any fiscal month. As of December 31, 2011, we were in compliance with all covenants. However, please refer to “Risk Factors - Risks Related to our Indebtedness” for discussion regarding our ability to remain in compliance.
The agreement governing the Amended Credit Facility permits the lenders to accelerate payment of the outstanding principal and accrued and unpaid interest and/or to terminate their commitment to lend any additional amounts upon certain events of default, including but not limited to failure to pay principal or interest or other amounts when due, breach of certain covenants or representations including breach of the springing covenant, cross-defaults to certain other agreements and indebtedness in excess of specified amounts, a change of control, or default under our obligation of the AGY Asia option exercise.
As of December 31, 2011, the Company had issued letters of credit totaling $2.9 million and had cash borrowings of $25.0 million leaving total undrawn availability of $12.8 million after giving effect to the total borrowing base of $40.7 million.
Senior Second Lien Notes. In connection with our refinancing on October 25, 2006, we issued $175.0 million aggregate principal amount of 11% senior second lien notes (“Old Notes”) to an initial purchaser, which were subsequently resold to qualified institutional buyers and non-U.S. persons in reliance upon Rule 144A and Regulation S under the Securities Act of 1933, as amended. We consummated an exchange offer of the Old Notes in June 2008. Interest on the Notes is payable semi-annually on May 15 and November 15 of each year. Our obligations under the Notes are fully and unconditionally guaranteed, jointly and severally, on a second-priority basis, by each of our existing and future domestic subsidiaries, other than immaterial subsidiaries, that guarantee our indebtedness, including our new Credit Facility, or the indebtedness of any our restricted subsidiaries. The indenture does not allow us to pay dividends or distributions on our outstanding capital stock (including to our parent) and limits or restricts our ability to incur additional debt, repurchase securities, make certain prohibited investments, create liens, transfer or sell assets, enter into transactions with affiliates, issue or sell stock of a subsidiary or merge or consolidate. The indenture permits the trustee or the holders of 25% or more of the Notes to accelerate payment of the outstanding principal and accrued and unpaid interest upon certain events of default, including failure to make required payments of principal and interest when due, uncured violations of the material covenants under the indenture or if lenders accelerate payment of the outstanding principal and accrued unpaid interest due to an event of default with respect to at least $15.0 million of our other debt, such as our Credit Facility.
The indenture does not contain any financial maintenance covenants.
In February 2009, we repurchased $3.0 million face amount of Notes for $1.8 million plus accrued interest and commission, resulting in a net gain on extinguishment of debt of approximately $1.1 million (net of deferred financing fees written off), classified as “other non-operating income”.
As of December 31, 2011, the estimated fair value of the Notes was $82.6 million compared to a recorded book value of $172 million.
AGY Asia
Our AGY Asia subsidiary has a credit facility consisting of a $29.2 million term loan, an $11.6 million working capital loan and a $2 million letter of credit facility.
The term loan is secured by AGY Asia’s building, alloy metals and equipment and bears interest annually at the rate of either the five-year lending rate as published by the People’s Bank of China, plus a margin, or six-month LIBOR plus 3.0%. Term loan borrowings may be made in both local currency and US dollars, up to certain limits. At December 31, 2011, approximately $27.6 million was drawn under the facility, with a remaining undrawn commitment of $1.6 million. The weighted average interest rate for cash borrowings outstanding as of December 31, 2011, was 7.0%. AGY Asia has mandatory term loan repayment obligations of $11.0 million in 2012, of which $5.1 million is due in April, and $5.9 million is due in October. We have an agreement in principle with the AGY Asia lender to defer the April 2012 required principal payment for three months, to July 2012; however, such deferral is subject to execution of definitive documents which we expect to complete shortly. Notwithstanding the expected deferral, if AGY Asia is unable to reach agreement with its lender to modify the term loan amortization schedule beyond July 2012, then AGY Asia may default under its loan agreement and the total outstanding debt of $27.6 million may be accelerated. As a result, all the outstanding borrowings under the term loan were classified as current liabilities as of December 31, 2011.
The working capital loan facility is a one-year financing agreement, which matures in June 2012. It is secured by existing and future equipment and assets acquired by AGY Shanghai and bears interest annually at the rate of either the one-year lending rate as published by the People’s Bank of China, or three-month LIBOR plus 3.0%. Working capital loan borrowings may be made in both local currency and US Dollars, up to certain limits. At December 31, 2011, the Company had approximately $11.6 million of borrowings outstanding under the working capital loan. The weighted average interest rate for cash borrowings outstanding as of December 31, 2011, was 6.9%.
During the second quarter of 2011, AGY Asia entered into a letter of credit (“LC”) discounting arrangement whereby certain trade receivables backed by LCs may be discounted with recourse and borrowed against at a nominal interest cost. At December 31, 2011, AGY Asia had discounted LCs with a face value of approximately $1.4 million (which amount is recorded in trade receivables at December 31, 2011), receiving proceeds of approximately $1.3 million and maintaining equity of approximately $0.1 million in such receivables. At December 31, 2011, proceeds of $1.3 million received from discounting were recorded as short-term debt payable.
The letter of credit facility is a one-year facility for the issuance of documentary letters of credit up to a maximum term of 120 days. A 15% deposit is required upon issuance with the balance due upon settlement of the underlying obligation.
The loan agreements contain customary representations and warranties and customary affirmative and negative covenants, including, among other things, interest coverage, restrictions on indebtedness, liens, investments, mergers and consolidations, dividends and other payments in respect to capital stock, and transactions with affiliates. The loan agreements also include customary events of default, including a default upon a change of control. AGY Shanghai was in compliance with all such covenants at December 31, 2011.
All amounts borrowed under the AGY Asia Credit Facility are non-recourse to AGY Holding Corp. or any other domestic subsidiary of AGY Holding Corp.
Other Balance Sheet Items
Net Property, Plant and Equipment and Alloy Metals. Net property, plant and equipment and alloy metals decreased $55.3 million from December 31, 2010 to December 31, 2011, primarily due to (a) impairment charge of certain AGY Asia long-lived assets of $37.9 million, (b) $22.8 million of depreciation and alloy metals depletion expenses and (c) the sale of $4.8 million of excess alloy metals at book value for proceeds of $6.1 million. We expended $5.7 million for capital projects, including accrued construction in progress. Additionally, AGY Asia had $4.5 million of positive currency translation adjustments.
Off-Balance Sheet Resources and Obligations
Alloy Metal Leases
We lease under short term operating leases (generally with lease terms from six to twelve months) a significant portion of the alloy metals needed to support our manufacturing operations. For the year ended December 31, 2011, total lease costs of alloy metals were approximately $4.3 million, compared to $3.6 million for the year ended December 31, 2010, and were classified as a component of cost of goods sold. Our lease expense is dependent on several factors, including the amount of alloy leased, market spot rates for the alloy and associated lease rates. Market spot rates are subject to daily fluctuation and this fluctuation could result in material changes to our alloy lease expense.
In 2011, 2010 and 2009, we leased alloy metals under the following agreements:
Metal Consignment Facility
From August 2005 to October 2009, we had a consignment agreement with The Bank of Nova Scotia, as assignee of Bank of America, N.A., to lease platinum, one of the alloy metals used in our manufacturing operations. Effective October 7, 2009, we terminated the Metal Consignment Facility with Bank of Nova Scotia and entered into a new master lease agreement with Deutsche Bank as discussed below.
Deutsche Bank New Master Lease Agreement
In connection with the termination of the Metal Consignment Facility with Bank of Nova Scotia on October 7, 2009, we entered into a new master lease agreement (the “New Master Lease Agreement”) with DB Energy Trading LLC (“DB”). The New Master Lease Agreement has a three-year term and allows AGY to enter into leases of alloy metals, up to 51,057 ounces of platinum and up to 3,308 ounces of rhodium, with terms of one to twelve months. Lease costs are determined by the quantity of metal leased, multiplied by a benchmark value of the applicable precious metal and a margin above the lease rate index based on DB’s daily precious metal rates. The New Master Lease Agreement is secured by a security interest in rhodium up to a value that is the lesser of 35% of the leased platinum or $24.4 million. The New Master Lease Agreement contains customary events of default, including, without limitation, nonpayment of lease payments, inaccuracy of representations and warranties in any material respect and a cross-default provision with any credit facility or leasing facility greater than $0.5 million, including the Credit Facility and the Notes. There are no financial maintenance covenants included in the New Master Lease Agreement.
At December 31, 2011, we leased approximately 49,800 ounces of platinum and 3,300 ounces of rhodium under the New Master Lease Agreement, with a total notional value of approximately $88.9 million. All of the leases outstanding at December 31, 2011 had initial terms of six to twelve months, maturing no later than October 5, 2012, with future minimum rentals of approximately $1.8 million until maturity in 2012.
Commitments and Contingencies
We are not a party to any significant litigation or claims, other than routine matters incidental to the operation of the Company. We do not expect that the outcome of any pending claims will have a material adverse effect on the Company’s financial position, results of operations or cash flows. There may be insignificant levels of asbestos in certain manufacturing facilities; however, we do not expect to incur costs (which are undeterminable) in the foreseeable future to remediate any such asbestos. Accordingly, we did not record a conditional asset retirement obligation related to such asbestos remediation because we do not have sufficient information to estimate the fair value of the asset retirement obligation in accordance with the guidance of ASC 410.
In addition to the alloy metal leases discussed above, we also lease manufacturing and other equipment and property under operating leases. Total rent expense for the years ended December 31, 2011 and 2010 was approximately $1.6 million.
The following summarizes the future minimum lease payments for each of the next five years and the total thereafter (in millions):
As discussed in Note 3 of our Consolidated Financial Statements included in the Annual Report, in connection with the purchase of AGY Asia, we entered into an option agreement with Grace pursuant to which Grace granted AGY a call option and AGY granted Grace a put option in respect of the 30% interest held by Grace in AGY Asia, in each case until December 31, 2013, unless mutually extended. The option price is determined by a formula outlined in the agreement. The exercise of the call option requires certain minimum financial performance levels to be reached by AGY Asia and the put option became exercisable in June 2010. As of December 31, 2011 the redemption amount of the put option was nil compared to an initial carrying value of $12.4 million. Based on these provisions, the Company believes that neither the call option nor the put option will be exercised in 2012. If the acquisition of the noncontrolling interest is consummated, the Company intends to finance the consideration paid pursuant to the agreement through the sale of additional equity to its private equity sponsor, if available, or use other sources of liquidity.
RECENTLY ISSUED ACCOUNTING STANDARDS
In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820)-Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”), to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and IFRS. ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements, particularly for fair value measurements categorized within Level 3 of the fair value hierarchy. ASU 2011-04 is effective for our fiscal year beginning January 1, 2012 and must be applied prospectively. Given our immaterial amounts of assets and liabilities that require level 3 inputs, we do not expect the adoption of ASU 2011-04 to have a material impact on the Company’s consolidated financial statements.
In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income, which requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate, but consecutive, statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of equity. ASU 2011-05 is effective for our fiscal year beginning January 1, 2012 and must be applied retrospectively. We expect to present comprehensive income in two separate but consecutive statements. This is a change in presentation only and will not have an impact on the Company’s consolidated financial statements.
In September 2011, the FASB issued ASU No. 2011-08, Testing Goodwill for Impairment, which allows an entity to use a qualitative approach to test goodwill for impairment. ASU 2011-08 permits an entity to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If it is concluded that this is the case, it is necessary to perform the currently prescribed two-step goodwill impairment test. Otherwise, the two-step goodwill impairment test is not required. This guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, provided that the entity has not yet performed its 2011 annual impairment test or issued its financial statements. As the goodwill of the AGY US segment was fully impaired in 2009, the adoption of this guidance is not expected to have any material impact on the Company’s financial statements.
In December 2011, the FASB issued ASU 2011-11, Disclosures about Offsetting Assets and Liabilities (Topic 210, Balance Sheet). The update requires new disclosures about balance sheet offsetting and related arrangements. For derivatives and financial assets and liabilities, the amendments require disclosure of gross asset and liability amounts, amounts offset on the balance sheet, and amounts subject to the offsetting requirements but not offset on the balance sheet. The guidance is effective December 1, 2013 and is to be applied retrospectively. This guidance does not amend the existing guidance on when it is appropriate to offset; the impact of the adoption of ASU 2011-11 is not expected to have a material impact on the Company’s consolidated financial statements.
QUARTERLY FINANCIAL DATA (Unaudited)
Quarterly financial data for the years ended December 31, 2011 and 2010 were (in thousands):
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rate risk
We are subject to interest rate risk in connection with our short- and long-term debt. Our principal interest rate exposures relate to the AGY US $50 million senior secured revolving credit facility and our AGY Asia credit facility. Assuming the AGY US revolver is fully available and drawn, each 100 basis point change in interest rates would result in approximately a $0.5 million change in annual interest expense on our revolving credit facility. Assuming the AGY Asia credit facility is fully drawn, each 100 basis point change in interest rates would result in a change of approximately $0.4 million in annual interest expense for AGY Asia.
Natural gas commodity risk and platinum/rhodium risk
Due to the nature of our manufacturing operations, we are exposed to risks due to changes in natural gas commodity prices. We may utilize derivative financial instruments in order to reduce the variability of the cash flows associated with our forecasted purchases of natural gas. In addition, because we use bushings made with a platinum-rhodium alloy as part of our manufacturing process and lease a significant portion of the bushings, we are exposed to risks due to changes in the prices of platinum and rhodium.
At December 31, 2011, we had existing contracts for physical delivery of natural gas at our Aiken, SC and Huntingdon, PA facilities that fix the commodity cost of natural gas for approximately 62 % of our 2012 expected requirements for the estimated natural gas purchases of the AGY US operating segment. We also entered into fixed-price electricity contracts for our Huntingdon, PA facility to cover approximately 80% of our 2012 expected requirements. Although these contracts are considered derivative instruments, they meet the normal purchases exclusion contained in ASC 815, and are therefore exempted from the related accounting requirements.
Foreign exchange risk
We are subject to inherent risks attributed to operating in a global economy. For AGY US, all of the debt and most of our costs are denominated in U.S. dollars. Approximately 2% percent of our sales in AGY US are denominated in currencies other than the U.S. dollar. Although our level of foreign currency exposure is limited, we may utilize derivative financial instruments to manage foreign currency exchange rate risks.
Approximately 13% of the debt of our subsidiary, AGY Asia, is denominated in U.S. dollars, with the balance denominated in Chinese renminbi. In addition, approximately 83% of the sales of AGY Asia are denominated in U.S. dollars, while approximately 86% of its costs are denominated in Chinese RMB.
At December 31, 2011, we had no foreign currency hedging agreements in effect.
We may be exposed to credit loss in the event of non-performance by the other party to derivative financial instruments. We mitigate this risk by entering into agreements directly with counterparties that meet our credit standards and that we expect to fully satisfy their contractual obligations. We view derivative financial instruments purely as a risk management tool and, therefore, do not use them for speculative trading purposes.
Impact of Inflation and Economic Trends
Historically, inflation has not had a material effect on our results of operations, as we have been able to offset most of the impact of inflation through price increases for our products. However, we cannot guarantee that we will be able to offset any future price increases in energy, commodities and precious metals through price increases to our customers.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS
The information required by Item 8 is contained on pages to of this Annual Report on Form 10-K under “Consolidated Financial Statements”. The Report of Independent Registered Public Accounting Firm is contained on page of this Annual Report on Form 10-K under the caption “Report of Independent Registered Public Accounting Firm”.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
As of the end of the period covered by this Annual Report, the Company’s Principal Executive Officer and Principal Financial Officer have conducted an evaluation regarding the effectiveness of the Company’s disclosure controls and procedures. Based on their evaluation, the Company’s Principal Executive Officer and Principal Financial Officer have concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the applicable Securities and Exchange Commission rules and forms and (ii) accumulated and communicated to the Company’s management, including the Company’s Principal Executive Officer and the Company’s Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
(b) Changes in internal control over financial reporting.
There have been no changes in internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
(c) Management’s report on internal control over financial reporting.
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed under the supervision of its principal executive officer and principal financial officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with generally accepted accounting principles.
As of December 31, 2011, the Company’s management conducted an assessment of the effectiveness of the internal control over financial reporting, as defined in Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934 (the “Exchange Act”) based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concluded that the Company’s internal control over financial reporting (as so defined under the Exchange Act) was effective as of December 31, 2011. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
All of our directors serve until a successor is duly elected and qualified or until the earlier of his death, resignation or removal. Our executive officers are appointed and serve at the discretion of our board of directors. There are no family relationships between any of our directors or executive officers.
The following table sets forth information with respect to our executive officers and directors as of March 1:
The following biographies describe the business experience of our executive officers and directors:
Richard C. Jenkins, Chief Executive Officer, Interim. Mr. Jenkins has served as our Interim Chief Executive Officer since December 2011. He is a Managing Director and National Practice Leader of Alvarez & Marsal’s Private Equity Services-Operations Group. He specializes in improving financial management of operating companies, analyzing strategic business plans, managing cash requirements of his clients, developing plans to improve the cost structure of companies and implementing programs to reduce working capital. With 17 years of experience, Mr. Jenkins’ assignments have spanned numerous industries including manufacturing, telecommunications, high tech and service businesses. Prior to joining A&M, Mr. Jenkins was a Director with the Business Recovery Services practice of PricewaterhouseCoopers and a financial consultant with Peterson Consulting. Mr. Jenkins holds a Bachelor of Science degree in Finance from Colorado State University.
Drew Walker, President. Mr. Walker joined us in January 2005 as Vice President of Sales and Marketing. He was appointed President and elected as a director in December 2011 upon the resignation of our former President and Chief Executive Officer. He has 20 years of experience in marketing consumer brands and business-to-business industrial products in various international commercial roles. Before joining us in January 2005, Mr. Walker served as Global Sales Director for SAPPI (South Africa Paper & Pulp Industries) High Performance Release Paper Division for the synthetic fabrics and decorative laminates markets for two years. Prior to joining SAPPI, he held several worldwide sales and marketing roles with Victrex plc, a manufacturer of high performance materials in the form of Thermoplastic PEEK (Polyetheretherketone) for the aerospace, automotive, semiconductor, medical and industrial markets based in Blackpool, England. Mr. Walker was educated at Sheffield University, England, receiving a Bachelor of Arts Honors Degree in Industrial Product Design. As a result of these and other professional experiences, Mr. Walker possesses particular knowledge and experience in the glass fiber industry, in developing global specialty businesses and technical knowledge that strengthen the Board’s collective qualifications, skills and experience.
Douglas J. Mattscheck, Chief Executive Officer, President and Director. Mr. Mattscheck served as our Chief Executive Officer and as a director from April 2004 and as President from May 2010 until his resignation in December 2011. Prior to joining AGY, he served for seven years as President of St. Gobain Technical Fabrics. From 1989 to 1996, Mr. Mattscheck served as Senior Vice President of Surface Protection Industries, a high-end architectural paint and coatings business. From 1987 to 1989, Mr. Mattscheck managed an architectural products business for H.B. Fuller Company, a manufacturer of specialty chemicals. From 1982 to 1987, he held several positions for Schlegel Corp., including managing a construction products manufacturing business. Mr. Mattscheck holds a Bachelor of Science degree in Mechanical Engineering from Villanova University and a Masters of Business Administration from the University of Rochester.
C. Steven Smoot, Chief Financial Officer. Mr. Smoot has served as our Chief Financial Officer since June 2010. Prior to joining AGY, Mr. Smoot served as Executive Vice President and Chief Financial Officer of Family Health International, a global non-profit research and public health services organization from 2005 to 2009. From 2001 to 2004, Mr. Smoot served in various financial positions at Reichhold Chemicals, Incorporated, a global resins manufacturing company and subsidiary of DaiNippon Ink and Chemical, including as its Senior Vice President, Chief Financial Officer and Chief Information Officer. Previously Mr. Smoot held numerous financial positions within Owens Corning Composites, Building Materials and International Operations. Mr. Smoot holds a Masters of Business Administration from the University of Tennessee and a Bachelors of Science degree in Business Administration from Wake Forest University.
Thomas Skidmore, Executive Vice President of Operations, Interim. Mr. Skidmore has served as our Executive Vice President of Operations since December 2011. He is a Senior Director with Alvarez & Marsal’s Private Equity Services-Operations Group. Mr. Skidmore has 20 years of advisory and operating experience across a well-diversified set of industries. Mr. Skidmore’s advisory experience includes twelve years of supply chain, operations, and restructuring with Alvarez & Marsal, A.T. Kearney and several operations focused advisory firms. Mr. Skidmore’s operations experience includes eight years engineering and operations management with firms including ExxonMobil and Texaco. Mr. Skidmore earned a Master’s degree in Business Administration and Industrial Engineering from The J. L. Kellogg Graduate School of Business at Northwestern University, and a Bachelor’s degree in Mechanical Engineering from The University of Texas at El Paso.
Catherine A. Cuisson, Vice President, Finance and Corporate Controller. Ms. Cuisson has served as our Vice President of Finance and Corporate Controller since July 2007. Previously, she served as our Chief Financial Officer from 1999 until assuming her new position with the Company. Ms. Cuisson was transferred to the U.S. by Porcher Industries, our former majority owner, to organize and manage the financial operations of the newly formed joint venture with Owens Corning. Before joining us in early 1999, Ms. Cuisson served as the Consolidation Manager and Corporate Controller of Porcher Industries, a textile weaver, for four years. Prior to joining Porcher Industries in late 1994, Ms. Cuisson was an Audit Manager for PricewaterhouseCoopers in Lyon, France from 1987 to 1994. Ms. Cuisson has been a French equivalent Certified Public Accountant since 1993. She obtained a Masters of Accounting and a Masters of Business Administration upon graduating from the Institut Commercial de Nancy, France.
Dennie Rexroad, Vice President of Operations. Mr. Rexroad joined us in January 2005 as Vice President of Operations after serving for three years as Vice President of Operations for The Cooley Group, a manufacturer of high performance engineered laminates and coated fabrics. Prior to working with The Cooley Group, Mr. Rexroad was the Plant Manager for Toray Plastics’ Polyolefin Operation for three years. From 1997 to 2000, he was the Director of Manufacturing for Toray Plastics’ polyester resin and film plants. Prior to joining Toray in 1992, Mr. Rexroad had a ten-year career with ICI Americas, which included an international assignment as Commissioning and Training Manager for the polyester films division at a greenfield site in Ibaraki, Japan. Mr. Rexroad holds a Bachelor of Science degree in Mechanical Engineering from Virginia Tech.
Christopher Lacovara, Director. Mr. Lacovara is the Chairman of the Board of Directors and a member of our compensation committee. He has been a member of our Board of Directors since April 7, 2006. Mr. Lacovara is a Partner of Kohlberg & Company, L.L.C., which he joined in 1988. Prior to joining Kohlberg, Mr. Lacovara was with Lazard Frères & Co. and Goldman, Sachs & Co. He is a member of the board of directors of Centerplate, Inc., Chronos Life Group, Concrete Technologies Worldwide, Inc., Katy Industries, Inc., KCOF Holdings LLC., Kohlberg Capital Corporation, Pittsburgh Glass Works LLC., and Trico Products Corporation. Mr. Lacovara received an A.B. from Harvard College, a B.E.E.S. from Hofstra University and an M.S. from Columbia University. As a result of these professional experiences, Mr. Lacovara possesses particular knowledge and experience in corporate finance, corporate governance, strategic planning, business evaluation and oversight and financial analysis that strengthen the Board’s collective qualifications, skills and experience.
Samuel P. Frieder, Director. Mr. Frieder is a director and a member of our audit committee. He has been a member of our board of directors since April 7, 2006. Mr. Frieder is the Managing Partner of Kohlberg & Company, LLC, which he joined in 1989. Prior to joining Kohlberg, Mr. Frieder was with Security Pacific Business Credit and Manufacturers Hanover Trust Company. He is a member of the board of directors of Bauer Performance Sports, BioScrip, Inc., Centerplate, Inc., Central Parking Corporation, Chronos Life Group, Concrete Technologies Worldwide, Inc., e+ CancerCare, Katy Industries, Inc., Kellermeyer Bergensons Services, LLC, Nielsen & Bainbridge, Inc., Packaging Dynamics Corporation, Phillips-Medisize Corporation, Pittsburgh Glass Works LLC., SouthernCare, Inc., Stanadyne Corporation, SVP Holdings, Ltd., Thomas Nelson, Inc., and Trico Products Corporation. Mr. Frieder received an A.B. from Harvard College. As a result of these professional experiences, Mr. Frieder possesses particular knowledge and experience in corporate finance, corporate governance, corporate and business development, business evaluation and oversight and financial analysis that strengthen the Board’s collective qualifications, skills and experience.
Seth H. Hollander, Director. Mr. Hollander is a director and a member of our compensation committee and our audit committee. He has been a member of our Board of Directors since April 7, 2006. Mr. Hollander is a Partner of Kohlberg & Company, L.L.C., which he joined in 2001. Prior to joining Kohlberg, Mr. Hollander was with Bear, Stearns & Co., Inc. in their Leveraged Finance Group. He is a member of the board of directors of Centerplate, Inc., Central Parking Corporation, Concrete Technologies Worldwide, Inc., Kellermeyer Bergensons Services, LLC, Nielsen & Bainbridge, Inc., Packaging Dynamics and Stanadyne Corporation, Inc. Mr. Hollander received a B.B.A. from the University of Michigan, Ann Arbor. As a result of these professional experiences, Mr. Hollander possesses particular knowledge and experience in corporate finance, accounting, strategic planning, business evaluation and oversight and financial analysis that strengthen the Board’s collective qualifications, skills and experience.
George B. DeHuff, Director. Mr. DeHuff is a director and joined the Board on August 15, 2011. Mr. DeHuff is an Operating Partner at Kohlberg & Co., L.L.C., which he also joined in 2011. Prior to joining Kohlberg, Mr. DeHuff was the Chief Executive
Officer of Behavioral Interventions (BI), Incorporated, formerly a Kohlberg portfolio company. Prior to his role at BI, Mr. DeHuff served as President and Chief Operating Officer at Total Renal Care, President and Chief Executive Officer of American Medical Response and President and Chief Operating Officer at Lifefleet, Inc. He is also a member of the board of directors of e+CancerCare. Mr. DeHuff received a M.B.A. from the University of Michigan and a B.A. from Oakland University. As a result of these professional experiences, Mr. DeHuff possesses particular knowledge and experience as a senior level executive officer in corporate finance, corporate governance, corporate and business development, business evaluation and oversight and financial analysis that strengthen the Board’s collective qualifications, skills and experience.
As a group, the directors associated with our Sponsor possess experience in owning and managing enterprises like the Company and are familiar with corporate finance, strategic business planning activities and issues involving stakeholders more generally.
Corporate Governance
Our Board of Directors manages our business and affairs. Under a stockholder’s agreement among investment funds associated with our Sponsor and certain members of our management as part of the Acquisition, investment funds associated with our Sponsor are entitled to designate the members of our Board of Directors.
Code of Conduct
We currently maintain a written Code of Conduct that provides a statement regarding the Company’s expectations as to the legal and ethical nature of conduct of the Company’s directors, officers, employees and agents while acting on behalf of AGY. A copy of the Code of Business Ethics and Business Conduct is posted on our web site at http://www.agy.com/investor/index.htm.
Section 16(a) Beneficial Ownership Reporting Compliance
There is no established public trading market for our common stock. We are a wholly-owned subsidiary of Holdings, which holds all of our outstanding common stock. Holdings is a privately-held corporation.
Audit Committee
The audit committee selects our independent auditors and reviews the independence of such auditors, approves the scope of the annual audit activities of the independent auditors, approves the audit fee payable to the independent auditors and reviews such audit results with the independent auditors. The audit committee is currently composed of Seth H. Hollander and Samuel P. Frieder. Seth H. Hollander serves as our “audit committee financial expert” as defined in Item 407(d)(5) of Regulation S-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Compensation Discussion and Analysis
For purposes of this discussion, our officers are defined as senior level executives of the Company responsible for developing and leading the execution of our strategies. We refer to our Chief Executive Officer, our Chief Financial Officer and our next four highly compensated executives of the Company (excluding Interim officers) as our “named executive officers.”
Objectives of Our Compensation Program
The Compensation Committee of our Board of Directors (the “committee”) seeks to use compensation to attract and retain qualified officers, to offer our officers incentives to continually improve both their personal and overall company performance, and to align the interests of our officers and our stockholders.
The committee sets targeted in-service compensation for our officers at or near the market median. This policy covers base salaries as well as the incentive awards that officers will receive if we meet annual business goals. Under this policy, if our performance exceeds our goals, our officers earn incentive awards above the median, resulting in total compensation in excess of the median. However, if we fail to meet our business goals, incentive compensation levels and, as a result, total compensation levels, would fall below the market median.
The committee generally believes “target” performance levels should be ones that represent significant performance improvements, and be levels that we will not easily achieve.
The committee has a general policy of making variable compensation a significant component of each officer’s total compensation. The term “variable compensation” refers to amounts that vary in amount depending on performance - poor performance leads to little or no awards while superior performance leads to superior awards. Variable compensation generally consists of a combination of annual cash bonus opportunities and equity-based compensation. The policy of making variable compensation a significant portion of our officers’ total compensation is intended to implement a culture in which the officers know that their pay, to a large extent, depends on our performance and to reward superior Company performance.
The committee has a general policy of using compensation to more closely align management’s interests with those of our shareholders. In an effort to achieve this, we systematically include some form of equity grant, or potential equity grant, as part of our compensation program at the time an officer’s employment commences. When we refer to equity grants in this report, we refer to grants of equity awards of Holdings. If our officers own shares of our common stock with values that are significant to them, we believe they will be more likely to act to maximize longer-term shareholder value instead of short-term gain. Officers currently have stock options that will become more valuable if the performance of the Company improves on a year over year basis and certain options will only vest if we meet specified performance targets. In addition, the committee seeks to provide an incentive for officers to remain with the Company by imposing time vesting requirements on the options.
Finally, the committee aims to provide a package of non-cash benefits which are consistent with benefits provided by others in the industry and which are not tied to performance.
Elements of Compensation
Compensation for officers generally consists of cash compensation, including base salary and, as appropriate, bonus awards, equity participation, and various non-cash perquisites and benefits, though in 2009, 2010 and 2011, the committee and the Board did not approve any plan with respect to cash bonus awards or opportunities for management because of the Company’s forecasted financial performance. The committee attempts to offer each officer a mix of fixed compensation, such as base salary, and variable compensation, such as bonus opportunity and equity based compensation, which strikes an appropriate balance between offering each officer a predictable level of baseline compensation and a personal incentive to improve company performance.
Base Salary
We pay each of our officers a base salary, which is intended to give each of them a steady cash flow during the course of the year that is not contingent on short-term variation in our performance. In 2008, the committee sought to set each officer’s base salary at or near the market median. No salary adjustments were made in 2009 for our officers given the financial performance of the Company and because of required cost reductions initiatives. Merit increases were made in 2010 and 2011 based on achievement of individual performance targets. The committee believes that paying competitive base salaries is required in order to attract and retain qualified officers.
Bonus Opportunity
Payment of annual bonuses to our officers depends entirely on our corporate performance, though in certain instances the committee may modify the payment to reflect personal performance. The committee typically provides each officer with a bonus opportunity each year in an effort to give each officer a personal financial incentive to help us reach annual business goals, however, in 2009, 2010 and 2011, no bonus opportunities were provided to the officers because of the Company’s financial performance.
Long-Term Incentives
The committee provided stock options for the named executive officers at the time of their commencement of service. These options vest based on a schedule that includes length of service and also achievement of selected adjusted EBITDA targets. In deciding how many options to grant a particular officer, the committee considers the responsibilities of such person’s position and his or her tenure with the Company.
The committee believes that offering equity-based compensation is required in order to attract and retain qualified officers, to offer a personal incentive for them to improve company performance and align the interests of our officers with our stockholders.
Perquisites and Other In-Service Benefits
Certain named executive officers are provided vehicles based on company guidelines and the Company pays for the related expenses. The CEO is provided a country club membership and supplemental life insurance policy that are paid by the Company.
Our officers also receive the following benefits, which we provide to all salaried employees as compensation for their services to us:
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Group health, dental and life insurance, part of which we pay for;
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Optional term, life and accidental death and disability and long-term disability insurance, the cost of which the employee pays;
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We sponsor a 401(k) plan, under which each participant can defer into his 401(k) plan account a portion of his plan-eligible compensation, generally base salary, up to the annual limit set by the IRS and can then direct how his account will be invested. We match each participant’s deferrals under this plan, on a monthly basis at a rate of 50% up to the first 6% of compensation contributed by the participant. Our matching contributions are vested based on a three-year vesting schedule. In addition, the Company may elect to make a discretionary contribution to an individual’s 401(k) based on the Company’s achievement of certain financial metrics.
The committee believes that offering competitive benefits is required in order to attract and retain qualified officers and employees.
Change-In-Control Arrangements
In a situation involving a change in control of our Company, our officers would likely face a far greater risk of termination than the average salaried employee. To attract qualified individuals who could have other job alternatives that may appear to them to be less risky absent these arrangements, and to provide these individuals with an incentive to stay with us in the event of an actual or potential change in control, we have a severance plan in which our executive officers participate. We view this as an important part of a competitive compensation package.
The severance plan provides for the individual to continue employment for a specified period after a change in control, with the same responsibilities and authorities and generally the same benefits and compensation as he had immediately prior to the change in control (including average annual increases). The term “change in control” is defined in the severance plan to include various corporate transactions resulting in a change in ownership in the Company and would also include the election of a majority of the board of directors not nominated by the incumbent board of directors. If we or our successor were to terminate the individual’s employment during the one hundred and eighty (180) days prior to, or twelve months (12) following, a change of control or sale for reasons other than “cause”, or the individual voluntarily terminated his employment for a “good reason” (in each case as defined in the agreements) during that same period, he would be entitled to certain payments and other benefits.
Severance Policy
We have severance policies under which we provide other severance benefits to our officers. Specific details about these policies are described more fully below under “Potential Payments Upon Termination or Change of Control.” We maintain these severance policies because we believe that they are consistent with market compensation packages for officers and therefore an important component of a competitive compensation package.
Compensation Program Design and Tools
The Compensation Committee has used a number of tools in designing the compensation program for our officers and assessing practices within the industry, including corporate guidelines regarding compensation, studies of internal pay fairness, external market guidelines and benchmarks, and long-term compensation histories and tax and accounting rules. The Company does not believe that the risks arising from our compensation practices are reasonably likely to have a material adverse effect on the Company.
Compensation Committee Report
The following report of the Compensation Committee is included in accordance with the rules and regulations of the Securities and Exchange Commission. It is not incorporated by reference into any of our registration statements under the Securities Act of 1933, as amended.
Compensation Committee Report
The Committee has reviewed and discussed the Compensation Discussion and Analysis (CD&A) with management. Based upon the review and discussions, the Committee recommended to the Board of Directors, and the Board approved, that the CD&A be included in the Form 10-K for the year ended December 31, 2011.
Respectfully submitted on March 29, 2012 by the members of the Compensation Committee of the Board of Directors:
Christopher Lacovara
Seth H. Hollander
Summary Compensation Table
The following table sets forth for certain compensation information for our named executive officers:
(1) No restricted stock awards were granted in 2009, 2010 and 2011.
(2) In 2009, 2010 and 2011, only time-based options vested for the participants, except for Mr. Walker who had the vesting of 40,000 existing share option awards accelerated. The value of the options awards was calculated based on the value of the option as of the grant date, multiplied by the number of shares awarded.
(3) Non-equity incentive compensation is based on the achievement of certain financial performance goals. No non-equity incentive compensation was earned or recognized in 2009, 2010 and 2011, as the financial performance goals were not achieved for these years.
(4) Other compensation for fiscal year 2009 includes the following: (a) Mr. Mattscheck: $4,997 in 401(k) company match and $3,210 in taxable life, $3,225 in car allowance and company paid supplemental life insurance policy; (b) Mr. Walker: $3,644 in 401(k) company match, $3,115 in car allowance and $612 in taxable life insurance (c) Ms. Cuisson: $3,435 in 401(k) company match, $7,125 in car allowance and $382 in taxable life insurance; and (d) Mr. Rexroad: $3,718 in 401(k) company match, $2,815 in car allowance and $960 in taxable life insurance.
(5) Other compensation for fiscal year 2010 includes the following: (a) Mr. Mattscheck: $8,250 in 401(k) company match, $3,385 in taxable life, $10,483 in car allowance, $1,730 in a company paid supplemental life insurance policy, and $11,700 in country club membership dues reimbursement for the years 2008, 2009 and 2010; (b) Mr. Walker: $5,982 in 401(k) company match, $2,505 in car allowance and $628 in taxable life insurance; (c) Mr. Smoot: $3,200 in car allowance and $1,204 in taxable life insurance; (d) Ms. Cuisson: $5,550 in 401(k) company match and $587 in taxable life insurance; and (e) Mr. Rexroad: $6,103 in 401(k) company match, $3,669 in car allowance and $985 in taxable life insurance.
(6) Other compensation for fiscal year 2011 includes the following: (a) Mr. Mattscheck: $8,052 in 401(k) company match, $3,550 in taxable life, $14,400 in car allowance, $1,761 in a company paid supplemental life insurance policy, and $4,140 in country club membership dues reimbursement for 2011; (b) Mr. Walker: $5,515 in 401(k) company match, $2,326 in car allowance and $675 in taxable life insurance (c) Mr. Smoot: $8,000 in car allowance and $1,762 in taxable life insurance; (d) Ms. Cuisson: $5,076 in 401(k) company match, $8,171 in car allowance and $607 in taxable life insurance; and (e) Mr. Rexroad: $5,495 in 401(k) company match, $7,116 in car allowance and $1,021 in taxable life insurance.
(7) Mr. Mattscheck’s 2011 compensation information is based on his termination date of December 20, 2011. Mr. Mattscheck is entitled to receive severance payments under his employment agreement in the amount of $499,286. In addition, Mr. Mattscheck retained 200,000 shares of common stock as well as an option to an additional 100,000 shares of common stock pursuant to, and subject to the terms of, the outstanding option award granted to him in 2006. All the other vested unexercised options awards were forfeited at Mr. Mattscheck’s termination date.
(8) Mr. Smoot’s 2010 compensation information is based on his start date of June 1, 2010.
(9) Represents in 2009 nominal year-end payments to all salaried employees, other than the Company’s chief executive officer. In 2010 Ms. Cuisson received a special bonus in consideration of her increased responsibilities before the hiring of Mr. Smoot.
(10) Mr. Jenkins continues to be employed by Alvarez & Marsal and is not eligible for compensation from the Company or participation in the Company’s employee benefit plans.
Employment and termination agreements with named executive officers
We have entered into an employment agreement with each of Mr. Walker and Ms. Cuisson and employment offer letters with each of Mr. Smoot and Mr. Rexroad. We have also entered into an agreement with Alvarez & Marsal Private Equity Performance Improvement Group, LLC (“Alvarez & Marsal”) regarding the services provided by Mr. Jenkins as our Interim Chief Executive Officer. In addition, we have entered into a separation agreement with Mr. Mattscheck. The material terms of these employment and termination agreements are summarized below.
Employment Agreement with Mr. Walker. Mr. Walker is party to an employment agreement with the Company that governs the terms and conditions of his employment as President of the Company. This agreement entitles him to an annual base salary of $350,000 and eligibility to receive a target annual bonus equal to 100% of annual base salary, subject to performance targets and the provisions of a management incentive plan. Under the agreement, Mr. Walker was granted an option to acquire 280,000 shares of KAGY Holding Company, Inc. (“KAGY”), subject to a four-year vesting schedule. Mr. Walker is entitled to participate in employee benefit plans for executives of the Company generally and is eligible to participate in the Company’s severance plan, which provides for severance under certain circumstances.
Letter Agreements with Messrs. Smoot and Rexroad. Messrs. Smoot and Rexroad are parties to offer letter agreements with the Company that provide for a specific minimum level of base salary, eligibility to participate in the Company’s management incentive plan with specified target or maximum bonus opportunities under such plan, a car allowance, eligibility for general salaried benefits provided to employees of the Company and participation in the Company’s severance plan. In addition, under the terms of his offer letter agreement, Mr. Smoot was granted an option to acquire 70,000 shares of common stock of KAGY, subject to a three-year vesting schedule and certain performance vesting conditions.
Employment Agreement with Ms. Cuisson. Ms. Cuisson is party to an employment agreement with the Company that provides for annual base salary of $173,250 and eligibility to receive a target annual bonus equal to 60% of annual base salary, subject to performance targets and the provisions of a management incentive plan. In addition, Ms. Cuisson is entitled to participate in employee benefit plans of the Company and is eligible to participate in the Company’s severance plan. Ms. Cuisson is also entitled to a car allowance and reimbursement of reasonable costs associated with trips to France.
Agreement Regarding the Employment of Mr. Jenkins. The Company is party to an agreement with Alvarez & Marsal which governs the terms and conditions of Mr. Jenkins’s services as Interim Chief Executive Officer of the Company. Under the terms of the agreement, Mr. Jenkins continues to be employed by Alvarez & Marsal and is not eligible for compensation from the Company or participation in the Company’s employee benefit plans. The agreement provides for compensation to Alvarez & Marsal in the amount of $700 per hour for the services of Mr. Jenkins, reimbursement of the reasonable out-of-pocked expenses of Mr. Jenkins and an additional payment of up to 3% of the amount charged for the services of Mr. Jenkins to cover miscellaneous expenses. The agreement may be terminated by either party at any time by written notice to the other party.
Separation Agreement with Mr. Mattscheck. Mr. Mattscheck is party to a separation agreement with the Company that provides for severance and other benefits following his resignation as Chief Executive Officer and President of the Company effective December 20, 2011. The separation agreement provides that, in addition to the benefits set forth in his employment agreement, Mr. Mattscheck will retain 200,000 shares of KAGY common stock held by him and an option, that was granted to him in 2006, to purchase up to an additional 100,000 shares of KAGY common stock, in each case subject to the terms of the applicable stock option award and equity incentive plan and the terms of any applicable stockholders agreement.
Grants of Plan-Based Awards
Mr. Walker was granted upon his promotion to President of the Company and election to the Company’s Board of Directors in December 2011, options for 280,000 shares of common stock, subject to a four-year vesting schedule with a fair value of $1.58 for each option. In addition, the vesting of the existing unexercised and unexercisable options awards granted in 2006 for 40,000 shares of common stock was accelerated.
There were no other grants of any plan-based awards to the other named executive officers in the year ended December 31, 2011.
Outstanding Equity Awards at Fiscal Year-End
The following table provides information concerning unexercised options and stock awards for each named executive officer outstanding as of December 31, 2011. All option and stock awards are granted with respect to the common stock of KAGY Holding Company, Inc., our parent company.
(1) The unexercised options unexercisable represent performance-based stock options that vest upon a change of control or at the sole discretion of the Board of Directors.
(2) The unexercised options unexercisable represent time-based options that have a four-year vesting schedule in equal installments beginning on the first anniversary of the grant date, or December 2011, and acceleration in the event of a change of control.
(3) Includes 35,000 time-based stock options that have a three-year vesting schedule in equal annual installments beginning on the first anniversary of employment, or June 2011, and acceleration in the event of change of control. The remaining represents performance-based stock options that vest upon a change of control or at the sole discretion of the Board of Directors
Option Exercises and Stock Vested
No options were exercised by the named executive officers in 2011, and no restricted stock awards vested in 2011.
Potential Payments Upon Termination or Change of Control
Pursuant to the terms of the applicable agreements and plans, set forth below is a description of the potential payments the named executive officers would receive if their employment was terminated.
Termination by the Company without Cause or by the Officer for Good Reason. If we terminate a named executive officer’s employment without cause, or if the officer terminates his or her employment for good reason, then:
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the Company will pay the officer (i) a cash severance amount equal to twelve (12) months base salary in effect at the time of termination, to be paid in twelve (12) equal monthly installments; and (ii) an amount equal to the greater of (i) a pro rata portion of the annual bonus earned through the date of termination, or (ii) 30% of the maximum annual bonus, to be paid in twelve (12) equal monthly installments;
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the Company will provide for continued coverage under health and dental benefits, at the Company’s expense, for a period ending on the earlier of (i) twelve months from the date of termination, or (ii) the date comparable coverage is obtained from a successor employer;
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all unvested options are forfeited.
Termination Preceding or Following a Change in Control or Sale of Business Transaction. If a named executive officer’s employment is terminated involuntarily or for good cause one hundred and eighty (180) days prior to or twelve months (12) following a change of control or sale of the business, then:
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the Company will pay the officer (i) a cash severance amount equal to twenty-four (24) months base salary in effect at the time of termination, to be paid in twenty-four (24) equal monthly installments; and (ii) an amount equal to the greater of (i) a pro rata portion of the annual bonus earned through the date of termination, or (ii) 30% of the maximum annual bonus, to be paid in twenty-four (24) equal monthly installments;
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the Company will provide for continued coverage under health and dental benefits, at the Company’s expense, for a period ending on the earlier of (i) twenty-four (24) months from the date of termination, or (ii) the date comparable coverage is obtained from a successor employer;
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All unvested options, performance or time based, granted to the officer immediately vest.
Termination by the Company for Cause or by the Officer without Good Reason. If the Company terminates a named executive officer’s employment for cause or the officer terminates employment without good reason, then:
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the Company is not obligated to pay the officer any form of compensation other than amount of base salary earned through the date of termination; and
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all unexercised options are forfeited.
Disability or Death. If a named executive officer’s employment is terminated due to his or her disability or death, then:
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the Company will pay the officer (or his or her beneficiary in the event of death) (i) a lump sum cash payment of all accrued compensation and (ii) an amount equal to the greater of (i) a pro rata portion of the annual bonus earned through the date of termination, or (ii) 30% of the maximum annual bonus, to be paid in twelve (12) equal monthly installments.
In order to receive any of the above-described severance benefits, a named executive officer is required to execute a release of all claims against the Company and must comply with the terms of the applicable agreement or plan pursuant to which such benefits are made available to such named executive officer.
The tables below reflect the amount of compensation payable to each of the named executive officers in the event of termination of such officer’s employment. The amounts shown assume that such termination was effective as of December 31, 2011, and thus includes amounts earned through such time and are estimates of the amounts which would be paid out to the officer upon his or her termination. The actual amounts to be paid, if any, can only be determined at the time of such officer’s separation from the Company.
Potential Termination Payments and Benefits for Termination Without Cause or for Good Reason
(1) Bonus payment is calculated as 30% of the maximum payment under the non-equity incentive plan awards. The officer would be entitled to a pro rata portion of the annual bonus earned through the date of termination, if such amount were higher. No restricted stock was outstanding as of the reporting date.
(2) No restricted stock was outstanding as of the reporting date.
(3) The Company is required to provide continued coverage under health and dental benefits, at its expense, for a period ending on the earlier of (i) twelve months from the date of termination, or (ii) the date comparable coverage is obtained from a successor employer. The cost was calculated by multiplying the Company’s monthly COBRA rate by the maximum number of months for which benefits would be provided.
Potential Termination Payments and Benefits for Termination as a Result of Change of Control or Sale of the Business Transaction
(1) Bonus payment is calculated as 30% of the maximum payment under the non-equity incentive plan awards. The officer would be entitled to a pro rata portion of the annual bonus earned through the date of termination, if such amount were higher.
(2) No restricted stock was outstanding as of the reporting date.
(3) The Company is required to provide continued coverage under health and dental benefits, at its expense, for a period ending on the earlier of (i) twenty-four months from the date of termination, or (ii) the date comparable coverage is obtained from a successor employer. The cost was calculated by multiplying the Company’s monthly COBRA rate by the maximum number of months for which benefits would be provided.
Potential Termination Payments and Benefits for Termination As a Result of Death or Disability
(1) Bonus payment is calculated as 30% of the maximum payment under the non-equity incentive plan awards. The officer would be entitled to a pro rata portion of the annual bonus earned through the date of termination, if such amount were higher.
(2) No restricted stock was outstanding as of the reporting date.
Director Compensation
Mr. DeHuff is the only director eligible to receive compensation for services as a director of the Company of $50,000 for each fiscal year served as a director, payable at the anniversary of his election date, or in August 2012. All the other members of our Board of Directors did not receive direct compensation from the Company relative to their participation on our Board for the year ended December 31, 2011.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Beneficial Ownership
All of the outstanding shares of our issued and outstanding common stock are held by Holdings. The table below presents information regarding beneficial ownership of the equity securities of Holdings as of March 29, 2012 by each person who is known by us to beneficially own more than 5% of the equity securities of Holdings, by each of our directors, by each of our executive officers, and by all of our directors and currently employed executive officers as a group.
As of March 29, 2012, Holdings had 11,483,915 shares of common stock outstanding. The number of shares of common stock outstanding used in calculating the percentage for each listed person includes the shares of common stock underlying options beneficially owned by that person that are exercisable within 60 days following March 30, 2012. Notwithstanding the beneficial ownership of common stock presented below, various stockholder agreements govern the stockholders’ exercise of their voting rights with respect to the election of directors and certain other material events. The parties to these stockholders agreements have agreed to vote their shares to elect the board of directors as set forth therein. See “Certain Relationships and Related Party Transactions.”
Except as described in the agreements mentioned above or as otherwise indicated in a footnote, each of the beneficial owners listed has, to our knowledge, sole voting and investment power with respect to the indicated shares of common stock. Unless otherwise indicated in a footnote, the address for each individual listed below is c/o AGY Holding Corp., 2556 Wagener Road, Aiken, South Carolina, 29801.
* indicates less than 1% of common stock
(1) Includes 5,776,453 shares owned by Kohlberg Investors V, LP (“Kohlberg V”), 4,201,138 shares owned by Kohlberg TE Investors V, LP (“Kohlberg TE V”), 477,421 shares owned by Kohlberg Partners V (“Partners V”), 386,937 shares owned by Kohlberg Offshore Investors V, LP (“Offshore V”) and 102,966 shares owned by KOCO Investors V, LP (“KOCO V”). Kohlberg Management V, LLC is the general partner of each of Kohlberg V, Kohlberg TE V, Partners V, Offshore V and KOCO V and is affiliated with Kohlberg & Company, LLC. The address of each of the entities described in this footnote (1) is 111 Radio Circle Mount Kisco, NY 10549.
(2) Mr. Jenkins continues to be employed by Alvarez & Marsal and was not granted any stock options
(3) Includes 120,000 shares, which Mr. Walker has the right to acquire within 60 days of March 30, 2012 by exercising stock options.
(4) Includes 100,000 shares, which Mr. Mattscheck has the right to acquire within 60 days of March 30, 2012 by exercising stock options.
(5) Includes 11,667 shares, which Mr. Smoot has the right to acquire within 60 days of March 30, 2012 by exercising stock options
(6) Includes 133,333 shares, which Ms. Cuisson has the right to acquire within 60 days of March 30, 2012 by exercising stock options.
(7) Includes 80,000 shares, which Mr. Rexroad has the right to acquire within 60 days of March 30, 2012 by exercising stock options.
(8) Christopher Lacovara, Samuel Frieder, and Seth Hollander each own membership interests in Kohlberg Management V, L.L.C., which is the general partner of the various investment funds that own shares as described in footnote (1) above.
(9) No stock options granted to Mr. DeHuff have vested yet.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table summarizes the securities authorized for issuance as of December 31, 2011 under our KAGY 2006 Stock Option Plan, the number of shares of our common stock issuable upon the exercise of outstanding options, the weighted average exercise price of such options and the number of additional shares of our common stock still authorized for issuance under such plans. The KAGY Stock Option Plan has been approved by our shareholders.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Pursuant to our Conflicts of Interest Policy, our executive officers and certain other employees who have, or whose immediate family members have, any financial interest in an entity that engages in business with the Company or competes with the Company are required to report to us this financial interest. If the Company considers the financial interest to be in conflict with the Company’s best interests, the Company may require divestiture of the interest. However, under the Company’s bylaws, a contract or transaction between the Company and one or more of its directors or officers, or between the Company and any other corporation, partnership, association, or other organization in which one or more of the Company’s directors or officers are directors or officers, or have a financial interest will not be voidable solely because of such relationship or interest if (i) the Board is aware of such relationship or interest and a majority of the disinterested directors approves the contract or transaction in good faith, (ii) the stockholders entitled to vote on the contract or transaction are aware of such relationship or interest and approve the contract or transaction in good faith or (iii) the contract or transaction is fair as to the Company as of the time it is authorized, approved or ratified, by the Board, a committee or the stockholders.
Stockholders Agreement
We have entered into a stockholders agreement with Holdings and the stockholders of Holdings, including investment funds associated with our Sponsor and certain members of our management. Future stockholders may also be required to become parties to the agreement. The stockholders agreement contains agreements among the parties with respect to the election of our directors and the directors of Holdings, restrictions on the issuance of shares (including certain participation rights), restrictions on the transfer of shares (including tag-along rights, drag-along rights and a right of first offer) and other special corporate governance provisions (including the right of our Sponsor and its affiliates to approve various corporate actions).
Registration Rights Agreement
We have entered into a registration rights agreement with Holdings and the stockholders of Holdings, including investment funds associated with our Sponsor and certain members of our management. The registration rights agreement contains customary demand and piggyback registration rights. The agreement also requires Holdings and us to indemnify each holder of registrable securities and certain of their affiliates from liability arising from any violation of the securities laws by Holdings or us or any material misstatements or omissions made by Holdings or us in connection with a public offering.
Management Agreement
The Company has a management agreement with the principal shareholder of Holdings pursuant to which this party provides management and other advisory services to the Company. The management agreement requires AGY to pay this party an annual management fee of $750,000 and to reimburse this party for out-of-pocket expenses incurred in connection with its services. The management agreement also provides that our Sponsor will receive transaction fees in connection with certain subsequent financings and acquisition transactions. The management agreement includes customary indemnification provisions in favor this party and its affiliates. Under this management agreement, this related party was paid $750,000 for the year ended December 31, 2010, and was paid $562,500 and deferred $187,500 in the year ending December 31, 2011.
Interim Management and Corporate Advisory Guarantees
In December 2011, the Company entered into an agreement with the principal shareholder of Holdings, pursuant to which this party agreed to guarantee the Company’s payment, in case of default, of up to $2.9 million for services rendered by a global professional services firm, which the Company engaged in September 2011 for interim management and corporate advisory services.
Director Independence
AGY Holding Corp. is a privately held corporation. None of our directors meets the standards for “independent directors” of a national stock exchange.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
PricewaterhouseCoopers LLP, and its affiliates (“PwC”), the Company’s independent registered public accounting firm and principal accountant for the fiscal years ended December 31, 2011 and December 31, 2010, billed the fees set forth below (in thousands).
(1) Audit Fees billed in the fiscal years ended December 31, 2010 and 2011 represented fees billed by the Company’s independent registered public accounting firm and principal accountant for the following services: the audit of the Company’s annual financial statements, reviews of the Company’s quarterly financial statements, and other services normally provided in connection with statutory and regulatory filings.
(2) The Company did not incur any “Audit-Related Fees” in the fiscal years ended December 31, 2011 and 2010.
(3) Tax fees billed in 2011 represent primarily fees for the tax services related to the federal and state tax filings. Tax fees billed in 2010 represent fees for the tax services related to some individual 2008 tax return and other tax filings assistance preparation performed prior to the engagement of PwC as the Company’s independent registered public accounting firm and principal accountant.
(4) The Company did not incur any “All Other Fees” in the fiscal years ended December 31, 2010 and 2011 with its principal independent registered accounting firm.
The audit committee was formed on July 20, 2006. The audit committee approves all engagements of the independent registered public accounting firm in advance, including approval of related fees.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements
The financial statements are filed as part of this Annual Report on Form 10-K under Item 8 - “Financial Statements.”
(b) Financial Statement Schedules
Financial statement schedules have been omitted because they are either not required, not applicable, or the information is presented in the Consolidated Financial Statements and the notes thereto in Item 8 above.
(c) Exhibits
* Management contract.
 Filed herewith.
** This exhibit was filed separately with the Securities and Exchange Commission pursuant to an application for confidential treatment. The confidential portions have been omitted and have been marked with an asterisk.
SIGNATURES
Pursuant to the requirements of Section 13 or Section 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Aiken, State of South Carolina, on the 30st day of March, 2012.
AGY HOLDING CORP.
(Registrant)
By:
/s/ Richard C. Jenkins
Richard C. Jenkins
Interim Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the date indicated below.
AGY HOLDING CORP. AND SUBSIDIARIES
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholder of
AGY Holding Corp. and Subsidiaries
Aiken, SC
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of AGY Holding Corp. and its subsidiaries at December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America. These financial statements 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 of these statements 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Charlotte, North Carolina
March 30, 2012
AGY Holding Corp. And Subsidiaries
Consolidated Balance Sheets
As of December 31, 2011 and 2010
(Dollars in thousands except per share amounts)
The accompanying notes are an integral part of the consolidated financial statements.
AGY Holding Corp. And Subsidiaries
Consolidated Statements of Operations
For the Years Ended December 31, 2011, 2010 and 2009
(Dollars in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
AGY Holding Corp. And Subsidiaries
Consolidated Statements of Changes in Shareholder’s Equity
For the Years Ended December 31, 2011, 2010 and 2009
(Dollars in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
AGY Holding Corp. And Subsidiaries
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2011, 2010 and 2009
(Dollars in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
AGY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 AND 2009
(Dollars in thousands, unless otherwise noted)
1. OVERVIEW AND BASIS OF PRESENTATION
Overview - As used in this Form 10-K and in these notes, the terms “AGY”, the “Company”, “we”, “us”, “our” mean AGY Holding Corp and subsidiary companies.
AGY Holding Corp. is a Delaware corporation with its headquarters in South Carolina. KAGY Holding Company, Inc. (“Holdings”) is the sole shareholder. AGY Holding Corp. and its subsidiaries (collectively, “AGY” or the “Company”) is a leading manufacturer of advanced glass fibers that are used as reinforcing materials in numerous diverse high-value applications, including aircraft laminates, ballistic armor, pressure vessels, roofing membranes, insect screening, architectural fabrics, and specialty electronics. AGY is focused on serving end-markets that require glass fibers for applications with demanding performance criteria, such as the aerospace, defense, construction, electronics, automotive, and industrial end-markets.
As discussed in Note 3, on June 10, 2009, the Company acquired a 70% interest in a foreign company, whose results of operations since the acquisition date are included in the accompanying consolidated financial statements. Currently the Company has two manufacturing facilities located in the United States and one in the People’s Republic of China (“PRC” or “China”) and operates as two reportable segments (each a single operating segment) consisting of AGY US manufacturing operations (“AGY US”) and AGY’s Asian manufacturing operations (”AGY Asia”). .
Basis of Consolidation and Presentation - The accompanying financial statements and related notes present and discuss our consolidated financial position as of December 31, 2011 and 2010, and the consolidated results of our operations, cash flows, and changes in shareholder’s equity (deficit) for the years ended December 31, 2011, 2010 and 2009. The business is conducted through AGY Holding Corp., its two wholly owned domestic subsidiaries AGY Aiken LLC and AGY Huntingdon LLC and its wholly owned foreign subsidiaries, AGY Europe SARL (France) and AGY Cayman LLC (Cayman Islands). AGY Cayman LLC (Cayman Islands) is the holding company of the 70% controlling ownership in AGY Hong Kong Ltd. (former Main Union Industrial Ltd.) and its subsidiaries (which are collectively referred to herein as “AGY Asia”) since June 10, 2009. All significant intercompany accounts and transactions have been eliminated in consolidation.
Operations and Liquidity Management - As of December 31, 2011, AGY US had total liquidity of $13.3 million, consisting of $0.5 million in unrestricted cash and approximately $12.8 million of borrowing availability under the Senior Secured revolving credit facility (“Amended Credit facility”). As further disclosed in Note 10, if our borrowing availability under the Amended Credit Facility falls below $6.25 million, we will be subject to a springing financial maintenance covenant that would likely result in a default under the Amended Credit Facility. The Company intends to manage its liquidity needs through enhancements to the gross margins from production process improvements, enhanced sales of higher margin products and other operating focused efforts.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements and related notes have been prepared in accordance with the Accounting Standard Codification, issued by the Financial Accounting Standards Board (“FASB”) in June 2009 (the “Codification” or “ASC”) and effective after September 15, 2009. The Codification superseded all then-existing non-SEC accounting and reporting standards and established the FASB as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. All guidance contained in the Codification carries an equal level of authority. The adoption of the Codification in the third quarter of 2009 did not have an effect on the Company’s results of operations, cash flows, or financial position.
Cash - The Company considers cash on hand, cash deposited in financial institutions, and money market accounts with maturities of less than 90 days at date of purchase to be cash and cash equivalents. These are stated at cost, which approximates market value. At December 31, 2011 and 2010, the Company had no cash
equivalents. The financing agreements of AGY Asia restrict the payment of dividends and cash repatriation. As of December 31, 2011, $1.8 million of cash was not available for general corporate use because such amounts are held by the foreign Chinese subsidiary where the Company considers earnings to be indefinitely invested.
Revenue Recognition - Revenues are recognized when title and risk of loss pass to the customer. Most of the Company’s revenues are recognized upon shipment to customers or upon usage notification for customers on consignment. Provisions for discounts and rebates to customers, returns and other adjustments are provided in the same period that the related sales are recorded and are based on historical experience, current conditions and contractual obligations, as applicable.
Inventories - net - Inventories are stated at the lower of cost or market. Cost includes material, labor, and overhead, and is determined using the first-in, first-out method, except for certain packaging materials valued on an average-cost method. Inventories are stated net of estimated reserves for excess, obsolete, and lower of cost or market adjustments.
Property, Plant, and Equipment and Alloy Metals - Property, plant, and equipment are recorded at cost or when acquired as part of a business combination, at their estimated fair market value pursuant to the purchase accounting guidance in Accounting Standards Codification (“ASC”) 805, Business Combinations. Depreciation is computed by the straight-line method over the estimated useful lives of the respective assets. Depreciation on leasehold improvements is based on the lesser of the terms of the respective leases or the estimated economic life of the assets. Substantially all depreciation expense is included in cost of goods sold. Improvements are capitalized, while repair and maintenance costs are expensed as incurred.
The estimated useful lives of property, plant, and equipment are as follows:
Glass-melting furnaces periodically require substantial rebuilding. The time period between rebuilds varies depending upon the utilization of the furnace. The Company capitalizes the cost to rebuild glass-melting furnaces. Such costs are capitalized when incurred and depreciated on a straight-line basis over the estimated useful lives of the rebuilt furnaces, which is approximately 14 years.
Alloy metals are the primary component of the heat-resistant, glass-forming bushings in the Company’s glass-melting furnaces. Molten glass is passed through the bushings to form glass filaments. In addition, alloy metals are an integral part of the Company’s installed glass-melting furnaces and therefore, are classified as property, plant, and equipment.
During the manufacturing process, a small portion of the alloy metal is physically consumed. The portion of the alloy metals physically consumed is measured at the time a bushing is reconditioned and is charged to income. The amount of metal loss and the service life of the bushings are dependent upon a number of factors, including the type of furnace and the products being produced. Generally, bushings are reconditioned between 1 and 9 months depending on the glass melting technology used (and the associated melting temperature), with reconditioning charges incurred monthly.
Alloy metal additions are recorded at cost, or at fair value if acquired in a business combination, and alloy metal loss is recognized based on weighted-average historical cost per type of alloy metal.
Significant Customers and Concentration of Credit Risk - Two customers accounted for approximately 26% and 13%, respectively, of the Company’s gross consolidated accounts receivable as of December 31, 2011, compared to 19% and 14%, respectively, as of December 31, 2010. Sales to the two largest customers represented approximately 17% and 8% of the Company’s total sales, respectively, for the year ended December 31, 2011, compared to 18% and 7%, respectively, of total sales for the year ended December 31, 2010. The Company generally does not require collateral from customers and provides a reserve for uncollectible accounts based on customers’ credit history, aging of the receivables, and past due delinquency status.
The Company invests its unrestricted cash and cash equivalents in money market and other interest-bearing accounts. The Company’s primary objective is to ensure capital preservation of its invested funds. Regularly during the year, the Company maintains unrestricted cash and cash equivalents in accounts with various financial institutions in excess of the amount insured by the Federal Deposit Insurance Corporation.
Stock-Based Compensation - The Company applies the provisions of ASC 718, Compensation - Stock Compensation, regarding accounting for Share-Based Payment, which requires companies to recognize in the consolidated statement of operations the grant-date fair value of stock awards issued to employees and directors.
Foreign Currency Translation and Transactions - The assets and liabilities of the international subsidiaries whose functional currency is a foreign currency are translated into U.S. dollars at the period-end spot exchange rate. Cumulative currency translation adjustments are included in “accumulated other comprehensive income (loss)” in the shareholder’s equity section of the consolidated balance sheets. Income and expenses in foreign currencies are translated at the average exchange rates prevailing during each year. Gains and losses from foreign currency transactions are recorded in “Other income” and were not material for the years ended December 31, 2011, 2010 and 2009.
Use of Estimates - The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The Company’s most significant estimates include assessment of intangible and long-lived assets for impairment, estimates used in determining pension and postretirement medical obligations, estimates used in determining stock-based compensation, determination of the allowance for sales discounts and rebates and establishing the valuation allowance on deferred tax assets. Actual results could differ from those estimates.
Goodwill and Intangible Assets - The Company accounts for goodwill and other intangible assets in accordance with the provisions of ASC 350, Intangibles - Goodwill and Others. Goodwill and intangible assets with indefinite lives are not amortized, but instead are subject to annual impairment testing conducted each year as of October 31. The goodwill asset impairment test involves comparing the fair value of a reporting unit to its carrying amount. If the carrying amount of a reporting unit exceeds its fair value, a second step comparing the implied fair value of the reporting unit’s goodwill to the carrying amount of that goodwill is required to measure the potential goodwill impairment loss. Interim tests may be required if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.
As defined in ASC 350-20-35, a reporting unit is an operating segment, or one level below an operating segment. Since the Company’s Asian business combination in June 2009, the Company determined that it operates as two reportable units consisting of AGY US and AGY Asia, each a separate operating segment, as discussed in the Segment Information footnote. As there are no reporting units below the operating segment level, the reportable units are the level at which the Company tests for goodwill impairment.
All of the Company’s goodwill and other intangible assets with indefinite lives relate to AGY US, and accordingly, the Company’s test for impairment is based on the fair value of the AGY US reporting unit.
As discussed in Note 7 and Note 19, management concluded that as of October 31, 2009, the goodwill associated with the AGY US reporting segment was fully impaired. As a result, the Company recognized a non-cash pre-tax goodwill impairment charge of approximately $85.0 million, classified as a “loss from operations” for the year ended December 31, 2009.
Other intangible assets are recorded at cost, or when acquired as part of a business combination, at their estimated fair value. These assets relate only to the AGY US reporting segment and include customer relationships, process technology, non-compete covenant, deferred financing fees and trademarks as discussed in Note 6. The Company’s process technology consists of several patents that relate to the design, application or manufacturing for key products, and its estimated life is based on the average legal life of the patents and the Company’s estimated economic life of the processes. Intangibles with indefinite lives (trademarks) are subject to at least annual impairment testing, which compares the fair value of the intangible asset with its carrying amount. The results of these assessments did not indicate any impairment to these intangible assets for the years presented. As of December 31, 2011 and 2010, the fair value of the trademarks exceeded their carrying value of $5,613 by 4% and 18%, respectively.
Impairment of Long-Lived Assets - Pursuant to ASC 360-10, the Company evaluates its long-lived assets, including its tangible assets consisting of property plant, and equipment, and alloy metals (which are an integral part of the Company’s installed glass-melting furnaces) and its definite-lived intangible assets, for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. A significant decrease in the spot market price of alloy precious metals is one of the factors considered by management in determining the need to test this asset group for recoverability. However, management also takes into account that the market price of the precious metals may be volatile over short periods of time. Accordingly, changes in the market price of alloy precious metals may not trigger impairment assessment because such changes may not significantly impact future cash flows expected from the use of the alloy metals on an ongoing basis.
An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset, plus net proceeds expected from the disposition of the asset (if any), are less than the related asset’s carrying amount. Estimating future cash flows requires the Company to make judgments regarding future economic conditions, product demand, and pricing. Although the Company believes its estimates are appropriate, significant differences in the actual performance of the asset or group of assets may materially affect the Company’s asset values and results of operations.
As a result of the first step of the annual goodwill impairment on October 31, 2009 for the AGY US reporting segment, management tested for impairment the long-lived assets of this reporting segment. Based on the analysis performed by management, the total recoverable cash flows of the long-lived assets group substantially exceeded its carrying value. No impairment charge was recognized.
During the fourth quarter of 2011, our US reporting segment continued to incur losses due to operational performance challenges, experienced a decrease in liquidity and there was a significant decline in precious metal market price. Accordingly, management evaluated for impairment the long-lived assets of this reporting segment at December 31, 2011. Based on the analysis performed by management, the total recoverable cash flows of the long-lived assets group substantially exceeded its carrying value. No impairment charge was recognized for the US reporting segment.
As further discussed in Note 5, the Company performed a similar evaluation on the AGY Asia reporting segment, and recorded an impairment of $37.9 million as of December 31, 2011.
Derivative Instruments - The Company is exposed to market risk, such as fluctuations in foreign currency exchange rates, commodity prices, and interest rates. To manage the volatility relating to these exposures that are not offset within its operations, the Company enters into various derivative transactions pursuant to its risk management policies. The Company does not hold or issue derivative financial instruments for trading or speculative purposes.
The Company’s only derivative financial instruments at December 31, 2011 and 2010 were forward contracts to purchase natural gas and electricity used in the manufacturing operations.
Cost of Goods Sold - Cost of Goods Sold includes all costs of manufacturing, including direct manufacturing labor and fringe benefits, direct material, direct energy, and direct repairs and maintenance. In addition, Cost of Goods Sold includes indirect manufacturing expenses such as expenses of manufacturing support labor, indirect energy and consumable supplies, as well as inbound and outbound freight, duties, inspection, quality and distribution activities. The Company includes inbound freight charges, purchasing and receiving costs, inspection costs, internal transfer costs and other costs of its distribution network in Cost of Goods Sold.
Selling, General and Administrative expenses - Selling, General and Administrative expenses include salaries, wages, travel, outside services and supplies of the Management, Sales and Marketing, and Science and Technology functions, which are unrelated to the manufacturing processes.
Income Taxes - The Company accounts for income taxes using the asset and liability method approach under ASC 740, Income Taxes. Deferred income tax assets and liabilities reflect tax net operating loss and credit carryforwards and the tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. Deferred tax assets require a valuation allowance when it is more likely than not, based on the evaluation of positive and negative evidence, that some portion of the deferred tax assets may not be realized. The realization of deferred tax assets is dependent upon the timing and magnitude of future taxable income prior to the expiration of the deferred tax assets’ attributes. On an on-going basis, the Company evaluates whether its deferred tax assets are realizable and the need for a valuation allowance considering objective evidence such as reversal of the Company’s existing deferred tax liabilities, and forecasts of future taxable income. The provisions of ASC 740 require that uncertain tax positions be sustainable under regulatory review by tax authorities assumed to have all relevant information at a more-likely-than-not level. The Company recognizes the largest benefit that will more likely than not be realized upon settlement based upon its technical merits.
The Company considers its foreign earnings in AGY Europe SARL and in AGY Asia to be permanently invested and accordingly, the Company did not provide U.S. income taxes on the undistributed earnings of AGY Europe SARL and AGY Asia.
Environmental Costs - Environmental expenditures relating to current operations are expensed or capitalized as appropriate. Expenditures relating to existing conditions caused by past operations, that have no significant future economic benefit, are expensed. Liabilities for remediation costs are recorded when they are probable and reasonably estimable, generally no later than the completion of feasibility studies or the Company commitment to a plan of action. Expenditures that prevent or mitigate environmental contamination that is yet to occur are capitalized. The Company currently has not recorded any significant provision or reserves for environmental liabilities.
Conditional Asset Retirement Obligations - The Company accounts for conditional asset retirement obligations in accordance with the provisions of ASC 410, Accounting for Conditional Asset Retirement Obligations, which requires that any legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may not be within the Company’s control be recognized as a liability at the fair value of the conditional asset retirement obligation, if the fair value of the liability can be reasonably estimated. However, sufficient information may not be available to reasonably estimate the fair value of an asset retirement obligation. See Note 22 for additional discussion regarding conditional asset retirement obligations.
Fair Value of Financial Instruments - The fair value of financial instruments in the accompanying consolidated financial statements approximates the carrying value, unless otherwise disclosed.
Adoption of New Accounting Standards - In October 2009, the FASB issued new authoritative guidance regarding Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements - a Consensus of the FASB Emerging Issues Task Force, which amends ASC 605. This update establishes a selling price hierarchy, whereby vendor-specific objective evidence (“VSOE”), if available, should be utilized. If VSOE is not available, then third party evidence should be utilized; if third party evidence is not available, then an entity should use the estimated selling price for the good or service. This update eliminates the residual method and requires allocation of revenues at the inception of the contractual arrangement and additional disclosures surrounding multiple-deliverable revenue arrangements. This update was effective for the Company beginning January 1, 2011 and applied prospectively. The adoption of the new guidance did not materially affect the Company’s results of operations, cash flows, or financial position.
Effective January 1, 2009, the Company adopted the provisions of ASC 805 (formerly FSP FAS No. 141 (revised 2007), Business Combinations (Statement of Financial Accounting Standards (“SFAS”) No. 141(R)”), which became effective on a prospective basis for all business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Among other things, ASC 805 requires that all acquisition-related costs be expensed as incurred. At December 31, 2008, under the prior guidance of SFAS No. 141(R), the Company had deferred $1,098 of acquisition-related costs associated with its proposed acquisition of a majority interest in a Chinese company. In adopting this new accounting standard, the Company expensed (classified as “other operating expense” in the statement of operations for the year ended December 31, 2009) the $1,098 of acquisition-related costs incurred and deferred at December 31, 2008. The Company also expensed $1,627 of incremental advisory, legal and accounting fees that it incurred during the year ended December 31, 2009 in connection with this transaction. The previously described business combination was consummated on June 10, 2009, and as discussed in Note 3, the Company applied the other provisions of ASC 805 to the accounting for this acquisition.
On January 1, 2009, the Company adopted ASC 810 (formerly SFAS No. 160, Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB No. 51), which establishes accounting and reporting standards that require the noncontrolling interest to be identified, labeled, and presented in the consolidated balance sheet within equity, but separate from the parent’s equity. ASC 810 also requires that the amount of consolidated net income attributable to the parent and to the noncontrolling interest be identified and presented on the face of the consolidated statement of operations. The initial adoption of ASC 810 had no impact on the Company’s results of operations, cash flows or financial position, as all its subsidiaries were wholly owned on January 1, 2009. The previously described business combination consummated on June 10, 2009, included the obligation under a put/call for the noncontrolling interest classified between liabilities and stockholder’s equity on the consolidated balance sheet and separately presented the net loss attributable to the NCI in the statement of operations.
On January 1, 2009, the Company adopted ASC 815 (formerly SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133), which requires enhanced disclosures about an entity’s derivative and hedging activities. ASC 815 does not change the accounting for derivative instruments. See Note 16 to the consolidated financial statements for the enhanced disclosures required by ASC 815.
Recently Issued Accounting Standards - In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820)-Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”), to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and IFRS. ASU 2011-04 changes certain fair value measurement principles and
enhances the disclosure requirements, particularly for fair value measurements categorized within Level 3 of the fair value hierarchy. ASU 2011-04 is effective for our fiscal year beginning January 1, 2012 and must be applied prospectively. Given our immaterial amounts of assets and liabilities that require level 3 inputs, we do not expect the adoption of ASU 2011-04 to have a material impact on the Company’s consolidated financial statements.
In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income, which requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of equity. ASU 2011-05 is effective for our fiscal year beginning January 1, 2012 and must be applied retrospectively. We expect to present comprehensive income in two separate, but consecutive, statements. This is a change in presentation only and will not have an impact on the Company’s consolidated financial statements.
In September 2011, the FASB issued ASU No. 2011-08, Testing Goodwill for Impairment, which allows an entity to use a qualitative approach to test goodwill for impairment. ASU 2011-08 permits an entity to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If it is concluded that this is the case, it is necessary to perform the currently prescribed two-step goodwill impairment test. Otherwise, the two-step goodwill impairment test is not required. This guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, provided that the entity has not yet performed its 2011 annual impairment test or issued its financial statements. As the goodwill of the AGY US segment was fully impaired in 2009, the adoption of this guidance is not expected to have any material impact on the Company’s financial statements.
In December 2011, the FASB issued ASU 2011-11, Disclosures about Offsetting Assets and Liabilities (Topic 210, Balance Sheet). The update requires new disclosures about balance sheet offsetting and related arrangements. For derivatives and financial assets and liabilities, the amendments require disclosure of gross asset and liability amounts, amounts offset on the balance sheet, and amounts subject to the offsetting requirements but not offset on the balance sheet. The guidance is effective December 1, 2013 and is to be applied retrospectively. This guidance does not amend the existing guidance on when it is appropriate to offset; the impact of the adoption of ASU 2011-11 is not expected to have a material impact on the Company’s consolidated financial statements.
3. BUSINESS COMBINATION
2009 Chinese Business Combination
On June 10, 2009, pursuant to the terms of the Sale and Purchase Agreement dated March 12, 2009 (the “AGY Asia Purchase Agreement”), by and among AGY Cayman, Grace Technology Investment Co., Ltd., and Grace THW Holding Limited (together, “Grace”), AGY Cayman, a company incorporated in the Cayman Islands and a wholly-owned subsidiary of the Company, completed its acquisition of 70% of the outstanding shares of Main Union Industrial Ltd. (renamed AGY Hong Kong Ltd.), a company incorporated in Hong Kong and a previously wholly-owned subsidiary of Grace Technology Investment Co., Ltd., a company incorporated in the British Virgin Islands and previously a wholly-owned subsidiary of Grace THW Holding Limited. AGY Hong Kong Ltd. owns 100% controlling interest in Shanghai Grace Technology Co., Ltd (renamed AGY Shanghai Technology Co., Ltd. (“AGY Shanghai”)), a company incorporated in China, which is also a glassfiber yarns manufacturer. This acquisition expands AGY’s geographic, manufacturing, and servicing capabilities in the Asia-Pacific region relative to the electronics and industrial end-markets.
In connection with the execution of the AGY Asia Purchase Agreement, the parties entered into several other agreements, including: (1) an option agreement, pursuant to which Grace granted AGY Cayman a call option, and AGY Cayman granted Grace a put option, in respect of the 30% interest held by Grace in AGY Hong Kong Ltd., (2) a supply agreement, pursuant to which Grace will purchase certain fiberglass yarn products from AGY, which will have an initial term through December 31, 2013, (3) an intellectual property license agreement pursuant to which AGY Holding Corp. grants to AGY Hong Kong Ltd. a non exclusive, royalty-free, non-transferable know-how and trademarks license for the production and the sale of certain products for specific territories, and (4) a technical service agreement pursuant to which AGY provides certain technical and manufacturing support services to AGY Shanghai.
The Company paid $20 million in cash for a 70% controlling interest in Main Union Industrial Ltd. and its subsidiaries (which is collectively referred to as “AGY Asia” and is also the Company’s second operating
segment) and financed this consideration through additional capital contributions from the Company’s private equity sponsors. As noted previously, the Company entered into an option agreement that grants the Company the right to purchase the remaining 30% ownership at a stipulated multiple of earnings before interest, taxes, depreciation and amortization if certain financial parameters are achieved and grants Grace the right to put their remaining 30% ownership to the Company after the one year anniversary of the execution of the AGY Asia Purchase Agreement at a stipulated multiple of earnings before interest, taxes, depreciation and amortization. The call / put option expires on December 31, 2013. Management does not believes that either the call option or the put option will be exercised in 2012 as the redemption value as of December 31, 2011 was nil (Note 20) compared to an initial carrying value of $12.4 million and based on the financial projections of AGY Asia. If the acquisition of the noncontrolling interest is consummated, the Company intends to finance the consideration to be paid pursuant to the agreement through the sale of additional equity to its private equity sponsor, if available or other available liquidity.
Fair Value Determination and Allocation of Consideration Transferred
As noted above, the Company paid $20,000 in cash and assumed $39.0 million of debt of the acquired business for a total purchase price of approximately $71,398, assuming a 100% controlling interest. The acquisition is being accounted for under the purchase method of accounting and AGY Asia is included in the Company’s consolidated financial statements from the June 10, 2009 acquisition date. With the assistance of an independent third-party valuation specialist, management’s final assessment of the fair value of all the assets acquired and all the liabilities assumed concluded that a bargain purchase gain of approximately $20,376 resulted at the acquisition date. The Company recognized the gain as a component of non-operating income for the year ended December 31, 2009. Management believes that the Company was able to negotiate a bargain purchase price as a result of the then prevailing economic environment and its access to the liquidity necessary to complete the acquisition.
Following is a summary of the estimates of the fair value of the acquired assets less assumed liabilities at the acquisition date:
Net assets acquired and liabilities assumed (in millions):
(i) The fair value of the trade receivables at the acquisition date represents the gross contractual amounts receivable less an $84 reserve to account for the best estimate at the acquisition date of the contractual cash flows not expected to be collected.
The previously described put and call options are redemption features which result in the classification of the noncontrolling interest as temporary equity in the accompanying consolidated balance sheet at December 31, 2009, presented between total liabilities and shareholder’s equity. The fair value of the noncontrolling interest at the acquisition date of approximately $12,431 was determined by management with the assistance of an independent third-party valuation specialist. The determination of the fair value of the noncontrolling interest included consideration of the purchase price paid by the Company for its 70% interest and the estimated fair value of the put and call options between the parties discounted to present value using an industry weighted average cost of capital.
Acquisition-related Costs
At December 31, 2008, under the prior guidance of SFAS No. 141, the Company had deferred $1,098 of acquisition-related costs associated with the Chinese business combination. In adopting the new accounting standard ASC 805 on January 1, 2009, the Company wrote-off (classified as “other operating expense” in the statement of operations for the year ended December 31, 2009) the $1,098 of acquisition-related costs incurred and deferred at December 31, 2008. During the year ended December 31, 2009, the Company also expensed $1,627 of incremental advisory, legal and accounting fees that were incurred in 2009 in connection with the acquisition.
4. INVENTORIES - NET
Inventories, net of reserves for excess and obsolete inventory and write-downs to lower of cost or market of $2,684 and $1,829 as of December 31, 2011 and 2010, respectively, consist of the following:
5. PROPERTY, PLANT, AND EQUIPMENT AND ALLOY METALS
Property, plant and equipment and alloy metals consist of the following:
Depreciation expense was $15,453, $18,646 and $12,608 in 2011, 2010 and 2009, respectively. Depletion of alloy metals was $7,310, $8,103 and $6,733 (net of recoveries and excluding expense to process such recoveries), in 2011, 2010 and 2009, respectively.
As discussed in Note 8, the Company recognized $162 and $ 4,114 of accelerated depreciation related to its North American manufacturing footprint optimization in 2011 and 2010, respectively.
In 2011 and 2010, the Company sold alloy metals for net proceeds of $6,090 and $14,146, respectively, and recognized a gain of $1,299 and a loss of $331, respectively, classified as “other operating income”.
As a result of various factors in the AGY Asia reporting segment, including (a) continued losses due to operational performance challenges, (b) decreased liquidity, (c) pending service debt requirements, and (d) significant capital needs for the rebuilding of the furnace during 2012, the Company believes that a triggering event for evaluating the possible impairment of the long-lived assets in the AGY Asia segment occurred. With assistance of independent valuation experts, the Company initially determined that the carrying amounts of long-lived assets of AGY Asia were not recoverable as they exceeded the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the assets. Next, the Company determined the fair value of the AGY Asia long-lived assets and recognized an impairment loss for the amount by which the carrying amounts of the long-lived assets exceeded their fair values. The following table summarizes the calculation of the impairment loss, and the adjustments by major category of long-lived assets.
The valuation methodologies used to measure fair value are discussed in Note 19. Accumulated depreciation of $14,641 related to the impaired assets was reversed at December 31, 2011.
6. INTANGIBLE ASSETS
Intangible assets subject to amortization and trademarks, which are not amortized, consist of the following:
In March 2011, the Company entered into an amended senior secured loan and security agreement (“Amended Credit Facility”) for AGY US and incurred approximately $1.0 million in debt issuance costs. These costs are treated as additional deferred financing fees amortized by the straight-line method over the remaining life of the Amended Credit Facility, which approximates the effective interest method.
The Company’s process technology consists of several patents that relate to the design, application or manufacturing for key products, and its estimated useful life is based on the average legal life of the patents and the Company’s estimated economic life of the processes.
Estimated future amortization expense for the intangible assets subject to amortization for each of the next five years and the amount thereafter is as follows:
7. GOODWILL
Goodwill recognized in the AGY US segment with a carrying value of $84,992 as of January 1, 2009 was determined to be impaired during 2009. Non-cash, pre-tax goodwill impairment charges of $44,466 and $40,526, respectively, were recorded in the second and fourth quarters of 2009, and classified as a “loss from operations”. There are no remaining goodwill balances in the Company.
8. RESTRUCTURING ACTIONS
2011 Restructuring Actions
In the fourth quarter of 2011, we initiated restructuring actions in our AGY US segment to improve our cost structure and mitigate the adverse impact of the decline in precious metals markets on our borrowings availability. The approved plan included (a) the severance of 13 salaried positions, and (b) the engagement of a global professional services firm to lead rapid operational improvement opportunities and to provide interim senior management services following the change in our leadership organization. These actions resulted in a restructuring charge of $1,370 (net of the impact of the change in estimate of prior year restructuring actions) in 2011. The remaining reserve of $1.3 million at December 31, 2011 for the above initiatives is expected to be paid in 2012 and we expect to incur additional professional advisory services throughout 2012.
2010 Restructuring Actions
As part of the Company’s continuing review and improvement of its cost structure, actions were taken in 2010 to further optimize the AGY US segment manufacturing footprint. The Company downsized and flexed certain underutilized manufacturing facilities in the U.S. to improve profitability and better adjust its production capacity to projected future worldwide market demand. In conjunction with these actions, during 2010, the Company recorded charges of $6,772, of which $2,658 was related primarily to the relocation of certain manufacturing equipment and was included in “Restructuring charges” and $4,114 was related to accelerated depreciation expense and was included in “Cost of goods sold.” Most of the cash costs related to these actions were incurred and paid during the same period. During 2011, $162 of additional accelerated depreciation expense was recorded and included in “Cost of goods sold”.
The following table summarizes the status of unpaid liabilities from the Company’s 2011 and 2010 restructuring initiatives:
2009 Restructuring Actions
During the twelve months ended December 31, 2009, the Company recorded $789 in restructuring charges that related primarily to severance and outplacement costs for the salaried positions that the Company eliminated within the AGY US segment. These 2009 cost reduction actions and their payment were completed in 2010.
9. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
In August 2009, the United Bankruptcy Court approved the stipulation of final settlement for disputed real and personal property tax claims resulting from the Company, under prior ownership, emerging from bankruptcy in 2004. As a result of the approved settlement for the years 2002 to 2004, the Company recognized in 2009 a net gain of approximately $415 in cost of goods sold, and released $1,239 of restricted cash in escrow for such disputed taxes. At December 31, 2011, the Aiken property tax bill of $1,068 payable in 2012 had been received and was therefore included in accounts payable instead of accrued liabilities.
In November 2010, the Company terminated a supply agreement entered into by AGY Asia in 2009 at the time of the acquisition. The termination resulted from multiple uncured breaches of material obligations and responsibilities by the counterparty in relation to this agreement. As a result of the termination of this agreement, the remaining balance of the Company’s obligation for incentive payment accrued to date was reversed and the Company recorded a $6,276 gain from contract termination, classified as “other operating income”.
10. DEBT
Principal amounts of indebtedness outstanding under the Company’s financing arrangements consist of the following:
Senior Secured Notes
On October 25, 2006, the Company issued $175,000 aggregate principal amount of 11% senior secured second lien notes (“Old Notes”) due in 2014 to an initial purchaser, which were subsequently resold to qualified institutional buyers and non-U.S. persons in reliance upon Rule 144A and Regulation S under the Securities Act of 1933, as amended. On May 8, 2008, the Company filed with the United States Securities and Exchange Commission (“SEC”) a registration statement on Form S-4 under the Securities Act of 1933 to exchange all of the Old Notes for the 11% senior secured second lien exchange notes (“Notes”); such exchange was fully consummated and closed on July 11, 2008.
The Notes are identical in all respects to the Old Notes except:
•
the Notes are registered under the Securities Act;
•
the Notes are not entitled to any registration rights which were applicable to the Old Notes under the registration rights agreement; and
•
the liquidated damages provisions of the registration rights agreement are no longer applicable.
Interest on the Notes is payable semi-annually on May 15 and November 15 of each year beginning May 15, 2007. The Company’s obligations under the Notes are fully and unconditionally guaranteed, jointly and severally, on a second-priority basis, by each of its existing and future domestic subsidiaries, other than immaterial subsidiaries, that guarantee the indebtedness of the Company, including the Credit Facility, or the indebtedness of any restricted subsidiaries.
In February 2009, the Company repurchased $3,000 face amount of Notes for $1,792 plus accrued interest of $92 and commission of $8, resulting in a net gain on extinguishment of debt of $1,138 (net of $70 of deferred financing fees written off), classified as “other non-operating income”.
As of December 31, 2011 and 2010, the estimated fair value of the Notes was $82,560 and $155,455, respectively, compared to a recorded book value of $172,000 for both periods. The fair value of the Notes is estimated on the basis of quoted market prices; however, trading in these securities is limited and may not reflect fair value. The fair value is subject to fluctuations based on, among other things, the Company's performance, its credit rating and changes in interest rates for debt securities with similar terms.
The indenture governing the Notes contains a Fixed Charge Coverage Ratio (calculated based on “Consolidated Cash Flow” (as defined)), which is used to determine our ability to make restricted payments, incur additional indebtedness, issue preferred stock and enter into mergers or consolidations or sales of substantially all assets. The indenture does not allow us to pay dividends or distributions on our outstanding capital stock (including to our parent) and limits or restricts our ability to incur debt, repurchase securities, make certain prohibited investments, create liens, transfer or sell assets, enter into transactions with affiliates, issue or sell stock of a subsidiary or merge or consolidate. The indenture does not contain any financial maintenance covenants.
Under certain events of default, including defaults under the Credit Facility, payment of the outstanding principal and interest could be accelerated.
Senior Secured Revolving Credit Facility
The Company’s $40,000 Senior Secured Revolving Credit Facility (“Credit Facility”) was originally scheduled to mature in October 2011 and included a $20,000 sub-limit for the issuance of letters of credit and a $5,000 sub-limit for swing line loans. On March 8, 2011, the Company entered into the Amended Credit Facility that provides for an expanded credit facility of up to $50,000 and matures on the earlier of March 8, 2015 or 90 days prior to the maturity date of the Notes. The Amended Credit Facility includes a $20,000 sub-limit for the issuance of letters of credit and a $5,000 sub-limit for swing line loans. The terms and conditions of the Amended Credit Facility are similar to the superseded facility and summarized below. Availability under the Amended Credit Facility is subject to a borrowing base equal to the sum of: (i) an advance rate against eligible accounts receivable of up to 85%, plus (ii) the lesser of (A) 65% of the book value of eligible inventory (valued at the lower of cost or market) or (B) 85% of the net orderly liquidation value for eligible inventory, plus (iii) up to $40,000 of eligible alloy inventory, minus (iv) 100% of market-to-market risk on certain interest hedging arrangements, minus (v) a reserve of $7,500, and minus (vi) other reserves as the lender may determine in its permitted discretion.
The interest rate for borrowings was LIBOR plus 3.0% or Base Rate plus 2.0% through September 1, 2011 and then may be adjusted downward to LIBOR plus 2.5% or Base Rate plus 1.5%, depending on the Company’s fixed charge coverage ratio. In addition, there are customary commitment and letter of credit fees under the Amended Credit Facility.
All obligations under the Amended Credit Facility are guaranteed by Holdings. The Company’s obligations under the Amended Credit Facility are secured, subject to permitted liens and other agreed upon exceptions, by a first-priority security interest in substantially all of the Company’s assets.
Proceeds from the Amended Credit Facility loan were used to repay all amounts, and terminate all commitments outstanding under our previous $40,000 Credit Facility and to pay fees and expenses in connection with the refinancing.
The Company incurred approximately $1,000 in issuance costs, which have been deferred and will be expensed over the life of the Amended Credit Facility.
The Amended Credit Facility contains customary representations and warranties and customary affirmative and negative covenants, including, among other things, restrictions on indebtedness, liens, investments, mergers and consolidations, dividends and other payments in respect to capital stock, transactions with affiliates, and optional payments and modifications of subordinated and other debt instruments.
The foreign subsidiary indebtedness of AGY Asia or its subsidiaries is permitted provided that it is non-recourse indebtedness; the investment associated with the purchase of the remaining 30% (“Secondary Asia Purchase”) is permitted provided that after giving effect thereto, the Company’s excess availability under the facility is (i) at least $10,000 for 60 days prior to the consummation date and the Company maintains a minimum 0.5 to 1.0 fixed charge ratio (as defined) immediately prior to and immediately following such consummation if the Secondary Asia Purchase is made on or before June 30, 2012, or (ii) at least $ 8,750 for 60 days prior to the consummation date and the Company maintains a minimum 1.0 to 1.0 fixed charge ratio (as defined) immediately prior to and immediately following such consummation if the Secondary Asia Purchase is made after June 30, 2012.
In addition, the agreement contains a “springing financial maintenance covenant.” Specifically, if any revolving credit facility commitments are outstanding and after the occurrence of (a) a default or an event of default, or (b) the availability under the facility falling below the greater of $6,250 and 12.5% of the Borrowing Base (as defined) as of the last day of the most recent fiscal month ended, the Company must maintain a fixed charge coverage ratio of at least 1.0 to 1.0 for each period of four fiscal quarters ended during, or on the last day of, the fiscal quarter immediately before the events listed in (a) and (b) above. The Company is currently in negotiations with its revolving lenders to ensure that the springing financial maintenance covenant will not become effective in the next 12 months but there are no assurances that it will not become effective.
The agreement governing the Amended Credit Facility permits the lenders to accelerate payment of the outstanding principal and accrued and unpaid interest and/or to terminate their commitment to lend any additional amounts upon certain events of default, including but not limited to failure to pay principal or interest or other amounts when due, breach of certain covenants or representations including breach of the springing covenant, cross-defaults to certain other agreements and indebtedness in excess of specified amounts, a change of control, or default under our obligation regarding the AGY Asia option exercise. The Company was in compliance with all such covenants as of December 31, 2011.
As of December 31, 2011 our borrowing base, calculated in accordance with the terms of the Amended Credit Facility, was $40,700. As of December 31, 2011, the Company had issued letters of credit totaling approximately $2,900 and had cash borrowings of $25,000 under the facility. The weighted average interest rate for cash borrowings outstanding as of December 31, 2011 was 3.38%. Borrowing availability after giving effect to the borrowing base at December 31, 2011 was approximately $12,800.
As of December 31, 2010, under our previous $40,000 Credit Facility, the Company had issued standby letters of credit totaling approximately $2,400 and had cash borrowings of $17,950 leaving total undrawn availability, after giving effect to the borrowing base, of $17,100.
AGY Asia Credit Facility- Non-recourse
In connection with the acquisition of AGY Asia, bank and shareholder debt of approximately $39.0 million was assumed and was refinanced as discussed below. In July, 2009, AGY Asia entered into a financing arrangement with the Bank of Shanghai (“AGY Asia Credit Facility”) for a five-year term loan and one-year working capital loan with original commitments of approximately $40.5 million and $11.7 million converted at the then-current exchange rate. Proceeds from the loans were used principally to repay the $37.6 million outstanding at the time of the refinancing under AGY Asia’s prior credit agreements.
At December 31, 2011, the unamortized term loan commitment was approximately $29.2 million (consisting of a commitment denominated in local currency of RMB 158.7 million, or approximately $25.2 million converted at an exchange rate of RMB 6.3 to 1 US dollar, the prevailing exchange rate as of December 31, 2011, and a US-dollar-denominated loan of $4 million), a one-year working capital loan in the aggregate amount of approximately $12.5 million (consisting of (i) a local currency loan of RMB 66.5 million, or approximately $10.6 million converted at the period-end exchange, and (ii) a US-dollar-denominated loan of $1.9 million), and a one-year letter of credit facility in the amount of $2 million.
Term loan
The term loan is secured by AGY Asia’s building, alloy metals and equipment and bears interest annually at the rate of either the five-year lending rate as published by the People’s Bank of China, plus a margin, or six-month LIBOR plus 3.0%. Term loan borrowings may be made in both local currency and US dollars, up to certain limits. At December 31, 2011 and 2010, AGY Asia had borrowings of approximately $27,600 and $33,400 outstanding under the term loan, respectively, consisting of a local currency loan of RMB 148,500 and RMB 183,500, respectively, or approximately $23,600 and $27,700, respectively, converted at the period-end exchange rate, and a U.S.-dollar-denominated loan of $4,000 and $5,700, respectively. The weighted average interest rate for cash borrowings outstanding as of December 31, 2011, was 7.0%.
There are semi-annual mandatory payments of principal on the term loan borrowings. At December 31, 2011, the remaining mandatory payments of principal were as follows:
The Company has initiated discussion with the AGY Asia lender to modify the term loan amortization and has an agreement in principle to defer the $5.1 million April 2012 required principal payment for three months to July 2012, at which time the rest of the amortization schedule and financing needs will be reexamined. The deferral is subject to the execution of definitive documents, which the Company expects to complete shortly. However, there is no assurance that we will be able to permanently revise the term loan amortization schedule on terms acceptable to us or at all. If AGY Asia is unable to reach agreement with its lender to modify the term loan amortization schedule beyond July 2012, then AGY Asia may default under its loan agreement and the total outstanding debt of $27.6 million may be accelerated. As a result of this uncertainty, all the outstanding borrowings under the term loan were classified as current liabilities as of December 31, 2011.
Working Capital Loan
The working capital loan facility is secured by existing and future equipment and assets acquired by AGY Asia and bears interest annually at the rate of either the one-year lending rate as published by the People’s Bank of China, or three-month LIBOR plus 3.0%. Working capital loan borrowings may be made in both local currency and US Dollars, up to certain limits.
At December 31, 2011 and 2010, the Company had borrowings of approximately $11,600 and $9,900, respectively, outstanding under the working capital loan consisting of (i) a local currency loan of RMB 66,500 and RMB 52,250, respectively, or approximately $10,600 and $7,900, respectively, converted at the period-end exchange rate, and (ii) a U.S.-dollar-denominated loan of $1,000 and $2,000. The weighted average interest rate for cash borrowings outstanding as of December 31, 2011, was 6.9%.
During the second quarter of 2011, AGY Asia entered into a letter of credit (“LC”) discounting arrangement whereby certain trade receivables backed by LCs may be discounted with recourse and borrowed against at a nominal interest cost. At December 31, 2011, AGY Asia had discounted LCs with a face value of approximately $1,410 (which amount is recorded in trade receivables at December 31, 2011), receiving proceeds of approximately $1,270 and maintaining equity of approximately $140 in such receivables. At December 31, 2011, proceeds of $1,270 received from discounting were recorded as short-term debt payable.
The letter of credit facility is a one-year facility for the issuance of documentary letters of credit up to a maximum term of 120 days. A 15% deposit is required upon issuance with the balance due upon settlement of the underlying obligation.
The loan agreements contain customary representations and warranties and customary affirmative and negative covenants, including, among other things, interest coverage, restrictions on indebtedness, liens, investments, mergers and consolidations, dividends and other payments in respect to capital stock, and transactions with affiliates. The loan agreements also include customary events of default, including a default upon a change of control. AGY Asia was in compliance with all such covenants at December 31, 2011 and 2010.
All amounts borrowed under the AGY Asia Credit Facility are non-recourse to AGY Holding Corp. or any other domestic subsidiary of AGY Holding Corp.
Shanghai Grace Fabric Corporation Loan
Prior to the acquisition date, AGY Shanghai entered into a working capital unsecured loan with Shanghai Grace Fabric Corporation, a predecessor sister company. The approximately $12,400 outstanding under this loan at the acquisition date and at June 30, 2009 was repaid in full in July 2009, using, in part, restricted cash for such repayment. There is no such financing agreement in place since the refinancing on July 10, 2009.
Maturities of Long-Term Debt
As discussed above we classified all AGY Asia borrowings outstanding under the term loan as current as of December 31, 2011due to the uncertainty of AGY Asia's ability to make required principal payments and/or to consummate a refinancing, which would create an event of default and activate an acceleration clause. As a result maturities of long-term debt at December 31, 2011 only relate to AGY US and consist of the following:
11. TRANSACTIONS WITH RELATED PARTIES
The Company has a management agreement with the principal shareholder of Holdings pursuant to which this party provides management and other advisory services to the Company. The management agreement requires AGY to pay this party an annual management fee of $750 and to reimburse this party for out-of-pocket expenses incurred in connection with its services. The management agreement also provides that this party will receive transaction fees in connection with certain subsequent financings and acquisition transactions. The management agreement includes customary indemnification provisions in favor of this party and its affiliates. Under this Agreement, this related party was paid $750 for each of the two years ended December 31, 2010 and 2009. The management fees expensed in 2011 aggregated $750, of which $562.5 was paid and $187.5 was deferred.
In the fourth quarter of 2011 the Company entered into an agreement with the principal shareholder of Holdings, pursuant to which this party guarantees in case of default of the Company, the payment of interim management and corporate advisory services to be rendered by a global professional services firm, up to approximately $2.9 million to be incurred during the engagement of the professional services firm since September 2011. Such fees, amounting to $695 have been accrued and expensed as of December 31, 2011 as restructuring costs (Note 8).
12. CAPITAL STOCK AND EQUITY
The authorized capital consists of a total of 1,000 shares of common stock with a par value of $0.01 per share. All 100 outstanding shares of the Company have been owned by Holdings since the Acquisition on April 7, 2006. The holder of each share has the right to one vote for each share of common stock held and no shareholder has special voting rights other than those afforded all shareholders generally under Delaware law. Shareholders share ratably, based on the number of shares held, in any and all dividends the Company may declare. As discussed in Note 10, the payment of dividends is restricted by the Credit Facility and no dividends were paid in any of the three years ended December 2011.
13. EMPLOYEES BENEFITS
Pension and other Postretirement Benefits
Pension Benefits- Prior to 1998, the hourly and salaried employees of AGY participated in defined benefit plans maintained by Owens Corning (“OC”), a predecessor owner of the Company. Under the plans, early retirement pension subsidies were generally based on an employee’s pay and number of years of service. In September 1998, as part of a predecessor owner’s acquisition of AGY from OC, all employees of OC who transferred to AGY as of October 1, 1998, became eligible to receive the same early retirement pension subsidy offered by OC, which created a pension obligation for AGY. The accrued pension benefit was frozen as of October 1, 1998, and remains a liability of OC. Upon retirement from the Company, participants are entitled to begin receiving benefits from OC, recognizing service with OC and the Company for retirement eligibility purposes. Accordingly, the Company is obligated to reimburse OC for the value of the early retirement subsidy, which is based on the difference between (a) and (b) at the time of the employee’s early retirement:
(a) Present value of the October 1, 1998, frozen benefit available immediately based on the normal form of payment and applicable early retirement factors
(b) Present value of the October 1, 1998, frozen benefit deferred to age 65
Both present values are determined on the then-applicable General Agreement on Tariffs and Trade (GATT) basis. Employees who terminate before early retirement eligibility (defined under the OC plan as age 55 with 10 years of service) or work until normal retirement (defined under the OC plan as age 65) represent no liability to the Company.
The Company’s obligation to OC is unfunded.
During 2011, 2010 and 2009, the plan incurred settlement charges of $748, $376 and $780, respectively, in accordance with ASC 715 as a result of higher benefits payments than projected. Of these total settlements, the Company recorded $304, $146 and $220 as charges to earnings in 2011, 2010 and 2009, respectively, with the remainder recorded as a deferred loss in Other Comprehensive Income.
Other Postretirement Benefits - The Company has health care and life insurance benefit plans for certain domestic retired employees and their dependents. The health care plan is unfunded and pays either (1) stated percentages of covered “medically necessary” expenses, after subtracting payments by Medicare or other providers and after stated deductibles have been met, or (2) fixed amounts of medical expense reimbursement. Currently, the retiree medical plans have the following terms: (a) eligibility requirement at age 62; (b) a $3,500 cap on the amount the Company will contribute annually toward pre-Medicare retiree medical expenses, with retiree contributions adjusted annually; and (c) provides a post-Medicare spending account at levels of $0 to $1,500, depending on years of service. Approximately 50 retirees, under an election they were permitted during AGY’s bankruptcy under predecessor ownership, elected COBRA, and such retirees are required to pay the monthly COBRA contribution in effect at the date of election and as adjusted each year.
The Company continues to reserve the right to change or eliminate these benefit plans subject to the terms of collective bargaining agreements, if applicable.
Certain retirees who retired between October 1, 1998, and December 31, 1999, participate in the retiree medical program of OC. Such employees became eligible to participate in the health care plans upon retirement if they had accumulated 10 years of service after age 45. Some of the plans were contributory, with some retiree contributions adjusted annually. OC reserved the right to change or eliminate these benefit plans subject to the terms of collective bargaining agreements. The predecessor owner of AGY assumed the liability for these health care benefits on September 30, 1998. As a result, the Company reimburses OC for actual expenses incurred for these certain retirees.
During 2011 as a result of a change in the Huntingdon collective bargaining agreement that triggered the termination of a significant number of employees and the elimination of their accrued benefits, the Company recorded a curtailment gain in “Cost of Goods Sold” of approximately $1.3 million which included the unamortized prior service cost and the change in projected benefit obligation, in accordance with ASC 715.
The following tables set forth the accumulated benefit obligation as of December 31, 2011 and 2010, and the changes in projected benefit obligations and plan assets of the Company’s pension and other postretirement plans as of and for the years ended December 31, 2011 and 2010.
The net actuarial loss (gain) recognized in accumulated other comprehensive income (pre-tax) consists of the following at December 31, 2011, 2010, and 2009:
The pension benefit obligation and other postretirement benefits are recognized in the consolidated balance sheets at December 31, 2011 and 2010 as follows:
Net periodic benefit costs for the Company’s pension and postretirement plans for 2011, 2010, and 2009 were as follows:
The estimated net (gain) loss and prior service cost that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year are $(242) and $95 for Other Postretirement Benefits and Pension Benefits, respectively.
Assumptions used to estimate the actuarial present value of benefit obligations and the net periodic benefit costs for 2011, 2010, and 2009 were as follows:
The discount rate reflects the current rate at which the pension and other postretirement liabilities could be effectively settled at the end of the year. The discount rate was determined by matching the Company’s expected benefit payments, taking into account the plans’ demographics, to payments from a stream of corporate AA or higher bonds.
A one percentage point change in the assumed health care cost trend rate would have an insignificant impact on the other postretirement benefits obligation at December 31, 2011 and 2010.
Future estimated annual benefit payments (and 2012 contributions) for pension and other postretirement benefit obligations are as follows:
Defined Contribution Plan
The Company has a defined contribution 401(k) plan that allows qualifying employees to contribute up to 30% of their annual pretax or after-tax compensation subject to Internal Revenue Service (IRS) limitations. Effective January 1, 2007, AGY may provide a voluntary matching employer contribution of 50% on up to 6% of each participant’s before-tax salary deferral. In addition, AGY may make an employer contribution to the plan based on the Company’s annual financial performance. For the years ended December 31, 2011, 2010 and 2009, the Company contributed or accrued $526, $645, and $550 respectively. Effective December 2011, the Company suspended matching contributions for hourly employees at its Aiken SC location and for all salaried employees.
14. STOCK BASED COMPENSATION
The Company’s stock-based compensation includes Holdings’ stock options and restricted stock. Total stock-based compensation was approximately $199, $43 and $415 in 2011, 2010 and 2009, respectively.
Stock Options - On April 7, 2006, Holdings adopted the 2006 stock option plan that provides that up to 1,335,000 shares of Holdings’ common stock are reserved for issuance under this plan, pursuant to the exercise of options under this plan, all contingent upon continuous employment through the date of vesting. Holdings had 11,483,915 shares of common stock outstanding as of December 31, 2011.
For the stock options granted through 2010, 50% vest over a three-year period from the grant date. The remaining 50% vest based on the Company achieving annual or cumulative financial targets over a three-year period from the grant date. As of December 31, 2011, the Company exceeded one of the three-year plan financial targets, which triggered the vesting of one-third of the performance-based stock options granted in 2006. Up to their expiration date, the remainder of the performance-based stock options can vest upon a change of control or at the sole discretion of the Board of Directors.
Beginning with grants in 2011, all the options granted under the 2006 stock option plan vest over a four-year period from the grant date.
These options expire in 2016, or 10 years from the first grants date. The Company accounts for the options under the provisions of ASC 718, which requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The grant-date fair value is to be estimated using option-pricing models adjusted for the unique characteristics of those instruments. In calculating the impact for options and restricted stock units granted, the Company has estimated the fair value of each option grant by using the Black-Scholes option-pricing model and the vesting probability of these stock awards. This model derives the fair value of stock options based on certain assumptions related to expected stock price volatility, expected option life, risk-free interest rate, and dividend yield. The Company’s estimated volatility is based on the historical volatility of publicly traded companies in the same industry. The Company’s expected option life is based upon the average of the vesting term and the life of the options. The risk-free interest rate is based upon the U.S. Treasury yield curve appropriate to the term of the Company’s stock option awards. The estimated dividend rate is zero and no forfeiture rate was applied. Assumptions will be evaluated and revised, as necessary, to reflect market conditions and experience for new options granted.
The fair value of each grant was calculated with the following weighted-average assumptions:
The weighted-average fair value of options outstanding was $3.30 and $4.04 per share at December 31, 2011 and 2010, respectively. Based on the fair value of the stock options, the stock-based compensation was $199, $43 and $415 in 2011, 2010 and 2009, respectively. The remaining unrecognized compensation at December 31, 2011 is estimated at approximately $500 and is expected to be recognized as expense over the next four years.
A summary of Holdings’ stock options outstanding and exercisable and activity for 2009, 2010 and 2011 is summarized below:
Restricted Stock Units - On April 7, 2006, Holdings also granted 100,000 restricted stock units (“RSU”) pursuant to the terms of an executive employment agreement. These RSUs vested 50% on both April 7, 2007, and April 8, 2008, and were subject to certain forfeiture conditions.
The stock-based compensation cost related to RSUs was nil for the three years ended December 31, 2011. There is no remaining unrecognized compensation expense for the RSUs at December 31, 2011.
15. COMPREHENSIVE LOSS
The following table presents comprehensive loss, which represents net loss and other gains and losses affecting shareholder’s equity that are not reflected in the Company’s consolidated statements of operations:
16. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company from time to time enters into fixed-price agreements for the energy requirements of its AGY US segment to reduce the variability of the cash flows associated with forecasted purchases of natural gas. Although these contracts are considered derivatives instruments, they typically meet the normal purchases exclusion contained in ASC 815 and are therefore exempted from the related accounting requirements. At December 31, 2011, the Company had existing contracts for physical delivery of natural gas at its Aiken, SC facility and at its Huntingdon, PA facility that fix the commodity cost of natural gas for approximately 60% and 80%, respectively, of its estimated natural gas purchase requirements in the next twelve months.
At December 31, 2011, the Company also had existing contracts for physical delivery of electricity at its Huntingdon, PA facility that fix the commodity cost of approximately 80% of its estimated electricity purchase requirements in the next twelve months.
The Company also uses, on occasion, foreign currency derivatives to manage the risk associated with fluctuations in foreign exchange rates. At December 31, 2011 and 2010, respectively the Company had no foreign currency hedging agreements in effect.
17. INCOME TAXES
The income tax expense (benefit) for the years ended December 31, 2011, 2010 and 2009, consists of the following:
The differences between the effective tax rate used in the consolidated statements of income and the expected tax rate (computed by applying the U.S. federal corporate tax rate of 34% to income before income taxes) are as follows:
The tax effect of temporary differences, which give rise to deferred tax assets (liabilities) are as follows at December 31, 2011 and 2010:
The net deferred tax liabilities are recognized as follows in the consolidated balance sheets at December 31, 2011 and 2010:
The Company has determined that, at present, it is more likely than not that its foreign net operating loss (“NOL”) carryforward will not be realized. Therefore, a valuation allowance has been provided to reduce the carrying amount of the NOL carryforward to zero at December 31, 2011. The Company recorded during 2010 a valuation allowance for domestic deferred tax assets, which are not more-likely-than-not to be realized and do not relate to assets with indefinite useful life. Generally, the Company can recognize deferred tax assets for the losses incurred until such time that the aggregate deferred tax assets exceed aggregate deferred tax liabilities that do not relate to assets with an indefinite useful life. The Company remains in a valuation allowance position for domestic deferred tax assets, which are not more-likely-than-not to be realized and do not relate to assets with indefinite useful life at December 31, 2011.
At December 31, 2011, the Company had domestic federal NOL carryforwards of approximately $86,850 and state NOL carryforwards of approximately $40,967 that will begin expiring in 2026. Also at December 31, 2011, the Company had foreign NOL carryforwards of approximately $29,663 that begin expiring in 2013.
Uncertain Tax Positions
The total amount of unrecognized tax benefits, excluding the impact of interest and penalties, as of December 31, 2011 and 2010, was $262 and $262, respectively, of which approximately $6 would impact the effective rate for both years if recognized. In accordance with its accounting policy, the Company recognizes accrued interest and penalties related to unrecognized tax benefits as a component of tax expense. During 2011 and 2010, accrued interest and penalties were minimal. The Company’s consolidated balance sheet as of December 31, 2011 includes interest and penalties of $2 and $2 respectively.
The following table summarizes the activity related to the Company’s unrecognized tax benefits, excluding interest and penalties:
The Company does not anticipate the balance of gross unrecognized tax benefits at December 31, 2011, to significantly change during the next 12 months.
As of December 31, 2011, the Company is subject to U.S. federal income tax examinations for the tax years 2009 through 2011. In addition, the Company is subject to state and local income tax examinations for the tax years 2008 through 2010. The Company concluded a U.S. federal income tax examination during 2010 for the year ended December 31, 2007, which resulted in no adjustments.
18. ALLOY METAL LEASES
The Company leases under short-term operating leases (generally with lease terms from six to twelve months) a significant portion of the alloy metals needed to support our manufacturing operations. During the years ended December 31, 2011, 2010 and 2009, total lease costs of alloy metals were approximately $4,280, $3,648 and $3,595, respectively, and were classified as a component of cost of goods sold.
The Company has leased alloy metals under the following agreements during 2011, 2010 and 2009:
Metal Consignment Facility - From August 2005 to October 2009, AGY had a consignment agreement in place with Bank of Nova Scotia, as assignee of Bank of America, N.A., which was assignee of Fleet Precious Metals Inc., to lease platinum, one of the alloy metals used in our manufacturing operations. Effective October 7, 2009, the Company terminated the Metal Consignment Facility with Bank of Nova Scotia and entered into a new master lease agreement with Deutsche Bank as discussed below.
Deutsche Bank Master Lease Agreement - In connection with the termination of the Metal Consignment Facility with Bank of Nova Scotia in October 2009, the Company entered into a new master lease agreement (the "Master Lease Agreement") with DB. The Master Lease Agreement has a three-year term and allows AGY to enter into leases of alloy metals, up to 51,057 ounces of platinum and up to 3,308 ounces of rhodium, with terms of one to twelve months. Lease costs are determined by the quantity of metal leased, multiplied by a benchmark value of the applicable precious metal and a margin above the lease rate index based on DB's daily precious metal rates. The Master Lease Agreement is secured by a security interest in rhodium up to a value that is the lesser of 35% of the leased platinum or $24,400. The Master Lease Agreement contains customary events of default, including, without limitation, nonpayment of lease payments, inaccuracy of representations and warranties in any material respect and a cross-default provision with any credit facility or leasing facility greater than $500, including the Amended Credit Facility and the Notes. There are no financial maintenance covenants included in the New Master Lease Agreement.
At December 31, 2011, the Company leased approximately 49,800 ounces of platinum and 3,300 ounces of rhodium under the New Master Lease Agreement, with a notional value of approximately $82,700 and $6,200, respectively. All of the leases outstanding at December 31, 2011 had initial terms of six to twelve months, maturing no later than October 5, 2012 (with future minimum rentals of approximately $1,850 until maturity in October 2012).
We are currently in discussions with DB to extend the facility beyond its original maturity date, or in October 2012 but there is no assurance that we will be able to obtain replacement financing on terms acceptable to us or at all. If we are unable to refinance the facility by June 15, 2012, in a manner acceptable to our senior secured revolving lenders, this will be an event of default under that agreement and the lenders may accelerate amounts due under that facility, which could then trigger a default under our senior second lien notes.
19. FAIR VALUE MEASUREMENTS
The Company utilized the valuation hierarchy provided in ASC 820-10 to determine the fair value of assets measured on a non-recurring basis in periods subsequent to the initial adoption of ASC 820-10:
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Level 1: Observable inputs such as quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.
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Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly based on inputs not quoted on active markets, but corroborated by market data.
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Level 3: Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.
In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible.
At December 31, 2011, long-lived assets of AGY Asia were tested for impairment. Accordingly, as discussed in Note 5, the Company recorded an impairment charge of $37.9 million based on the orderly liquidation value in exchange basis of the long-lived assets given the uncertainty for AGY Asia to operate as a going concern beyond 2012. The valuation methodologies used to determine fair value, with the assistance of a third party valuation specialist, were a market approach for those assets where a secondary market exists and a replacement cost approach for the remainder. Since there were primarily unobservable inputs, management concluded that this was a Level 3 fair value measurement.
At December 31, 2010, there were no assets or liabilities required to be measured at fair value in periods subsequent to their initial recognition.
At December 31, 2009, assets or liabilities measured at fair value in periods subsequent to their initial recognition only include the AGY US segment goodwill, which was partially impaired as of June 30, 2009 and was tested for annual impairment during the fourth quarter of 2009. The valuation methodologies used to determine fair value, with the assistance of a third party valuation specialist, were:
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Market approach: The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business).
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Income approach: The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present amount (discounted). The measurement is based on the value indicated by current market expectations about those future amounts and significant assumptions used include projected cash flows, discount rate and terminal business value that are primarily the Company’s own data.
Since there were unobservable inputs, management concluded that this was a Level 3 fair value measurement.
In accordance with the provisions of ASC 350-20, the goodwill of the AGY US segment with a carrying amount of approximately $84,992 was written off as of December 31, 2009.
20. NONCONTROLLING INTEREST
As discussed in Note 3, on June 10, 2009 the Company purchased a 70% controlling interest in AGY Asia. The 30% noncontrolling interest (“NCI”) was recorded at the acquisition date at a fair value of $12,431, which was derived from an option agreement, pursuant to which the Company has the right to purchase the remaining 30% NCI at a stipulated multiple of earnings before interest, taxes, depreciation and amortization if certain financial performances are achieved. Grace has the right to put their remaining 30% ownership to the Company after the one-year anniversary of the execution of the AGY Asia Purchase Agreement at a stipulated multiple of earnings before interest, taxes, depreciation and amortization. The put option became exercisable upon the first anniversary of the completion date of the AGY Asia acquisition, June 10, 2010, and will expire on December 31, 2013.
The Company assessed the option agreement under the guidance of ASC 815 and ASC 480-10 and considered it was not a freestanding financial instrument but a redeemable equity interest, which is not solely within the control of the Company. Therefore, at the acquisition date, the fair value of the redeemable portion of the NCI was reclassified as temporary, or mezzanine, equity presented in the accompanying consolidated balance sheet between total liabilities and shareholder’s equity.
At December 31, 2011, 2010 and 2009, the Company recorded the attribution of the NCI net income (loss) and other comprehensive income (loss) and performed a subsequent measurement of the probable redemption amount. As the present value of the probable redemption price was below the initial carrying value of the NCI and as the redemption was still probable, the Company concluded that the mezzanine classification was still appropriate as of December 31, 2009. As of December 31, 2011 and 2010 the equity instrument is redeemable but remains below its initial carrying value and became nil as of December 31, 2011. Therefore, only the redemption amount determined as of the end of the period is classified in mezzanine equity and any NCI above this amount is presented in permanent equity.
Changes in noncontrolling interest during the years ended December 31, 2009, 2010 and 2011 are set forth below:
21. VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(1) Includes rebates accrued to sales.
(2) Includes rebates paid to customers
22. COMMITMENTS AND CONTINGENCIES
The Company is not a party to any significant litigation or claims, other than routine matters incidental to the operation of the Company. The Company does not expect that the outcome of any pending claims will have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows.
There may be insignificant levels of asbestos in certain manufacturing facilities, however, the Company does not expect to incur costs (which are undeterminable) in the foreseeable future to remediate any such asbestos, which may be present in the facilities. Accordingly, management did not record a conditional asset retirement obligation related to such asbestos remediation because, in accordance with the guidance of ASC 410, the Company does not have sufficient information to estimate the fair value of the asset retirement obligation.
In addition to the alloy metal leases discussed in Note 18, the Company also leases manufacturing and other equipment and property under operating leases. Total rent expense for the years ended December 31, 2011, 2010 and 2009, was approximately $1,600, $1,630 and $1,970, respectively. The following summarizes the future minimum lease payments for each of the next five years and the total thereafter:
23. SEGMENT INFORMATION
Since the acquisition of AGY Asia on June 10, 2009 as discussed in Note 3, the Company has two reportable segments, each a separate operating segment. The AGY US segment includes the US manufacturing operations and its sale of advanced glass fibers that are used worldwide as reinforcing materials in numerous high-value applications and end-markets through AGY Holding Corp., its wholly owned domestic and French subsidiaries. The AGY Asia segment includes the manufacturing operations of the Company’s 70% controlling ownership of AGY Hong Kong Limited and its sale of advanced glass fibers that are used primarily in the Asian electronics markets. The Company’s operating segments are managed separately based on differences in their manufacturing and technology capabilities, products and services and their end-markets as well as their distinct financing agreements. The financial results for the Company’s operating segments are prepared using a management approach, which is consistent with the basis and manner in which the Company internally segregates financial information for the purpose of making internal operating decisions. The Company evaluates the performance of its operating segments based on operating profit. Corporate and certain other expenses are not allocated to the operating segments, except to the extent that the expense can be directly attributable to the operating segment.
(1) Operating loss for the year ended December 31, 2011 within the corporate and other segment includes $1,370 of restructuring expense (discussed in Note 8), stock compensation expense, and the management fees payable to the Company’s sponsor. These are partially offset by a $1,299 gain recorded on the sale of alloy metals.
(2) Operating loss for the year ended December 31, 2010 within the corporate and other segment includes primarily, $2,658 of restructuring expense and $4,114 of accelerated depreciation expense (discussed in Note 8), stock compensation expense, the management fees payable to the Company’s sponsor, a $331 loss recorded on the sale of assets. These are partially offset by a $6,276 gain from contract termination (discussed in Note 9).
Twelve Months Ended December 31, 2009
(3) Operating loss for the year ended December 31, 2009 within the corporate and other segment includes primarily, $84,992 of goodwill impairment charge related to the AGY US segment (discussed in Note 7), $2,725 of acquisition-related cost (discussed in Note 3), $789 of restructuring expense (discussed in Note 8), stock compensation expense and the management fees payable to the Company’s sponsor. These are partially offset by the gain recorded on the sale of assets.
24. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
As described in Note 10, an aggregate of $172,000 of the Notes remain outstanding as of December 31, 2011. The Notes are guaranteed, fully, unconditionally and jointly and severally, by each of AGY Holding Corp.’s existing and future wholly-owned domestic subsidiaries, other than immaterial subsidiaries (collectively, the “Combined Guarantor Subsidiaries”).
For the purpose of the following footnote:
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AGY Holding Corp. is referred to as “Parent”;
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The Combined Guarantor Subsidiaries represent all subsidiaries other than the Combined Nonguarantor subsidiaries defined below; and
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The “Combined Nonguarantor Subsidiaries” as of December 31, 2011 include only the subsidiaries forming AGY Asia: AGY Cayman LLC, AGY Hong Kong Ltd and AGY Shanghai.
All the Parent’s subsidiaries were domestic guarantors of the Notes through June 10, 2009, when the Company acquired the entities comprising AGY Asia, which became the only Nonguarantor subsidiaries. The following supplemental condensed consolidating financial information is presented on the equity method and reflects the Parent’s separate accounts, the accounts of the Combined Guarantor Subsidiaries, the accounts of the Nonguarantor Subsidiaries, the consolidating adjustments and eliminations and the total consolidated accounts for the dates and periods indicated.
Condensed Consolidating Balance Sheet
Condensed Consolidating Statements of Operations
Condensed Consolidating Statements of Cash Flows
Condensed Consolidating Balance Sheet
Condensed Consolidating Statements of Operations
Condensed Consolidating Statements of Cash Flows
Condensed Consolidating Statements of Operations
Condensed Consolidating Statements of Cash Flows
25. Subsequent Events
None to report.