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AGY HOLDING CORP. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) This Quarterly Report contains forward-looking statements with respect to our operations, industry, financial condition and liquidity. These statements reflect our management's assessment of a number of risks and uncertainties. Our actual results could differ materially from the results anticipated in these forward-looking statements as a result of certain factors identified in this Quarterly Report. An additional statement made pursuant to the Private Securities Litigation Reform Act of 1995 and summarizing certain of the principal risks and uncertainties inherent in our business is included herein under the caption "Disclosure Regarding Forward- Looking Statements." You are encouraged to read this statement carefully. You should read the following discussion and analysis in conjunction with the accompanying financial statements and related notes, and with the consolidated financial statements and notes thereto included in our 2010 Annual Report on Form 10-K (the "2010 Form 10-K") filed with the Securities and Exchange Commission. Unless the context requires otherwise, the terms "AGY", the "Company", "we" and "our" in this report refer to AGY Holding Corp. and its subsidiaries. GENERAL 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, insect screening, 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 in 2009, 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 Holding Corp. and its wholly-owned domestic and French subsidiaries. The AGY Asia segment includes the manufacturing operations of the Company's 70% controlling interest in AGY Hong Kong Ltd. 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. 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. CRITICAL ACCOUNTING POLICIES The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. 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 critical accounting policies that affect the Company's more complex judgments and estimates are described in our 2010 Form 10-K. There were no significant changes in our accounting policies and estimates since the end of fiscal 2010. Adoption of new accounting standards There were no accounting standards issued during the quarter that the Company believes would have a material impact on the financial statements. - 23 --------------------------------------------------------------------------------- Table of Contents Results of Operations The following tables summarize our results of operations in dollars and as a percentage of net sales for the three and six months ended June 30, 2011 and 2010 (dollars in thousands): Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 Net Sales AGY US $ 42,207 $ 42,926 $ 80,185 $ 83,754 AGY Asia 8,212 7,412 15,166 12,855 50,419 50,338 95,351 96,609 Intersegment sales (413 ) (1,030 ) (413 ) (1,728 ) Total net sales 50,006 49,308 94,938 94,881 Cost of goods sold (46,258 ) (46,724 ) (88,140 ) (87,689 ) Gross profit 3,748 2,584 6,798 7,192 Selling, general and administrative expenses (3,769 ) (4,128 ) (7,750 ) (8,024 ) Restructuring charges (33 ) (702 ) (50 ) (1,030 ) Amortization of intangible assets (251 ) (251 ) (502 ) (502 ) Other operating income (expense), net 28 (694 ) (126 ) (2,395 ) Loss from operations (277 ) (3,191 ) (1,630 ) (4,759 ) Other non-operating income, net 43 42 86 63 Interest expense (5,886 ) (5,909 ) (11,645 ) (11,786 ) Loss before income taxes (6,120 ) (9,058 ) (13,189 ) (16,482 ) Income tax (expense) benefit (40 ) 3,190 (40 ) 5,549 Net loss (6,160 ) (5,868 ) (13,229 ) (10,933 ) Less: Net loss attributable to noncontrolling interest 40 140 221 425 Net loss attributable to AGY Holding Corp. $ (6,120 ) $ (5,728 ) $ (13,008 ) $ (10,508 ) Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 Net Sales AGY US 84.4 % 87.1 % 84.4 % 88.3 % AGY Asia 16.4 % 15.0 % 16.0 % 13.5 % 100.8 % 102.1 % 100.4 % 101.8 % Intersegment sales (0.8 )% (2.1 )% (0.4 )% (1.8 )% Total net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of goods sold (92.5 )% (94.8 )% (92.8 )% (92.4 )% Gross profit 7.5 % 5.2 % 7.2 % 7.6 % Selling, general and administrative expenses (7.5 )% (8.4 )% (8.2 )% (8.5 )% Restructuring charges (0.1 )% (1.4 )% (0.1 )% (1.1 )% Amortization of intangible assets (0.5 )% (0.5 )% (0.5 )% (0.5 )% Other operating income (expense), net 0.1 % (1.4 )% (0.1 )% (2.5 )% Loss from operations (0.5 )% (6.5 )% (1.7 )% (5.0 )% Other non-operating income, net 0.1 % 0.1 % 0.1 % 0.1 % Interest expense (11.8 )% (12.0 )% (12.3 )% (12.4 )% Loss before income taxes (12.2 )% (18.4 )% (13.9 )% (17.3 )% Income tax (expense) benefit (0.1 )% 6.5 % (0.0 )% 5.8 % Net loss (12.3 )% (11.9 )% (13.9 )% (11.5 )% Less: Net loss attributable to noncontrolling interest 0.1 % 0.3 % 0.2 % 0.4 % Net loss attributable to AGY Holding Corp. (12.2 )% (11.6 )% (13.7 )% (11.1 )% As further discussed below, we use EBITDA and Adjusted EBITDA, which are non-GAAP financial measures, to measure our operating performance. - 24 --------------------------------------------------------------------------------- Table of Contents EBITDA and Adjusted EBITDA (which are defined below) are reconciled from net income (loss) determined under GAAP as follows (dollars in thousands): Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 Statement of operations data: Net loss $ (6,160 ) $ (5,868 ) $ (13,229 ) $ (10,933 ) Interest expense 5,886 5,909 11,645 11,786 Income tax expense (benefit) 40 (3,190 ) 40 (5,549 ) Depreciation and amortization 3,985 6,484 8,089 10,485 EBITDA $ 3,751 $ 3,335 $ 6,545 $ 5,789 Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 EBITDA $ 3,751 $ 3,335 $ 6,545 $ 5,789 Adjustments to EBITDA: Alloy depletion charge, net (a) 2,189 1,562 3,808 4,842 Non-cash compensation charges (b) 7 11 14 31 Management fees (c) 189 187 377 375 Restructuring charges (d) 33 702 50 1,030 Loss on disposition of assets and others (e) - 773 - 2,623 Adjusted EBITDA 6,169 6,570 10,794 14,690 Less: Adjusted EBITDA attributable to the noncontrolling interest (643 ) (567 ) (1,134 ) (963 ) Adjusted EBITDA attributable to AGY Holding Corp. $ 5,526 $ 6,003 $ 9,660 $ 13,727 Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2011 Adjusted EBITDA allocated to AGY Holding Corp. segment breakdown: AGY US and Corporate $ 4,026 $ 4,681 $ 7,013 $ 11,480 AGY Asia 1,500 1,322 2,647 2,247 $ 5,526 $ 6,003 $ 9,660 $ 13,727 (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 the charges associated with such recovery treatment. (b) Reflects 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 management fee payable to our sponsor, Kohlberg & Company, LLC, pursuant to a management agreement entered into in connection with the Acquisition. (d) Reflects the elimination of the restructuring charges associated primarily with the relocation of some manufacturing equipment in 2010 to reduce our cost structure, streamline processes and optimize AGY US manufacturing footprint. (e) Reflects primarily the elimination of the loss recorded versus historical book value on the sale or exchange of some non-operating assets. EBITDA is generally 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) - 25 - -------------------------------------------------------------------------------- Table of Contents 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. Three Months Ended June 30, 2011 Compared to Three Months Ended June 30, 2010 Net sales. Net sales increased $0.7 million, or 1.4%, to $50.0 million for the three months ended June 30, 2011, compared to $49.3 million during the comparable quarter of 2010. AGY Asia contributed $1.4 million of additional revenue, or a 22.2% revenue growth compared to the second quarter of 2010 (after accounting for the elimination of $0.4 and $1.0 million of intercompany sales in 2011 and 2010, respectively) due primarily to continued pricing momentum in the Asian electronics market. The $0.7 million, or 1.7% net decrease in sales attributable to AGY US in the second quarter of 2011, compared to the second quarter of 2010, was primarily due to lower sales volumes, partly offset by a favorable product mix and price increases, which we implemented and retained across most markets since early 2011. Aerospace and defense revenues were $12.9 million, up globally 9% when compared to the second quarter of 2010. This increase reflects a record sales level for aerospace, which increased 21% compared to the second quarter of 2010 as a result of continued robust demand for both aircraft retrofit, new build activity, and pricing actions, while defense sales were negatively impacted by delays in certain major programs. The electronics market revenues increased to $10.0 million, or 32% and 30%, compared to the second quarter of 2010 and the first quarter of 2011, respectively, reflecting the benefit of providing additional volumes at a price premium to fill product shortages in the Asian market associated with the recent natural disaster in Japan and its aftermath, plus pricing actions and increasing demand for specialty electronics fibers, which also drove mix enrichment within this market compared to 2010. The general and industrial ("G&I") market revenues decreased globally to $19.2 million, or 18%. This $4.2 million decrease was largely caused by our Continuous Filament Mat ("CFM") business, which decreased by 37% to $4.6 million when compared to the second quarter of 2010 as a result of market share loss at key accounts following 2010 pricing actions but improved by 31% when compared to the first quarter of 2011 as AGY's market share has stabilized at a higher level. In addition, G&I revenues were negatively impacted by lower construction market revenues, which decreased $2.6 million to $3.2 million for the second quarter, reflecting some continued capacity-constrained sales only in part offset by 2011 pricing actions. Gross profit. We reported a consolidated gross profit of $3.7 million, or 7.5% of net sales for the three months ended June 30, 2011, compared to $2.6 million, or 5.2% during the comparable quarter of 2010. Our AGY US segment contributed largely to the $1.1million increase in profitability, while AGY Asia's contribution to the total gross profit increased $0.2 million in the second quarter of 2011 compared to the second quarter of 2010. The profitability of our AGY US segment benefited from $6.1 million of margin from a more favorable product mix and pricing actions, but was negatively impacted by $2.4 million of lower shipments due to constrained sales and reduced demand in certain markets. The $3.7 million net gain resulting from sales, however, was offset by increased manufacturing costs. We experienced greater than expected manufacturing efficiency losses, training and other expansion related expenses resulting from major capacity scale up in our Aiken, SC plant. In 2010, the AGY US segment results were also negatively impacted by $2.7 million of accelerated depreciation expenses related to the 2010 restructuring initiatives to optimize the U.S manufacturing footprint, which were not recurring in 2011. Selling, general and administrative expenses. Selling, general and administrative expenses decreased from $4.1 million during the second quarter of 2010 to $3.8 million during the second quarter of 2011. This decrease reflects primarily $0.4 million of lower expenses for our AGY US operating segment resulting from lower - 26 - -------------------------------------------------------------------------------- Table of Contents professional fees, recruiting and relocation expenses, in part offset by merit increases. Selling, general and administrative expenses decreased from 8.4% of net sales for the three months ended June 30, 2010 to 7.5% of net sales for the three months ended June 30, 2011. Restructuring charges. In the three months ended June 30, 2010, we recorded $0.7 million in restructuring charges in conjunction with our structural cost reduction initiatives to further optimize the AGY US manufacturing footprint. These charges related primarily to the relocation of manufacturing equipment and were not recurring in 2011. Other operating income (expense). During the three months ended June 30, 2011, other operating income was not significant. During the three months ended June 30, 2010, other operating expense of $0.7 million consisted primarily of a net $0.8 million loss recognized on the sale of alloy metals. Interest expense. Interest expense was flat at $5.9 million for the three months ended June 30, 2010 and 2011. Income tax expense. Income taxes decreased from a $3.2 million tax benefit for the three months ended June 30, 2010 to a $0.04 million tax expense for the three months ended June 30, 2011. The significant change from June 30, 2010 primarily relates to the establishment of a valuation allowance for domestic deferred losses with no benefit beginning with the third quarter of 2010. During the second quarter of 2011, the Company's effective tax rate was -0.7%. This rate varied from the statutory rate of 34% due primarily to change of valuation allowance for domestic deferred tax assets, which are not more-likely-than-not to be realized, changes in foreign valuation allowances, losses on domestic and foreign subsidiaries with no tax benefit, and foreign rate differential. During the three months ended June 30, 2010, the Company's effective tax rate was a benefit of 35.2%. This rate varied from the statutory rate of 34% due primarily to losses on foreign subsidiaries with no tax benefit, changes in valuation allowances, and foreign rate differential. 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. Net loss. As a result of the aforementioned factors including primarily the increase in operating profit for the AGY US segment, losses on domestic and foreign subsidiaries with no tax benefit recognition in the 2011 period and loss recognized on the sale of alloy metals in the 2010 period, we reported a net loss attributable to AGY Holding Corp. of $6.1 million for the three months ended June 30, 2011, compared to a net loss of $5.7 million for the three months ended June 30, 2010. The net result attributable to the 30% noncontrolling interest in AGY Asia not owned by AGY Holding Corp. was approximately nil for the second quarter of 2011 compared to a $0.1 million loss for the comparable period in 2010. Six Months Ended June 30, 2011 Compared to Six Months Ended June 30, 2010 Net sales. Net sales were $94.9 million during the six months ended June 30, 2011 and June 30, 2010. AGY Asia contributed $3.6 million of additional revenue, or a 32.6% revenue growth compared to the first six months of 2010 (after accounting for the elimination of $0.4 and $1.7 million of intercompany sales in 2011 and 2010, respectively) due primarily to continued pricing momentum in the Asian electronics market. The $3.6 million, or 4.3% net decrease in sales generated by AGY US in the first half of 2011, compared to the first half of 2010 was primarily due to $12.9 million of lower sales volumes, while a favorable product mix and pricing actions accounted for an increase in sales of $9.3 million. Aerospace and defense revenues were $24.9 million, or globally up 4.5% when compared to the first half of 2010. This increase reflects a record sales level for aerospace, which increased 11% compared to the first half of 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 $17.8 million, or 20%, compared to the first six months of 2010 reflecting pricing actions, the second quarter of 2011 benefit from filling at a price premium product shortages in the Asian market place associated with the recent natural disaster in Japan and its aftermath, plus increasing demand for specialty electronics fibers, which also drove mix enrichment within this market during the first half of 2011. The G&I market revenues decreased globally to $37.6 million, or 17%. This $7.5 million decrease was largely caused by our CFM business, which decreased by 35% to $8.0 million when compared to the six months ended June 30, 2010 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 37% to $7.7 million for the six months ended June 30, 2011, reflecting some capacity-constrained sales only in part offset by 2011 pricing actions. - 27 --------------------------------------------------------------------------------- Table of Contents Gross profit. We reported a consolidated gross profit of $6.8 million, or 7.2% of net sales for the six months ended June 30, 2011, compared to a $7.2 million, or 7.6% of net sales for the six months ended June 30, 2010. AGY US segment profitability contribution decreased $0.8 million, while AGY Asia's contribution to the total gross profit increased $0.3 million due primarily to pricing momentum during the six months ended June 30, 2011 when compared to the same period of 2010. The profitability of our AGY US segment benefited from $10.7 million of margin from a more favorable product mix and pricing actions executed over the last three quarters, but was negatively impacted by $4.9 million of lower shipments due to constrained sales and reduced demand in certain markets. The $5.8 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 $2.7 million of accelerated depreciation expenses related to the 2010 restructuring initiatives to optimize the U.S. manufacturing footprint, which were not recurring in 2011. Selling, general and administrative expenses. Selling, general and administrative expenses decreased from $8.0 million during the first half of 2010 to $7.8 million during the first half of 2011. This decrease reflects primarily $0.4 million of lower expenses for our AGY US operating segment resulting from lower professional fees, recruiting and relocation expenses, in part offset by merit increases. Selling, general and administrative expenses decreased from 8.5% of net sales for the six months ended June 30, 2010 to 8.2% of net sales for the six months ended June 30, 2011. Restructuring charges. For the six months ended June 30, 2010, we recorded $1.0 million in restructuring charges in conjunction with our structural cost reduction initiatives to further optimize the AGY US manufacturing footprint. These charges related primarily to the relocation of manufacturing equipment and were not recurring in 2011. Other operating expense. During the six months ended June 30, 2011, other operating expense of $0.13 million was not significant. During the six months ended June 30, 2010, other non-operating expense of $2.4 million consisted primarily of a net $2.7 million loss recognized on the sale of alloy metals. Interest expense. Interest expense decreased $0.2 million from $11.8 million for the six months ended June 30, 2010 to $11.6 million for the six months ended June 30, 2011. The decrease was primarily due to a decrease in AGY Asia interest expense due to lower borrowings in the first half of 2011 compared to 2010, offset in part by an increase in AGY US interest expense due to higher borrowings in the first half of 2011 compared to 2010. Income tax expense. Income tax benefit decreased from a $5.5 million tax benefit for the six months ended June 30, 2010 to a $0.04 million tax expense for the six months ended June 30, 2011. The significant change from June 30, 2010 primarily relates to the establishment of a valuation allowance for domestic deferred losses with no benefit beginning with the third quarter of 2010. During the six months ended June 30, 2011, the Company's effective tax rate was -0.3%. This rate varied from the statutory rate of 34% due primarily to change of valuation allowance for domestic deferred tax assets, which are not more-likely-than-not to be realized, changes in foreign valuation allowances, losses on domestic and foreign subsidiaries with no tax benefit, and foreign rate differential. During the six months ended June 30, 2010, our effective tax rate was a benefit of 33.7%. This rate varied from the statutory rate of 34% due primarily to losses on foreign subsidiaries with no tax benefit, changes in valuation allowances, 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. Net loss. As a result of the aforementioned factors including primarily the increase in operating profit for the AGY US segment, losses on domestic and foreign subsidiaries with no tax benefit recognition in the 2011 period and loss recognized on the sale of alloy metals in the 2010 period, we reported a net loss attributable to AGY Holding Corp. of $13.0 million for the six months ended June 30, 2011, compared to a net loss of $10.5 million for the six months ended June 30, 2010. The net loss attributable to the 30% noncontrolling interest in AGY Asia not owned by AGY Holding Corp. was $0.2 million for the first six months of 2011 compared to $0.4 million for the comparable period in 2010. LIQUIDITY AND CAPITAL RESOURCES AGY Holding Corp. and its Domestic Subsidiaries' Liquidity In the first half of 2011 our principal sources of domestic liquidity were borrowings under our financing arrangements and our cash on hand. Our domestic need for liquidity will arise primarily from interest payments on the outstanding $172.0 million principal amount of our Notes, interest and principal payments on our Amended Credit Facility, the funding of capital expenditures, alloy metals, strategic initiatives, normal - 28 --------------------------------------------------------------------------------- Table of Contents recurring operating expenses and working capital requirements and the financing of the consideration to be paid pursuant to the put/call agreement for our 30% noncontrolling interest in AGY Asia not owned by us. At June 30, 2011, AGY US had total liquidity of $17.4 million, consisting of $0.8 million in unrestricted cash and approximately $16.6 million of borrowing availability under the Amended Credit Facility. 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 Since we acquired AGY Asia in June 2009, AGY Asia's sources of liquidity have been borrowings under approximately $54.0 million of non-recourse financing arrangements with the Bank of Shanghai ("AGY Asia Credit Facility"), which consists of a $12.1 million one-year working capital loan and a $41.9 million five-year term loan. AGY Asia's need for liquidity arises primarily from interest and principal payments on the AGY Asia Credit Facility and the funding of capital expenditures, alloy metals, strategic initiatives, normal recurring operating expenses and working capital requirements. There are semi-annual mandatory payments on principal on the term loan borrowings, the amounts of which depend on the borrowings outstanding. At June 30, 2011, the remaining mandatory payments of principal were approximately $4.9 million in 2011, $10.3 million in 2012, $10.9 million in 2013 and $4.2 million in 2014. At June 30, 2011, AGY Asia had total liquidity of $7.6 million, consisting of $1.8 million of unrestricted cash and approximately $5.8 million of borrowing availability under the AGY Asia Credit Facility. Liquidity summary Based upon our current and anticipated levels of operations, we believe, but cannot guarantee, that our cash flows from operations together with availability under our credit facilities for our U.S. and Asian segments, will be adequate to meet our liquidity needs for the next twelve months. We renewed the one-year working capital loan in June 2011 and have begun discussions with the AGY Asia lender to modify the term loan amortization schedule. However, there is no assurance that we will be able to revise the loan on terms acceptable to us or at all. Working capital The Company has historically defined working capital as total current assets, excluding unrestricted cash, less total current liabilities, including short-term borrowings and the current portion of long-term debt. Working capital was $16.6 million and $14.9 million on June 30, 2011 and December 31, 2010, respectively. The $1.7 million net increase was primarily attributable to our AGY US segment due to a $5.4 million increase in trade receivables resulting from a change in the geographic distribution of receivables and the increase in sales for the second quarter of 2011 compared to the fourth quarter of 2010, partly reduced by a $1.4 million increase in trade payables primarily from increased operational costs and higher production capacity levels in our AGY US segment and a $0.8 million decrease in current deferred tax assets and other current assets. The working capital of AGY Asia decreased by $2.2 million from December 31, 2010 to June 30, 2011 as a result of a decrease in short-term borrowings and current maturities of long-term debt, offset in part by an increase in trade receivable driven by sales growth. Other balance sheet items Net Property, Plant and Equipment and Alloy Metals. Net property, plant and equipment and alloy metals decreased $5.6 million from December 31, 2010 to June 30, 2011, primarily due to $11.4 million of depreciation and alloy metals depletion expenses. We expended $3.7 million for capital projects, including accrued construction in progress. Additionally, AGY Asia had $2.1 million of currency translation adjustments. Long Term Debt. Long-term debt increased $8.5 million from December 31, 2010 to June 30, 2011 as a result of a $13.1 million increase in borrowings under our Amended Credit Facility and a $4.5 million net decrease in AGY Asia's long-term debt as a result of a $4.9 million reclassification to current portion of long term debt partly offset by $0.4 million of currency translation. Six Months Ended June 30, 2011 Compared to Six Months Ended June 30, 2010. Cash flows from operating activities Cash used by operating activities was $5.9 million for the six months ended June 30, 2011, compared to $2.6 million used during the six months ended June 30, 2010. The $3.3 million increase in cash used by operating activities is attributed to a global $5.0 million increase in operating working capital during the first six months of 2011 as compared to a $4.5 million increase during the first six months of 2010. In addition to this increase - 29 --------------------------------------------------------------------------------- Table of Contents in cash used by working capital components, we recognized during the period a $0.9 million loss (as adjusted for non cash items) compared to a $1.9 million income (as adjusted for non cash items) recognized during the comparable period of 2010. During the first half of 2011 cash used by operating activities of our AGY US segment was $6.0 million higher whereas cash provided by operating activities of AGY Asia segment was $2.7 million higher than during the comparable period of 2010. Cash flows from investing activities Cash used by investing activities was $4.0 million for the six months ended June 30, 2011, compared to cash provided by investing activities of $1.4 million for the six months ended June 30, 2010. The $5.4 million decrease in cash provided by investing activities was primarily due to activities at our AGY US segment including (i) the $6.5 million sale of alloy that occurred in the six months ended June 30, 2010 that was not recurring in the comparable period of 2011 and (ii) a $0.7 million increase in capital spending in the comparable period, partially offset by a $1.8 million decrease in capital expenditures by AGY Asia. Cash flows from financing activities Cash provided by financing activities was $9.4 million for the six months ended June 30, 2011, compared to $1.5 million for the six months ended June 30, 2010. The $7.9 million increase was attributable to (i) a $12.8 million increase in AGY US revolver borrowings for the first half of 2011 compared to the same period of 2010, partly offset by (ii) a $5.9 million decrease in AGY Asia Credit Facility borrowings for the first half of 2011 compared to the same period of 2010, and (iii) $1.0 million of debt issuance costs incurred by AGY US in the first quarter of 2011 related to our Amended Credit Facility. Indebtedness AGY US On March 8, 2011, the Company entered into the Amended Credit Facility that provides for an expanded credit facility of up to $50 million. The Amended Credit Facility matures on the earlier of March 8, 2015 or 90 days prior to the maturity date of the Notes and includes a $20 million sub-limit for the issuance of letters of credit and a $5 million sub-limit for swing line loans. The borrowing base for the Amended Credit Facility is 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 million of eligible alloy inventory, minus (iv) 100% of mark-to-market risk on certain interest hedging arrangements, minus (v) a reserve of $7.5 million, 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% through June 1, 2011 and then may be adjusted downward to LIBOR plus 2.5% or Base Rate plus 1.5%, depending on our fixed charge coverage ratio. In addition, we pay customary commitment fees 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 perfected (subject to customary exceptions) security interest in substantially all of the Company's assets. Proceeds from the revolving loan were used to repay all amounts, and terminate all commitments outstanding under our previous $40 million Credit Facility and to pay fees and expenses in connection with the refinancing. 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." 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 $6.25 million 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 does not currently anticipate that the springing financial maintenance covenant will 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 at June 30, 2011. - 30 - -------------------------------------------------------------------------------- Table of Contents As of June 30, 2011, the Company had issued letters of credit totaling $2.4 million and had cash borrowings of $31.0 million under the Amended Credit Facility, with remaining unused availability of $16.6 million. In connection with our refinancing on October 25, 2006, we issued $175 million aggregate principal amount of 11% senior second lien 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 for the Notes. 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 Amended 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 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 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 June 30, 2011, the estimated fair value of the Notes was $165.1 million compared to a recorded book value of $172 million. AGY Asia The AGY Asia Credit Facility now consists of a five-year term loan in the aggregate amount of approximately $42.3 million (consisting of a loan denominated in local currency of RMB 222.2 million, or approximately $34.3 million converted at an exchange rate of RMB 6.47 to 1 US dollar, the prevailing exchange rate as of June 30, 2011 and a US-dollar-denominated loan of $8 million), a one-year working capital loan in the aggregate amount of approximately $12.2 million (consisting of a local currency loan of RMB 59.5 million, or approximately $9.2 million converted at an exchange rate of RMB 6.47 to 1 US dollar, and a US-dollar-denominated loan of $3 million), and a one-year letter of credit facility in the amount of $2 million. 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 June 30, 2011, AGY Asia had approximately $30.4 million outstanding under the term loan, consisting of a local currency loan of RMB 166.5 million, or approximately $25.7 million converted at the period-end exchange rate, and a US-dollar-denominated loan of $4.7 million. The weighted average interest rate for cash borrowings outstanding as of June 30, 2011 was 6.7%. 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 June 30, 2011, the Company had approximately $9.4 million of borrowings outstanding under the working capital loan consisting of a local currency loan of RMB 54.5 million, or approximately $8.4 million, converted at the period-end exchange rate, and a US-dollar-denominated loan of $1 million. The weighted average interest rate for cash borrowings outstanding as of June 30, 2011, was 6.5%. 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 June 30, 2011, AGY Asia had discounted LCs totaling approximately $2.5 million (which amount is recorded in trade receivables at June 30, 2011), receiving proceeds of approximately $1.6 million and maintaining equity of approximately $0.9 million in such receivables. At June 30, 2011, proceeds of $1.6 million received from discounting were recorded as short-term debt payable. - 31 - -------------------------------------------------------------------------------- Table of Contents 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 June 30, 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. FINANCIAL OBLIGATIONS AND COMMITMENTS We are obligated to make approximately $0.5 million minimum purchases of marbles from Chinese marble producers during the remainder of 2011. We lease under short-term operating leases a significant portion of the alloy needed to support our manufacturing operations. At June 30, 2011, we leased in our AGY US segment approximately 47,650 ounces of platinum and 3,285 ounces of rhodium under the Deutsche Bank Master Lease Agreement, with a notional value of approximately $81.0 million and $7.7 million, respectively. For the six months ended June 30, 2011, total lease costs of alloy metals were approximately $2.0 million, and were classified as a component of cost of good 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. All of the leases outstanding at June 30, 2011 had initial terms of three to twelve months, maturing no later than March 2012 (with future minimum rentals of approximately $1.2 million until maturity in March 2012). We also have various operating leases for certain manufacturing equipment, personal and real property. As discussed in Note 3 of our Consolidated Financial Statements in our 2010 Form 10-K, 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 June 30, 2011 the redemption amount of the put option was $6.1 million compared to an initial carrying value of $12.4 million. Based on these provisions and the financial projections of AGY Asia, the Company believes that either the call option or 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 other available liquidity. DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS This management's discussion and analysis of financial condition and results of operations includes "forward-looking statements." All statements included herein, other than statements of historical fact, may constitute forward-looking statements. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Important factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements include, among others, the following factors: competition from other suppliers of glass fibers, as well as suppliers of competing products; the cyclical nature of certain of the end-markets for our products; adverse macroeconomic and business conditions, continued disruption in credit markets and government policy generally leading to global market downturn; an inability to develop product innovations and improve our production technology and expertise; the loss of a large customer or end-user application; a decision by an end-user to modify or discontinue production of an end-product that has specified the use of our product; an inability to protect our intellectual property rights; liability for damages based on product liability claims; increases in energy costs and other raw materials or in the cost of acquiring or leasing alloy metals required for the production of glass fibers; labor disputes or increases in labor costs; difficulties and delays in manufacturing; disruption and increased competitive pressure in the Asian electronics market associated with the recent natural disaster in Japan and its aftermath; a reliance on Owens Corning for some of our bushing fabrication; an inability to successfully implement our cost reduction initiatives relating to efficiency, throughput and process technology developments; an inability to successfully integrate future acquisitions including AGY Asia; our inability to successfully implement our cost reduction initiatives; interest rate and - 32 --------------------------------------------------------------------------------- Table of Contents foreign exchange rate fluctuations; business risks associated with doing business internationally; an inability to finance the consideration to be paid pursuant to the put/call agreement for the 30% noncontrolling interest in AGY Asia; the loss of key members of our management; an inability or failure to comply with environmental, health or safety laws and regulations; our limited history of profitable operations since our emergence from Chapter 11 protection on April 2, 2004; our substantial indebtedness; and certain covenants in our debt documents. We do not have any intention or obligation to update forward-looking statements included in this management's discussion and analysis of financial condition and results of operations. |