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[December 17, 2012]
AMERICAN PACIFIC CORP - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations (Dollars in Thousands, Except Per Share Amounts)
(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis is intended to provide a narrative discussion of our financial results and an evaluation of our financial condition and results of operations with respect to the fiscal years ended September 30, 2012 ("Fiscal 2012"), September 30, 2011 ("Fiscal 2011") and September 30, 2010 ("Fiscal 2010"). The discussion should be read in conjunction with our consolidated financial statements and notes thereto included in Item 8 of this annual report on Form 10-K. A summary of our significant accounting policies is included in Note 1 to our consolidated financial statements included in Item 8 of this report. In addition to discussing historical information, we make statements relating to the future, called "forward-looking" statements, which are provided under the "safe harbor" protection of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are generally written in the future tense and/or are preceded or accompanied by words such as "can", "could", "may", "should", "will", "would", "expect", "anticipate", "believe", "estimate", "future", "forecast", "intend" or the negative of these terms or other similar words or expressions. Moreover, statements that speculate about future events are forward-looking statements such as with respect to the fiscal year ending September 30, 2013 ("Fiscal 2013"). These forward-looking statements involve a number of known and unknown risks, uncertainties and other important factors that could cause the actual results and outcomes to differ materially from any future results or outcomes expressed or implied by such forward-looking statements. You should carefully review the "Risk Factors" section set forth in Item 1A of this annual report on Form 10-K and in any more recent filings with the SEC, each of which describes these risks, uncertainties and other important factors in more detail. All forward-looking statements in this document are made as of the date hereof, based on current information available to us and based on our current expectations as of the date hereof, and, while they are our best prediction at the time that they are made, you should not rely on them. We undertake no obligation, unless as otherwise required by law, to update or revise any forward-looking statements in order to reflect new information, events or circumstances that may arise after the date of this annual report on Form 10-K.
33 -------------------------------------------------------------------------------- OUR COMPANY American Pacific Corporation and its predecessors have been engaged in chemical manufacturing since 1955. We are a leading custom manufacturer of fine chemicals and specialty chemicals within our focused markets. Through our Fine Chemicals segment, we supply active pharmaceutical ingredients ("APIs") and registered intermediates to the pharmaceutical industry. Our Specialty Chemicals segment produces various perchlorate chemicals and is the only North American producer of Ammonium Perchlorate ("AP"), which is the predominant oxidizing agent for solid propellant rockets, booster motors and missiles used in space exploration, commercial satellite transportation and national defense programs. We produce clean agent chemicals for the fire protection industry, as well as electro-chemical equipment for the water treatment industry. Our products are designed to meet customer specifications and often must meet certain governmental and regulatory approvals. Our technical and manufacturing expertise and customer service focus has gained us a reputation for quality, reliability, technical performance and innovation. Given the critical nature of our products, we maintain long-standing strategic customer relationships and generally sell our products through long-term contracts under which we are the sole-source or limited-source supplier.
34 -------------------------------------------------------------------------------- OUR BUSINESS SEGMENTSOur continuing operations comprise three reportable business segments: Fine Chemicals, Specialty Chemicals, and Other Businesses. The following table reflects the revenue contribution percentage from our business segments and each of their major product lines for the fiscal years ended September 30: 2012 2011 2010 Fine Chemicals 60% 56% 50% Specialty Chemicals: Perchlorates 33 % 37 % 40 % Sodium azide 2 % 2 % 2 % Halotron 2 % 3 % 3 % Total specialty chemicals 37 % 42 % 45 % Other Businesses: Real estate * * * Water treatment equipment 3 % 2 % 5 % Total other businesses 3 % 2 % 5 % Total revenues 100 % 100 % 100 % * less than 1% FINE CHEMICALS. Our Fine Chemicals segment, operated through our wholly-owned subsidiaries Ampac Fine Chemicals LLC and AMPAC Fine Chemicals Texas, LLC (collectively "AFC"), is a custom manufacturer of APIs and registered intermediates for customers in the pharmaceutical industry. The pharmaceutical ingredients we manufacture are used by our customers in drugs with indications in three primary areas: anti-viral, oncology, and central nervous system. AFC's customers include some of the world's largest pharmaceutical and biotechnology companies, as well as emerging pharmaceutical companies. Most of the products AFC sells are proprietary to our customers and used in existing drugs that are FDA approved and commercially available. We operate in compliance with the U.S. Food and Drug Administration's (the "FDA") current Good Manufacturing Practices ("cGMP") and the requirements of certain other regulatory agencies such as the European Union's European Medicines Agency and Japan's Pharmaceuticals and Medical Devices Agency. Our Fine Chemicals segment's strategy is to focus on high growth markets where our technological position, combined with our chemical process development and engineering expertise, leads to strong customer allegiances and limited competition. We have distinctive competencies and specialized engineering capabilities in performing chiral separations, manufacturing products that require high containment and performing energetic chemistries at commercial scale. We have recently expanded our technology offering to include commercial scale production of Schedule II to V controlled substances in our high-security facilities in Rancho Cordova, California.
We have invested significant resources in our facilities, workforce and technology base. We believe we are the U.S. leader in performing chiral separations using SMB technology and own and operate two large-scale SMB systems, both of which are among the largest in the world operating under cGMP.
We offer a full range of SMB equipment and related services from laboratory-scale to our large systems. We believe our distinctive competency in manufacturing chemical compounds that require specialized high containment facilities and handling expertise provide us a significant competitive advantage in competing for various opportunities associated with high potency, highly toxic and cytotoxic products. Many oncology drugs are made with APIs that are high potency or cytotoxic. AFC is one of the few companies in the world that can manufacture such compounds at a multi-ton annual rate. Moreover, our significant experience and highly engineered facilities make us one of the few companies in the world with the capability to use energetic chemistry on a commercial-scale under cGMP. We use this capability in development and production of products such as those used in anti-viral drugs, including HIV-related and influenza-combating drugs.
35 -------------------------------------------------------------------------------- We have established long-term, and in some cases sole-source contracts with customers that represent the majority of our revenues. Contracts that are not sole-source are limited-source considering the nature of our industry and the products we manufacture. The inherent nature of custom pharmaceutical fine chemicals manufacturing encourages stable, long-term customer relationships. We work collaboratively with our customers to develop reliable, safe and cost-effective, custom solutions. Once a custom manufacturer has been qualified as a supplier on a cGMP product, there are several potential barriers that discourage transferring the manufacturing of the product to an alternative supplier. For example, applications to and approvals from the FDA and other regulatory authorities generally require the chemical contractor to be named.
Switching contractors may require additional regulatory approvals and could take as long as two years to complete. Switching contractors and amending various filings can result in significant costs associated with technology transfer, process validation and re-filing with the FDA and other regulatory authorities around the world.
SPECIALTY CHEMICALS. Our Specialty Chemicals segment is principally engaged in the production of perchlorates, which include several grades of ammonium perchlorate ("AP"), sodium perchlorate and potassium perchlorate. AP is the predominant oxidizing agent for solid propellant rockets, booster motors and missiles used in national defense, space exploration and commercial satellite transportation programs. We have supplied rocket-grade AP for use in space and defense programs for over 50 years and we have been the only rocket-grade AP supplier in North America since 1998, when we acquired the AP business of our principal competitor, Kerr-McGee Chemical Corporation. AP is a key component of solid propellant rockets, booster motors and missiles that are utilized in U.S.
Department of Defense ("DOD") tactical and strategic missile programs, as well as various space programs such as the Delta and Atlas families of commercial space launch vehicles and space exploration programs for the National Aeronautics and Space Administration ("NASA"). There is currently no domestic alternative to these solid rocket motors. As a result, we believe that the U.S. government views us as a strategic national asset.
Alliant Techsystems Inc. or "ATK" is a significant AP customer. We sell rocket-grade AP to ATK under a long-term contract that requires us to maintain a ready and qualified capacity for rocket-grade AP and that requires ATK to purchase its rocket-grade AP requirements from us, subject to certain terms and conditions. The contract, which expires in 2013, provides fixed pricing in the form of a price volume matrix for annual rocket-grade AP volumes ranging from 3 million to 20 million pounds. Pricing varies inversely to volume and includes annual escalations.
In addition, we produce and sell sodium azide, a chemical primarily used in pharmaceutical manufacturing, and Halotron®, a series of clean fire extinguishing agents used in fire extinguishing products ranging from portable fire extinguishers to total flooding systems.
OTHER BUSINESSES. Our Other Businesses segment contains our water treatment equipment division and real estate activities. Our water treatment equipment business markets, designs, and manufactures electrochemical On Site Hypochlorite Generation, or OSHG systems. These systems are used in the disinfection of drinking water, control of noxious odors, and the treatment of seawater to prevent the growth of marine organisms in cooling systems. We supply our equipment to municipal, industrial and offshore customers. Our real estate activities are not material.
DISCONTINUED OPERATIONS. In May 2012, our board of directors approved and we committed to a plan to sell our Aerospace Equipment segment, which is comprised of Ampac-ISP Corp. and its wholly-owned foreign subsidiaries ("AMPAC-ISP"). We completed the sale of substantially all of the assets of AMPAC-ISP effective August 1, 2012. The divestiture is a strategic shift that allows us to place more focus on the growth and performance of our pharmaceutical-related product lines. Revenues and expenses associated with the operations of AMPAC-ISP are presented as discontinued operations for all periods presented.
36 -------------------------------------------------------------------------------- CONSOLIDATED RESULTS OF OPERATIONS REVENUES Year Ended September 30, Percentage Change 2012 2011 2010 12 vs. 11 11 vs. 10 Fine Chemicals $ 111,536 $ 89,497 $ 69,632 25 % 29 % Specialty Chemicals 68,513 66,905 62,611 2 % 7 % Other Businesses 5,578 4,312 6,341 29 % (32 %) Total Revenues $ 185,627 $ 160,714 $ 138,584 16 % 16 % For Fiscal 2012, revenues increased 16% to $185,627 as compared to $160,714 for Fiscal 2011. Fiscal 2011 revenues increased 16% compared to Fiscal 2010. See further discussion below under Business Segment Results.
COST OF REVENUES AND GROSS PROFIT Year Ended September 30, Percentage Change 2012 2011 2010 12 vs. 11 11 vs. 10 Revenues $ 185,627 $ 160,714 $ 138,584 16 % 16 % Cost of Revenues 119,477 113,863 92,211 5 % 23 % Gross Profit $ 66,150 $ 46,851 $ 46,373 41 % 1 % Gross Margin 36% 29% 33% In addition to the factors discussed below under the heading Business Segment Results, one of the most significant factors that affects, and should continue to affect, the comparison of our consolidated gross profit and gross margin from period to period is the change in revenue mix between our segments. Our Fine Chemicals segment accounted for 60%, 56% and 50% of consolidated revenues in Fiscal 2012, Fiscal 2011 and Fiscal 2010, respectively. Our Specialty Chemicals segment accounted for 37%, 42% and 45% of consolidated revenues in Fiscal 2012, Fiscal 2011 and Fiscal 2010, respectively. See further discussion below under "Business Segment Results".
OPERATING EXPENSES Year Ended September 30, Percentage Change 2012 2011 2010 12 vs. 11 11 vs. 10 Operating Expenses $ 39,066 $ 35,895 $ 39,438 9 % (9 %) Percentage of Revenues 21% 22% 28% Fiscal 2012 operating expenses increased $3,171 compared to Fiscal 2011 primarily as a result of increases in operating expenses of our Fine Chemicals Segment.
Fiscal 2011 operating expenses decreased $3,543 to $35,895 from $39,438 for Fiscal 2010 primarily as a result of our company-wide cost reduction initiative.
The most significant reductions were from corporate expenses with the Fine Chemicals segment and Specialty Chemicals segment also achieving meaningful reductions. See further discussion below under "Business Segment Results".
ENVIRONMENTAL REMEDIATION CHARGES. During Fiscal 2012 and Fiscal 2011, we recorded environmental remediation charges of $700 and $6,000, respectively, reflecting increases in our total cost estimate of probable costs for our Henderson, Nevada groundwater remediation operations. See detailed discussion under the heading "Environmental Remediation - AMPAC Henderson Site" below.
OTHER OPERATING GAINS. During Fiscal 2012 and Fiscal 2011, our Fine Chemicals segment reported other operating gains of $1,714 and $2,929, respectively, that resulted from the resolution of gain contingencies. The reported gains are comprised of the following two matters.
37 -------------------------------------------------------------------------------- Our Fine Chemicals segment is undertaking several mandatory capital projects.
Certain of the capital activities are complete and others are in progress or otherwise expected to be completed during Fiscal 2013. In connection with these projects, our Fine Chemicals segment held, and continues to hold, negotiations with the former owner of the facilities. During Fiscal 2012 and Fiscal 2011, we received from the former owner cash consideration in the amount of $1,714 and $258, respectively, for a limited release of liability of the former owner with respect to one of the completed projects.
We made a series of filings with the County of Sacramento, California, to appeal the assessed values in prior years of our real and personal property located at our Fine Chemicals segment's Rancho Cordova, California facility. During Fiscal 2011, we received $2,671 for cash property tax refunds resulting from our appeals and the related favorable reassessment of historical property values.
INTEREST AND LOSS ON DEBT EXTINGUISHMENT Year Ended September 30, Percentage Change 2012 2011 2010 12 vs. 11 11 vs. 10 Interest and Other Income, Net $ 38 $ 235 $ 42 (84 %) 460 % Interest Expense $ 10,173 $ 10,514 $ 10,647 (3 %) (1 %) Loss on Debt Extinguishment $ 1,397 $ - $ - - - We earn interest income on our cash and cash equivalents balances. Interest income varies with these balances and the applicable interest rate. In addition, during Fiscal 2011, we received interest income in the amount of $190 related to above-mentioned property tax refunds.
Interest expense was consistent between Fiscal 2012, Fiscal 2011 and Fiscal 2010 because the interest rate for our then outstanding debt was fixed.
On August 9, 2012, we called $40,000 of the outstanding principal amount of the Senior Notes. On September 10, 2012 we completed the redemption, using net cash proceeds from the sale of AMPAC-ISP and available cash balances. The redemption price for the Notes was 102.25% of the principal amount of the Notes being redeemed, plus accrued and unpaid interest to the redemption date. The transaction resulted in a net loss on debt retirement of $1,397 which includes the call premium of $900, unamortized debt issuances costs of $482 and other expenses of $15. See further discussion below under the heading "Long Term Debt and Credit Facilities".
INCOME TAXES. Our income tax expense (benefit) rate for continuing operations differs from the federal statutory rate due to state income taxes, amounts that were expensed for book purposes that are not deductible for income tax purposes, changes in our valuation allowances, and other adjustments to our estimates of tax liabilities.
A reconciliation of the federal statutory rate to our effective tax (benefit) rate for continuing operations is as follows for the years ended September 30: 2012 2011 2010 Federal income tax at the statutory rate 35.0 % (35.0 %) (35.0 %) State income tax, net of federal benefit 4.1 % (3.6 %) (6.6 %) Nondeductible expenses 1.4 % 8.6 % 8.8 % Valuation allowance (62.9 %) 318.6 % 0.0 % Interest and penalties 0.4 % 1.1 % 12.1 % Other (0.7 %) 2.0 % (0.1 %) Effective tax rate (22.7 %) 291.7 % (20.8 %) 38 -------------------------------------------------------------------------------- Deferred tax assets are comprised of the following at September 30: 2012 2011 Deferred tax assets: Pension obligations $ 22,270 $ 17,687 Environmental remediation reserves 9,997 12,849 Inventory 9,183 6,837 Accrued expenses 3,824 3,025 Deferred gain on sale of business 1,448 - Intangible assets 475 1,564 Tax credits and carryforwards 66 7,263 Other 964 1,001 Subtotal 48,227 50,226 Valuation allowance (66 ) (11,527 ) Deferred tax assets 48,161 38,699 Deferred tax liabilities: Property, plant and equipment (13,805 ) (15,849 ) Prepaid expenses (432 ) (430 ) Other (100 ) (100 ) Deferred tax liabilities (14,337 ) (16,379 ) Net deferred tax assets $ 33,824 $ 22,320 Deferred tax assets arise primarily because expenses have been recorded in historical financial statement periods which will not become deductible for income taxes until future tax years. We record valuation allowances to reduce the book value of our deferred tax assets to amounts that are estimated to be more likely than not realized. This assessment requires judgment and is performed on the basis of the weight of all available evidence, both positive and negative, with greater weight placed on information that is objectively verifiable such as historical performance.
For Fiscal 2011, we evaluated negative evidence noting that for the three-year period then ended, we reported a cumulative net loss. Pursuant to FASB guidance, a cumulative loss in recent years is a significant piece of negative evidence that must be considered and this form of negative evidence is difficult to overcome without sufficient objectively verifiable positive evidence. Our then objectively verifiable positive evidence included certain aspects of our historical results. Additional positive evidence includes forecasts of future taxable income. However, since this latter form of evidence was not objectively verifiable, its weight is not sufficient to overcome the negative evidence. As a result of this evaluation, we increased our valuation allowance for deferred tax assets by $10,420 as of September 30, 2011. Of this amount, $7,628 was recorded as income tax expense and $2,792 was charged to other comprehensive loss offsetting deferred tax assets that were generated in the current year.
For Fiscal 2012, we reported significant income before tax from continuing operations which resulted in cumulative earnings for the three-year period then ended. We evaluated the current facts and circumstances and concluded that the negative evidence that existed as of September 30, 2011, no longer existed.
Accordingly, we relied on positive evidence, which included taxable income in the current year, a forecast of significant taxable income in coming years and the absence of credit carry forward balances. As a result, we reversed the valuation allowance of $10,420. Of this amount, $2,792 increased other comprehensive income and $7,628 was recorded as an income tax benefit for continuing operations.
The ultimate realization of deferred tax assets depends on having sufficient taxable income in the future years when the tax deductions associated with the deferred tax assets become deductible. The establishment or reversal of a valuation allowance, if any, does not impact cash nor does it preclude us from using our tax credits, loss carryforwards and other deferred assets in the future.
39 -------------------------------------------------------------------------------- DISCONTINUED OPERATIONS. In May 2012, our board of directors approved and we committed to a plan to sell our Aerospace Equipment segment, or AMPAC-ISP. The divestiture is a strategic shift that allows us to place more focus on the growth and performance of our pharmaceutical-related product lines.
On June 4, 2012, we entered into an Asset Purchase Agreement with Moog Inc.
("Moog") (the "Asset Purchase Agreement"), pursuant to which we sold to Moog substantially all of the assets of the Ampac-ISP Corp., including all of the equity interests in its foreign subsidiaries (collectively, the "Purchased Assets"). Additionally, Moog assumed certain liabilities related to the operations and the Purchased Assets. The transaction was completed effective August 1, 2012.
Under the terms of the Asset Purchase Agreement, the total consideration was approximately $46,000 (the "Purchase Price") in cash. In addition, $4,000 of the Purchase Price (the "Escrow Amount") will be held in an escrow account for 15 months following the closing of the transaction (the "Escrow Period") and applied towards our indemnification obligations in favor of Moog, if any. The Asset Purchase Agreement provides that we, subject to certain limitations, indemnify Moog for damages and losses incurred or suffered by Moog as a result of, among other things, breaches of our respective representations, warranties and covenants contained in the Asset Purchase Agreement as well as any of the liabilities that we retain. The balance of the Escrow Amount remaining at the end of the Escrow Period shall be released to us. We have accounted for the Escrow Amount as a contingent gain, and accordingly have deferred recognition of the amount until all contingencies have lapsed or been resolved.
Revenues and expenses associated with the operations of AMPAC-ISP are presented as discontinued operations for all periods presented. Summarized financial information for AMPAC-ISP is as follows: Year Ended September 30, 2012 2011 2010 Revenues $ 44,039 $ 48,941 $ 37,608 Discontinued Operations: Operating income (loss) before tax $ 643 $ 3,328 $ (270 ) Income tax provision (benefit) 506 1,185 101 Net income (loss) from discontinued operations 137 2,143 (371 ) Gain (Loss) on Sale fo Discontinued Operations Gain on sale of discontinued operations before tax 5,059 - - Income tax provision (benefit) 209 - - Net gain on sale of discontinued operations 4,850 - - $ 4,987 $ 2,143 $ (371 ) 40 -------------------------------------------------------------------------------- BUSINESS SEGMENT RESULTS FINE CHEMICALS SEGMENT Year Ended September 30, 2012 2011 2010 Revenues 111,536 89,497 69,632 Operating Income (Loss) 8,678 (6,283 ) (7,583 ) Operating Margin 8 % (7 %) (11 %) As discussed above under the heading "Other Operating Gains", our Fine Chemicals segment operating income (loss) for Fiscal 2012 and Fiscal 2011 includes other gains of $1,714 and $2,929, respectively. To facilitate comparison of the Fiscal 2012, Fiscal 2011 and Fiscal 2010 operating results, the following table computes Adjusted Segment Operating Loss and Adjusted Segment Operating Margin which excludes these gains.
Year Ended September 30, 2012 2011 2010 Adjustments for Other Operating Gains: Operating Income (Loss), as reported 8,678 (6,283 ) (7,583 ) Exclude Other Operating Gains (1,714 ) (2,929 ) - Segment Operating Income (Loss), as adjusted 6,964 (9,212 ) (7,583 ) Operating Margin, as adjusted 6 % (10 %) (11 %) Revenues. Fine Chemicals segment revenues increased 25% in Fiscal 2012 as compared to Fiscal 2011, led by strong anti-viral product revenues. Compared to Fiscal 2011, anti-viral products revenues increased 94% for Fiscal 2012.
Anti-viral products revenues in the Fiscal 2011 periods were at reduced levels due to a gap between production campaigns for a particular product. Production of this product resumed in early calendar 2011 under a renewed three-year agreement resulting in a significant increase in anti-viral products revenues in Fiscal 2012.
Revenues from our Central Nervous System ("CNS") products increased 54% compared to Fiscal 2011 reflecting improved pricing and favorable volumes. During Fiscal 2012 we renewed the production contract for the primary group of products within this therapeutic indication. The new contract has a five-year term, favorable pricing as compared to the prior contract, and contains minimum purchase requirements for our customer.
The increases in anti-viral and CNS products revenues were offset somewhat by lower oncology products revenues. During the later part of Fiscal 2012, we began to recognize revenue from the commercial production of three new products with oncology indications. The introduction of new commercial products is an important achievement for this segment. Nonetheless, the Fiscal 2012 initial revenues for these new products did not fully replace revenue declines from our legacy oncology product. Our legacy oncology product is an active pharmaceutical ingredient for a drug facing generic competition and, as a result, is experiencing volume and related revenue declines. We anticipate volume for these new products, and products currently considered development products, to grow and replace or exceed revenues from mature oncology products in the coming years. The introduction of these new products into our commercial product lines is an example of how our emphasis on our pipeline of development products can result in a successful replacement cycle for maturing products.
Development products are products which are not yet commercialized, and products which are commercial but for which we are not a current commercial producer.
Development product revenues were approximately $19,800 in Fiscal 2012 compared to approximately $21,100 in Fiscal 2011. The small variance in revenues reflects project timing. Typically, development product activities are the source of developing new long-term customer relationships and often lead to future core products. The products categorized as development products are used by our customers primarily for drugs with indications in anti-viral, CNS, oncology and pain management.
41 -------------------------------------------------------------------------------- Fine Chemicals segment revenues increased 29% in Fiscal 2011 compared to Fiscal 2010. Revenues from oncology and CNS products increased 118% and 49%, respectively. We experienced a gap in production for our most significant anti-viral product that impacted the later part of Fiscal 2010 and the early part of Fiscal 2011. Since both fiscal periods were affected, anti-viral product revenues were consistent between Fiscal 2011 and Fiscal 2010. Sales of this anti-viral product, under a renewed three-year supply agreement, began in the Fiscal 2011 third quarter. The increase in oncology revenues is largely due to timing shifts from Fiscal 2010 into Fiscal 2011, driven by customer inventory levels and production line availability. The increase in CNS revenue is largely due to one customer's timing of its product demand. Revenues from development products continue to become an increasing component of Fine Chemicals segment revenues, exceeding 20% of Fine Chemicals segment revenues in Fiscal 2011.
Growth in this area has resulted from an intensified focus on core technologies and diversification of products and customers.
Operating Income (Loss). The Fine Chemicals segment returned to profitability during Fiscal 2012, reporting adjusted operating income of $6,964 compared to an adjusted operating loss of $9,212 in Fiscal 2011. Fine Chemicals segment gross margin improved by 16 points in Fiscal 2012 as compared to Fiscal 2011. Our Fine Chemicals segment has dedicated significant efforts over the last two years to improving the efficiency of its manufacturing activities. Redesigned key processes are now yielding targeted throughput rates. Other efficiencies and cost savings initiatives, such as solvent recycling, have been implemented.
These actions, along with improved overhead absorption due to the higher production volumes, have resulted in increased gross margin for all major product categories in our Fine Chemicals segment.
Improvements in gross profit for Fiscal 2012 periods were offset by increases in general and administrative expenses of approximately $3,200. The higher general and administrative expenses include approximately $2,200 of incentive compensation which is based on the segment's improved performance. Incentive compensation was zero in Fiscal 2011 and 2010. Fiscal 2012 also includes higher insurance and retirement benefits related expenses.
For Fiscal 2011, the Fine Chemicals segment gross margin percentage declined five points compared to the prior fiscal year. The primary reason for the decline in gross margin was continued difficulties with implementation of a process improvement that was intended to offset reduced pricing on a core product and extended equipment maintenance. These difficulties contributed to below-target through-put rates and material reprocessing.
Fine Chemicals segment operating expenses in Fiscal 2011 were reduced by $937, reflecting property tax and insurance savings.
Backlog. Agreements with our Fine Chemicals segment customers typically include multi-year supply agreements. These agreements may contain provisional order volumes, minimum order quantities, take-or-pay provisions, termination fees and other customary terms and conditions, which we do not include in our computation of backlog. Fine Chemicals segment backlog includes unfulfilled firm purchase orders received from a customer, including both purchase orders which are issued against a related supply agreement and stand-alone purchase orders. Fine Chemicals segment backlog was $80,500 and $50,900 as of September 30, 2012 and 2011, respectively. We anticipate order backlog as of September 30, 2012 to be substantially filled during Fiscal 2013.
Outlook. The pharmaceutical markets we target are expected to continue to be driven by strong demand for products that use our core technologies, including anti-viral and oncology drugs, many of which are expected to benefit from the use of energetic chemistry or require high containment or other unique engineering expertise. Since a growing percentage of future drugs are anticipated to be based on chirally-pure material, we believe our investment in SMB technology may prove to be a strong, long-term competitive advantage for us.
We believe there is a continuing trend toward more outsourcing by the pharmaceutical industry, especially for pharmaceutical ingredients that require specialized equipment or technologies, such as SMB or high-containment manufacturing, and chemicals that are sensitive from a proprietary standpoint.
In addition, we have recently seen examples of customer 42 -------------------------------------------------------------------------------- outsourcing trends shifting back to chemical suppliers in the U.S. and Western Europe from Asian suppliers. As discussed above, AFC's pipeline of development products continues to grow and diversify, reflecting this trend. We are targeting 20% of revenues as an average, long-term goal for sales of development products.
Fine Chemicals segment revenues are anticipated to increase in Fiscal 2013 by a range of approximately 5% to 10% compared to Fiscal 2012, supported by expected growth in revenues from development products and new core products that were introduced in Fiscal 2012.
SPECIALTY CHEMICALS SEGMENT Year Ended September 30, 2012 2011 2010 Revenues 68,513 66,905 62,611 Operating Income (Loss) 34,919 35,600 30,571 Operating Margin 51 % 53 % 49 % Revenues. Specialty Chemicals segment revenues include revenues from our perchlorate, sodium azide and Halotron product lines, with perchlorates comprising 88%, 89% and 90% of Specialty Chemicals revenues in Fiscal 2012, 2011 and 2010, respectively. The year over year variances in Specialty Chemicals revenues reflect the following factors: - A 10% decrease in perchlorate volume offset by a 13% increase in the related average price per pound for Fiscal 2012.
- An 18% decrease in perchlorate volume offset by a 28% increase in the related average price per pound for Fiscal 2011.
- Sodium azide revenues increased 8% in Fiscal 2012 and 23% in Fiscal 2011, each compared to the prior fiscal year.
- Halotron revenues decreased 1% in Fiscal 2012 and increased 19% in Fiscal 2011, each compared to the prior fiscal year.
The decrease in total perchlorate volume for Fiscal 2012 is primarily due to a 39% decline in volume for our lower-priced, non rocket-grade perchlorates.
Rocket-grade AP volume increased in Fiscal 2012, supported by the return in Fiscal 2012 of quantities for development motors for the National Aeronautics and Space Administration ("NASA") Heavy Lift Vehicle which is part of the new Space Launch System. Tactical and strategic missile related demand remained stable.
The increase in the average price per pound for Fiscal 2012 is a result of a change in product mix. The Fiscal 2012 periods include a smaller volume of our lower-priced perchlorate products. The average price per pound of rocket-grade perchlorate was consistent between the Fiscal 2012 and Fiscal 2011 periods.
In addition, rocket-grade AP revenues are typically derived from relatively few large orders. As a result, quarterly revenue amounts can vary significantly depending on the timing of individual orders throughout the year. Average price per pound may continue to fluctuate somewhat in future periods, depending upon product mix and volume.
The decrease in total perchlorate volume for Fiscal 2011 is primarily due to limited demand for rocket-grade AP for usage on space programs. Tactical and strategic missile program demand continued to be stable and accounted for the largest component of rocket-grade AP volume in Fiscal 2011. The Ares program was the largest component of volume in Fiscal 2010. The decline in rocket-grade AP demand was offset by an increase in volume for our other perchlorate products, which was approximately 22% higher in Fiscal 2011 than in Fiscal 2010.
43-------------------------------------------------------------------------------- The increase in the average price per pound of perchlorates in Fiscal 2011 compared to Fiscal 2010 reflects two offsetting factors.
- The average price per pound of rocket-grade AP increased approximately proportionate and inverse to the decrease in rocket-grade AP volume consistent with the contractual rocket-grade AP price-volume matrix, under which price and volume move inversely, and comparable catalog pricing.
- This increase was partially offset because revenues from our other lower-value perchlorate products, such as sodium perchlorate and potassium perchlorate, accounted for a substantially greater percentage of all perchlorate product volume in Fiscal 2011. This has the effect of reducing the average unit price for perchlorates.
The changes in sodium azide revenues in Fiscal 2012 and Fiscal 2011 are due primarily to fluctuation in demand for sodium azide used in pharmaceutical applications. We do not anticipate a significant increase in demand for sodium azide in Fiscal 2013.
Changes in Halotron revenues have been driven by volume changes which have been and are expected to be relatively consistent year over year.
Operating Income (Loss). Specialty Chemicals segment reported operating income of $34,919 and operating margin of 51% for Fiscal 2012. The operating margin declined in Fiscal 2012 when compared to the atypically high operating margin generated in Fiscal 2011. Fiscal 2012 product mix reflects a more typical mix of re-determinable and firm fixed-price orders. As a result, gross margin declined three percentage points from Fiscal 2011. Specialty Chemicals segment operating expenses were consistent between Fiscal 2012 and Fiscal 2011.
Specialty Chemicals segment profits for Fiscal 2011 were atypically high compared to profits generated in fiscal years with a more traditional mix of product revenues. Gross margin increased two percentage points in Fiscal 2011 compared to Fiscal 2010 primarily as a result of a much larger percentage of firm-fixed price AP sales orders compared to re-determinably priced sales orders in the fiscal year, while, the opposite was true in Fiscal 2010. Firm-fixed price orders carry more profit risk because of potential sales volume volatility, but also provide the potential of higher margins when the volatility works in our favor. Secondary reasons for the gross margin increase in Fiscal 2011 include increased sales of multi-purpose perchlorates and recycled perchlorates compared to the prior fiscal year. During Fiscal 2011, Specialty Chemicals segment achieved operating expenses savings of approximately $700 reflecting primarily lower insurance and professional services costs.
Backlog. Specialty Chemicals segment backlog includes unfulfilled firm purchase orders received from a customer, including both purchase orders which are issued against long-term supply agreements and stand-alone purchase orders. Specialty Chemicals segment backlog was $25,100 and $46,800 as of September 30, 2012 and 2011, respectively. We anticipate order backlog as of September 30, 2012 to be substantially filled during Fiscal 2013. Specialty Chemicals product orders are typically characterized by individually large orders which at various times during the fiscal year. This usually results in a backlog and revenue pattern which can vary significantly from quarter to quarter. Specialty Chemicals segment backlog as of September 30, 2011, is atypically high relative to its annual sales volume.
Outlook. Specialty Chemicals segment revenues are expected to increase in Fiscal 2013 by approximately 10%. This segment is currently performing under several non-recurring development projects that should contribute to the expected revenue increase in Fiscal 2013. The core products for this segment are expected to continue to perform within their historical stable range. While the U.S.
government budgeting process will affect the total demand for rocket-grade AP, we expect steady demand within the range of 2.5 million to 5.0 million pounds per year. Further, we expect that unit pricing will continue to vary inversely to volume. Our pricing structure is designed to absorb our substantial fixed manufacturing costs regardless of our annual production volume. As a result, we forecast that this segment will continue to achieve stable annual revenues, without significant growth opportunities. This forecasted range of production volume contemplates the current annual high and low scenarios for both 44-------------------------------------------------------------------------------- DOD and NASA programs over the next five years, including tactical and strategic missile programs, military and commercial space launch programs, and NASA's SLS.
SLS is developing the HLV. The current baseline configuration for HLV uses two solid rocket boosters, similar to, but larger than, the retired Space Shuttle Reusable Solid Rocket Motor. Hence, this will demand the use of rocket-grade AP.
During the development phase of approximately four years, the demand should be one to two million pounds per year. In the launch phase after development, the demand for rocket-grade AP from HLV should be more significant. While there is still potential to shift to liquid boosters in the future, once the new solid rocket boosters are developed, we believe there will be no advantage to switching to a different technology.
The most predictable and steady use of AP is expected to be in the DOD applications. The need for tactical rockets and strategic missiles is anticipated to provide the base demand over the coming five-year period and beyond.
OTHER BUSINESSES SEGMENT Year Ended September 30, 2012 2011 2010 Revenues 5,578 4,312 6,341 Operating Loss (473 ) (1,308 ) (206 ) Operating Margin (8 %) (30 %) (3 %) Other Businesses segment revenues include PEPCON Systems' water treatment equipment and related spare parts sales and real estate revenues. The increase in revenues for Fiscal 2012 reflects a 16% increase in equipment sales and an 81% increase in spare parts sales. From time to time, spare parts sales include an infrequent large order, which was the cause of the increase in Fiscal 2012.
Equipment sales decreased $1,828 in Fiscal 2011 compared to Fiscal 2010. The variances in equipment sales were driven by the timing of new system shipments.
The operating loss was reduced in Fiscal 2012. The magnitude of cost overruns to complete equipment orders was not as large in Fiscal 2012 due to improvements in order execution.
CORPORATE EXPENSES Year Ended September 30, 2012 2011 2010 Corporate Expenses 14,326 14,124 15,847 Corporate operating expenses increased $202 in Fiscal 2012 compared to Fiscal 2011, largely due to increases in board of directors and shareholder matter related costs. In Fiscal 2011, corporate operating expenses were reduced by $1,723 compared to Fiscal 2010. Cost reduction activities generated savings of $1,990, primarily in the areas of travel and professional services, which were offset somewhat by increases in board of director expenses.
45 -------------------------------------------------------------------------------- LIQUIDITY AND CAPITAL RESOURCES CASH FLOWS Year Ended September 30, Percentage Change 2012 2011 2010 12 vs. 11 11 vs. 10 Cash Provided (Used) By: Operating activities $ 11,647 $ 20,743 $ 20,775 (44%) (0%) Investing activities 28,010 (13,151 ) (13,352 ) (313%) (2%) Financing activities (39,171 ) (900 ) (5,053 ) 4,252% (82%) Effect of changes in exchange rates on cash (7 ) 26 (66 ) NM NM Net change in cash for period $ 479 $ 6,718 $ 2,304 (93%) 192% NM = Not meaningful Operating Activities Fiscal 2012 compared to Fiscal 2011 Operating activities provided cash of $11,647 for Fiscal 2012 compared to $20,743 for the prior fiscal year, resulting in a decrease of $9,096.
Significant components of the change in cash flow from operating activities include: - An increase in cash due to an improvement in cash profits generated by our continuing operations.
- A decrease in cash provided by working capital accounts of approximately $19,600, excluding the effects of interest and income taxes.
- A decrease in cash taxes refunded of approximately $3,100.
- An increase in cash used for environmental remediation of approximately $6,400.
- An increase in cash used to fund pension obligations of $2,500.
- An increase in cash paid for debt extinguishment costs of approximately $1,300.
- Other increases in cash provided by operating activities, primarily discontinued operations, of approximately $9,200.
The decrease in cash provided by working capital accounts relates primarily to changes in customer deposits. In March 2011, the Specialty Chemicals segment received an atypically high customer deposit that resulted from favorable contract terms. This did not recur in Fiscal 2012. Remaining variances in working capital are within our customary ranges, including an increase in Fine Chemicals segment inventory at September 30, 2012.
During Fiscal 2011, we received income tax refunds from federal income tax carryback claims. This did not recur in Fiscal 2012, resulting in a decrease in income tax refunds when comparing the periods.
During Fiscal 2012 we spent $10,119 for remediation activities compared to $3,697 in Fiscal 2011. The increase reflects cash used for the capital elements of the Henderson, Nevada, expansion project. See detailed discussion under the heading "Environmental Remediation - AMPAC Henderson Site" below.
During Fiscal 2012 and Fiscal 2011, we made payments to fund defined benefit pension obligations at 80% of the obligation. In Fiscal 2012, the company contribution needed to meet this funding level increased because the return on pension plan assets in the preceding year was not sufficient to maintain our target funding requirements.
Cash used by discontinued operations working capital accounts decreased because these operations did not experience the same working capital requirements in Fiscal 2012 (prior to their divestiture) as they experienced in Fiscal 2011.
We consider the working capital changes to be routine and within the normal production cycle of our products. The production of most fine chemical products requires a length of time that exceeds one 46 -------------------------------------------------------------------------------- quarter. In any given quarter, accounts receivable, work-in-progress inventory or deferred revenues and customer deposits can increase or decrease significantly. We expect that our working capital may vary normally by as much as $10,000 from quarter to quarter.
Fiscal 2011 compared to Fiscal 2010 Operating activities provided cash of $20,743 for Fiscal 2011 compared to $20,775 for the prior fiscal year.
Significant components of the change in cash flow from operating activities include: - An increase in cash due to an improvement in cash profits generated by our operations.
- An increase in cash used for working capital accounts of $9,200, excluding the effects of interest and income taxes.
- An increase in cash income taxes refunded of $2,400.
- A decrease in cash paid for interest of $500.
- An increase in cash used for environmental remediation of $900.
- An increase in cash used to fund pension obligations of $2,200.
- Other increases in cash provided by operating activities of $300.
The increase in cash used for working capital accounts includes several primary components. Cash provided by Specialty Chemicals segment working capital accounts increased approximately $22,800. Specialty Chemicals segment accounts receivable balances were unusually high at September 30, 2010. Collection of these balances in Fiscal 2011 generated improvement in cash flow. Cash used by Fine Chemicals segment working capital accounts increased by approximately $16,500 consistent with the growth in business in Fiscal 2011. Cash used by discontinued operations working capital accounts increased by approximately $12,200 in part due to business growth and in part because certain active contracts had less favorable billing terms than was typical for this business.
The increase in cash income taxes refunded is a result of federal income tax carryback claims that were filed and collected during Fiscal 2011.
The increase in cash used for environmental remediation relates to the Henderson, Nevada, expansion project. See detailed discussion under the heading "Environmental Remediation - AMPAC Henderson Site" below.
Cash used to fund pension obligations increased because the return on pension plan assets alone was not sufficient to maintain the minimum funding requirements.
Investing Activities Fiscal 2012 compared to Fiscal 2011 Capital expenditures of $8,788 for Fiscal 2012 reflect a decrease from Fiscal 2011 of $3,143. During Fiscal 2012, our Fine Chemicals segment required less investment in capital equipment associated with new products and contracts.
Maintenance capital spending was consistent between Fiscal 2012 and Fiscal 2011.
We are anticipating our capital expenditures, which do not include environmental remediation spending, for Fiscal 2013 to range from approximately $12,000 to approximately $14,000. During Fiscal 2013 we plan to make investments to expand our mid-range production capacity for our Fine Chemicals segment.
As discussed above under the heading "Discontinued Operations", effective on August 1, 2012, we sold our Aerospace Equipment segment. Total consideration was $46,000, of which $4,000 will be held in an escrow account for 15 months following the close of the transaction. After reducing the total consideration by the amount placed in escrow, cash sold with the foreign entities, and transaction expenses, the net proceeds to us during Fiscal 2012 were $37,418.
47 -------------------------------------------------------------------------------- Fiscal 2011 compared to Fiscal 2010 Capital expenditures of $11,931 for Fiscal 2011 are consistent with capital expenditure levels in Fiscal 2010. The capital expenditures relate to our Fine Chemicals segment, in particular, additional equipment to support a new three-year core product agreement for the supply of anti-viral products and facilities improvements to enhance quality compliance.
Financing Activities Fiscal 2012 compared to Fiscal 2011 On August 9, 2012, we called $40,000 of the outstanding principal amount of our Senior Notes (defined below). On September 10, 2012 we completed the redemption, using net cash proceeds from the sale of AMPAC-ISP and available cash balances.
See further discussion below under the heading "Long Term Debt and Credit Facilities".
During Fiscal 2012, net cash from the exercise of stock options increased compared to Fiscal 2011. During Fiscal 2012, 98,692 stock options were exercised at an average exercise price of $7.64 per share compared to 16,500 stock options at an average exercise price of $4.87 per share during Fiscal 2011.
Fiscal 2011 compared to Fiscal 2010 Cash used for financing activities for Fiscal 2011 relates primarily to costs associated with establishing our asset based lending facility in January 2011.
Cash used for financing activities for Fiscal 2010, reflects the repurchase and cancellation of $5,000 in principal amount of senior notes. The purchase price was $4,900, which approximated the carrying value of the notes, net of deferred financing costs.
LIQUIDITY AND CAPITAL RESOURCES. As of September 30, 2012, we had cash of $31,182. Our primary source of working capital is cash flows from operations and our revolving credit facility.
In October 2012, we called and terminated our senior notes with an aggregate principal amount of $65,000 and replaced the notes with a credit facility that includes a $60,000 term loan and a $25,000 revolving credit line. Funds used to call the notes of $68,315, were provided by the net proceeds from the term loan and available cash balances. The revolving credit line, which was undrawn at inception, provides a committed revolving credit line, up to a maximum of $25,000. For further discussion, see below under the heading "Long Term Debt and Credit Facilities". The term loan requires quarterly principal and interest payments, which differs from the senior notes which had no principal amortization requirements. We do not anticipate that the principal payment requirements of the new facility will have a significant impact on our liquidity because we expect that the cash requirements for principal payments will be substantially offset by lower interest expense.
We believe that changes in cash flow from operations during our fiscal periods reflect short-term timing and as such do not represent significant changes in our sources and uses of cash. Because our revenues, and related customer invoices and collections, are characterized by relatively few individually significant transactions, our working capital balances can vary normally by as much as $10,000 from period to period.
We may incur additional debt to fund capital projects, strategic initiatives or for other general corporate purposes, subject to our existing leverage, the value of our unencumbered assets and borrowing limitations imposed by our lenders. The availability of our cash inflows is affected by the timing, pricing and magnitude of orders for our products. From time to time, we may explore options to refinance our borrowings.
The timing of our cash outflows is affected by payments and expenses related to the manufacture of our products, capital projects, pension funding, interest on our debt obligations and environmental remediation or other contingencies, which may place demands on our short-term liquidity. Although we 48 -------------------------------------------------------------------------------- are not currently party to any material pending legal proceedings, we are from time to time subject to claims and lawsuits related to our business operations and we have incurred legal and other costs as a result of litigation and other contingencies. We may incur material legal and other costs associated with the resolution of litigation and contingencies in future periods, and, to the extent not covered by insurance, they may adversely affect our liquidity.
In contemplating the adequacy of our liquidity and available capital, we consider factors such as: - current results of operations, cash flows and backlog; - anticipated changes in operating trends, including anticipated changes in revenues and margins; - cash requirements related to our debt agreements and pension plans; and - cash requirements related to our remediation activities.
We do not currently anticipate that the factors noted above will have material effects on our ability to meet our future liquidity requirements. We continue to believe that our cash flows from operations, existing cash balances and existing or future debt arrangements will be adequate for the foreseeable future to satisfy the needs of our operations on both a short-term and long-term basis.
LONG TERM DEBT AND CREDIT FACILITIES Senior Notes. In February 2007, we issued and sold $110,000 aggregate principal amount of 9.0% Senior Notes due February 1, 2015 (the "Senior Notes"). The Senior Notes accrued interest at an annual rate of 9.0%, payable semi-annually in February and August. The Senior Notes were guaranteed on a senior unsecured basis by all of our existing and future material U.S. subsidiaries.
In June 2010, we repurchased and cancelled $5,000 in principal amount of our Senior Notes for $4,900. As a result of this repurchase, we recorded an immaterial loss of $16 in other income (expense), net of deferred financing costs of $116.
On August 9, 2012, we called $40,000 of the outstanding principal amount of the Senior Notes. On September 10, 2012 we completed the redemption, using net cash proceeds from the sale of AMPAC-ISP and available cash balances. The redemption price for the Notes was 102.25% of the principal amount of the Notes being redeemed, plus accrued and unpaid interest to the redemption date. The transaction resulted in a net loss on debt retirement of $1,397 which includes the call premium of $900, unamortized debt issuances costs of $482 and other expenses of $15.
In connection with our entering into the Credit Facility (as defined below), on October 26, 2012, a notice of redemption was issued for all remaining outstanding Senior Notes specifying a redemption date of November 25, 2012. The Redemption Price for the Notes was 102.250% of the outstanding principal amount of $65,000, plus accrued and unpaid interest to, but not including, the redemption date. On October 26, 2012, we irrevocably deposited funds with the trustee in an amount equal to the Redemption Price for the Senior Notes and the related indenture was discharged. This transaction will result in a net loss on debt retirement, including the call premium of $1,463, which will be recorded in the three-month period ending December 31, 2012.
ABL Credit Facility. On January 31, 2011, American Pacific Corporation, as borrower, entered into an asset based lending credit agreement (the "ABL Credit Facility") with Wells Fargo Bank, National Association, as agent and as lender, and certain domestic subsidiaries of the Company, as guarantors, which provided a secured revolving credit facility in an aggregate principal amount of up to $20,000 at any time outstanding with an initial maturity of 90 days prior to the maturity date of the Senior Notes, which is February 1, 2015. The maximum borrowing availability under the ABL Credit Facility was based upon a percentage of our eligible account receivables and eligible inventories. On September 30, 2012, under the ABL Credit Facility, we had no outstanding borrowings and were not subject to compliance with the financial covenants. On October 26, 2012, we terminated the ABL Credit Facility.
49 -------------------------------------------------------------------------------- Credit Facility. On October 26, 2012, we entered into an $85,000 senior secured credit agreement (the "Credit Facility") by and among American Pacific Corporation, the lenders party thereto (the "Lenders") and KeyBank National Association, as the swing line lender, issuer of letters of credit under the Credit Facility and as the Administrative Agent of the Lenders. Under the Credit Facility, we (i) obtained a term loan in the aggregate principal amount of $60,000 with an initial maturity in 5 years (the "Term Loan"), and (ii) may obtain revolving loans of up to $25,000 in aggregate principal amount, of which up to $5,000 may be outstanding in connection with the issuance of letters of credit (the "Revolving Facility"). There were no amounts drawn upon the Revolving Facility upon issuance. We may prepay and terminate the Credit Facility at any time, without premium or penalty. The Credit Facility contains certain mandatory prepayment provisions which are based upon certain asset sales, equity issuances, incurrence of certain indebtedness and events of loss.
For any borrowings under the Credit Facility, we elect between two options to determine the annual interest rates applicable to loans under the Credit Facility: Base Rate Loans and Eurodollar Loans. These elections can be renewed or changed from time to time during the term of the Credit Facility. The interest rate for an election period is determined as the Base Rate or the Adjusted Eurodollar Rate (each as defined in the Credit Facility), and in each case, plus an applicable margin, which shall range from 0.75% to 1.50% for Base Rate Loans or from 1.75% to 2.50% for Eurodollar Loans, subject to adjustment based on the leverage ratio. Interest payments are due at least quarterly and may be more frequent under certain Eurodollar Loan elections. The Term Loan includes quarterly principal amortization payments which will commence on December 31, 2012. Scheduled Amortization of the Term Loan is $4,500, $6,000, $6,000, $6,000 and $7,500 for each of the five years in the period ending September 30, 2017, respectively. The remaining balance of the Term Loan of $30,000 is due upon maturity.
The Credit Facility is guaranteed by our current and future domestic subsidiaries and is secured by substantially all of our assets and the assets of our current and future domestic subsidiaries, subject to certain exceptions as set forth in the Credit Facility. The Credit Facility contains customary affirmative, negative and financial covenants which, among other things, restrict our ability to: - pay dividends, repurchase our stock, or make other restricted payments; - make certain investments or acquisitions; - incur additional indebtedness; - create or permit to exist certain liens; - enter into certain transactions with affiliates; - consummate a merger, consolidation or sale of assets; - change our business; and - wind up, liquidate, or dissolve our affairs.
In each case, the covenants set forth above are subject to customary and negotiated exceptions and exclusions.
The Credit Facility includes two financial covenants that are measured quarterly.
Leverage Ratio. The Leverage Ratio must be less than or equal to 3.00 to 1.00.
The Credit Facility defines the Leverage Ratio as the ratio of Consolidated Total Debt as of the last day of a quarter ("Test Date") to Consolidated EBITDA for the four consecutive quarters preceding the Test Date, each as defined in the Credit Facility.
Debt Service Coverage Ratio. The Debt Service Coverage Ratio must be at least 2.00 to 1.00, with increases to 2.25 to 1.00 for the period commencing September 30, 2014 to September 29, 2015, and increasing to 2.50 to 1.00 for the period commencing September 30, 2015 and thereafter. The Credit Facility defines the Debt Service Coverage Ratio as the ratio of Consolidated EBITDA minus Consolidated Capital Expenditures to Scheduled Repayments plus Consolidated Adjusted Interest Expense, each as defined in the Credit Facility.
50 -------------------------------------------------------------------------------- With respect to these covenant compliance calculations, Consolidated EBITDA, as defined in the Credit Facility (hereinafter, referred to as "Credit Facility EBITDA"), differs from typical EBITDA calculations and our calculation of Adjusted EBITDA, which is used in certain of our public releases and in connection with our incentive compensation plan. The most significant difference in the Credit Facility EBITDA calculation is the inclusion of cash payments for environmental remediation as part of the calculation. The following statements summarize the elements of those definitions that are material to our computations. Consolidated Total Debt generally includes principal amounts outstanding under our Credit Facility, capital leases, drawn amounts for outstanding letters of credit and other indebtedness for borrowed money. Credit Facility EBITDA is generally computed as consolidated net income (loss) plus income tax expense (benefit), interest expense, depreciation and amortization, stock-based compensation expense, and certain non-cash charges and less cash payments for environmental remediation, extraordinary gains and certain other non-cash gains.
The Credit Facility also contains usual and customary events of default (subject to certain threshold amounts and grace periods). If an event of default occurs and is continuing, the Company may be required to repay the obligations under the Credit Facility prior to the Credit Facility's stated maturity and the related commitments may be terminated.
Principal Maturities. As discussed above, in October 2012, we redeemed our outstanding Senior Notes in the amount of $65,000 and entered into a Credit Facility which includes a Term Loan in the amount of $60,000. Funds used to call the notes were provided by the net proceeds from the Term Loan and available cash balances. The table below is presented after the effects of our October 2012 refinancing activities. Principal maturities for our Credit Facility and capital leases that were outstanding as of September 30, 2012 are as follows: Years ending September 30: 2013 $ 4,516 2014 6,004 2015 6,000 2016 6,000 2017 7,500 Thereafter 30,000 Total $ 60,020 PENSION BENEFITS. We maintain three defined benefit pension plans which cover substantially all of our employees: the Amended and Restated American Pacific Corporation Defined Benefit Pension Plan, the Ampac Fine Chemicals LLC Pension Plan for Salaried Employees, and the Ampac Fine Chemicals LLC Pension Plan for Bargaining Unit Employees, each as amended to date. Collectively, these three plans are referred to as the "Pension Plans". In May 2010, our board of directors approved amendments to our Pension Plans which effectively closed the Pension Plans to participation by any new employees. Retirement benefits for existing U.S. employees and retirees through June 30, 2010 were not affected by this change. Beginning July 1, 2010, new U.S. employees began participating solely in one of the Company's 401(k) plans. Pension Plan benefits are paid based on an average of earnings, retirement age, and length of service, among other factors.
Benefit obligations are measured annually as of September 30. As of September 30, 2012, the Pension Plans had an unfunded benefit obligation of $44,740. For Fiscal 2012, we made contributions to the Pension Plans in the amount of $9,320. We anticipate making Pension Plan contributions in the amount of approximately $4,510 during Fiscal 2013. We are required to make minimum contributions to our Pension Plans pursuant to the minimum funding requirements of the Internal Revenue Code of 1986, as amended, and the Employee Retirement Income Security Act of 1974, as amended. In accordance with federal requirements, our minimum funding obligations are determined annually based on a measurement date of October 1. The fair value of Pension Plan assets is a key factor in determining our minimum funding obligations. Holding all other variables constant, a 10% decline in asset value as of September 30, 2012 would increase our minimum funding obligations for Fiscal 2013 by approximately $295.
51 -------------------------------------------------------------------------------- In addition, we maintain the American Pacific Corporation Supplemental Executive Retirement Plan, as amended and restated (the "SERP"), that includes three active and two former executive officers. The SERP is an unfunded plan and as of September 30, 2012 the SERP obligation was $11,087. For Fiscal 2012, we paid SERP retirement benefits of $527. We anticipate contributing the amount of approximately $527 to the SERP during Fiscal 2013 for the payment of retirement benefits. Payments for retirement benefits should increase in future years when each of the three current active participants retires. The future increase in such retirement benefits will be determined based on certain variables including each participating individual's actual retirement date, rate of compensation and years of service.
During Fiscal 2012 and Fiscal 2011, our aggregate Pension Plans and SERP liability increased significantly primarily due to reductions in the actuarial assumption for the discount rate on the obligation, returns on plan assets at levels substantially lower than the expected long-term rate of return on plan assets and losses on certain plan assets. These changes are recorded as an increase in Pension Obligations and a corresponding decrease in Stockholders' Equity (Accumulated Other Comprehensive Loss). If interest rates remain low and/or returns on plan assets do not trend with the expected long-term rate of return, our liquidity could be impacted by pension plan funding requirements.
ENVIRONMENTAL REMEDIATION - AMPAC HENDERSON SITE. During the fiscal years ended September 30, 2005 and September 30, 2006, we recorded aggregate charges for $26,000 representing our then estimates of the probable costs of our remediation efforts at our former perchlorate chemicals manufacturing facility in Henderson, Nevada (the "AMPAC Henderson Site"), including the costs for capital equipment and on-going operating and maintenance ("O&M").
Late in the fiscal year ended September 30, 2009 ("Fiscal 2009"), we gained additional information from groundwater modeling that indicates groundwater emanating from the AMPAC Henderson Site in certain areas in deeper zones (more than 150 feet below ground surface) is moving toward our existing remediation facility at a much slower pace than previously estimated. Utilization of our existing facilities alone, at this lower groundwater pace, could, according to this groundwater model, extend the life of our remediation project to well in excess of fifty years. As a result of this additional data, related model interpretations and consultations with NDEP, we re-evaluated our remediation operations and determined that we should be able to improve the effectiveness of the treatment program and significantly reduce the total project time by expanding the then existing treatment system. The expansion includes installation of additional groundwater extraction wells in the deeper, more concentrated areas, construction of an underground pipeline to move extracted groundwater to our treatment facility, and the addition of fluidized bed reactor ("FBR") bioremediation treatment equipment (the "Expansion Project") that will enhance, and in some cases replace, primary components of the existing treatment system. In our Fiscal 2009 fourth quarter, we accrued $13,700 as our initial estimate of the capital cost of the Expansion Project and the related estimates of the effects of the enhanced operations on the on-going O&M costs and project life.
Through June 2011, and in cooperation with NDEP, we worked to develop the formal design, engineering and permitting of the Expansion Project. Based on data obtained through that date, which was largely comprised of firm quotations, we determined that significant modifications to our Fiscal 2009 assumptions were required. As a result, in June 2011, we accrued an additional $6,000 for the estimated increase in cost of the capital component of the Expansion Project, offset slightly by reductions in O&M cost estimates. The estimated capital costs of the Expansion Project increased by approximately $6,400. The increase reflects (i) an increase in the capacity of the FBR bioremediation treatment equipment to accommodate technical requirements based on the testing of new extraction wells in the fall of 2010, and (ii) higher than initially anticipated cost associated with the installation of the equipment and construction of the pipeline. Our estimate of total O&M costs was reduced by approximately $400.
In September 2012, we commenced initial operation of the Expansion Project.
Related system optimization and other start-up activities will continue into the early months of Fiscal 2013. In September 2012, we recorded an additional remediation charge in the amount of $700, which is substantially 52-------------------------------------------------------------------------------- attributed to the true-up of estimates to the expected final cost of the expansion project. Due to uncertainties inherent in making estimates, our estimates of capital and O&M costs may later require significant revision as new facts become available and circumstances change.
The estimated life of the project is a key assumption underlying the accrued estimated cost of our remediation activities. Groundwater modeling and other information regarding the characteristics of the surrounding land and demographics indicate that at our targeted processing rate of 450 gallons per minute for the new groundwater extraction wells (750 gallons per minute in the aggregate with existing wells), the life of the project could range from 5 to 18 years from the date that the Expansion Project is placed in service. Further, the data indicates that within that range, 7 to 14 years is the more likely range. In accordance with generally accepted accounting principles, if no point within the more likely range is considered more likely than another, then estimates should be based on the low end of the range. Accordingly, our accrued remediation cost includes estimated O&M costs through 2019, which is the low end of the likely range of the project life. Groundwater speed, perchlorate concentrations, aquifer characteristics and forecasted groundwater extraction rates will continue to be key factors considered when estimating the life of the project. If additional information becomes available in the future that leads to a different interpretation of the model, thereby dictating a change in equipment and operations, our estimate of the resulting project life could change significantly.
The estimate of the annual O&M cost of the project is a key assumption in our computation of the estimated cost of our remediation activities. To estimate O&M costs, we consider, among other factors, the project scope and historical expense rates to develop assumptions regarding labor, utilities, repairs, maintenance supplies and professional services costs. We estimate average annual O&M costs to be approximately $1,900. If additional information becomes available in the future that is different than information currently available to us and thereby leads us to different conclusions, our estimate of O&M expenses could change significantly.
In addition, certain remediation activities are conducted on public lands under operating permits. In general, these permits may require us to relocate our underground pipeline or equipment to accommodate future public utilities and features and require us to return the land to its original condition at the end of the permit period. If we are required to relocate our underground pipeline or equipment in the future, the costs of such activities would be incremental to our current cost estimates. Estimated costs associated with removal of remediation equipment from the land are not material and are included in our range of estimated costs.
As of September 30, 2012, the aggregate range of anticipated environmental remediation costs was from approximately $13,000 to approximately $36,900. This range represents a significant estimate and is based on the estimable elements of cost for capital and O&M costs, and an estimated remaining operating life of the project through a range from the years 2017 to 2030. As of September 30, 2012, the accrued amount was $16,754, based on an estimated remaining life of the project through the year 2019, or the low end of the more likely range of the expected life of the project. Cost estimates are based on our current assessments of the facility configuration. As we proceed with the project, we have, and may in the future, become aware of elements of the facility configuration that must be changed to meet the targeted operational requirements. Certain of these changes may result in corresponding cost increases. Costs associated with the changes are accrued when a reasonable alternative, or range of alternatives, is identified and the cost of such alternative is estimable. Our estimated reserve for environmental remediation is based on information currently available to us and may be subject to material adjustment upward or downward in future periods as new facts or circumstances may indicate.
53 -------------------------------------------------------------------------------- OTHER ARRANGEMENTS We have no off balance sheet arrangements.
Operating Leases. We lease our corporate offices under an operating lease that expires in 2018 and contains step rent provisions, escalation clauses and also provides for cash allowances toward the funding of capital improvements. Our minimum lease payments include these considerations. Total rental expense for continuing operations under operating leases was $1,735, $1,642 and $1,587 for the years ended September 30, 2012, 2011, and 2010, respectively.
Minimum lease payments are recognized as rental expense on a straight-line basis over the minimum lease term. Estimated future minimum lease payments under operating leases as of September 30, 2012, are as follows: Years ending September 30: 2013 1,339 2014 1,125 2015 1,091 2016 1,099 2017 1,130 Thereafter 669 Total $ 6,453 Employee Agreements. We have an employment agreement with our Chief Executive Officer. The term of the employment agreement currently ends on September 30, 2015, unless amended or extended in accordance with the terms of the agreement or otherwise. Significant contract provisions include annual base salary, health care benefits, and non-compete provisions. The employment agreement is primarily an "at will" employment agreement, under which we may terminate the executive officer's employment for any or no reason. Generally, the agreement provides that a termination without cause obligates us to pay certain severance benefits specified in the contract.
We maintain severance agreements with each of our Vice President, Administration and our Chief Financial Officer, which, generally, provide that a termination of the executive without cause obligates us to pay certain severance benefits specified in the contract. In addition, certain other key divisional executives are eligible for severance benefits. Estimated minimum aggregate severance benefits under all of these agreements and arrangements was approximately $4,700 as of September 30, 2012.
Letters of Credit. As of September 30, 2012, we had $532 in outstanding standby letters of credit which mature through April 2016. These letters of credit principally secure performance of certain water treatment equipment sold by us.
The letters of credit are collateralized by cash on deposit with the issuing bank in the amount of 105% of the outstanding letters of credit. Collateral deposits are classified as other assets on our consolidated balance sheets.
INFLATION. Generally, inflation did not have a material or significant effect on our sales and operating revenues or costs during the three-year period ended September 30, 2012.
CRITICAL ACCOUNTING POLICIES The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires that we adopt accounting policies and make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of revenue and expenses.
Application of the critical accounting policies discussed below requires significant judgment, often as the result of the need to make estimates of matters that are inherently uncertain. If actual results were to differ materially from the estimates made, the reported results could be materially affected. However, we are not currently aware of any reasonably likely events or circumstances that would result in materially different results.
54 -------------------------------------------------------------------------------- SALES AND REVENUE RECOGNITION. We recognize revenues when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, title passes, the price is fixed or determinable and collectability is reasonably assured. Almost all products sold by our Fine Chemicals segment are subject to customer acceptance periods. Specifically, these customers have contractually negotiated acceptance periods from the time they receive certificates of analysis and compliance ("Certificates") to reject the material based on issues with the quality of the product, as defined in the applicable agreement. At times we receive payment in advance of customer acceptance. If we receive payment in advance of customer acceptance, we record deferred revenues and deferred costs of revenue upon delivery of the product and recognize revenues in the period when the acceptance period lapses or the customer's acceptance has occurred.
Some of our perchlorate and fine chemicals products customers have requested that we store materials purchased from us in our facilities ("Bill and Hold" transactions or arrangements). We recognize revenue prior to shipment of these Bill and Hold transactions when we have satisfied the applicable revenue recognition criteria, which include the point at which title and risk of ownership transfer to our customers. These customers have specifically requested in writing, pursuant to a contract, that we invoice for the finished product and hold the finished product until a later date. For our Bill and Hold arrangements that contain customer acceptance periods, we record deferred revenues and deferred costs of revenues when such products are available for delivery and Certificates have been delivered to the customers. We recognize revenue on our Bill and Hold transactions in the period when the acceptance period lapses or the customer's acceptance has occurred. The sales value of inventory, subject to Bill and Hold arrangements, at our facilities was $19,346 and $24,040 as of September 30, 2012 and September 30, 2011, respectively.
DEPRECIABLE OR AMORTIZABLE LIVES OF LONG-LIVED ASSETS. Our depreciable or amortizable long-lived assets include property, plant and equipment, which are recorded at cost. Depreciation or amortization is recorded using the straight-line method over the shorter of the asset's estimated economic useful life or the lease term, if the asset is subject to a capital lease. Economic useful life is the duration of time that we expect the asset to be productively employed by us, which may be less than its physical life. Significant assumptions that affect the determination of estimated economic useful life include: wear and tear, obsolescence, technical standards, contract life, and changes in market demand for products.
The estimated economic useful life of an asset is monitored to determine its appropriateness, especially in light of changed business circumstances. For example, changes in technological advances, changes in the estimated future demand for products, or excessive wear and tear may result in a shorter estimated useful life than originally anticipated. In these cases, we would depreciate the remaining net book value over the new estimated remaining life, thereby increasing depreciation expense per year on a prospective basis.
Likewise, if the estimated useful life is increased, the adjustment to the useful life decreases depreciation expense per year on a prospective basis.
IMPAIRMENT OF LONG-LIVED ASSETS. We test our property, plant and equipment for recoverability when events or changes in circumstances indicate that their carrying amounts may not be recoverable. Examples of such circumstances include, but are not limited to, operating or cash flow losses from the use of such assets or changes in our intended uses of such assets. To test for recovery, we group assets (an "Asset Group") in a manner that represents the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities. Our Asset Groups are typically identified by facility because each facility has a unique cost overhead and general and administrative expense structure that is supported by cash flows from products produced at the facility. The carrying amount of an Asset Group is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the Asset Group.
If we determine that an Asset Group is not recoverable, then we would record an impairment charge if the carrying value of the Asset Group exceeds its fair value. Fair value is based on estimated discounted future cash flows expected to be generated by the Asset Group. The assumptions 55 -------------------------------------------------------------------------------- underlying cash flow projections would represent management's best estimates at the time of the impairment review. Some of the factors that management would consider or estimate include: industry and market conditions, sales volume and prices, costs to produce and inflation. Changes in key assumptions or actual conditions which differ from estimates could result in an impairment charge. We would use reasonable and supportable assumptions when performing impairment reviews but cannot predict the occurrence of future events and circumstances that could result in impairment charges.
When we review Asset Groups for recoverability, we also consider depreciation estimates and methods or the amortization period, in each case as required by applicable accounting standards. Any revision to the remaining useful life of a long-lived asset resulting from that review also is considered in developing estimates of future cash flows used to test the Asset Group for recoverability.
ENVIRONMENTAL COSTS. We are subject to environmental regulations that relate to our past and current operations. We record liabilities for environmental remediation costs when our assessments indicate that remediation efforts are probable and the costs can be reasonably estimated. On a quarterly basis, we review our estimates of future costs that could be incurred for remediation activities. In some cases, only a range of reasonably possible costs can be estimated. In establishing our reserves, the most probable estimate is used; otherwise, we accrue the minimum amount of the range. Estimates of liabilities are based on currently available facts, existing technologies and presently enacted laws and regulations. These estimates are subject to revision in future periods based on actual costs or new circumstances. Accrued environmental remediation costs include the undiscounted cost of equipment, operating and maintenance costs, and fees to outside law firms and consultants, for the estimated duration of the remediation activity and do not include an assumption for inflation. Estimating environmental cost requires us to exercise substantial judgment regarding the cost, effectiveness and duration of our remediation activities. Actual future expenditures could differ materially from our current estimates.
We evaluate potential claims for recoveries from other parties separately from our estimated liabilities. We record an asset for expected recoveries when recoveries of the amounts are probable.
INCOME TAXES. We account for income taxes under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax basis.
Deferred tax assets and liabilities are measured, separately for each tax-paying entity in each tax jurisdiction, using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date.
When measuring deferred tax assets, we assess whether a valuation allowance should be established by evaluating both positive and negative factors. This evaluation requires that we exercise judgment in determining the relative significance of each factor. A valuation allowance is established if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The assessment of valuation allowance requirements, if any, involves significant estimates regarding the timing and amount of reversal of taxable temporary differences, future taxable income and the implementation of tax planning strategies. We rely on deferred tax liabilities in our assessment of the realizability of deferred tax assets if the temporary timing difference is anticipated to reverse in the same period and jurisdiction and the deferred tax liabilities are of the same character as the temporary differences giving rise to the deferred tax assets.
We weigh both positive and negative evidence in determining whether it is more likely than not that a valuation allowance is required. Greater weight is given to evidence which is objectively verifiable such as historical results. If we report a cumulative loss from continuing operations before income taxes for a three-year period, we do not rely on forecasted improvements in earnings to recover deferred tax assets.
We account for uncertain tax positions in accordance with an accounting standard which creates a single model to address uncertainty in income tax positions and prescribes the minimum recognition 56-------------------------------------------------------------------------------- threshold a tax position is required to meet before being recognized in the financial statements. The standard also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition.
Under this standard, we may recognize tax benefits from an uncertain position only if it is more likely than not that the position will be sustained upon examination by taxing authorities based on the technical merits of the issue.
The amount recognized is the largest benefit that we believe has greater than a 50% likelihood of being realized upon settlement. Actual income taxes paid may vary from estimates depending upon changes in income tax laws, actual results of operations, and the final audit of tax returns by taxing authorities. Tax assessments may arise several years after tax returns have been filed.
PENSION BENEFITS. We sponsor four defined benefit pension plans in various forms for employees who meet eligibility requirements. Applicable accounting standards require that we make assumptions and use statistical variables in actuarial models to calculate our pension obligations and the related periodic pension expense. The most significant assumptions are the discount rate and the expected rate of return on plan assets. Additional assumptions include the future rate of compensation increases, which is based on historical plan data and assumptions on demographic factors such as retirement, mortality and turnover. Depending on the assumptions selected, pension expense could vary significantly and could have a material effect on reported earnings. The assumptions used can also materially affect the measurement of benefit obligations.
The discount rate is used to estimate the present value of projected future pension payments to all participants. The discount rate is generally based on the yield on AAA/AA-rated corporate long-term bonds. At September 30 of each year, the discount rate is determined using bond yield curve models matched with the timing of expected retirement plan payments. Our discount rate assumption was 5.40 percent as of September 30, 2012. Holding all other assumptions constant, a hypothetical increase or decrease of 25 basis points in the discount rate assumption would increase or decrease annual pension expense by approximately $526.
The expected long-term rate of return on plan assets represents the average rate of earnings expected on the plan funds invested in a specific target asset allocation. The expected long-term rate of return assumption on pension plan assets was 8.00 percent in Fiscal 2012. Holding all other assumptions constant, a hypothetical 25 basis point increase or decrease in the assumed long-term rate of return would increase or decrease annual pension expense by approximately $131.
RECENTLY ISSUED OR ADOPTED ACCOUNTING STANDARDS. In June 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2011-05, which amends Topic 220, Comprehensive Income. The amendment allows 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, and eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. The amendments do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. This standard was effective for us beginning on October 1, 2012. The adoption of this standard is not expected to have a material impact on our results of operations, financial position or cash flows.
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