-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AujE7EA2qctFIPrcS8xdhOlU72UpVPbIllUzKaBD7c77dSIXI6VdjCZLYjRXPxm5 I3ZzAjJGecX0+XL8w3MZLA== 0000950152-06-002190.txt : 20060316 0000950152-06-002190.hdr.sgml : 20060316 20060316154442 ACCESSION NUMBER: 0000950152-06-002190 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20051231 FILED AS OF DATE: 20060316 DATE AS OF CHANGE: 20060316 FILER: COMPANY DATA: COMPANY CONFORMED NAME: BRUSH ENGINEERED MATERIALS INC CENTRAL INDEX KEY: 0001104657 STANDARD INDUSTRIAL CLASSIFICATION: PRIMARY SMELTING & REFINING OF NONFERROUS METALS [3330] IRS NUMBER: 341919973 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-15885 FILM NUMBER: 06691882 BUSINESS ADDRESS: STREET 1: 17876 ST. CLAIR AVE. CITY: CLEVELAND STATE: OH ZIP: 44110 BUSINESS PHONE: 2163834062 MAIL ADDRESS: STREET 1: 17876 ST. CLAIR AVE. CITY: CLEVELAND STATE: OH ZIP: 44110 10-K 1 l17862ae10vk.htm BRUSH ENGINEERED MATERIALS 10-K BRUSH ENGINEERED MATERIALS 10-K
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
FORM 10-K
 
     
(Mark One)
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005
OR
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from           to          
 
Commission file number 1-15885
 
 
BRUSH ENGINEERED MATERIALS INC.
(Exact name of Registrant as specified in its charter)
 
 
     
Ohio   34-1919973
(State or other jurisdiction of
incorporation or organization) 		  (I.R.S. Employer
Identification No.)
17876 St. Clair Avenue, Cleveland, Ohio   44110
(Address of principal executive offices)   (Zip Code)
 
Registrant’s telephone number, including area code 216-486-4200
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of each class
 
Name of each exchange on which registered
 
Common Stock, no par value
  New York Stock Exchange
 
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o     No þ
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ     No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One)
 
Large accelerated filer o          Accelerated filer þ          Non-accelerated filer o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o     No þ
 
The aggregate market value of Common Stock, no par value, held by non-affiliates of the registrant (based upon the closing sale price on the New York Stock Exchange) on July 1, 2005 was approximately $276,481,844.
 
As of March 3, 2006, there were 19,278,942 shares of Common Stock, no par value, outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the annual report to shareholders for the year ended December 31, 2005 are incorporated by reference into Parts I, II and IV. Portions of the proxy statement for the annual meeting of shareholders to be held on May 2, 2006 are incorporated by reference into Part III.
 

 

 
BRUSH ENGINEERED MATERIALS INC.
 
Index to Annual Report
On Form 10-K for
Year Ended December 31, 2005
 
             
       
  Business   1
  Risk Factors   5
  Unresolved Staff Comments   14
  Properties   14
  Legal Proceedings   16
  Submission of Matters to a Vote of Security Holders   18
       
  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   19
  Selected Financial Data   19
  Management’s Discussion and Analysis of Financial Condition and Results of Operations   19
  Quantitative and Qualitative Disclosures About Market Risk   19
  Financial Statements and Supplementary Data   19
  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   19
  Controls and Procedures   19
  Other Information   20
       
  Directors and Executive Officers of the Registrant   21
  Executive Compensation   21
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   21
  Certain Relationships and Related Transactions   21
  Principal Accounting Fees and Services   21
       
  Exhibits, Financial Statement Schedules   22
    Signatures   27
 EX-13 Financials
 EX-21 Subsidiaries
 EX-23 Consent - E & Y
 EX-24 Power of Attorney
 EX-31.1 Certification 302 - CEO
 EX-31.2 Certification 302 - CFO
 EX-32.1 Certifications 906 - CEO and CFO

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PART I
 
Forward-Looking Statements
 
Portions of the narrative set forth in this document that are not statements of historical or current facts are forward-looking statements. Our actual future performance may materially differ from that contemplated by the forward-looking statements as a result of a variety of factors. These factors include, in addition to those mentioned elsewhere herein:
 
  •  The global and domestic economies;
 
  •  The condition of the markets which we serve, whether defined geographically or by segment, with the major market segments being telecommunications and computer, magnetic and optical data storage, aerospace and defense, automotive electronics, industrial components and appliance;
 
  •  Changes in product mix and the financial condition of customers;
 
  •  Our success in developing and introducing new products and applications;
 
  •  Our success in integrating newly acquired businesses;
 
  •  Our success in implementing our strategic plans and the timely and successful completion of any capital projects;
 
  •  The availability of adequate lines of credit and the associated interest rates;
 
  •  Other financial factors, including cost and availability of materials, tax rates, exchange rates, pension and other employee benefit costs, energy costs, regulatory compliance costs, and the cost and availability of insurance;
 
  •  The uncertainties related to the impact of war and terrorist activities;
 
  •  Changes in government regulatory requirements and the enactment of new legislation that impacts our obligations; and,
 
  •  The conclusion of pending litigation matters in accordance with our expectation that there will be no material adverse effects.
 
Item 1.   BUSINESS
 
Brush Engineered Materials Inc., through its wholly owned subsidiaries, is a leading manufacturer of high-performance engineered materials serving the global telecommunications and computer, magnetic and optical data storage, aerospace and defense, automotive electronics, industrial components and appliance markets. As of December 31, 2005, we had 1,970 employees.
 
Our subsidiaries are organized under two reportable segments: the Metal Systems Group and the Microelectronics Group. The Metal Systems Group includes Brush Wellman Inc. (Alloy Products and Beryllium Products), Technical Materials, Inc. (TMI) and Brush Resources Inc. (BRI). Starting in 2005, BRI, a wholly owned subsidiary that manages our mining and milling operations in Utah, is included in the Metal Systems Group while previously it was included in the “All Other” column in the segment reporting details. This change was made because we believe that the operating issues affecting BRI, the management of the operations and the flow of materials are more closely aligned with the Metal Systems Group and this change is more reflective of how the operations are now managed. Segment results for the prior year comparisons have been restated to reflect this change. The Microelectronics Group includes Williams Advanced Materials Inc. (WAM) and Electronic Products, which in turn, consists of Zentrix Technologies Inc. (Zentrix), a wholly owned subsidiary of the Company, and Brush Ceramics Products Inc., (BCP), a wholly owned subsidiary of Brush Wellman Inc. Portions of Brush International Inc. are included in both segments.
 
Our parent company, Brush Engineered Materials Inc., and other corporate expenses, as well as the operating results from BEM Services, Inc., a wholly owned subsidiary, are not part of either segment and remain in the All


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Other column. BEM Services charges a management fee for the services it provides, primarily corporate, administrative and financial oversight, to our other businesses on a cost-plus basis. Corporate employees not covered as part of either reportable segment, including employees of BEM Services, Inc., totaled 85 as of December 31, 2005.
 
METAL SYSTEMS GROUP
 
The Metal Systems Group is comprised of Alloy Products, Beryllium Products, TMI and BRI. In 2005, 57% of our sales were from this segment (61% in both 2004 and 2003). As of December 31, 2005 the Metal Systems Group had 1,233 employees.
 
Alloy Products manufactures beryllium-containing and other high performance-based materials including copper-nickel-tin alloys that are metallurgically tailored to meet specific customer performance requirements. These products exhibit high electrical and thermal conductivities, high strength and hardness, good formability and excellent resistance to corrosion, wear and fatigue. These alloys, sold in strip and bulk form, are ideal choices for demanding applications in the telecommunications and computer, automotive electronics, aerospace, industrial components including oil and gas, heavy equipment and plastic mold tooling and appliances markets. These products are sold domestically through Brush distribution centers and internationally through Company-owned and independent distribution centers and independent sales representatives.
 
Alloy Products’ primary direct competitor in strip form beryllium alloys is NGK Insulators, Ltd. of Nagoya, Japan, with subsidiaries in the U.S. and Europe. Alloy Strip Products also competes with alloy systems manufactured by Olin Corporation, Wieland Electric, Inc., Stolberger Metallwerke GmbH, Nippon Mining, PMX and also with other generally less expensive materials, including phosphor bronze, stainless steel and other specialty copper and nickel alloys which are produced by a variety of companies around the world. In the area of bulk products (bar, plate, tube and rod), in addition to NGK Insulators, Brush competes with several smaller regional producers such as Freedom Alloys in the U.S., LaBronze Industriel in Europe and Young II in Asia.
 
Beryllium Products manufactures products that include beryllium, AlBeMet® and E-materials. Beryllium is a lightweight metal possessing unique mechanical and thermal properties. Its specific stiffness is much greater than other engineered structural materials such as aluminum, titanium and steel. Beryllium is extracted from both bertrandite and imported beryl ore. Beryllium products are used in a variety of high performance applications in the defense, space, industrial, scientific equipment and medical and optical scanning markets. Beryllium-containing products are sold throughout the world through a direct sales organization and through Company-owned and independent distribution centers. While Beryllium Products is the only domestic producer of metallic beryllium, it competes with other fabricators as well as with designs utilizing other materials.
 
TMI manufactures engineered material systems that are combinations of precious and non-precious metals in continuous strip form, and are used in complex electronic and electrical components in telecommunications systems, automotive electronics, semi-conductors and computers. TMI’s products are sold directly and through its sales representatives. TMI has limited competition in the United States and several European manufacturers are competitors for the sale of inlaid strip. A major competitor of TMI is Tanaka in Asia.
 
BRI manages our mine and milling operations. The milling operations produce beryllium hydroxide from mined bertrandite ore and purchased beryl ore. The hydroxide is used primarily as a raw material input by the other businesses within the Metal Systems Group. BRI also sells hydroxide externally to Alloy Products’ primary competitor in beryllium alloys, NGK Insulators, Ltd.


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Metal Systems Group — Sales and Backlog
 
The backlog of unshipped orders for the Metal Systems Group as of December 31, 2005, 2004 and 2003 was $88,107,000, $81,457,000 and $74,058,000, respectively.1 Backlog is generally represented by purchase orders that may be terminated under certain conditions. We expect that substantially all of our backlog of orders for this segment at December 31, 2005 will be filled during 2006.
 
Sales are made to approximately 1,575 customers. Government sales, principally subcontracts, accounted for about 0% of Metal Systems Group sales in 2005, 2004 and 2003. Sales outside the United States, principally to Europe, Canada and Asia, accounted for approximately 42% of the Metal Systems Group sales in 2005, 41% in 2004 and 42% in 2003. Other segment reporting and geographic information set forth on page 50 in Note M to the consolidated financial statements in the annual report to shareholders for the year ended December 31, 2005 is incorporated herein by reference.
 
Metal Systems Group — Research and Development
 
Active research and development programs seek new product compositions and designs as well as process innovations. Expenditures for research and development for the Metal Systems Group amounted to $3,790,000 in 2005, $3,373,000 in 2004 and $2,820,000 in 2003. A staff of 20 scientists, engineers and technicians was employed in this effort as of year-end 2005. Some research and development projects, expenditures for which are not material, were externally sponsored.
 
MICROELECTRONICS GROUP
 
The Microelectronics Group is comprised of WAM and Electronic Products, which consists of Zentrix and BCP. In 2005, 43% of our sales were from this segment (39% in both 2004 and 2003). As of December 31, 2005 the Microelectronics Group had 652 employees.
 
WAM manufactures and fabricates precious metal and specialty metal products for the magnetic and optical data storage, magnetic head, including magnetic resistive and giant magnetic resistive materials, electron tube, medical and the wireless, semiconductor, photonic and hybrid segments of the microelectronics market. WAM’s major product lines include vapor deposition materials, clad and precious metals preforms, high temperature braze materials, ultra fine wire, sealing lids for the semiconductor/hybrid markets and restorative dental alloys.
 
WAM’s products are sold directly from WAM’s facilities in Buffalo, New York; Brewster, New York; Wheatfield, New York; Buellton, California; Milwaukee, Wisconsin; Ireland, Singapore, Taiwan and the Philippines, as well as through direct sales offices and independent sales representatives throughout the world. Principal competition includes companies such as Sumitomo Metals, Praxair, Inc., Honeywell International Inc. and a number of smaller regional and national suppliers.
 
Electronic Products manufactures electronic packaging, circuitry and beryllia ceramics through two of our subsidiaries, Zentrix and BCP. Production sites include Oceanside, California; Tucson, Arizona and Newburyport, Massachusetts. These products are used in wireless telecommunication, fiberoptics, automotive and defense applications. Products are sold directly and through its sales representatives. Competitors include Kyocera Corporation, Semx Corporation, Aeroflex, Inc., American Technical Ceramics and Anaren Microwave, Inc. Competitive materials include alumina, aluminum nitride and composites. Principal competitors in beryllia ceramics are CBL Ceramics Ltd. and American Beryllia Inc.
 
 
1 Effective January 1, 2005, Brush Resources Inc. became a part of the Metals Systems Group. In addition, the backlog for foreign subsidiaries was inadvertently omitted in years 2004 and 2003. The 2004 and 2003 backlog amounts for the Metals Systems Group have been revised to include Brush Resources Inc. and the foreign subsidiaries.


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Microelectronics Group — Sales and Backlog
 
The backlog of unshipped orders for the Microelectronics Group as of December 31, 2005, 2004 and 2003 was $23,463,000, $18,266,000 and $16,110,000, respectively.2 Backlog is generally represented by purchase orders that may be terminated under certain conditions. We expect that substantially all of our backlog of orders for this segment at December 31, 2005 will be filled during 2006.
 
Sales are made to approximately 1,896 customers. Government sales, principally subcontracts, accounted for less than 1% of Microelectronics Group sales in 2005 as compared to 0% in 2004 and less than 1% in 2003. Sales outside the United States, principally to Europe, Canada and Asia, accounted for approximately 22% of Microelectronics Group sales in 2005, 22% in 2004 and 15% in 2003. Other segment reporting and geographic information set forth on page 50 in Note M to the consolidated financial statements in the annual report to shareholders for the year ended December 31, 2005 is incorporated herein by reference.
 
Microelectronics Group — Research and Development
 
Active research and development programs seek new product compositions and designs as well as process innovations. Expenditures for research and development for the Microelectronics Group amounted to $1,200,000 for 2005, $1,154,000 for 2004 and $1,409,000 for 2003. A staff of 10 scientists, engineers and technicians was employed in this effort as of year-end 2005.
 
GENERAL
 
Availability of Raw Materials
 
The principal raw materials we use are beryllium (extracted from both imported beryl ore and bertrandite mined from our Utah properties), copper, gold, silver, nickel, platinum, palladium and aluminum. Ore reserve data in Management’s Discussion and Analysis of Financial Condition and Results of Operations on page 25 of our annual report to shareholders for the year ended December 31, 2005 is incorporated herein by reference. We have agreements to purchase stated quantities of beryl ore, beryllium metal and beryllium-copper master alloy from the Defense Logistics Agency of the United States Government. In addition, we have a long-term supply arrangement with Ulba/Kazatomprom of the Republic of Kazakhstan and its marketing representative, Nukem, Inc. of New York, to purchase quantities of beryllium-copper master and beryllium vacuum cast billet. The availability of these raw materials, as well as other materials we use, is adequate and generally not dependent on any one supplier.
 
Patents and Licenses
 
We own patents, patent applications and licenses relating to certain of our products and processes. While our rights under the patents and licenses are of some importance to our operations, our business is not materially dependent on any one patent or license or on all of our patents and licenses as a group.
 
Regulatory Matters
 
We are subject to a variety of laws which regulate the manufacture, processing, use, handling, storage, transport, treatment, emission, release and disposal of substances and wastes used or generated in manufacturing. For decades we have operated our facilities under applicable standards of in plant and out plant emissions and releases. The inhalation of airborne beryllium particulate may present a health hazard to certain individuals. Standards for exposure to beryllium are under review by the United States Occupational Safety and Health Administration and by other governmental and private standard-setting organizations. One result of these reviews will likely be more stringent worker safety standards. More stringent standards may affect buying decisions by the users of beryllium-containing products. If the standards are made more stringent or our customers decide to reduce their use of beryllium-containing products, our operating results, liquidity and capital resources could be materially
 
 
2 The backlog for foreign subsidiaries within Williams Advanced Materials Inc. for the Microelectronics Group was inadvertently omitted in years 2004 and 2003. The 2004 and 2003 backlog amounts for the Microelectronics Group have been revised to include Williams Advanced Materials worldwide.


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adversely affected. The extent of this adverse effect would depend on the nature and extent of the changes to the standards, the cost and ability to meet the new standards, the extent of any reduction in customer use and other factors that cannot be estimated.
 
Executive Officers of the Registrant
 
The following table shows the name, age and position of each of our executive officers as of December 31, 2005:
 
             
Name
 
Age
   
Positions and Offices
 
Gordon D. Harnett
    63     Chairman of the Board, Chief Executive Officer and Director.  Mr. Harnett was elected Chairman of the Board, Chief Executive Officer and Director of the Company effective January 1991. In addition, Mr. Harnett had served as President of the Company from January 1991 to May 2001 and from May 2002 to May 2005. Prior to January 1991, he had served as a Senior Vice President of The B. F. Goodrich Company from November 1988. Mr. Harnett has announced his intention to retire effective at this year’s annual meeting of shareholders.
Richard J. Hipple
    53     President and Chief Operating Officer.  Mr. Hipple joined Brush Wellman, a wholly owned subsidiary, in July 2001 and served as its Vice President of Strip Products from July 2001 until May 2002, at which time he was appointed as President of Alloy Products. In May of 2005, Mr. Hipple was named President and Chief Operating Officer of Brush Engineered Materials Inc. Prior to joining Brush, Mr. Hipple was President of LTV Steel Company, a business unit of the LTV Corporation. Prior to running LTV’s steel business, Mr. Hipple held numerous leadership positions in Engineering, Operations, Strategic Planning, Sales and Marketing and Procurement since 1975 at LTV. Mr. Hipple will stand for election to our Board of Directors at this year’s annual meeting of shareholders. It is also anticipated that our Board of Directors will appoint Mr. Hipple as Chairman of the Board, President and Chief Executive Officer upon Mr. Harnett’s retirement.
John D. Grampa
    58     Vice President Finance and Chief Financial Officer.  Mr. Grampa was elected Vice President Finance and Chief Financial Officer in November 1999. He had served as Vice President Finance since October 1998. Prior to that, he had served as Vice President, Finance for the Worldwide Materials Business of Avery Dennison Corporation since March 1994 and held other various financial positions at Avery Dennison Corporation from 1984.
Daniel A. Skoch
    56     Senior Vice President Administration.  Mr. Skoch was elected Senior Vice President Administration in July 2000. Prior to that time, he had served as Vice President Administration and Human Resources since March 1996. He had served as Vice President Human Resources since July 1991 and prior to that time, he was Corporate Director — Personnel.
 
Item 1A.  RISK FACTORS
 
Our business, financial condition, results of operations and cash flows can be affected by a number of factors, including but not limited to those set forth below and elsewhere in the Annual Report on Form 10-K, any one of which could cause our actual results to vary materially from recent results or from our anticipated future results. Therefore, an investment in us involves some risks, including the risks described below. The risks discussed below are not the only risks that we may experience. If any of the following risks occur, our business, results of operations or financial condition could be negatively impacted.


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Health issues and litigation relating to machining and manufacturing of beryllium-containing products could significantly reduce demand for our products, limit our ability to operate and cause us to pay material amounts in respect of product liability claims.
 
If exposed to respirable beryllium fumes, dusts or powder, some individuals may demonstrate an allergic reaction to beryllium and may later develop a chronic lung disease known as chronic beryllium disease, or CBD. Some people who are diagnosed with CBD do not develop clinical symptoms at all. In others, the disease can lead to scarring and damage of lung tissue, causing clinical symptoms that include shortness of breath, wheezing and coughing. Severe cases of CBD can cause disability or death.
 
Further, some scientists claim there is evidence of an association between beryllium exposure and lung cancer, and certain standard-setting organizations have classified beryllium and beryllium compounds as human carcinogens.
 
The health risks relating to exposure to beryllium have been, and will continue to be, a significant issue confronting the beryllium-containing products industry. The health risks associated with beryllium have resulted in product liability claims, employee and third-party lawsuits and increased levels of scrutiny by federal, state, foreign and international regulatory authorities of ours and our customers. Concerns over CBD and other potential adverse health effects relating to beryllium, as well as concerns regarding potential liability from the use of beryllium, may discourage our customers’ use of our beryllium-containing products and significantly reduce demand for our products.
 
One of our subsidiaries, Brush Wellman Inc., is a defendant in proceedings in various state and federal courts brought by plaintiffs alleging that they have contracted, or have been placed at risk of contracting, chronic beryllium disease or other lung conditions as a result of exposure to beryllium. Plaintiffs in beryllium cases seek recovery under negligence and various other legal theories and seek compensatory and punitive damages, in many cases of an unspecified sum. Spouses, if any, claim loss of consortium. As of December 31, 2005 there were 13 cases pending. Approximately 92% of our pending beryllium-related claims are covered by various syndicates of Lloyd’s of London (now reinsured through Equitas Holdings Limited) and other London insurance market companies, some of whom are or may become insolvent. If our insurance carriers are insolvent or become insolvent, we may become directly responsible for payments relating to product liability claims, which could divert funds from other intended purposes, including capital expenditures or other operating requirements.
 
Our profitability could be affected adversely by unfavorable results in one or more of those cases. In addition, continued or increased adverse media coverage relating to our beryllium-containing products could damage our reputation or cause a decrease in demand for beryllium-containing products, which could adversely affect our profitability. Further, an unfavorable outcome or settlement of a pending beryllium case or additional adverse media coverage could encourage the commencement of additional similar litigation. We are unable to estimate the potential exposure to unasserted claims.
 
We are currently self-insured for product liability claims based on exposure to beryllium after July 2001, and we may incur material losses from those claims, which could adversely affect our profitability.
 
Although we have varying levels of insurance coverage from insurance carriers for product liability claims based on exposure to beryllium for most periods prior to July 2001, we are self-insured for product liability claims based on exposure to beryllium after July 2001 and for a short period in the 1980s. We may not be able to provide adequate coverage against all potential liabilities. We may incur significant losses from claims for which we are self-insured.
 
Our bertrandite ore mining and our manufacturing operations and our customers’ businesses are subject to extensive health and safety regulations that impose, and will continue to impose, significant costs and liabilities, and future regulation could increase those costs and liabilities or effectively prohibit production or use of beryllium-containing products.
 
We and our customers are subject to laws regulating worker exposure to beryllium. Standards for exposure to beryllium are under review by the United States Occupational Safety and Health Administration and by other


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governmental and private standard-setting organizations. One result of these reviews will likely be more stringent worker safety standards. More stringent standards may affect buying decisions by the users of beryllium-containing products. If the standards are made more stringent or our customers decide to reduce their use of beryllium- containing products, our operating results, liquidity and capital resources could be materially adversely affected. The extent of this adverse effect would depend on the nature and extent of the changes to the standards, the cost and ability to meet the new standards, the extent of any reduction in customer use and other factors that cannot be estimated.
 
Our bertrandite ore mining and our manufacturing operations are subject to extensive environmental regulations that impose, and will continue to impose, significant costs and liabilities on us, and future regulation could increase these costs and liabilities or prevent production of beryllium-containing products.
 
We are subject to a variety of governmental regulations relating to the environment, including those relating to our handling of hazardous materials and air and wastewater emissions. Some environmental laws impose substantial penalties for noncompliance. Others, such as the federal Comprehensive Environmental Response, Compensation, and Liability Act, impose strict, retroactive and joint and several liability upon entities responsible for releases of hazardous substances. Bertrandite ore mining is also subject to extensive governmental regulation on matters such as permitting and licensing requirements, plant and wildlife protection, reclamation and restoration of mining properties, the discharge of materials into the environment and the effects that mining has on groundwater quality and availability. If we fail to comply with present and future environmental laws and regulations, we could be subject to liabilities or our operations could be interrupted. In addition, future environmental laws and regulations could restrict our ability to expand our facilities or extract our bertrandite ore deposits. They could also require us to acquire costly equipment or to incur other significant expenses in connection with our business, which would increase our costs of production.
 
The availability of competitive substitute materials for beryllium-containing products may reduce our customers’ demand for these products and reduce our sales.
 
In certain product applications, we compete with manufacturers of non-beryllium-containing products, including organic composites, metal alloys or composites, titanium and aluminum. Our customers may choose to use substitutes for beryllium-containing products in their products for a variety of reasons, including, among other things, the lower costs of those substitutes, the health and safety concerns relating to these products and the risk of litigation relating to beryllium-containing products. If our customers use substitutes for beryllium-containing products in their products, the demand for our beryllium-containing products may decrease, which could reduce our sales.
 
The markets for our beryllium-containing and non-beryllium-containing products are experiencing rapid changes in technology.
 
We operate in markets characterized by rapidly changing technology and evolving customer specifications and industry standards. New products may quickly render an existing product obsolete and unmarketable. For example, we used to produce beryllium-copper alloys that were used in the production of some golf club heads; however, these beryllium-copper alloy club heads are no longer produced by any of our customers. Our growth and future results of operations depend in part upon our ability to enhance existing products and introduce newly developed products on a timely basis that conform to prevailing and evolving industry standards, meet or exceed technological advances in the marketplace, meet changing customer specifications, achieve market acceptance and respond to our competitors’ products.
 
The process of developing new products can be technologically challenging and requires the accurate anticipation of technological and market trends. We may not be able to introduce new products successfully or do so on a timely basis. If we fail to develop new products that are appealing to our customers or fail to develop products on time and within budgeted amounts, we may be unable to recover our significant research and development costs, which could adversely affect our margins and profitability.


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Our beryllium-containing and non-beryllium-containing products are deployed in complex applications and may have errors or defects that we find only after deployment.
 
Our products are highly complex, designed to be deployed in complicated applications and may contain undetected defects, errors or failures. Although our products are generally tested during manufacturing, prior to deployment, they can only be fully tested when deployed in specific applications. For example, we sell beryllium-copper alloy strip products in a coil form to some customers, who then stamp the alloy for its specific purpose. On occasion, it is not until such customer stamps the alloy that a defect in the alloy is detected. Consequently, our customers may discover errors after the products have been deployed. The occurrence of any defects, errors, or failures could result in installation delays, product returns, termination of contracts with our customers, diversion of our resources, increased service and warranty costs and other losses to us or to our customers or end users. Any of these occurrences could also result in the loss of or delay in market acceptance of our products and could damage our reputation, which could reduce our sales.
 
We have incurred significant losses in the past, and may not be able to sustain profitability on an ongoing basis.
 
Although we have been profitable in 2004 and 2005 (net income of $15.5 million and $17.8 million, respectively), we have incurred significant losses in the past (net loss of $35.6 million in 2002 and $13.2 million in 2003) and may not be able to sustain this recent profitability on an ongoing basis. We have implemented strategic initiatives designed to improve our operating performance on an ongoing basis. We may not be able to successfully implement or realize the expected benefits of any of those initiatives or sustain improvements made to date. We may not meet our strategic goals or sustain profitability if we fail to achieve the goals of these initiatives.
 
Our customers are subject to significant fluctuations as a result of the cyclical nature of their industries and their sensitivity to general economic conditions, which could adversely affect their demand for our products and reduce our sales.
 
A substantial number of our customers are in the telecommunications and computer, magnetic and optical data storage, aerospace and defense and automotive electronics industries. Each of these industries is cyclical in nature, influenced by a combination of factors which could have a negative impact on our business, including, among other things, periods of economic growth or recession, strength or weakness of the United States dollar, the strength of the automotive electronics and computer industries and the rate of construction of telecommunications infrastructure equipment and government spending on defense.
 
The demand for our products is generally affected by macroeconomic fluctuations in the global economies in which we sell our products. Future economic downturns, stagnant economies or global currency fluctuations could also negatively affect our financial performance.
 
Our business is dependent on continued capital spending by the global telecommunications and computer industries, and a decrease in capital spending for infrastructure and equipment could affect our revenue from these markets. Our business could be exposed to unexpected or extended downturns in capital spending, which could adversely affect our sales. In addition, a decrease in military, aerospace or defense-related spending could adversely reduce demand for our products.
 
We may not be able to complete our acquisition strategy or successfully integrate acquired businesses.
 
We have been active over the last twelve months in pursuing niche acquisitions for one of our subsidiaries, Williams Advanced Materials Inc. We intend to continue to consider further growth opportunities through the acquisition of assets or companies involved in the engineered materials industry and routinely review acquisition opportunities. While we believe that there are available a number of potential acquisition candidates that would complement our businesses, we currently have no agreements, understandings or arrangements to acquire any specific business or material assets. We cannot predict whether we will be successful in pursuing any acquisition opportunities or what the consequences of any acquisition would be. Future acquisitions may involve the expenditure of significant funds and management time. Depending upon the nature, size and timing of future


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acquisitions, we may be required to raise additional financing, which may not be available to us on acceptable terms. Further, we may not be able to successfully integrate any acquired business with our existing businesses or recognize any expected advantages from any completed acquisition.
 
The terms of our indebtedness may restrict our ability to pursue our growth and acquisition strategies.
 
The terms of our credit facilities restrict our ability to, among other things, borrow and make investments, acquire other businesses and make capital expenditures. In addition, the terms of our indebtedness require us to satisfy specified financial covenants. Our ability to comply with these provisions depends, in part, on factors over which we may have no control. These restrictions could adversely affect our ability to pursue our growth and acquisition strategies. If we breach any of our financial covenants or fail to make scheduled payments, our creditors could declare all amounts owed to them to be immediately due and payable, and we may not have sufficient available funds to repay the amounts due, in which case we may be required to seek legal protection from our creditors.
 
We conduct our sales and distribution operations on a worldwide basis and are subject to the risks associated with doing business outside the United States.
 
We sell to customers outside of the United States from our United States and international operations. We have been and are continuing to expand our geographic reach in Europe and Asia. Shipments to customers outside of the United States accounted for approximately 33% of our sales in 2005, 33% in 2004 and 31% in 2003. We anticipate that international shipments will account for a significant portion of our sales for the foreseeable future. Revenue from non-United States operations (principally Europe and Asia) amounted to approximately 25% of our sales in 2005, 24% in 2004 and 22% in 2003. There are a number of risks associated with international business activities, including:
 
  •  burdens to comply with multiple and potentially conflicting foreign laws and regulations, including export requirements, tariffs and other barriers, environmental health and safety requirements and unexpected changes in any of these factors;
 
  •  difficulty in obtaining export licenses from the United States government;
 
  •  political and economic instability and disruptions, including terrorist attacks;
 
  •  potentially adverse tax consequences due to overlapping or differing tax structures; and
 
  •  fluctuations in currency exchange rates.
 
Fluctuations in currency exchange rates, particularly for the euro and the yen, have impacted our sales, margins and profitability in the past. The fair value of our asset relating to outstanding foreign currency contracts was $1.5 million at December 31, 2005, indicating that the average hedge rates were favorable compared to the actual year-end market exchange rates. Additionally, foreign and international regulations have also impacted our sales, margins and profitability in the past. See also “— Health issues and litigation relating to machining and manufacturing of beryllium-containing products could significantly reduce demand for our products, limit our ability to operate and cause us to pay material amounts in respect of product liability claims”, found on page 5 and “— Our bertrandite ore mining and our manufacturing operations and our customers’ businesses are subject to extensive health and safety regulations that impose, and will continue to impose, significant costs and liabilities, and future regulation could increase those costs and liabilities or effectively prohibit production or use of beryllium-containing products”, found on page 6. Further, any of these risks could continue in the future.
 
A major portion of our bank debt consists of variable-rate obligations, which subjects us to interest rate fluctuations.
 
Our credit facilities are secured by working capital and certain assets, such as plant, property and equipment. Our working capital line-of-credit includes variable-rate obligations, which expose us to interest rate risks. If interest rates increase, our debt service obligations on our variable-rate indebtedness would increase even if the amount borrowed remained the same, resulting in a decrease in our net income. We have developed a hedging


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program to manage the risks associated with interest rate fluctuations, but our program may not effectively eliminate all of the financial exposure associated with interest rate fluctuations. We currently have an instrument in place that has the effect of fixing the interest rate on a portion of our outstanding debt for three years. In addition, the appraised value of the collateral may not allow us to take advantage of the full capacity of our line of credit. For additional information regarding our market risks, please refer to pages 28 and 29 of our annual report to shareholders for the period ended December 31, 2005.
 
Our tax position may create volatility in our net income, and our ability to use our net operating loss carryforwards and alternative minimum tax credits may be impaired.
 
At December 31, 2005, we had a deferred tax asset of approximately $11.1 million relating to alternative minimum tax credits and approximately $20.8 million of net operating loss carryforwards. We evaluated our deferred tax assets and determined it is more likely than not that $5.9 million will be realized, while $19.9 million is subject to a valuation allowance. If we continue to generate pre-tax profit, all or a significant portion of the remaining valuation allowance of $19.9 million will be reversed. If subsequent years generate pre-tax losses, all or a portion of the $5.9 million asset may require a valuation allowance that will be reflected as tax expense.
 
The availability and prices of some raw materials we use in our manufacturing operations fluctuate, and increases in raw material costs can increase our operating costs.
 
We manufacture engineered materials using various precious and non-precious metals, including gold, silver, palladium, platinum, copper and nickel. The availability of and prices for these raw materials are subject to volatility and are influenced by worldwide economic conditions, speculative action, world supply and demand balances, inventory levels, availability of substitute metals, the United States dollar exchange rate, production costs of United States and foreign competitors, anticipated or perceived shortages and other factors. Decreased availability and fluctuating prices of precious and non-precious metals that we use in our manufacturing can increase our operating costs. For example, prices for copper have recently reached an all-time high due to, among other things, smelting capacity and increased demand from China. We currently cannot pass on the increased cost of copper to all of our customers. Further, we maintain some precious metals on a consigned inventory basis. Should the market price for precious metals increase by 15% from the prices on December 31, 2005, the additional pre-tax cost to us on an annual basis would be approximately $0.2 million. The owners of the precious metals charge a fee that fluctuates based on the market price of those metals and other factors. A significant increase in the market price of precious metals or the consignment fee could increase our financing costs, which could increase our operating costs.
 
Because we experience seasonal fluctuations in our sales, our quarterly results will fluctuate, and our annual performance will be affected by the fluctuations.
 
Because many of our European and automotive electronics customers slow or cease operations during the summer months, we sometimes experience weaker demand in the quarters ending in September compared to the quarters ending in March, June and December. We expect this seasonal pattern to continue, which causes our quarterly results to fluctuate. If our revenue during any quarter were to fall below the expectations of investors or securities analysts, our share price could decline, perhaps significantly. Unfavorable economic conditions, lower than normal levels of demand and other occurrences in any of the other quarters could also harm our operating results.
 
Natural disasters, equipment failures, work stoppages and other unexpected events may lead our customers to curtail production or shut down their operations.
 
Our customers’ manufacturing operations are subject to conditions beyond their control, including raw material shortages, natural disasters, interruptions in electrical power or other energy services, equipment failures, work stoppages due to strikes or lockouts, particularly those affecting the automotive industry, one of our major markets, and other unexpected events. Any of those events could also affect other suppliers to our customers. In either case, those events could cause our customers to curtail production or to shut down a portion or all of their operations, which could reduce their demand for our products and reduce our sales.


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Unexpected events and natural disasters at our mine could increase the cost of operating our business.
 
A portion of our production costs at our mine are fixed regardless of current operating levels. Our operating levels are subject to conditions beyond our control that may increase the cost of mining for varying lengths of time. These conditions include, among other things, fire, natural disasters, pit wall failures and ore processing changes. Our mining operations also involve the handling and production of potentially explosive materials. It is possible that an explosion could result in death and injuries to employees and others and material property damage to third parties and us. Any explosion could expose us to adverse publicity or liability for damages and materially adversely affect our operations. Any of these events could increase our cost of operations.
 
Equipment failures and other unexpected events at our facilities may lead to manufacturing curtailments or shutdowns.
 
The manufacturing processes that take place in our mining operation, as well as in our manufacturing facilities, depend on critical pieces of equipment. This equipment may, on occasion, be out of service because of unanticipated failure, and some equipment is not readily available or replaceable. In addition to equipment failures, our facilities are also subject to the risk of loss due to unanticipated events such as fires, explosions or other disasters. Material plant shutdowns or reductions in operations could harm our ability to fulfill our customers’ demands, which could harm our sales and cause our customers to find other suppliers. Further, remediation of any interruption in production capability may require us to make large capital expenditures, particularly associated with our Metal Systems Group business which is more capital intensive, which may have a negative effect on our profitability and cash flows. Our business interruption insurance may not cover all of the lost revenues associated with interruptions in our manufacturing capabilities.
 
Many of our manufacturing facilities are dependent on single source energy suppliers, and interruption in energy services may cause manufacturing curtailments or shutdowns.
 
Many of our manufacturing facilities depend on one source for electric power and for natural gas. For example, Utah Power is the sole supplier of electric power to the processing facility for our mining operations in Utah. A significant interruption in service from our energy suppliers due to equipment failures, terrorism or any other cause may result in substantial losses that are not fully covered by our business interruption insurance. Any substantial unmitigated interruption of our operations due to these conditions could harm our ability to meet our customers’ demands and reduce our sales.
 
If the price of electrical power, fuel or other energy sources increases, our operating expenses could increase significantly.
 
We have 19 milling and manufacturing facilities and a mining operation, which depend on electrical power, fuel or other energy sources. See “Item 2. — Properties,” found on page 14. Our operating expenses are sensitive to changes in electricity prices and fuel prices, including natural gas prices. Prices for electricity and natural gas have continued to increase and can fluctuate widely with availability and demand levels from other users. During periods of peak usage, supplies of energy may be curtailed, and we may not be able to purchase energy at historical market rates. While we have some long-term contracts with energy suppliers, we are exposed to fluctuations in energy costs that can affect our production costs. Although we enter into forward fixed price supply contracts for natural gas and electricity for use in our operations, those contracts are of limited duration and do not cover all of our fuel or electricity needs. Price increases in fuel and electricity costs will continue to increase our cost of operations.
 
We have a limited number of manufacturing facilities, and damage to those facilities could interrupt our operations, increase our costs of doing business and impair our ability to deliver our products on a timely basis.
 
Some of our facilities are interdependent. For instance, our manufacturing facility in Elmore, Ohio relies on our mining operation for its supply of beryllium hydroxide used in production of most of its beryllium-containing materials. Additionally, our Shoemakersville, Pennsylvania; Fremont, California and Tucson, Arizona manufacturing facilities are dependent on materials produced by our Elmore, Ohio manufacturing facility and our


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Wheatfield, New York manufacturing facility is dependent on our Buffalo, New York manufacturing facility. See “Item 2 — Properties,” found on page 14. The destruction or closure of any of our manufacturing facilities or our mine for a significant period of time as a result of fire, explosion, act of war or terrorism or other natural disaster or unexpected event may interrupt our manufacturing capabilities, increase our capital expenditures and our costs of doing business and impair our ability to deliver our products on a timely basis. In such an event, we may need to resort to an alternative source of manufacturing or to delay production, which could increase our costs of doing business. Our property damage and business interruption insurance may not cover all of our potential losses and may not continue to be available to us on acceptable terms, if at all.
 
Our lengthy and variable sales and development cycle makes it difficult for us to predict if and when a new product will be sold to customers.
 
Our sales and development cycle, which is the period from the generation of a sales lead or new product idea through the development of the product and the recording of sales, may typically take up to two or three years, making it very difficult to forecast sales and results of operations. Our inability to accurately predict the timing and magnitude of sales of our products, especially newly introduced products, could affect our ability to meet our customers’ product delivery requirements or cause our results of operations to suffer if we incur expenses in a particular period that do not translate into sales during that period, or at all. In addition, these failures would make it difficult to plan future capital expenditure needs and could cause us to fail to meet our cash flow requirements.
 

Future terrorist attacks and other acts of violence or war may directly harm our operations.
 
Future terrorist attacks or other acts of violence or war may directly impact our physical facilities. For example, our Elmore, Ohio facility is located near and derives power from a nuclear power plant, which could be a target for a terrorist attack. In addition, future terrorist attacks, related armed conflicts or prolonged or increased tensions in the Middle East or other regions of the world could cause consumer confidence and spending to decrease, decreasing demand for consumer goods that contain our products. Further, when the United States armed forces are involved in active hostilities or large-scale deployments, defense spending tends to focus more on meeting the physical needs of the troops, and planned expenditures on weapons and other systems incorporating our products may be reduced or deferred. Any of these occurrences could also increase volatility in the United States and worldwide financial markets, which could negatively impact our sales.
 
We may be unable to access the financial markets on favorable terms.
 
The inability to raise capital on favorable terms, particularly during times of uncertainty in the financial markets, could impact our ability to sustain and grow our business and would increase our capital costs. We rely on access to financial markets as a significant source of liquidity for capital requirements not satisfied by cash on hand or operating cash flow. Our access to the financial markets could be adversely impacted by various factors, including:
 
  •  Changes in credit markets that reduce available credit or the ability to renew existing liquidity facilities on acceptable terms;
 
  •  A deterioration of our credit;
 
  •  Extreme volatility in our markets that increases margin or credit requirements;
 
  •  A material breakdown in our risk management procedures; and
 
  •  The collateral pledge of substantially all of our assets in connection with our existing indebtedness, which limits our flexibility in raising additional capital.
 
All of these factors, except a material breakdown in our risk management procedures, have adversely impacted our access to the financial markets at various times over the last five years.


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Low investment performance by our pension plan assets may require us to increase our pension liability and expense, which may also lead us to accelerate funding our pension obligations and divert funds from other potential uses.
 
We provide defined benefit pension plans to eligible employees. Our pension expense and our required contributions to our pension plans are directly affected by the value of plan assets, the projected rate of return on plan assets, the actual rate of return on plan assets and the actuarial assumptions we use to measure our defined benefit pension plan obligations, including the rate at which future obligations are discounted to a present value, or the discount rate. For pension accounting purposes, we assumed an 8.5% rate of return on pension assets.
 
Lower investment performance of our pension plan assets resulting from a decline in the stock market could significantly increase the deficit position of our plans. Should the assets earn an average return less than 8.5% over time, it is likely that future pension expenses would increase. Investment earnings in excess of 8.5% may reduce future pension expenses. The actual return on our plan assets for the twelve months ending December 31, 2005 was 6.5% and the ten-year average annualized return as of year-end 2005 was 7.8%.
 
We establish the discount rate used to determine the present value of the projected and accumulated benefit obligation at the end of each year based upon the available market rates for high quality, fixed income investments. An increase in the discount rate would reduce the future pension expense and, conversely, a lower discount rate would raise the future pension expense.
 
Based on current guidelines, assumptions and estimates, including stock market prices and interest rates, we anticipate that we will be required to make a cash contribution of approximately $1.9 million to our pension plan in 2006. If our current assumptions and estimates are not correct, a contribution in years beyond 2006 may be greater than the projected 2006 contribution required.
 
We cannot predict whether changing market or economic conditions, regulatory changes or other factors will further increase our pension expenses or funding obligations, diverting funds we would otherwise apply to other uses.
 
Our expenditures for post-retirement health benefits could be materially higher than we have predicted if our underlying assumptions prove to be incorrect.
 
We also provide post-retirement health benefits to eligible employees. Our retiree health expense is directly affected by the assumptions we use to measure our retiree health plan obligations, including the assumed rate at which health care costs will increase and the discount rate used to calculate future obligations. For retiree health accounting purposes, we decreased the assumed rate at which health care costs will increase for the next year to 9% at December 31, 2005 from 10% at December 31, 2004. In addition, we have assumed that this health care cost increase trend rate will decline to 5% by 2010. We have used the same discount rates for our retiree health plans that we use for our pension plan accounting.
 
Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A 1.0% increase in assumed health care cost trend rates would have increased the post-employment benefits included among the liabilities in our balance sheet by $1.0 million at December 31, 2005.
 
We cannot predict whether changing market or economic conditions, regulatory changes or other factors will further increase our retiree health care expenses or obligations, diverting funds we would otherwise apply to other uses.
 
We are subject to fluctuations in currency exchange rates, which may negatively affect our financial performance.
 
A significant portion of our sales is conducted in international markets and priced in currencies other than the United States dollar. Revenues from customers outside of the United States (principally Europe and Asia) amount to 33%, 33% and 31% for the years 2005, 2004 and 2003, respectively. A significant part of these international sales are priced in currencies other than the U.S. dollar. Significant fluctuations in currency values relative to the United


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States dollar may negatively affect our financial performance. While we may hedge our currency transactions to mitigate the impact of currency price volatility on our earnings, any hedging activities may not be successful.
 
Our holding company structure causes us to rely on funds from our subsidiaries.
 
We are a holding company and conduct substantially all our operations through our subsidiaries. As a holding company, we are dependent upon dividends or other intercompany transfers of funds from our subsidiaries. The payment of dividends and other payments to us by our subsidiaries may be restricted by, among other things, applicable corporate and other laws and regulations, agreements of the subsidiaries and the terms of our current and future indebtedness.
 
Item 1B.  UNRESOLVED STAFF COMMENTS
 
None.
 
Item 2.  PROPERTIES
 
Our material properties, all of which are owned in fee except as otherwise indicated, are as follows:
 
Manufacturing Facilities
 
Brewster, New York — A 35,000 square foot leased facility on a 6.0 acre site for manufacturing services relating to non-precious metals.
 
Beullton, California — A leased complex of approximately 35,000 square feet on a 2.0 acre site providing facilities for the processing of precision coatings for photo lithography, thin film hybrid circuits and other specialized thin film coatings and services.
 
Buffalo, New York — A complex of approximately 97,000 square feet on a 3.8 acre site providing facilities for manufacturing, refining and laboratory services relating to high purity precious metals.
 
Delta, Utah — An ore extraction plant consisting of 86,000 square feet of buildings and large outdoor facilities situated on a 4,400 acre site. This plant extracts beryllium from bertrandite ore from our mines as well as from imported beryl ore.
 
Elmore, Ohio — A complex containing approximately 856,000 square feet (approximately 300,000 square feet of which is leased) of building space on a 439 acre plant site. This facility employs diverse chemical, metallurgical and metalworking processes in the production of beryllium, beryllium oxide, beryllium alloys and related products.
 
Fremont, California — A 16,800 square foot leased facility for the fabrication of precision electron beam welded, brazed and diffusion bonded beryllium structures.
 
Juab County, Utah — 7,500 acres with respective mineral rights from which the beryllium-bearing ore, bertrandite, is mined by the open pit method. A portion of the mineral rights is held under lease. Ore reserve data set forth on page 25 in the annual report to shareholders for the year ended December 31, 2005 is incorporated herein by reference.
 
Limerick, Ireland — An 18,000 square foot leased facility on an 0.8 acre site for the precision cleaning and surface treatment of electronic shielding kits and related items containing precious and non-precious metals.
 
Lincoln, Rhode Island — A manufacturing facility consisting of 140,000 square feet located on 7.5 acres. This facility produces reel-to-reel strip metal products which combine precious and non-precious metals in continuous strip form and related metal systems products.
 
Lorain, Ohio — A manufacturing facility consisting of 55,000 square feet located on 15 acres. This facility produces non-beryllium metal alloys in electronic induction furnaces, which are continually cast into bar stock and heat treated.
 
Newburyport, Massachusetts — A 30,000 square foot manufacturing facility on a 4 acre site that produces alumina, beryllia ceramic and direct bond copper products.


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Milwaukee, Wisconsin — Two buildings with a total of approximately 99,000 square feet located on 1.93 acres supplemented by 7,300 square feet of leased office space used in the manufacture and sale of specialty inorganic materials for the precious optics, security, ophthalmic and semiconductor industries.
 
Oceanside, California — A leased facility of approximately 12,000 square feet on 1.25 acres of leased land. Over three-quarters of this facility is comprised of clean rooms for the production of thick-film and other complex circuits.
 
Reading, Pennsylvania — A 123,000 square foot plant on a 55 acre site that produces thin precision strips of beryllium copper and other alloys and beryllium copper rod and wire.
 
Santa Clara, California — A 5,800 square foot leased facility that provides bonding services relating to physical vapor deposition (PVD) materials.
 
Singapore — A 4,500 square foot leased facility for the assembly and sale of precious metal hermetic sealing lids.
 
Subic Bay, Philippines — A 5,000 square foot leased facility that manufactures Combo-Lid® and performs preform assembly, inspection and packaging.
 
Taipei, Taiwan — A 5,000 square foot service/bonding center supporting the PVD product market in Asia.
 
Tucson, Arizona — A complex containing approximately 53,000 square feet of building space on a 7 acre site for the production of beryllium oxide ceramic substrates.
 
Wheatfield, New York — A 29,000 square foot facility on a 10.2 acre site for manufacturing services relating to braze materials and specialty alloys.
 
Research Facilities and Administrative Offices
 
Cleveland, Ohio — A 110,000 square foot building on an 18 acre site housing corporate and administrative offices, data processing and research and development facilities.
 
Sales and Administrative Offices
 
Singapore — A 2,500 square foot leased sales office that houses employees of Alloy Products and Williams Advanced Materials Far East Pte. Ltd.
 
Tokyo — A 5,400 square foot leased office that houses employees of Brush Wellman and Williams Advanced Materials.
 
The Company also has sales representative offices in Korea, Shanghai, Hong Kong and Taiwan.
 
Service and Distribution Centers
 
Elmhurst, Illinois — A 28,500 square foot leased facility principally for distribution of beryllium copper alloys.
 
Fairfield, New Jersey — A 24,500 square foot leased facility principally for distribution of beryllium copper alloys.
 
Fukaya, Japan — A 35,500 square foot facility on 1.8 acres of land in Saitama Prefecture principally for distribution of beryllium copper alloys.
 
Stuttgart, Germany — A 24,750 square foot leased facility principally for distribution of beryllium copper alloys.
 
Theale, England — A 19,700 square foot leased facility principally for distribution of beryllium copper alloys.
 
Warren, Michigan — A 34,500 square foot leased facility principally for distribution of beryllium copper alloys.


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Item 3.  LEGAL PROCEEDINGS
 
Our subsidiaries and our holding company are subject, from time to time, to a variety of civil and administrative proceedings arising out of our normal operations, including, without limitation, product liability claims, health, safety and environmental claims and employment-related actions. Among such proceedings are the cases described below.
 
Beryllium Claims
 
As of December 31, 2005, our subsidiary, Brush Wellman Inc., was a defendant in 13 proceedings in various state and federal courts brought by plaintiffs alleging that they have contracted, or have been placed at risk of contracting, chronic beryllium disease or other lung conditions as a result of exposure to beryllium. Plaintiffs in beryllium cases seek recovery under negligence and various other legal theories and seek compensatory and punitive damages, in many cases of an unspecified sum. Spouses of some plaintiffs claim loss of consortium.
 
During 2005, the number of beryllium cases increased from 12 (involving 56 plaintiffs) as of December 31, 2004 to 13 cases (involving 54 plaintiffs) as of December 31, 2005. During 2005, one case (involving one plaintiff) was settled and dismissed. Three cases (involving eight plaintiffs) were voluntarily dismissed by the plaintiffs. Five cases (involving seven plaintiffs) were filed in 2005.
 
The 13 pending beryllium cases as of December 31, 2005 fall into two categories: Nine cases involving third-party individual plaintiffs, with 13 individuals (and six spouses who have filed claims as part of their spouse’s case and two children who have filed claims as part of their parent’s case); and four purported class actions, involving 33 plaintiffs, as discussed more fully below. Claims brought by third party plaintiffs (typically employees of our customers or contractors) are generally covered by varying levels of insurance.
 
The first purported class action is Manuel Marin, et al. v. Brush Wellman Inc., filed in Superior Court of California, Los Angeles County, case number BC299055, on July 15, 2003. The named plaintiffs are Manuel Marin, Lisa Marin, Garfield Perry and Susan Perry. The defendants are Brush Wellman, Appanaitis Enterprises, Inc., and Doe Defendants 1 through 100. A First Amended Complaint was filed on September 15, 2004, naming five additional plaintiffs. The five additional named plaintiffs are Robert Thomas, Darnell White, Leonard Joffrion, James Jones and John Kesselring. The plaintiffs allege that they have been sensitized to beryllium while employed at the Boeing Company. The plaintiffs’ wives claim loss of consortium. The plaintiffs purport to represent two classes of approximately 250 members each, one consisting of workers who worked at Boeing or its predecessors and are beryllium sensitized and the other consisting of their spouses. They have brought claims for negligence, strict liability — design defect, strict liability — failure to warn, fraudulent concealment, breach of implied warranties, and unfair business practices. The plaintiffs seek injunctive relief, medical monitoring, medical and health care provider reimbursement, attorneys’ fees and costs, revocation of business license, and compensatory and punitive damages. Messrs. Marin, Perry, Thomas, White, Joffrion, Jones and Kesselring represent current and past employees of Boeing in California; and Ms. Marin and Ms. Perry are spouses. Defendant Appanaitis Enterprises, Inc. was dismissed on May 5, 2005.
 
The second purported class action is Neal Parker, et al. v. Brush Wellman Inc., filed in Superior Court of Fulton County, State of Georgia, case number 2004CV80827, on January 29, 2004. The case was removed to the U.S. District Court for the Northern District of Georgia, case number 04-CV-606, on May 4, 2004. The named plaintiffs are Neal Parker, Wilbert Carlton, Stephen King, Ray Burns, Deborah Watkins, Leonard Ponder, Barbara King and Patricia Burns. The defendants are Brush Wellman; Schmiede Machine and Tool Corporation; Thyssenkrupp Materials NA Inc., d/b/a Copper and Brass Sales; Axsys Technologies, Inc; Alcoa, Inc.; McCann Aerospace Machining Corporation; Cobb Tool, Inc.; and Lockheed Martin Corporation. Messrs. Parker, Carlton, King and Burns and Ms. Watkins are current employees of Lockheed. Mr. Ponder is a retired employee, and Ms. King and Ms. Burns and Ms. Watkins are family members. The plaintiffs have brought claims for negligence, strict liability, fraudulent concealment, civil conspiracy and punitive damages. The plaintiffs seek a permanent injunction requiring the defendants to fund a court-supervised medical monitoring program, attorneys’ fees and punitive damages. On March 29, 2005, the Court entered an order directing plaintiffs to amend their pleading to segregate out those plaintiffs who have endured only subclinical, cellular and subcellular effects from those who have sustained actionable tort injuries, and that following such amendment, the Court will enter an order dismissing


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the claims asserted by the former subset of claimants, dismissing Count I of the Complaint, which sought the creation of a medical monitoring fund; and dismissing the claims against defendant Axsys Technologies Inc. On April 20, 2005, the plaintiffs filed a Substituted Amended Complaint for Damages, contending that each of the eight named plaintiffs and the individuals listed on the attachment to the original Complaint, and each of the putative class members have sustained personal injuries; however, they allege that they identified five individuals whose injuries have manifested themselves such that they have been detected by physical examination and/or laboratory test.
 
The third purported class action is George Paz, et al. v. Brush Engineered Materials Inc., et al., filed in the U.S. District Court for the Southern District of Mississippi, case number 1:04CV597, on June 30, 2004. The named plaintiffs are George Paz, Barbara Faciane, Joe Lewis, Donald Jones, Ernest Bryan, Gregory Condiff, Karla Condiff, Odie Ladner, Henry Polk, Roy Tootle, William Stewart, Margaret Ann Harris, Judith Lemon, Theresa Ladner and Yolanda Paz. The defendants are Brush Engineered Materials Inc.; Brush Wellman Inc.; Wess-Del Inc.; and the Boeing Company. Plaintiffs seek the establishment of a medical monitoring trust fund as a result of their alleged exposure to products containing beryllium, attorneys’ fees and expenses, and general and equitable relief. The plaintiffs purport to sue on behalf of a class of present or former Defense Contract Management Administration (DCMA) employees who conducted quality assurance work at Stennis Space Center and the Boeing Company at its facility in Canoga Park, California; present and former employees of Boeing at Stennis; and spouses and children of those individuals. Messrs. Paz and Lewis and Ms. Faciane represent current and former DCMA employees at Stennis. Mr. Jones represents DCMA employees at Canoga Park. Messrs. Bryan, Condiff, Ladner, Polk, Tootle and Stewart and Ms. Condiff represent Boeing employees at Stennis. Ms. Harris, Ms. Lemon, Ms. Ladner and Ms. Paz are family members. We filed a Motion to Dismiss on September 28, 2004, which was granted and judgment was entered on January 11, 2005; however, the plaintiffs have filed an appeal, and the case is now in the U.S. Court of Appeals for the Fifth Circuit, case number 05-60157. Brush Engineered Materials Inc. was dismissed for lack of personal jurisdiction on the same date, which plaintiffs have not appealed.
 
The fourth purported class action is Gary Anthony v. Brush Wellman Inc., et al., filed in the Court of Common Pleas of Philadelphia County, Pennsylvania, case number 01718, on March 3, 2005. The case was removed to the U.S. District Court for the Eastern District of Pennsylvania, case number 05-CV-1202, on March 14, 2005. The only named plaintiff is Gary Anthony. The defendants are Brush Wellman Inc., Gary Kowalski, and Dickinson & Associates Manufacturers Representatives. The plaintiff purports to sue on behalf of a class of current and former employees of the U.S. Gauge facility in Sellersville, Pennsylvania who have ever been exposed to beryllium for a period of at least one month while employed at U.S. Gauge. The plaintiff has brought claims for negligence. Plaintiff seeks the establishment of a medical monitoring trust fund, cost of publication of approved guidelines and procedures for medical screening and monitoring of the class, attorneys’ fees and expenses.
 
Other Claims
 
One of our subsidiaries, Williams Advanced Materials Inc. (WAM) is a party to patent litigation with Target Technology Company, LLC (Target). In first actions filed in April 2003 by WAM against Target in the U.S. District Court, Western District of New York, consolidated under case number 03-CV-0276A (SR), WAM has asked the Court for a judgment declaring certain Target patents as invalid and/or unenforceable and awarding WAM damages in related cases. Target has counterclaimed alleging infringement and seeking a judgment for infringement, an injunction against further infringement and damages for past infringement. On August 3, 2005, the U.S. Court of Appeals for the Federal Circuit, case number 04-1602, affirmed the District Court’s decision denying Williams’ motion to enjoin Target from suing and threatening to sue Williams’ customers. The case reverted for further proceedings to the District Court, which has dismissed, without prejudice to their refiling, all other pending motions. Williams’ substitute revised supplemental and amended complaint with a proposed stipulated order was re-filed with the court on January 31, 2006, which the court approved on February 2, 2006. Trial is scheduled for February 2007. In September 2004, Target filed a separate action for patent infringement in U.S. District Court, Central District of California, case number SAC04-1083 DOC (MLGx), which action named as defendants, among others, WAM and WAM customers who purchase certain WAM alloys used in the production of DVDs. In the California action, Target alleges that the patent at issue, which is related to the patents at issue in the New York action, protects the use of certain silver alloys to make the semi-reflective layer in DVDs, and that in DVD-9s, a metal film is applied to the semi-reflective layer by a sputtering process, and that raw material for the procedure is


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called a sputtering target. Target alleges that WAM manufactures and sells sputtering targets made of a silver alloy to DVD manufacturers with knowledge that these targets are used by its customers to manufacture the semi-reflective layer of a DVD-9. In that action, Target seeks judgment that its patent is valid and that it is being infringed by the defendants, an injunction permanently restraining the defendants, damages adequate to compensate plaintiff for the infringement, treble damages, and attorneys’ fees and costs.
 
Item 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
No matters were submitted to a vote of security holders during the fiscal fourth quarter of 2005.


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PART II
 
Item 5.   MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Our shares of common stock are traded on the New York Stock Exchange. As of March 10, 2006 there were 1,564 shareholders of record. Information as to stock price as set forth on page 53 in Note S to the consolidated financial statements in the annual report to shareholders for the year ended December 31, 2005 is incorporated herein by reference. We suspended dividends in September 2001.
 
We did not purchase any of our shares of common stock or other securities during the year ended December 31, 2005.
 
Item 6.   SELECTED FINANCIAL DATA
 
Selected Financial Data on pages 54 and 55 of the annual report to shareholders for the year ended December 31, 2005 is incorporated herein by reference.
 
Item 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The management’s discussion and analysis of financial condition and results of operations on pages 14 through 29 of the annual report to shareholders for the year ended December 31, 2005 is incorporated herein by reference.
 
Item 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
The market risk disclosures on pages 28 and 29 of the annual report to shareholders for the year ended December 31, 2005 are incorporated herein by reference.
 
Item 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
The report of independent registered public accounting firm and the following consolidated financial statements of ours are included in the annual report to shareholders for the year ended December 31, 2005 are incorporated herein by reference:
 
Consolidated Balance Sheets — December 31, 2005 and 2004.
 
Consolidated Statements of Income — Years ended December 31, 2005, 2004 and 2003.
 
Consolidated Statements of Shareholders’ Equity — Years ended December 31, 2005, 2004 and 2003.
 
Consolidated Statements of Cash Flows — Years ended December 31, 2005, 2004 and 2003.
 
Notes to Consolidated Financial Statements.
 
Quarterly Data on page 53 in Note S to the consolidated financial statements in the annual report to shareholders for the year ended December 31, 2005 is incorporated herein by reference.
 
Item 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
None.
 
Item 9A.   CONTROLS AND PROCEDURES
 
We carried out an evaluation under the supervision and with participation of our management, including the chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2005 pursuant to Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, our management, including


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the chief executive officer and chief financial officer, concluded that our disclosure controls and procedures were effective as of the evaluation date.
 
There have been no changes in our internal controls over financial reporting identified in connection with the evaluation required by Rule 13a-15 under the Securities Exchange Act of 1934, as amended, that occurred during the quarter ended December 31, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
Management’s assessment on our internal control over financial reporting is contained in Management’s Report on Internal Control over Financial Reporting on page 31 in our annual report to shareholders for the year ended December 31, 2005 and is incorporated herein by reference.
 
The Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting opining on management’s assessment, included in Management’s Report on Internal Control over Financial Reporting, and opining on the effectiveness of our internal control over financial reporting is contained on page 31 in the annual report to shareholders for the year ended December 31, 2005 and is incorporated herein by reference.
 
The Company submitted an unqualified Section 12(a) CEO certification to the NYSE last year. In addition, the Company filed with the SEC the CEO/CFO certification required under Section 302 of the Sarbanes-Oxley Act in the annual report on Form 10-K for the year ended December 31, 2004.
 
Item 9B.   OTHER INFORMATION
 
None


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PART III
 
Item 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
The information under “Election of Directors” in the proxy statement for our 2006 annual meeting of shareholders, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, is incorporated herein by reference. The information required by this item relating to our executive officers is included under the caption “Executive Officers of the Registrant” in Part I of this report and is incorporated by reference into this section. The information required by Item 10 with respect to directors, the Audit Committee of the Board of Directors and Audit Committee financial experts is incorporated herein by reference from the section entitled “Corporate Governance; Committees of the Board of Directors” in the proxy statement for our 2006 annual meeting of shareholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A.
 
We have adopted a Policy Statement on Significant Corporate Governance Issues and a Code of Conduct Policy that applies to our chief executive officer, chief operating officer and senior financial officers, including the principal financial and accounting officer, controller and other persons performing similar functions in compliance with applicable New York Stock Exchange and Securities and Exchange Commission requirements. These materials, along with the charters of the Audit, Governance, Organization and Compensation and Retirement Plan Review Committees of our Board of Directors, which also comply with applicable requirements, are available on our website at www.beminc.com, and copies are also available upon request by any shareholder to Secretary, Brush Engineered Materials Inc., 17876 St. Clair Avenue, Cleveland, Ohio 44110. We make our reports on Forms 10-K, 10-Q and 8-K available on our website, free of charge, as soon as reasonably practicable after these reports are filed with the Securities and Exchange Commission, and any amendments or waivers to our Code of Conduct Policy Statement on Significant Corporate Governance Issues will also be made available on our website. The information on our website is not incorporated by reference into this annual report on Form 10-K.
 
Item 11.   EXECUTIVE COMPENSATION
 
The information required under this heading is incorporated by reference from the section entitled “Director Compensation” and “Executive Compensation” on pages 8, and 12 to 16 in the proxy statement for our 2006 annual meeting of shareholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A.
 
Item 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
The information required under this heading is incorporated by reference from the sections entitled “Beneficial Ownership Table” and “Equity Compensation Plan Information” in the proxy statement for our 2006 annual meeting of shareholders on pages 9, 10, 11 and 13 to be filed with the Securities and Exchange Commission pursuant to Regulation 14A.
 
Item 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
Information as to related transactions as set forth on page 53 in Note Q to the consolidated financial statements in the annual report to shareholders for the year ended December 31, 2005 is incorporated herein by reference.
 
Item 14.   PRINCIPAL ACCOUNTING FEES AND SERVICES
 
The information required under this heading is incorporated by reference on page 38 of the proxy statement for our 2006 annual meeting of shareholders, filed with the Securities and Exchange Commission pursuant to Regulation 14A.


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PART IV
 
Item 15.   EXHIBITS, FINANCIAL STATEMENT SCHEDULES
 
(a) 1. Financial Statements and Supplemental Information
 
Included in Part II of this Form 10-K annual report incorporated by reference to the annual report to shareholders for the year ended December 31, 2005 are the following consolidated financial statements:
 
Consolidated Balance Sheets — December 31, 2005 and 2004.
 
Consolidated Statements of Income — Years ended December 31, 2005, 2004 and 2003.
 
Consolidated Statements of Shareholders’ Equity — Years ended December 31, 2005, 2004 and 2003.
 
Consolidated Statements of Cash Flows — Years ended December 31, 2005, 2004 and 2003.
 
Notes to Consolidated Financial Statements.
 
Report of Independent Registered Public Accounting Firm.
 
(a) 2. Financial Statement Schedules
 
The following consolidated financial information for the years ended December 31, 2005, 2004 and 2003 is submitted herewith:
 
Schedule II — Valuation and qualifying accounts.
 
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.
 
(a) 3. Exhibits
 
         
(3a)
  Amended and Restated Articles of Incorporation of Brush Engineered Materials Inc. (filed as Annex B to the Registration Statement on Form S-4 filed by the Company on February 1, 2000, Registration No. 333-95917), incorporated herein by reference.
(3b)
  Amended and Restated Code of Regulations of Brush Engineered Materials Inc. (filed as Exhibit 4b to the Current Report on Form 8-K filed by Brush Wellman Inc. on May 16, 2000), incorporated herein by reference.
(4a)
  Rights Agreement, dated as of May 10, 2000, by and between Brush Engineered Materials Inc. and National City Bank, N.A. as Rights Agent (filed as Exhibit 4a to the Current Report on Form 8-K filed by Brush Engineered Materials Inc. on May 16, 2000), incorporated herein by reference.
(4b)
  First Amendment to Rights Agreement, dated as of December 7, 2004, by and between Brush Engineered Materials Inc. and LaSalle Bank, N.A. as Rights Agent (filed as Exhibit 4.1 to the Current Report on Form 8-K filed by Brush Engineered Materials Inc. on December 13, 2004), incorporated herein by reference.
(4c)
  Indenture Modification between Toledo-Lucas County Port Authority, dated as of May 30, 2003 (filed as Exhibit 4 to the Quarterly Report on Form 10-Q filed by Brush Engineered Materials Inc. on August 11, 2003), incorporated herein by reference.
(4d)
  Lease Modification from National City Bank, Trustee as Lessor to Brush Wellman Inc. as Lessee, dated as of May 30, 2003 (filed as Exhibit 4.1 to the Quarterly Report on Form 10-Q filed by Brush Engineered Materials Inc. on August 11, 2003), incorporated herein by reference.
(4e)
  Pursuant to Regulation S-K, Item 601 (b) (4), the Company agrees to furnish to the Commission, upon its request, a copy of the instruments defining the rights of holders of long-term debt of the Company that are not being filed with this report.
(4f)
  Credit Agreement dated December 4, 2003 among Brush Engineered Materials Inc. and other borrowers and Bank One, N.A, acting for itself and as agent for certain other banking institutions as lenders (filed as Exhibit 99.1 to the Company’s Form 8-K on December 5, 2003), incorporated herein by reference.


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(4g)
  Post-closing Letter Agreement dated December 4, 2003 among the Company, Bank One, N.A., as agent, and the other parties to the Credit Agreement dated as of the date hereof, and Associated Waivers (filed as Exhibit 4a to the Quarterly Report on Form 10-Q for the quarter ended July 2, 2004), incorporated herein by reference.
(4h)
  First Amendment to Credit Agreement dated March 1, 2004 among Brush Engineered Materials Inc. and other borrowers and Bank One, N.A., acting for itself and as agent for certain other banking institutions as lenders (filed as Exhibit 4f to the Company’s Form 10-K Annual Report for the year ended December 31, 2003), incorporated herein by reference.
(4i)
  Second Amendment to Credit Agreement dated December 22, 2004 among Brush Engineered Materials Inc. and other borrowers and Bank One, N.A., acting for itself and as agent for certain other banking institutions as lenders (filed as Exhibit 99.1 to the Current Report on Form 8-K filed by Brush Engineered Materials Inc. on December 27, 2004), incorporated herein by reference.
(4j)
  Third Amendment to Credit Agreement dated October 5, 2005 among Brush Engineered Materials Inc. and other borrowers and JPMorgan Chase Bank, N.A. (formerly Bank One, N.A.), acting for itself and as agent for certain other banking institutions as lenders (filed as Exhibit 99.1 to the Current Report on Form 8-K filed by Brush Engineered Materials Inc. on October 5, 2005), incorporated herein by reference.
(4k)
  Fourth Amendment to Credit Agreement dated December 29, 2005 among Brush Engineered Materials Inc. and other borrowers and JPMorgan Chase Bank, N.A. (formerly Bank One, N.A.), acting for itself and as agent for certain other banking institutions as lenders (filed as Exhibit 99.1 to the Current Report on Form 8-K filed by Brush Engineered Materials Inc. on January 3, 2006), incorporated herein by reference.
(4l)
  Precious Metals Agreement dated March 24, 2005 between Brush Engineered Materials Inc. and Fleet Precious Metals Inc., a corporation operating as Bank of America Precious Metals (filed as Exhibit 99.1 to the Current Report on Form 8-K filed by Brush Engineered Materials Inc. on March 31, 2005), incorporated herein by reference.
(4m)
  First Amendment to Precious Metals Agreement dated November 16, 2005 between Brush Engineered Materials Inc. and Fleet Precious Metals Inc., a corporation operating as Bank of America Precious Metals (filed as Exhibit 99.1 to the Current Report on Form 8-K filed by Brush Engineered Materials Inc. on November 16, 2005), incorporated herein by reference.
(4n)
  Second Amendment to Precious Metals Agreement dated December 29, 2005 between Brush Engineered Materials Inc. and Fleet Precious Metals Inc., a corporation operating as Bank of America Precious Metals (filed as Exhibit 99.2 to the Current Report on Form 8-K filed by Brush Engineered Materials Inc. on January 3, 2006), incorporated herein by reference.
(10a)*
  Form of Indemnification Agreement entered into by the Company and its executive officers and key employees (filed as Exhibit 10.2 to the Current Report on Form 8-K filed on May 5, 2005), incorporated herein by reference.
(10b)*
  Form of Indemnification Agreement entered into by the Company and its directors (filed as Exhibit 10.1 to the Current Report on Form 8-K filed on May 5, 2005), incorporated herein by reference.
(10c)*
  Form of Severance Agreement entered into by the Company and Messrs. Gordon D. Harnett, Daniel A. Skoch and John D. Grampa dated October 8, 2001 (filed as Exhibit 10f to the Company’s Form 10-K Annual Report for the year ended December 31, 2001), incorporated herein by reference.
(10d)*
  Form of Severance Agreement entered into by the Company and Mr. Richard J. Hipple, dated March 4, 2003 (filed as Exhibit 10d to the Company’s Form 10-K Annual Report for the year ended December 31, 2004), incorporated herein by reference.
(10e)*
  Form of Executive Insurance Agreement entered into by the Company and certain employees dated January 2, 2002 (filed as Exhibit 10g to the Company’s Form 10-K Annual Report for the year ended December 31, 1994), incorporated herein by reference.
(10f)*
  Form of Trust Agreement between the Company and Key Trust Company of Ohio, N.A. (formerly Ameritrust Company National Association) on behalf of the Company’s executive officers (filed as Exhibit 10e to the Company’s Form 10-K Annual Report for the year ended December 31, 1994), incorporated herein by reference.

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(10g)*
  2004 Management Performance Compensation Plan (filed as Exhibit 10.1 to the Current Report on Form 8-K filed on February 7, 2005), incorporated herein by reference.
(10h)*
  2005 Management Performance Compensation Plan (filed as Exhibit 10.2 to the Current Report on Form 8-K filed on February 7, 2005), incorporated herein by reference.
(10i)*
  2006 Management Performance Compensation Plan (filed as Exhibit 10.1 to the Current Report on Form 8-K filed on February 8, 2006), incorporated herein by reference.
(10j)*
  Long-term Incentive Plan for the performance period January 1, 2003 through December 31, 2004 (filed as Exhibit 10.3 to the Current Report on Form 8-K filed on February 7, 2005), incorporated herein by reference.
(10k)*
  Long-term Incentive Plan for the performance period January 1, 2004 through December 31, 2006 (filed as Exhibit 10.2 to the Current Report on Form 8-K filed on February 8, 2006), incorporated herein by reference.
(10l)*
  Long-term Incentive Plan for the performance period January 1, 2005 through December 31, 2007 (filed as Exhibit 10.5 to the Current Report on Form 8-K filed on February 7, 2005), incorporated herein by reference.
(10m)*
  1979 Stock Option Plan, as amended pursuant to approval of shareholders on April 21, 1982 (filed by Brush Wellman Inc. as Exhibit 15A to Post-Effective Amendment No. 3 to Registration Statement No. 2-64080), incorporated herein by reference.
(10n)*
  Amendment, effective May 16, 2000, to the 1979 Stock Option Plan (filed as Exhibit 4b to Post-Effective Amendment No. 5 to Registration Statement on Form S-8, No. 2-64080), incorporated herein by reference.
(10o)*
  1984 Stock Option Plan as amended by the Board of Directors on April 18, 1984 and February 24, 1987 (filed by Brush Wellman Inc. as Exhibit 4.4 to Registration Statement on Form S-8, No. 33-28605), incorporated herein by reference.
(10p)*
  Amendment, effective May 16, 2000, to the 1984 Stock Option Plan (filed as Exhibit 4b to Post-Effective Amendment No. 1 to Registration Statement on Form S-8, No. 2-90724), incorporated herein by reference.
(10q)*
  1989 Stock Option Plan (filed as Exhibit 4.5 to Registration Statement on Form S-8, No. 33-28605), incorporated herein by reference.
(10r)*
  Amendment, effective May 16, 2000, to the 1989 Stock Option Plan (filed as Exhibit 4b to Post-Effective Amendment No. 1 to Registration Statement on Form S-8, No. 33-28605, incorporated herein by reference.
(10s)*
  1995 Stock Incentive Plan (as Amended March 3, 1998) (filed as Appendix A to the Company’s Proxy Statement dated March 16, 1998), incorporated herein by reference.
(10t)*
  Amendment, effective May 16, 2000, to the 1995 Stock Incentive Plan (filed as Exhibit 4b to Post-Effective Amendment No. 1 to Registration Statement No. 333-63357), incorporated herein by reference.
(10u)*
  Amendment No. 2, effective February 1, 2005, to the 1995 Stock Incentive Plan (filed as Exhibit 10.4 to the Current Report on Form 8-K filed on February 7, 2005) incorporated herein by reference.
(10v)*
  2006 Stock Incentive Plan subject to approval by shareholders at the Company’s annual meeting to be held on May 2, 2006 (filed as Appendix B to the Proxy Statement dated March 16, 2006), incorporated herein by reference.
(10w)*
  Form of Nonqualified Stock Option Agreement, (filed as Exhibit 10t to the Company’s Form 10-K Annual Report for the year ended December 31, 2004) incorporated herein by reference.
(10x)*
  Form of Nonqualified Stock Option Agreement (filed as Exhibit 10.7 to the Current Report on Form 8-K filed on February 7, 2005) incorporated herein by reference.
(10y)*
  Form of Nonqualified Stock Option Agreement for Mr. Harnett (filed as Exhibit 10.6 to the Current Report on Form 8-K filed on February 7, 2005) incorporated herein by reference.
(10z)*
  Form of Special Restricted Stock Agreement (filed as Exhibit 10w to the Company’s Form 10-K Annual Report for the year ended December 31, 2004) incorporated herein by reference.
(10aa)*
  Form of 2004 Special Restricted Stock Agreement (filed as Exhibit 10x to the Company’s Form 10-K Annual Report for the year ended December 31, 2004) incorporated herein by reference.

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(10bb)*
  Form of 2005 Performance Share Agreement (filed as Exhibit 10y to the Company’s Form 10-K Annual Report for the year ended December 31, 2004) incorporated herein by reference.
(10cc)*
  Supplemental Retirement Plan as amended and restated December 1, 1992 (filed as Exhibit 10n to the Company’s Form 10-K Annual Report for the year ended December 31, 1992), incorporated herein by reference.
(10dd)*
  Amendment No. 2, adopted January 1, 1996, to Supplemental Retirement Benefit Plan as amended and restated December 1, 1992 (filed as Exhibit 10o to the Company’s Form 10-K Annual Report for the year ended December 31, 1995), incorporated herein by reference.
(10ee)*
  Amendment No. 3, adopted May 5, 1998, to Supplemental Retirement Benefit Plan as amended and restated December 1, 1992 (filed as Exhibit 10s to the Company’s Form 10-K Annual Report for the year ended December 31, 1998), incorporated herein by reference.
(10ff)*
  Amendment No. 4, adopted December 1, 1998, to Supplemental Retirement Benefit Plan as amended and restated December 1, 1992 (filed as Exhibit 10t to the Company’s Form 10-K Annual Report for the year ended December 31, 1998), incorporated herein by reference.
(10gg)*
  Amendment No. 5, adopted December 31, 1998, to Supplemental Retirement Benefit Plan as amended and restated December 1, 1992 (filed as Exhibit 10u to the Company’s Form 10-K Annual Report for the year ended December 31, 1998), incorporated herein by reference.
(10hh)*
  Amendment No. 6, adopted September 1999, to Supplemental Retirement Benefit Plan as amended and restated December 1, 1992 (filed as Exhibit 10u to the Company’s Form 10-K Annual Report for the year ended December 31, 2000), incorporated herein by reference.
(10ii)*
  Amendment No. 7, adopted May 2000, to Supplemental Retirement Benefit Plan as amended and restated December 1, 1992 (filed as Exhibit 10v to the Company’s Form 10-K Annual Report for the year ended December 31, 2000), incorporated herein by reference.
(10jj)*
  Amendment No. 8, adopted December 21, 2001, to Supplemental Retirement Benefit Plan as amended and restated December 1, 1992 (filed as Exhibit 10u to the Company’s Form 10-K Annual Report for the year ended December 31, 2000), incorporated herein by reference.
(10kk)*
  Amendment No. 9, adopted December 22, 2003, to Supplemental Retirement Benefit Plan as amended and restated December 1, 1992 (filed as Exhibit 10s to the Company’s Form 10-K Annual Report for the year ended December 31, 2000), incorporated herein by reference.
(10ll)*
  Key Employee Share Option Plan (filed as Exhibit 4.1 to the Registration Statement on Form S-8 No. 333-52141 filed by Brush Wellman Inc. on May 5, 1998, incorporated herein by reference.
(10mm)*
  Amendment No. 1 to the Key Employee Share Option Plan, (effective May 16, 2005) (filed as Exhibit 4b to Post-Effective Amendment No. 1 to Registration Statement on Form S-8, No. 333-52141), incorporated herein by reference.
(10nn)*
  1997 Stock Incentive Plan for Non-employee Directors, (As Amended and Restated as of May 1, 2001) (filed as Appendix B to the Company’s Proxy Statement dated March 19, 2001), incorporated herein by reference.
(10oo)*
  Amendment No 1 to the 1997 Stock Incentive Plan for Non-employee Directors, (filed as Exhibit 10gg to the Company’s Form 10-K Annual Report for the year ended December 31, 2003), incorporated herein by reference.
(10pp)*
  Form of Nonqualified Stock Option Agreement for Non-employee Directors (filed as Exhibit 10mm to the Company’s Form 10-K Annual Report for the year ended December 31, 2004), incorporated herein by reference.
(10qq)*
  Deferred Compensation Plan for Non-employee Directors (As Amended and Restated as of December 2, 1997) (filed as Exhibit 4d to the Registration Statement on Form S-8, No. 333-63353, filed by Brush Wellman Inc.), incorporated herein by reference.
(10rr)*
  2000 Reorganization Amendment, dated May 16, 2000, to the 1997 Deferred Compensation Plan for Non-employee Directors (filed as Exhibit 4b to Post-Effective Amendment No. 1 to Registration Statement No. 333-63353), incorporated herein by reference.
(10ss)*
  Amendment No. 1 (effective September 11, 2001) to the 1997 Deferred Compensation Plan for Non-employee Directors (filed as Exhibit 4c to the Company’s Post-Effective Amendment No. 1 to Registration Statement No. 333-74296), incorporated herein by reference.


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(10tt)*
  Amendment No. 2 (effective September 13, 2004) to the 1997 Deferred Compensation Plan for Non-employee Directors (filed as Exhibit 10.1 to the Company’s Form 10-Q Quarterly Report for the quarter ended October 1, 2004), incorporated herein by reference.
(10uu)*
  Amendment No. 3 (effective January 1, 2005) to the 1997 Deferred Compensation Plan for Non-employee Directors (filed as Exhibit 10rr to the Company’s Form 10-K Annual Report for the year ended December 31, 2004) incorporated herein by reference.
(10vv)*
  2005 Deferred Compensation Plan for Non-employee Directors (effective January 1, 2005) (filed as Exhibit 10.2 to the Current Report on Form 8-K filed by Brush Engineered Materials Inc. on December 13, 2004), incorporated herein by reference.
(10ww)*
  2006 Non-employee Director Equity Plan subject to approval by shareholders at the Company’s annual meeting to be held on May 2, 2006 (filed as Appendix C to the Proxy Statement dated March 16, 2006), incorporated herein by reference.
(10xx)*
  Executive Deferred Compensation Plan II (effective January 1, 2005) (filed as Exhibit 10.21 to the Current Report on Form 8-K filed by Brush Engineered Materials Inc. on December 13, 2004), incorporated herein by reference.
(10yy)*
  First Amendment to the Executive Deferred Compensation Plan II (effective January 1, 2005) (filed as Exhibit 10.3 to the Current Report on Form 8-K filed by Brush Engineered Materials Inc. on February 8, 2006), incorporated herein by reference.
(10zz)*
  Trust Agreement between the Company and National City Bank, N.A. dated January 1, 1992 on behalf of Non-employee Directors of the Company (filed as Exhibit 10k to the Company’s Form 10-K Annual Report for the year ended December 31, 1992), incorporated herein by reference.
(10ab)*
  Trust Agreement between the Company and LaSalle Bank, N.A. dated January 1, 2005 relating to the 2005 Deferred Compensation Plan for Non-employee Directors and the 1997 Stock Incentive Plan for Non-employee Directors (filed as Exhibit 10vv to the Company’s Form 10-K Annual Report for the year ended December 31, 2004), incorporated herein by reference.
(10ac)*
  Trust Agreement between the Company and Fifth Third, dated March 10, 2005 relating to the 2005 Executive Deferred Compensation Plan II (filed as Exhibit 10ww to the Company’s Form 10-K Annual Report for the year ended December 31, 2004), incorporated herein by reference.
(10ad)
  Lease dated as of October 1, 1996, between Brush Wellman Inc. and Toledo-Lucas County Port Authority (filed as Exhibit 10v to the Company’s Form 10-K Annual Report for the year ended December 31, 1996), incorporated herein by reference.
(10ae)
  Amended and Restated Inducement Agreement with the Prudential Insurance Company of America dated May 30, 2003 (filed as Exhibit 10 to the Company’s Form 10-Q Quarterly Report for the quarter ended June 27, 2003), incorporated herein by reference.
(10af)
  Amended and Restated Supply Agreement between RWE Nukem, Inc. and Brush Wellman Inc. for the sale and purchase of beryllium products (filed as Exhibit 10 to the Company’s Form 10-Q Quarterly Report for the quarter ended September 26, 2003), incorporated herein by reference.
(10ag)
  Supply Agreement between the Defense Logistics Agency and Brush Wellman Inc. for the sale and purchase of beryllium products (filed as Exhibit 10tt to the Company’s Form 10-K Annual Report for the year ended December 31, 2004), incorporated herein by reference.
(13)
  Annual report to shareholders for the year ended December 31, 2005.
(21)
  Subsidiaries of the Registrant
(23)
  Consent of Ernst & Young LLP
(24)
  Power of Attorney
(31.1)
  Certification of Chief Executive Officer required by Rule 13a-14(a) or 15d-14(a)
(31.2)
  Certification of Chief Financial Officer required by 18 U.S.C. Section 1350
(32.1)
  Certification of Chief Executive Officer and Chief Financial Officer required by 18 U.S.C. Section 1350


26

Table of Contents

SIGNATURES
 
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
BRUSH ENGINEERED MATERIALS INC.
 
     
By: /s/  GORDON D. HARNETT
Gordon D. Harnett
Chairman of the Board
and Chief Executive Officer
  By: /s/  JOHN D. GRAMPA
John D. Grampa
Vice President Finance
and Chief Financial Officer
 
March 16, 2006
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 
             
/s/  GORDON D. HARNETT*

Gordon D. Harnett* 		  Chairman of the Board, Chief Executive Officer and Director (Principal Executive Officer)   March 16, 2006
         
/s/  JOHN D. GRAMPA

John D. Grampa 		  Vice President Finance and Chief Financial Officer (Principal Financial and Accounting Officer)   March 16, 2006
         
/s/  ALBERT C. BERSTICKER*

Albert C. Bersticker* 		  Director   March 16, 2006
         
/s/  JOSEPH P. KEITHLEY*

Joseph P. Keithley* 		  Director   March 16, 2006
         
/s/  WILLIAM B. LAWRENCE*

William B. Lawrence* 		  Director   March 16, 2006
         
/s/  WILLIAM P. MADAR*

William P. Madar* 		  Director   March 16, 2006
         
/s/  WILLIAM G. PRYOR*

William G. Pryor* 		  Director   March 16, 2006
         
/s/  N. MOHAN REDDY*

N. Mohan Reddy* 		  Director   March 16, 2006
         
/s/  WILLIAM R. ROBERTSON*

William R. Robertson* 		  Director   March 16, 2006
         
/s/  JOHN SHERWIN, JR.*

John Sherwin, Jr.* 		  Director   March 16, 2006
 
*The undersigned, by signing his name hereto, does sign and execute this report on behalf of each of the above-named officers and directors of Brush Engineered Materials Inc., pursuant to Powers of Attorney executed by each such officer and director filed with the Securities and Exchange Commission.
 
             
             
By:  
/s/  JOHN D. GRAMPA

John D. Grampa
Attorney-in-Fact 		      March 16, 2006


27

Table of Contents

SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS
 
BRUSH ENGINEERED MATERIALS INC. AND SUBSIDIARIES
Years ended December 31, 2005, 2004 and 2003
 
                                         
COL. A   COL. B     COL. C     COL. D     COL. E  
          Additions              
    Balance at
 		    (1)
 		    (2)
 		          Balance
 		 
    Beginning
 		    Charged to Costs
 		    Charged to Other
 		    Deduction-
 		    at End
 		 
Description
  of Period     and Expenses     Accounts-Describe     Describe     of Period  
 
Year ended December 31, 2005
                                       
Deducted from asset accounts:
                                       
Allowance for doubtful accounts receivable
  $ 1,555,269     $ 160,885     $ 0     $ 401,206 (A)   $ 1,314,948  
Inventory reserves and obsolescence
  $ 3,166,000     $ 1,709,000     $ 0     $ 2,164,000 (B)   $ 2,711,000  
Year ended December 31, 2004
                                       
Deducted from asset accounts:
                                       
Allowance for doubtful accounts receivable
  $ 1,427,264     $ 532,482     $ 0     $ 404,477 (A)   $ 1,555,269  
Inventory reserves and obsolescence
  $ 4,301,000     $ 870,000     $ 0     $ 2,005,000 (B)   $ 3,166,000  
Year ended December 31, 2003
                                       
Deducted from asset accounts:
                                       
Allowance for doubtful accounts receivable
  $ 1,316,645     $ 768,914     $ 0     $ 658,295 (A)   $ 1,427,264  
Inventory reserves and obsolescence
  $ 3,843,000     $ 2,573,000     $ 0     $ 2,115,000 (B)   $ 4,301,000  
 
 
 
Note A — Bad debts written-off, net of recoveries.
 
Note B — Inventory write-off.


28

EX-13 2 l17862aexv13.txt EX-13 FINANCIALS EXHIBIT 13 MANAGEMENT'S DISCUSSION AND ANALYSIS OVERVIEW We are an integrated producer of engineered materials used in a variety of electrical, electronic, thermal and structural applications. Our products are sold into numerous markets, including telecommunications and computer, magnetic and optical data storage, aerospace and defense, automotive electronics, industrial components and appliance. Sales increased once again in 2005, growing 9% over 2004. Following significant declines in 2001 and 2002, sales have grown $168.5 million, or 45% over the last three years. This growth has primarily resulted from improved conditions in our key markets, market share gains, new product development and geographic expansion. Despite the $45.0 million improvement in sales in 2005, gross margin declined $0.8 million in 2005 from 2004. The increasing cost of copper, a key raw material in a number of our products, was a major factor in the margin decline. Competitive pressures and other factors have prevented us from passing this higher cost on to customers in all cases, thereby hampering margins. The cost of other raw materials and commodities increased as well in 2005. The margin growth was also hindered by an unfavorable change in product mix as sales from various higher margin-generating product lines declined and/or did not grow as fast as other products. Expenses increased slightly in 2005, largely in support of the higher sales level. We also continued to expand our sales and marketing efforts in the international markets, particularly in Asia. Expenses as a percent of sales, however, have declined in each of the last two years. We reduced our outstanding debt by $15.3 million in 2005. We prepaid our high rate subordinated debt in December 2005 after retiring our term notes early in January 2005. As a result of implementing these debt reducing actions, which will generate significant interest savings in 2006, we recorded a prepayment penalty and write-off of deferred costs totaling $4.4 million. Operating profit was $19.5 million in 2005, a reduction of $5.5 million from 2004 as a result of the debt prepayment charge and changes in the margin and expense levels. Based upon our analysis, we determined that it was more likely than not that we would be able to realize an additional $5.9 million of our deferred tax assets and that amount of the valuation allowance was reversed back to income in the fourth quarter 2005. As a result, net income was $17.8 million in 2005 compared to $15.5 million in 2004, a 15% improvement. Net income in 2005 was also a $31.0 million improvement over the net loss generated two years earlier. Cash declined during 2005, as in addition to reducing debt, we used our excess cash and the cash flow generated during 2005 to fund two small acquisitions, capital expenditures and a contribution to our defined benefit pension plan. Other key operating metrics improved or remained strong in 2005. Inventory turns increased in 2005 while accounts receivable collections remained timely with bad debts being minor. The debt to debt-plus-equity ratio improved once again in 2005 and the balance sheet leverage has been reduced. Employment levels increased slightly due to the acquisitions, but sales per employee grew for the third consecutive year. RESULTS OF OPERATIONS
2005 2004 2003 ------- ------- -------- (Millions, except for share data) Net sales........................... $ 541.3 $ 496.3 $ 401.0 Operating profit (loss)............. 19.5 25.0 (8.9) Net income (loss)................... 17.8 15.5 (13.2) Diluted E.P.S ...................... 0.92 0.85 (0.80)
SALES OF $541.3 MILLION in 2005 were 9% higher than sales in 2004 and represent the second highest annual sales level in our history. Sales have grown over the comparable quarter in the prior year for 12 consecutive quarters and sales in each quarter of 2005 were higher than the preceding quarter. Domestic and international sales both grew 9% in 2005 over 2004. Sales in 2004 of $496.3 million improved 24% over 2003, with domestic sales growing 20% and international sales 32%. The growth in sales in 2005 resulted from improved demand from several of our key markets. Demand from the magnetic and optical data storage market grew 30% in 2005 after growing 10% in 2004. The overall demand from the telecommunications and computer market was up modestly in 2005, primarily in the second half of the year, with various individual sectors showing different degrees of improvement. We believe that a portion of the softer demand from this market in the first half of 2005 was due to a downstream inventory correction. In 2004, sales to the telecommunications and computer market, our largest market, grew significantly. Demand from the appliance and medical markets, two smaller markets, grew 42% and 63%, respectively, in 2005 after growing at more modest rates in 2004. Sales for the James Webb Space Telescope, which were substantially completed in 2005, contributed to the sales growth in both 2005 and 2004 as compared to the prior year. Absent the Webb sales, other aerospace and defense shipments were only slightly higher in 2005 than 2004 and these sales slowed down in the second half of the year. Aerospace and defense sales were stronger in 2004 than in 2003. Automotive electronics demand declined 10% in 2005 after growing 10% in 2004. In addition to the improved overall demand, we continued to grow our sales through the development of new products and applications and improving our share in various existing markets or applications. Sales are affected by metal prices as changes in precious metal and a portion of the changes in base metal prices, primarily copper, may be passed on to our customers. Sales may also be impacted by foreign currency exchange rates, as changes in the value of the dollar relative to the euro, yen and pound sterling will affect the translated value of foreign currency denominated sales. Metal prices were higher in 2005 and 2004 than in the respective prior years while the dollar on average compared to the currencies in which we sell was slightly stronger in 2005 than 2004 and weaker in 2004 as compared to 2003. As a result, we estimate that these two factors combined accounted for $9.7 million of the $45.0 million growth in 2005 sales and $19.8 million of the $95.3 million growth in 2004 sales. 14. The sales order backlog was $111.6 million at December 31, 2005, an increase of 12% from the start of the year. The backlog as of year-end 2004 had also grown 11% over year-end 2003. The sales order entry rate strengthened in the second half of 2005 and has continued to be strong in early 2006. THE GROSS MARGIN was $110.2 million, or 20% of sales, in 2005, $111.1 million, or 22% of sales, in 2004, and $73.0 million, or 18% of sales in 2003. The gross margin declined slightly in 2005 from 2004, as the benefits from the higher sales volume were more than offset by the impact of the increased cost of copper and an unfavorable product mix shift. The cost of copper increased significantly throughout 2005, as it did in 2004, and the higher cost could not be passed through to customers in all cases, thereby reducing margins by approximately $2.7 million. The cost of other commodities, including nickel, was higher in 2005 than in 2004 as well. The change in product mix was unfavorable in that sales of products that generate lower margins increased more than the higher margin products. Manufacturing overhead expenses were slightly lower in 2005 than 2004. The higher level of sales was the major cause of the margin improvement in 2004 over 2003. The change in product mix had a favorable impact on margins in that year. Manufacturing efficiencies improved in 2004 as compared to 2003, particularly in the first half of the year. Margins also improved in 2004 over 2003 as a result of the refinancing in December 2003. Equipment that previously had been leased was purchased with proceeds from new loans; the resulting depreciation expense in 2004 was $6.0 million less than the lease expense in cost of sales in 2003. Offsetting a portion of these margin benefits was the negative impact of the higher cost of copper, to the extent that the additional cost could not be passed through to customers, and an increase in other manufacturing overhead expenses. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (SG&A) were $78.5 million in 2005 (14% of sales), $77.3 million (16% of sales) in 2004 and $68.8 million (17% of sales) in 2003. Expenses incurred by the two new businesses acquired by Williams Advanced Materials Inc. (WAM), a wholly owned subsidiary, in 2005 totaled $1.4 million. Overseas expenses incurred by Brush International, Inc., a wholly owned subsidiary, were $1.8 million higher in 2005 than 2004 as a result of expanded efforts to penetrate the overseas markets; most of this increase was for third-party sales commissions and manpower-related costs. Changes in the value of the dollar relative to the applicable foreign currencies reduced the translated value of Brush International's expenses by $0.1 million compared to the prior year. The weaker dollar caused a $1.1 million increase in the translated value of these expenses in 2004 over 2003. Various domestic sales-related expenses increased in each of the last two years in support of the higher sales volumes while compliance costs with Section 404 of the Sarbanes-Oxley Act were $0.7 million higher in 2005 than 2004 after being $0.8 million higher in 2004 than 2003. Other corporate costs increased in 2005 as well. In 2004, we recorded one-time favorable movements in the legal reserve and insurance recoverable accounts related to the chronic beryllium disease litigation against us as a result of court rulings, settlements and other activity. The difference in the movements in these accounts caused an increase in expense of $0.5 million in 2005 as compared to 2004 and a $0.5 million lower expense in 2004 as compared to 2003. Other corporate legal costs were $1.5 million higher in 2005 than in 2004 after declining $0.7 million in 2004 from 2003. Offsetting a large portion of these increases in expenses in 2005 was a reduction in incentive compensation expense; approximately two-thirds of the increase in SG&A expenses in 2004 over 2003 was due to the higher incentive expense as a result of the improved profitability in that year. RESEARCH AND DEVELOPMENT expenses (R&D) were $5.0 million in 2005, $4.5 million in 2004 and $4.2 million in 2003. R&D expenses were approximately 1% of sales in each of the last three years. Approximately three-quarters of the R&D spending supports the Metal Systems Group and one-fourth supports the Microelectronics Group. R&D efforts are focused on developing new products and applications, as well as continuing improvements in our existing products. The major components of OTHER-NET EXPENSE for each of the last three years are as follows:
Income/(Expense) -------------------------- 2005 2004 2003 ------ ------- ------- (Millions) Exchange losses.................... $ (1.1) $ (1.8) $ (0.9) Directors' deferred compensation... 0.2 (0.4) (0.9) Environmental reserve adjustment... - 1.0 - Derivative ineffectiveness......... 0.8 (0.4) (5.1) Debt prepayment costs.............. (4.4) - (0.1) Other items........................ (2.8) (2.7) (1.9) ------ ------ ------ Total........................... $ (7.3) $ (4.3) $ (8.9) ====== ====== ======
Foreign currency exchange losses result from movements in value of the U.S. dollar against the euro, yen and sterling and the maturity of hedge contracts. While exchange losses totaled $1.1 million in 2005, a strengthening dollar and the maturing contracts generated exchange gains of $1.0 million in the second half 2005. The income or expense on the directors' deferred compensation plan is a function of the outstanding shares in the plan and movements in the market price of our stock. In 2005, the share price declined, which reduced our liability to the plan and generated income. In 2003 and 2004, the stock price increased, creating an additional expense. The favorable environmental reserve adjustment in 2004 resulted from the sale of property formerly used by one of our subsidiaries whereby the buyer agreed to assume the associated environmental remediation liability. Derivative ineffectiveness represents changes in the fair value of derivative financial instruments that do not qualify for the favorable hedge accounting treatment. As a result of the refinancing in December 2003, an interest rate swap that previously hedged the variable payments on an operating lease no longer qualified for hedge accounting treatment since the lease was terminated. The swap's fair value of a loss of $4.6 million was reversed out of equity and charged against income at that time, accounting for the majority of the ineffectiveness recorded in 2003. Subsequent changes in this swap's fair value were charged or credited to ineffectiveness in 2004 and 2005 as well. The debt prepayment cost of 15. MANAGEMENT'S DISCUSSION AND ANALYSIS $4.4 million in 2005 includes the penalty and write-off of associated deferred financing costs totaling $3.8 million from the prepayment of the $30.0 million subordinated debt in the fourth quarter and the write-off of $0.6 million of deferred financing costs from the prepayment of the $18.6 million term notes in the first quarter 2005. See debt disclosures in the Financial Position section of this Management's Discussion and Analysis for additional information. Other-net expense also includes metal financing fees, which have increased slightly in each of the last two years, bad debt expense, cash discounts, gains and losses on the sale of fixed assets and other non-operating items. OPERATING PROFIT WAS $19.5 MILLION in 2005, a 22% reduction from $25.0 million in 2004. The higher cost of copper, the unfavorable changes in product mix, the slightly higher expenses and the debt prepayment charge more than offset the margin benefit of the higher sales volumes. The 2004 operating profit was a $33.9 million improvement over the $8.9 million operating loss in 2003 as a result of the increased margins generated by the higher sales and other factors partially offset by higher copper costs and changes in other expenses. INTEREST EXPENSE was $6.4 million in 2005, $8.4 million in 2004 and $3.8 million in 2003. The decline in interest expense in 2005 resulted from a reduction in the average level of debt outstanding, as the average borrowing rate was higher in 2005 than in 2004. A portion of the proceeds from the new share issuance in July 2004 was used to reduce debt in the second half of 2004 and cash was used to pay off the term notes in January 2005. Interest expense was higher in 2004 largely as a result of the December 2003 refinancing, as debt increased by over $50.0 million due to the purchase of previously leased assets with a portion of the loan proceeds. The higher interest expense in 2004 partially offsets the gross margin benefit generated by the refinancing previously discussed. The average borrowing rate was higher in 2004 than in 2003, primarily due to the high rate subordinated debt secured in December 2003. Amortization of deferred financing costs included in interest was $0.4 million lower in 2005 than 2004 and $1.1 million higher in 2004 than in 2003. Capitalization of interest expense associated with long-term capital projects was minor in each of the three years presented. INCOME BEFORE INCOME TAXES was $13.1 million in 2005 compared to $16.7 million in 2004. In 2003, the loss before income taxes was $12.7 million. THE INCOME TAX EXPENSE (BENEFIT) for 2005, 2004 and 2003, including the movement in the deferred tax valuation allowance, is summarized as follows:
Expense (benefit) -------------------------- 2005 2004 2003 ------ ------ ------ (Millions) Tax prior to valuation allowances.... $ 3.4 $ 10.4 $ (4.7) Valuation allowance.................. (8.1) (9.3) 5.3 ------ ------ ------ Total tax expense................. $ (4.7) $ 1.1 $ 0.6 ====== ====== ======
In calculating the tax expense or benefit prior to movements in the valuation allowance, the effects of foreign source income and percentage depletion were major causes of the differences between the effective and statutory rates for all three years. The impact of the company-owned life insurance program also caused a significant difference between the effective and statutory rates in 2004 and a more minor difference in 2003. See Note O to the Consolidated Financial Statements for a reconciliation of the statutory and effective tax rates. The deferred tax valuation allowance was initially recorded in accordance with Statement No. 109, "Accounting for Income Taxes", which requires a company to evaluate its deferred tax assets for impairment in the event of recent operating losses. This evaluation process is not based upon the specific expiration date of the individual deferrals but rather on the company's ability to demonstrate future taxable income will result in utilization of those assets. As a result of a review in the fourth quarter 2002, we determined that it was more likely than not that the majority of our deferred tax assets were impaired and a valuation allowance was recorded accordingly. Subsequent to 2002, the valuation allowance was either increased to offset the creation of additional deferred tax assets, as was the case in 2003, or reduced for the use of deferred tax assets as in 2004 and 2005. In 2005, in addition to reducing the valuation allowance $2.2 million for the use of net operating losses, we also reduced the valuation allowance by $5.9 million as, based upon the earnings trend of the past two years as well as various projections, we determined that it was more likely than not that we would utilize this additional portion of our deferred tax assets in future periods. The resulting net tax expense (benefit) on the Consolidated Statements of Income for each of the years includes taxes for state, local and certain foreign jurisdictions that were not affected by the valuation allowance. The tax expense also included minor amounts for the alternative minimum tax in 2005 and 2004. The deferred tax valuation allowance on the balance sheet was also adjusted in each of the last three years for the deferred tax assets associated with items in other comprehensive income (OCI) within shareholders' equity. These adjustments were recorded in OCI and did not affect net income. As a result, NET INCOME was $17.8 million, or $0.92 per share, in 2005 compared to $15.5 million, or $0.85 per share, in 2004 and a net loss of $13.2 million, or $0.80 per share, in 2003. SEGMENT DISCLOSURES We aggregate our businesses into two reportable segments - the Metal Systems Group and the Microelectronics Group. Beginning in 2005, Brush Resources Inc., a wholly owned subsidiary that manages our mining and milling operations in Utah, is included in the Metal Systems Group while previously it had been included in the "All Other" column in the segment reporting details. We made this change because we believe that the operating issues affecting Brush Resources, the management of the 16. operations and the flow of materials are more closely aligned with the Metal Systems Group, and this change is more reflective of how the operations are now managed. The segment results for the prior-year comparisons have been restated to reflect this change. Our parent company and other corporate expenses, as well as the operating results from BEM Services, Inc., a wholly owned subsidiary, are not part of either segment and are shown in the "All Other" column in the segment results contained in Note M to the Consolidated Financial Statements. BEM Services charges a management fee for the services it provides, primarily corporate, administrative and financial oversight, to our other businesses on a cost-plus basis. The operating loss within All Other increased in 2005 over 2004 as a result of the $4.4 million debt prepayment costs and higher corporate legal and Sarbanes-Oxley Act compliance costs offset in part by lower corporate incentive compensation expenses. The operating results within All Other improved in 2004 over 2003 due to charges associated with the refinancing in 2003 totaling $6.0 million, $2.0 million in savings resulting from winding down and terminating the company-owned life insurance program in 2004 and lower corporate legal and other costs. Audit and related costs associated with compliance with Section 404 of the Sarbanes-Oxley Act were higher in 2004 than 2003 as well. METAL SYSTEMS GROUP
2005 2004 2003 ------- ------- ------- (Millions) Net sales................. $ 306.3 $ 300.7 $ 243.7 Operating profit (loss)... 6.3 4.5 (16.4)
The Metal Systems Group, which is the larger of the two reportable segments and accounts for over 55% of total sales and over two-thirds of total assets, consists of Alloy Products, Technical Materials, Inc. (TMI), a wholly owned subsidiary of the Company, Beryllium Products and Brush Resources. These units manufacture a variety of engineered materials that provide superior performance in demanding applications and compete against beryllium and non-beryllium-containing alloys and other material systems and composites. Because of their superior performance, these materials are often premium priced. The Elmore, Ohio facility manufactures finished goods for Alloy Products and Beryllium Products as well as materials for further processing and sale by other operations within Alloy, Beryllium and TMI. Customers typically use the Company's materials as their raw material input and are also usually one or more tiers removed from the end-use demand generator in a given market. After sales bottomed out in 2002, primarily due to softness in the telecommunications and computer market, sales grew in each of the last three years. As a result of the higher sales and other operating improvements, the Metal Systems Group generated profits of $6.3 million in 2005 and $4.5 million in 2004 after recording a loss of $16.4 million in 2003. Sales to external customers by business unit within the Metal Systems Group during the three-year period ended December 31, 2005 were as follows:
2005 2004 2003 ------- ------- ------- (Millions) Alloy Products............. $ 208.2 $ 202.9 $ 162.3 Technical Materials, Inc... 49.9 53.6 41.9 Beryllium Products......... 42.6 39.5 35.2 Brush Resources Inc........ 5.6 4.7 4.3 ------- ------- ------- Total segment sales..... $ 306.3 $ 300.7 $ 243.7 ======= ======= =======
ALLOY PRODUCTS Alloy Products, the largest business within the Metal Systems Group, manufactures and sells copper and nickel-based alloy systems metallurgically tailored to meet customers' specific performance requirements. Strip products, the larger of Alloy's two main product families, includes thin gauge precision strip and thin diameter rod and wire. These products provide a combination of high conductivity, high reliability and formability for use as connectors, contacts, switches, relays and shielding. Major markets for strip products include telecommunications and computer, automotive electronics and appliance. Alloy's other major product family is bulk products, which includes plate, rod, bar, tube and other customized forms that, depending upon the application, may provide superior strength, corrosion or wear resistance or thermal conductivity. Applications for bulk products include plastic mold tooling, bearings, and bushings for aerospace and heavy equipment, welding rods, oil and gas drilling components, and telecommunications housing equipment. The majority of Alloy Products, including all strip products, are beryllium-containing alloys. Alloy Products are manufactured at our facilities in Ohio and Pennsylvania and are distributed worldwide through a network of company-owned service centers and outside distributors and agents. Sales from Alloy Products of $208.2 million in 2005 were 3% higher than sales of $202.9 million in 2004. The sales growth in 2005 was due to bulk products as strip sales declined slightly. Sales in 2004 were $40.6 million higher than sales of $162.3 million in 2003, a 25% improvement as sales of both strip and bulk products grew in that year over the previous year. Strip product shipment volumes declined 4% in 2005 after growing 19% in 2004. Shipments of thin diameter rod and wire products, which had shown double-digit growth in the prior two years, declined in 2005. Shipments of higher beryllium-containing strip products also declined in 2005 while shipments of the lower beryllium-containing alloys were essentially flat. The strip sales growth in 2004 was across both the higher and lower beryllium-containing alloys. The volume of bulk products shipped grew 9% in 2005 over 2004 as shipments of both traditional beryllium-containing alloys and non-beryllium-containing alloys increased. Shipments of bulk products volumes were 33% higher in 2004 than in 2003, with shipments growing significantly in the second half of 2004. 17. MANAGEMENT'S DISCUSSION AND ANALYSIS The growth in Alloy sales in 2005 was fueled by increased demand from the appliance and aerospace markets. Non-beryllium-containing alloy sales into the heavy equipment market contributed to the sales increase in 2005 and 2004. Sales in 2005 into the telecommunications and computer market were unchanged from 2004 after increasing significantly in 2004 over 2003. Automotive electronic sales softened in 2005 after improving in 2004. Overall sales into the industrial components market were off slightly in 2005 from 2004, but portions of this market showed improvements in 2005. International sales accounted for the growth in Alloy Products sales in 2005 as domestic sales declined. Domestic sales had improved in 2004, rebounding from a slight decline in 2003. International sales of Alloy Products have improved three years in a row, reflective of the increased sales and marketing efforts designed to capture additional portions of the growing overseas markets, particularly Asia. TECHNICAL MATERIALS, INC. TMI manufactures engineered materials systems, including clad inlay and overlay metals, precious and base metal electroplated systems, electron beam welded systems, contour profiled systems and solder-coated metal systems. These specialty strip metal products provide a variety of thermal, electrical or mechanical properties from a surface area or particular section of the material. TMI's cladding and plating capabilities allow for a precious metal or brazing alloy to be applied to a base metal only where it is needed, reducing the material cost to the customer as well as providing design flexibility. Major applications for TMI products include connectors, contacts and semiconductors. TMI's largest markets are automotive and telecommunications and computer electronics, while the energy and defense and medical electronic markets offer further growth opportunities. TMI manufactures its products at our Lincoln, Rhode Island facility. TMI sales of $49.9 million in 2005 were 7% lower than sales in the previous year, while sales of $53.6 million in 2004 were $11.7 million, or 28%, higher than 2003. The inlay and plating product lines showed the largest declines in 2005. All of TMI's major product lines contributed to the growth in 2004, with plated products accounting for over 40% of the growth. Demand for TMI products from the automotive industry was soft the last three quarters of 2005 while demand from telecommunications and computer showed signs of improvements in some areas in 2005, but was still down for the year. We believe a portion of the weakness in the telecommunications and computer market in 2005 was due to a temporary downstream inventory correction. The sales growth in 2004 over 2003 was largely due to the stronger demand from these two markets. The continued development of new disk drive arm applications for computers added to sales in 2005, and this application provides a long-term growth opportunity for TMI. Development work on new products and applications that serve TMI's large existing markets as well as new emerging markets, including the energy market and medical products, also had a positive impact on sales in 2005, which helped to offset a portion of the decline in sales of traditional products. Examples of these new applications include materials for fuses and micromotors. TMI is also expanding its international efforts and presence, particularly in Asia, as production capacity within portions of the traditional markets served by TMI continues to be transferred overseas. TMI's new sales order entry rate strengthened late in the fourth quarter 2005 and we anticipate that shipments of TMI products will improve in the first quarter 2006. BERYLLIUM PRODUCTS Beryllium Products manufactures beryllium-based metals and metal matrix composites in rod, tube, sheet, foil and a variety of customized forms at the Elmore, Ohio and Fremont, California facilities. These materials are used in applications that require high stiffness and/or low density and they tend to be premium priced due to their unique combination of properties. Defense and government-related applications, including aerospace, is the largest market for Beryllium Products, typically accounting for over 60% of sales, while other markets served include medical, telecommunications and computer, electronics (including acoustics), optical scanning and performance automotive. Sales from Beryllium Products were $42.6 million in 2005, an 8% improvement over 2004 and the sixth consecutive year of growth. Sales in 2004 of $39.5 million were 12% higher than the sales in 2003. Sales of materials for the James Webb Space Telescope program totaled $12.1 million in 2005 and $5.9 million in 2004. Shipments under the initial material supply contract were completed in the second quarter 2005, but we continued to ship smaller quantities of additional materials for the telescope in the last half of the year. Shipments for the Webb telescope will be significantly lower in 2006 than in 2005 as this program for us is substantially complete. Sales for other defense and government-related applications were strong throughout 2003 and 2004 and into the early part of 2005 as well. Defense platforms for Beryllium Products are mainly aerospace and missile system applications. However, government budget revisions diverted funds away from these types of applications in order to provide additional support for current military ground operations. Applications that utilize our materials were delayed and in some cases reduced. As a result, defense and government sales, other than the Webb telescope, softened in the last half of 2005 with the softening continuing into the first quarter 2006. Sales to the medical market, including X-ray window applications, which were strong in 2004, softened slightly in 2005. Sales to the electronics market for acoustic components were relatively unchanged throughout the three years. As expected, performance automotive sales, after declining in 2004 from the 2003 level, were significantly lower in 2005 than in 2004. BRUSH RESOURCES Brush Resources' milling operations produce beryllium hydroxide from mined bertrandite ore and purchased beryl ore. See the Ore Reserve section of this Management's Discussion and Analysis for additional 18. information. The hydroxide is used primarily as a raw material input by the other businesses within the Metal Systems Group. Brush Resources also had external sales of hydroxide totaling $5.6 million in 2005, $4.7 million in 2004 and $4.3 million in 2003. METAL SYSTEMS GROSS MARGIN AND EXPENSES The gross margin on Metal Systems' sales was $68.7 million (22% of sales) in 2005 compared to $72.4 million (24% of sales) in 2004. While the higher volumes generated approximately $1.7 million of additional margin in 2005, this benefit was more than offset by the higher cost of copper that could not be completely passed through to customers and unfavorable changes in product mix. The product mix shift was caused primarily by lower sales of higher margin thin diameter rod and wire products from Alloy in 2005 as well as various product mix shifts within TMI. TMI also incurred additional costs and inefficiencies associated with manufacturing various new products. Manufacturing overhead expenses were $1.4 million lower in 2005 than 2004 as a result of cost saving efforts at the Elmore and Lincoln facilities. The gross margin on Metal Systems' sales in 2004 improved $31.6 million over the 2003 margin. As a percent of sales, the margin also improved from 17% to 24%. The higher sales volumes contributed an additional $21.3 million in margins in 2004. Operational improvements and manufacturing efficiencies, primarily at the Elmore facility, a favorable change in the product mix and the foreign currency translation expense generated $14.4 million in additional margin compared to 2003. The higher cost of copper in 2004 that could not be passed through to customers reduced margins by an estimated $7.5 million compared to 2003. The previously discussed $6.0 million margin benefit from the December 2003 refinancing flowed through Metal Systems' gross margin in 2004. Other manufacturing overhead costs, including manpower, maintenance and supplies, were higher in 2004 than in 2003. SG&A, R&D and other-net expense within the Metal Systems Group were $5.5 million lower in 2005 than in 2004. Incentive compensation accruals were significantly lower in 2005 than in 2004 while net exchange losses declined as well. These benefits were partially offset by higher international sales-related and other marketing costs. R&D expenses were also slightly higher in the current year. SG&A, R&D and other-net expense within the Metal Systems Group were $10.7 million higher in 2004 than in 2003. However, as a percent of sales, these expenses declined from 23% in 2003 to 22% in 2004. Increased incentive compensation accruals resulting from the improved profitability accounted for approximately 30% of the increase in expenses. Higher exchange losses and the majority of the unfavorable translation impact on the foreign subsidiaries' expenses contributed to the Group's expense increase in 2004. Other sales-related expenses, including commissions, travel and advertising and various administrative costs also were higher in 2004 than in 2003. The Metal Systems Group generated a profit of $6.3 million in 2005 compared to a $4.5 million profit in 2004 and an operating loss of $16.4 million in 2003. Gross margins were lower in 2005 than in 2004 as the unfavorable mix and higher copper costs more than offset the benefits from the improved sales volume; however, the reduction in expenses was greater than the decline in margins. The significant improvement in profitability in 2004 over 2003 resulted from the growth in margins caused by the sales increase, product mix shift and improved manufacturing performance offset in part by the cost of copper and other expenses. MICROELECTRONICS GROUP
2005 2004 2003 ------- ------- ------- (Millions) Net sales............... $ 234.9 $ 195.6 $ 157.3 Operating profit........ 19.0 18.5 12.6
The Microelectronics Group includes Williams Advanced Materials Inc. (WAM), a wholly owned subsidiary, and Electronic Products. These businesses manufacture a variety of high quality precision parts that are sold to assemblers and other fabricators of electronic components and equipment. Sales grew 20% in 2005 over 2004 after growing 24% in 2004 over 2003. Operating profit, however, only improved slightly in 2005 after showing a significant improvement in 2004 compared to 2003. Sales to external customers by business unit within this group during the 2003 to 2005 time frame were as follows:
2005 2004 2003 ------- ------- ------- (Millions) Williams Advanced Materials Inc... $ 209.5 $ 165.7 $ 127.8 Electronic Products............... 25.4 29.9 29.5 ------- ------- ------- Total segment sales............ $ 234.9 $ 195.6 $ 157.3 ======= ======= =======
WILLIAMS ADVANCED MATERIALS INC. WAM manufactures precious, non-precious and specialty metal products at its facilities in New York, California, Asia and Europe. Specific products include physical vapor deposition targets, frame lid assemblies, clad and precious metal preforms, high temperature braze materials and ultra fine wire. Physical vapor deposition-related products account for approximately 60% of WAM's business. Major markets for WAM's products include magnetic and optical data storage, medical and the wireless, semiconductor, photonic and hybrid segments of the microelectronics market. A key competitive advantage for WAM is its ability to reclaim precious metals, from its own or customers' scrap, through its in-house refinery. Due to the high cost of its precious metal products, WAM emphasizes quality, delivery performance and customer service in order to attract and maintain applications. 19. MANAGEMENT'S DISCUSSION AND ANALYSIS WAM's sales have grown significantly in each of the last two years. Sales of $209.5 million in 2005 were 26% higher than 2004 while 2004 sales of $165.7 million were 30% higher than sales in 2003. WAM adjusts its selling prices daily to reflect the current cost of the precious and non-precious metals sold. The cost of the metal is a pass-through to the customer and WAM generates its margin on its fabrication efforts irrespective of the type or cost of the metal used in a given application. Therefore, the cost and mix of metals sold will affect sales but not necessarily the margins generated by those sales. Metal prices increased on average in both 2005 and 2004 as compared to the respective prior year and the metal content increased as a percent of sales in 2005 as well, meaning that the underlying volume growth was less than the growth in sales. Sales of physical vapor deposition targets grew in each of the last two years fueled by strong demand from the optical data storage market. Frame lid assembly sales also increased in each of the last two years. A portion of this growth is attributable to new product design and application development work. Applications for giant magnetic resistance film materials were strong in 2005 once again and remain a large market for WAM's products. Demand from the wireless and photonic segment of the microelectronics market for a variety of WAM's products, including targets, frame lids and wire, showed strong growth in 2005 after improving in 2004 as well. Development work continued for semiconductor applications for thin film products, which remain an attractive growth platform. Refining revenue increased in 2005 as well. In the second quarter 2005, WAM acquired OMC Scientific Limited (OMC), which provides physical vapor deposition material cleaning and reconditioning services to customers in Europe. In the fourth quarter 2005, WAM acquired Thin Film Technology, Inc. (TFT), which manufactures precision optical coatings, thin film circuits and coatings and other products. Both of these acquisitions serve to expand WAM's capabilities and add further breadth to WAM's product offerings. TFT was previously a WAM vendor, working closely with WAM on the development and production of lid assemblies. OMC and TFT were responsible for approximately 11% of WAM's sales growth in 2005 over 2004. The expansion of WAM's business continued into 2006 with the acquisition of CERAC, incorporated, which was completed in January 2006. CERAC manufactures physical vapor deposition and specialty inorganic materials to a variety of industries. Sales through WAM's operation in Taiwan grew at a double-digit rate in 2005. While still small, this operation that began as a joint venture in 2003 and became a wholly owned subsidiary in early 2004, has continued to grow and offers an additional long-term growth opportunity for WAM. WAM has also established, or is in the process of establishing, sales and marketing offices in Korea, Japan and China in order to take advantage of growth opportunities in Asia. ELECTRONIC PRODUCTS Electronic Products manufactures beryllia ceramics, electronic packages and circuitry for sale into the telecommunications and computer, medical, electronics, automotive and defense markets. These products provide specific thermal and/or electrical conductivity characteristics and are used as components in a variety of applications, including wireless telecommunications equipment, fiber optics, lasers for medical and other electronic equipment, automotive ignition module systems, satellites and radar systems. Electronic Products are manufactured by Zentrix Technologies Inc. and Brush Ceramic Products Inc., two wholly owned subsidiaries. Sales from Electronic Products were $25.4 million in 2005, a decline of 15% from 2004, while sales of $29.9 million in 2004 were relatively unchanged from 2003. Sales of beryllia ceramics declined 17% in 2005 after growing approximately 14% in 2004 over 2003. The softer sales in 2005 as well as the growth in 2004 sales resulted from changes in demand from sectors of the telecommunications and computer market, including infrastructure equipment applications. In addition, downstream inventories of our products were high at the end of 2004 and orders were reduced during 2005 as this high inventory position was being consumed. Beryllia ceramics is a mature product line with established applications but limited growth opportunities. Sales of electronic packages also declined in 2005 largely due to weaker demand from the automotive market. Sales of these products had improved in 2004 over 2003 due to changes in the build rates for telecommunications infrastructure equipment. Sales of circuitry, which are manufactured by Circuits Processing Technology, Inc., (CPT), a wholly owned subsidiary of Zentrix, improved 21% in 2005 over 2004 after declining 33% in 2004 from the 2003 sales level. While defense applications remain the largest market for circuits, CPT continued their efforts to develop additional commercial applications in order to diversify their product offerings. MICROELECTRONICS GROUP GROSS MARGIN AND EXPENSES The gross margin on Microelectronics Group sales was $43.0 million in 2005, $40.5 million in 2004 and $32.8 million in 2003. As a percent of sales, the gross margin was 18% in 2005 compared to 21% in both 2004 and 2003. The higher sales volumes in 2005 generated an additional $8.4 million in margin over 2004. However, the unfavorable product mix shift, resulting from changes within WAM as well as the lower automotive and telecommunication and computer market sales, reduced margins by an estimated $4.7 million. Manufacturing overhead costs increased in 2005, partially due to product development efforts, and inventory valuation adjustments were unfavorable as compared to the prior year. The growth in the gross margin in 2004 due to the higher sales volumes was approximately $9.1 million while the change in product mix impact was slightly unfavorable. Manufacturing overhead costs were $0.8 million higher in 2004, primarily within WAM, reflective of the higher level of production activity. 20. SG&A, R&D and other-net expenses within the Microelectronics Group increased $2.0 million in 2005 over 2004 with the expenses incurred by OMC and TFT accounting for $1.4 million of the increase. Other sales-related expenses were higher as well, including costs associated with expanding international marketing efforts. The sale of an unused building created a one-time gain of $0.3 million in 2004, reducing net expenses in that period. Incentive compensation expenses were slightly lower in 2005 than 2004. The precious metal consignment fee was unchanged in 2005 from 2004. SG&A, R&D and other-net expenses were $1.8 million higher in 2004 than in 2003, although as a percent of sales these expenses declined from 13% in 2003 to 11% in 2004. Administrative costs, including legal expenses, within WAM, were the major cause of the increase. Costs associated with the newly created and growing operation in Taiwan also contributed to the increase in expenses. The precious metal financing fee increased only slightly in 2004 over 2003 despite the increase in metal on hand. The Microelectronics Group operating profit was $19.0 million, or 8% of sales, in 2005, $18.5 million or 9% of sales, in 2004 and $12.6 million, or 8% of sales, in 2003. INTERNATIONAL SALES AND OPERATIONS We operate in worldwide markets and our international customer base continues to expand due to the development of various foreign nations' economies and the relocation of U.S. businesses overseas. Our international operations are designed to provide a cost-effective method of capturing the growing overseas demand for our products. Brush International has service centers in Germany, England, Japan and Singapore that primarily focus on the distribution of Alloy Products while also providing additional local support to portions of our other businesses. WAM has finishing operations in Singapore and the Philippines and a small manufacturing operation in Taiwan and this year acquired OMC in Ireland. We also have branch sales offices in various countries, including the Republic of China and Taiwan, and we utilize an established network of independent distributors and agents throughout the world. Total international sales, including sales from international operations as well as direct exports from the U.S., for the 2003 to 2005 time frame were as follows:
2005 2004 2003 ------- ------- ------- (Millions) From international operations.... $ 132.8 $ 119.8 $ 89.5 Exports from U.S. operations..... 46.3 44.3 34.9 ------- ------- ------- Total international sales........ $ 179.1 $ 164.1 $ 124.4 ======= ======= ======= Percent of total net sales....... 33% 33% 31%
The international sales presented in the above table are included in both the Metal Systems Group and Microelectronics Group sales figures previously discussed. The majority of international sales are to the Pacific Rim, Europe and Canada. The increase in international sales in 2005 was primarily in Asia, while the OMC acquisition added to the European sales base in 2005. The Asian sales growth resulted from a combination of additional market penetration, the relocation of U.S. production to overseas locations and increased market share. Sales in Europe and Asia both grew in 2004, partially due to a favorable currency exchange effect as compared to 2003. The currency effect on 2005 sales was negligible compared to 2004. We serve many of the same markets internationally as we do domestically. Telecommunications and computer and automotive electronics are the largest international markets for our products. The appliance market for Alloy Products is a more significant market, primarily in Europe, than it is domestically while government and defense applications are not as prevalent overseas as they are in the U.S. Our market share is smaller in the overseas markets than it is domestically and given the macro-economic growth potential for the international economies, including the continued transfer of U.S. business to overseas locations, the international markets may present greater long-term growth opportunities. We believe that a large portion of the long-term international growth will come from China and we continue to expand our marketing presence, distributor arrangements and customer relationships there. Sales from the international operations are typically denominated in the local currency, particularly in Europe and Japan. Exports from the U.S. and sales from the Singapore operations are predominately denominated in U.S. dollars. Movements in the foreign currency exchange rates will affect the reported translated value of foreign currency denominated sales while local competition limits our ability to adjust selling prices upwards to compensate for short-term exchange rate movements. We have a hedge program with the objective of minimizing the impact of fluctuating currency values on our reported results. LEGAL PROCEEDINGS One of our subsidiaries, Brush Wellman Inc., is a defendant in proceedings in various state and federal courts brought by plaintiffs alleging that they have contracted chronic beryllium disease or other lung conditions as a result of exposure to beryllium. Plaintiffs in beryllium cases seek recovery under negligence and various other legal theories and seek compensatory and punitive damages, in many cases of an unspecified sum. Spouses, if any, claim loss of consortium. The following table summarizes the associated activity with beryllium cases.
December 31, -------------------------- 2005 2004 2003 ----- ------ ------- Total cases pending....................... 13 12 15 Total plaintiffs (including spouses)...... 54 56 33 Number of claims (plaintiffs) filed during period ended.................... 5(7) 6(42) 11(22) Number of claims (plaintiffs) settled during period ended.................... 1(1) 6(10) 24(47) Aggregate cost of settlements during period ended (dollars in thousands).... $ 2 $ 370 $ 2,045 Number of claims (plaintiffs) otherwise dismissed.............................. 3(8) 3(9) 5(12)
21. MANAGEMENT'S DISCUSSION AND ANALYSIS Settlement payment and dismissal for a single case may not occur in the same period. The 2003 data includes five claims that were settled and dismissed late in the fourth quarter 2003. Payments of the claims were made in 2004 but are shown in the preceding table in 2003. Additional beryllium claims may arise. Management believes that we have substantial defenses in these cases and intends to contest the suits vigorously. Employee cases, in which plaintiffs have a high burden of proof, have historically involved relatively small losses to us. Third-party plaintiffs (typically employees of customers or contractors) face a lower burden of proof than do employees or former employees, but these cases are generally covered by varying levels of insurance. A reserve was recorded for beryllium litigation of $2.1 million at December 31, 2005 and $1.9 million at December 31, 2004. A receivable was recorded of $2.2 million at December 31, 2005 and $2.3 million at December 31, 2004 from our insurance carriers as recoveries for insured claims. An additional $0.4 million was reserved at December 31, 2005 and 2004 for insolvencies related to claims still outstanding as well as claims for which partial payments have been received. Although it is not possible to predict the outcome of the litigation pending against our subsidiaries and us, we provide for costs related to these matters when a loss is probable and the amount is reasonably estimable. Litigation is subject to many uncertainties, and it is possible that some of these actions could be decided unfavorably in amounts exceeding our reserves. An unfavorable outcome or settlement of a pending beryllium case or additional adverse media coverage could encourage the commencement of additional similar litigation. We are unable to estimate our potential exposure to unasserted claims. While we are unable to predict the outcome of the current or future beryllium proceedings, based upon currently known facts and assuming collectibility of insurance, we do not believe that resolution of these proceedings will have a material adverse effect on our financial condition or cash flow. However, our results of operations could be materially affected by unfavorable results in one or more of these cases. As of December 31, 2005, four purported class actions were pending. REGULATORY MATTERS. Standards for exposure to beryllium are under review by the United States Occupational Safety and Health Administration and by other governmental and private standard-setting organizations. One result of these reviews will likely be more stringent worker safety standards. More stringent standards may affect buying decisions by the users of beryllium-containing products. If the standards are made more stringent or our customers decide to reduce their use of beryllium-containing products, our operating results, liquidity and capital resources could be materially adversely affected. The extent of this adverse effect would depend on the nature and extent of the changes to the standards, the cost and ability to meet the new standards, the extent of any reduction in customer use and other factors that cannot be estimated. FINANCIAL POSITION WORKING CAPITAL CASH FLOW FROM OPERATIONS totaled $3.5 million in 2005 compared to $38.9 million in 2004. Cash received from the sale of goods totaled $531.2 million in 2005 and $492.7 million in 2004. Cash paid for goods and expenses was $518.9 million in 2005, an increase of $71.3 million over 2004. The cash balance was $10.6 million at December 31, 2005 compared to $49.6 million at December 31, 2004. This decline was due primarily to the retirement of debt, the funding of capital expenditures, two small acquisitions and a pension plan contribution. THE ACCOUNTS RECEIVABLE BALANCE was $69.9 million at year-end 2005 compared to $59.2 million at year-end 2004. After having improved for five consecutive years, the year-ending days sales outstanding (DSO), a measure of how quickly receivables are collected, after adjusting for the unearned revenue effect, increased by approximately three days from year-end 2004, although we believe collections are still being made on a timely basis. The slower collection period accounted for approximately 40% of the increased accounts receivable balance. The balance of the increase was due to higher sales in the fourth quarter 2005 than in the fourth quarter 2004 and the difference in the outstanding billings for unshipped items that were recorded through unearned revenue. Accounts receivable increased by $4.1 million in 2004 as a result of higher sales volumes and the unearned revenue effect. The DSO as of year-end 2004 improved approximately five days from year-end 2003. Accounts written off to bad debt expense remained relatively minor in 2005. Early in the fourth quarter 2005, Delphi Corporation, the largest U.S. supplier of automotive parts, filed for bankruptcy protection. Delphi is a customer of businesses within both the Metal Systems Group and the Microelectronics Group. However, our credit exposure with Delphi at the time of the bankruptcy filing was limited and any potential bad debt was minimal. THE INVENTORY BALANCE at December 31, 2005 was $104.1 million, an increase of $8.8 million since the previous year end. Inventories increased $7.9 million during 2004. Approximately half of the inventory build in 2005 occurred in the fourth quarter in response to the higher sales in that period and in preparation for the projected high sales level in the first quarter 2006. Alloy inventory pounds were 8% higher at year-end 2005 than year-end 2004 in part due to additional purchases of copper beryllium master alloy from the Defense Logistics Agency during the fourth quarter 2005. Alloy inventory pounds had declined 2% in 2004. Scrap utilization and manufacturing yield improvements had helped keep alloy inventory pounds at levels below the levels from 2003 and the preceding years. WAM's inventories climbed in each of the last two years to support the higher sales volumes, but the inventory increase was not proportional to the sales increase as the majority of WAM's inventory is maintained on an off-balance sheet consignment arrangement. Approximately 60% of the 2004 inventory build was in Beryllium Products and primarily as a result of the Webb Telescope project. With the completion of the majority of this project in 2005, however, year-end 2005 inventories within Beryllium Products remained relatively unchanged from the prior year end and their 22. months' supply of inventory has increased. Inventories within Brush Resources declined in 2005, as they did in 2004, as the level of mining activity has diminished due to sufficient supplies of beryllium hydroxide previously produced. The higher cost of copper, nickel, precious metals and other materials increased the value of the inventory on a first-in, first-out (FIFO) basis in each of the last two years; however, this impact was largely offset by the use of the last-in, first-out (LIFO) valuation method and the higher metal prices only had a small impact on the increase in inventory values during 2005 and 2004. The LIFO method also generally results in the higher cost of materials (as well as other costs) being charged to cost of sales in the current period. While the inventory level increased in 2005, the overall inventory turns, a measure of how efficiently inventory is utilized, improved as of year-end 2005 as compared to year-end 2004. Inventory turns were lower as of year-end 2004, primarily due to the Webb Telescope inventory, compared to year-end 2003. PREPAID EXPENSES as of December 31, 2005 included the fair value of the outstanding foreign exchange derivative contracts totaling $1.5 million and copper hedge contracts of $1.9 million. The fair value of the foreign exchange contracts outstanding as of December 31, 2004 was a loss of $3.9 million, with $3.4 million recorded in other liabilities and accruals and $0.5 million in other long-term liabilities, and there were no outstanding copper hedge contracts. The cause for the change from a liability to an asset in the fair value of the foreign currency derivatives was the relative strength of the U.S. dollar as compared to the strike price of the outstanding contracts at each year end. In addition to the impact of the fair value of the derivatives, prepaid expenses increased $2.7 million during 2005 due to an increase in the legal defense costs to be reimbursed by insurance carriers and the timing of other payments. Prepaid expenses increased $2.9 million in 2004 as a result of miscellaneous timing differences. Other assets were $8.3 million as of year-end 2005, a decline of $6.3 million during the year. The two major causes for the decline were the write-off of deferred financing costs associated with debt that was prepaid during the year and the write-off of the pension plan prior service cost intangible asset to OCI as a result of a plan amendment. These items are discussed in greater detail in other sections of this Management's Discussion and Analysis. Offsetting a portion of the decline in other assets from these two items was the addition of intangible assets from the TFT and OMC acquisitions totaling $2.1 million. These intangibles will be amortized over the next seven to ten years depending upon the item. THE ACCOUNTS PAYABLE BALANCE of $20.9 million was $7.6 million higher at year-end 2005 than year-end 2004 due to increased business levels and the timing of payments relative to year end while the 2004 year-end balance was $2.8 million lower than year-end 2003. Accrued salaries and wages were $7.4 million lower at year-end 2005 than the prior year end primarily due to the lower incentive compensation accruals in 2005. Unearned revenue, which is a liability representing billings to customers in advance of the shipment of product, was $0.3 million at December 31, 2005 compared to $7.8 million at December 31, 2004. The majority of the unearned revenue as of the prior year end was related to the Webb Telescope contract, which began in 2004 and was completed during the second quarter 2005. Other long-term liabilities of $8.2 million declined $2.6 million during 2005 after declining $3.9 million during 2004. The reduction in both years was due to movements in the environmental remediation reserve and changes in the long-term portion of the fair value of derivatives, primarily interest rate swaps. The legal reserve increased slightly in 2005 after declining in 2004. We paid less than $0.1 million for legal settlements related to chronic beryllium disease in 2005 compared to $1.4 million in 2004. We received $0.2 million in 2005 and $1.0 million in 2004 from our insurance carriers as partial reimbursement for the insured portions of claims paid in the current and prior years. DEPRECIATION AND AMORTIZATION Depreciation, amortization and depletion was $21.7 million in 2005, $21.2 million in 2004 and $19.1 million in 2003. The increase in 2005 is due to the current year capital expenditures while the $2.1 million increase in expense in 2004 over 2003 resulted primarily from the purchase of the previously leased assets for $51.8 million in December 2003. Amortization of deferred mine development was $1.2 million in both 2004 and 2003; there was no mine development amortization in 2005 as there was no mining activity due to the amount of available ore previously removed from the pits. Mine development costs are amortized based upon the units-of-production method as ore is extracted from the pits. Amortization of deferred financing costs included in interest expense was $1.1 million in 2005, $1.5 million in 2004 and $0.4 million in 2003. The increase in 2004 was due to the amortization of costs associated with the December 2003 refinancing. CAPITAL EXPENDITURES Capital expenditures for property, plant and equipment and mine development totaled $13.8 million in 2005, an increase of $4.6 million over the $9.2 million expended in 2004. Spending by the Metal Systems Group totaled $8.6 million in 2005 and $5.8 million in 2004, while the Microelectronics Group spending totaled $4.7 million in 2005 and $2.7 million in 2004. The majority of the spending in both years was on small infrastructure projects, equipment upgrades and discreet pieces of equipment. Spending at the Elmore facility accounted for over half of the Metal Systems Group spending in 2005, while spending within the various WAM facilities accounted for approximately 90% of the Microelectronics Group capital spending. While certain pieces of equipment may have been capacity constrained or operated near their capacity, in general, we had sufficient production capacity to meet the level of demand throughout 2005. We exercised the purchase option in various lease agreements and purchased previously leased assets at a cost of $0.4 million in 2005 and $0.9 million in 2004. We acquired the stock of OMC and TFT for a combined cost of $11.5 million in cash, net of cash received. Goodwill from the two acquisitions was valued at $4.8 million. 23. MANAGEMENT'S DISCUSSION AND ANALYSIS PENSION LIABILITY We annually remeasure the domestic defined benefit plan assets and liabilities at each year end. However, we also remeasured the plan during the second quarter 2005 as a result of a plan amendment that was deemed to be a significant event as defined by Statement No. 87, "Employers' Accounting for Pensions". The amendment revised the benefit payout formula for the majority of the plan participants, among other changes. Various assumptions, including the expected rate of return and discount rate, were reviewed and revised at that time as warranted. As a result of the remeasurement, the prior service cost asset of $5.0 million was charged off against OCI while the minimum pension liability increased $6.1 million with the offset also charged against OCI in the second quarter 2005. The market value of the assets in the domestic defined benefit pension plan was $94.8 million while the present value of the accumulated benefit obligation was $122.5 million as of December 31, 2005. In accordance with Statement No. 87 guidelines, we, therefore, increased the minimum pension liability by $8.5 million with the offset charged against OCI in the fourth quarter 2005. The OCI balance related to the domestic pension plan was $35.4 million as of year-end 2005. During 2005, the fair value of the assets in the domestic pension plan increased by $5.4 million as a result of a $5.0 million contribution to the plan and earnings that slightly exceeded plan disbursements. The pension plan assets earned an actual return of 6.5% in 2005 compared to 10.6% in 2004. No contribution to the plan was required in 2004. The accumulated benefit obligation for the defined benefit plan increased $18.1 million in 2005 due to a lower discount rate, an additional year of service earned by the participants and other actuarial assumptions. The associated expense, which also served to increase the liability, was $3.1 million in 2005. While this was higher than the expense of $2.7 million in 2004, the 2005 expense would have been higher had the plan not been amended. Brush International's subsidiary in Germany has an unfunded retirement plan for its employees. The minimum pension liability for this plan was $4.1 million as of December 31, 2005 and $1.4 million was charged against OCI in 2005 as a result of the annual remeasurement of the plan. COMMON STOCK We received $0.4 million for the exercise of 29,955 employee stock options in 2005 and $3.2 million for the exercise of 228,298 employee stock options in 2004. The market price for our common stock on average was lower relative to the strike price of the vested outstanding options in 2005 than in 2004. In the third quarter 2004, we issued 2.25 million shares of our common stock with the net proceeds, after deduction of all expenses, being $38.7 million. The new shares represented 13% of the shares previously issued and outstanding. Concurrent with the offering, the holders of 115,000 warrants, initially granted in conjunction with a debt refinancing in December 2003, exercised their rights and sold their shares. The exercise and issuance of the shares for these warrants did not have a material impact on our cash flows. DEBT AND OFF-BALANCE SHEET OBLIGATIONS During the fourth quarter 2005, we repaid the $30.0 million subordinated debt with a combination of excess cash and proceeds from borrowings under the revolving credit agreement. Repayment of this high-interest rate debt should generate cash and expense savings going forward. As a result of the repayment, we wrote off the associated remaining unamortized deferred financing costs of $2.2 million and paid a prepayment penalty of $1.6 million. During the first quarter 2005, we repaid the $18.6 million term notes. Only $2.9 million of these notes were due to be repaid in 2005, but we repaid the notes early due to our cash position. We retain the ability to re-borrow these funds under the revolving credit agreement in accordance with the term loan's original amortization schedule. Deferred financing costs of $0.6 million associated with the term loans were written off in the first quarter 2005. The subordinated debt and the term notes were secured as part of the December 2003 refinancing. Also during the fourth quarter 2005, we renegotiated our revolving credit agreement to increase the borrowing capacity to $125.0 million and to modify various financial covenants, including the level of allowable acquisitions. Total debt was $57.2 million at year-end 2005, a reduction of $15.3 million since the prior year end. Short-term debt totaled $23.6 million and included $6.2 million of foreign denominated debt and $12.3 million of gold-denominated debt designed as hedges against assets similarly denominated. The foreign debt increased during 2005 as we established a new line of credit in Germany. The outstanding gold debt is higher at year-end 2005 than year-end 2004 as a result of the increased price of gold. Other short-term domestic borrowings under the revolving credit agreement were $5.1 million. Long-term debt was $33.6 million at December 31, 2005 compared to $60.8 million at December 31, 2004. The long-term debt as of year-end 2005 included $22.0 million borrowed under the revolving credit agreement and three other variable rate instruments. Long-term debt repayments scheduled for 2006 totaled $0.6 million and were classified on the Consolidated Balance Sheet accordingly. See Note F to the Consolidated Financial Statements. We reduced our balance sheet debt by $42.0 million over the course of 2004 and 2005 as cash generated from the 2004 share offering, operational improvements and the higher level of profitability was used to retire debt. We were in compliance with all of our debt covenants as of December 31, 2005. We have an off-balance sheet operating lease with a notional value of $11.4 million as of December 31, 2005 that finances a building at the Elmore facility. Annual payments under this lease are $2.3 million. See Note G to the Consolidated Financial Statements for further leasing details. We maintain the majority of our precious metal inventories on a consignment basis in order to reduce our metal price exposure. See Market Risk Disclosures in this Management's Discussion and Analysis. The notional value of this off-balance sheet inventory was $43.7 million at December 31, 2005 compared to $17.2 million at December 31, 2004. Approximately $6.6 million of the increase in the consignment value was due to higher metal prices at year-end 2005 compared to year-end 2004. The remaining portion of the increase was due to additional ounces on 24. hand to support the increase in WAM's business volume and changes in product mix. The capacity under the precious metal consignment lines was increased to $98.0 million in 2005. CONTRACTUAL OBLIGATIONS A summary of contractual payments to be made under long-term debt agreements, operating leases and material purchase commitments by year is as follows:
There- (Millions) 2006 2007 2008 2009 2010 after Total ------ ------ ----- ------ ----- ------ ------ Long-term debt ......... $ 0.6 $ 0.6 $ 0.7 $ 22.7 $ - $ 9.0 $ 33.6 Building lease ......... 2.3 2.3 2.3 2.3 2.3 2.5 14.0 Other operating lease payments ...... 2.8 2.5 1.9 1.8 1.1 1.6 11.7 ------ ------ ----- ------ ----- ------ ------ Subtotal non- cancelable leases ... 5.1 4.8 4.2 4.1 3.4 4.1 25.7 Purchase commitments ......... 11.0 11.0 - - - - 22.0 ------ ------ ----- ------ ----- ------ ------ Total ............. $ 16.7 $ 16.4 $ 4.9 $ 26.8 $ 3.4 $ 13.1 $ 81.3 ====== ====== ===== ====== ===== ====== ======
The revolving credit agreement matures in 2009. We anticipate that a new debt agreement will be negotiated prior to the maturation of this agreement. Annual repayments are required to be made against other portions of our long-term debt in each of the next four years. See Note F to the Consolidated Financial Statements for additional debt information. The lease payments represent payments under non-cancelable leases with initial lease terms in excess of one year as of December 31, 2005. See Note G to the Consolidated Financial Statements. The purchase commitments include $0.4 million for capital equipment to be acquired in 2006. The $10.6 million balance of these obligations in 2006 and the $11.0 million in 2007 are for raw materials to be acquired under long-term supply agreements that end in 2007, although we have the opportunity to negotiate an extension for one of the agreements. See Note J to the Consolidated Financial Statements. Contractual obligations totaled $122.4 million as of December 31, 2004. OTHER We believe that cash flow from operations plus the available borrowing capacity, and the current cash balance are adequate to support operating requirements, capital expenditures, projected pension plan contributions, environmental remediation projects and small acquisitions. The repayment of the high rate subordinated debt and the amended revolving credit agreement allow for increased stability in our capital structure, more flexibility in terms of available credit and covenant structures and lower borrowing costs. The debt to debt-plus-equity ratio, a leverage measure, improved in each of the last two years. Cash flow from operations was positive in 2005 once again. While the year-end 2005 cash balance was $39.0 million lower than the unusually high balance at the end of 2004, $32.1 million of this decline was used to retire debt, acquire two businesses and fund a pension plan contribution. In addition to the $10.6 million cash balance, available borrowings under existing unused lines of credit totaled $75.5 million as of December 31, 2005. Portions of the cash balances may be invested in high quality, highly liquid investments with maturities of three months or less. ENVIRONMENTAL We have an active program of environmental compliance. We estimate the probable cost of identified environmental remediation projects and establish reserves accordingly. The environmental remediation reserve balance was $4.9 million at December 31, 2005 and $5.7 million at December 31, 2004. The reserve balance was reduced during 2005 as a result of revised detailed estimates of the projected remediation costs that were prepared by outside consultants and reviewed by management. Payments against the reserve totaled $0.3 million in 2005. See Note J to the Consolidated Financial Statements. ORE RESERVES Brush Resources' reserves of beryllium-bearing bertrandite ore are located in Juab County, Utah. An ongoing drilling program has generally added to proven reserves. Proven reserves are the measured quantities of ore commercially recoverable through the open-pit method. Probable reserves are the estimated quantities of ore known to exist, principally at greater depths, but prospects for commercial recovery are indeterminable. Ore dilution that occurs during mining is approximately seven percent. Approximately 87% of beryllium in ore is recovered in the extraction process. We augment our proven reserves of bertrandite ore through the purchase of imported beryl ore. This ore, which is approximately 4% beryllium, is also processed at Brush Resources' Utah extraction facility. We use computer models to estimate ore reserves, which are subject to economic and physical evaluation. Development drilling can also affect the total ore reserves to some degree. There was no development drilling activity in 2005 or 2004. The requirement that reserves pass an economic test causes open-pit mineable ore to be found in both proven and probable geologic settings. Proven reserves have decreased slightly in each of the last four years while probable reserves have remained unchanged over the last three years. We own approximately 95% of the proven reserves, with the remaining reserves leased. Based upon average production levels in recent years, proven reserves would last in excess of 100 years. Ore reserves classified as possible are excluded from the following table.
2005 2004 2003 2002 2001 ------ ------ ------ ------ ------ Proven bertrandite ore reserves at year end (thousands of dry tons) ....... 6,601 6,640 6,687 6,730 7,270 Grade % beryllium ................ 0.268% 0.268% 0.267% 0.267% 0.268% Probable bertrandite ore reserves at year end (thousands of dry tons) ....... 3,519 3,519 3,519 3,519 3,081 Grade % beryllium ................ 0.232% 0.232% 0.232% 0.232% 0.219% Bertrandite ore processed (thousands of dry tons, diluted) ......... 38 39 41 40 48 Grade % beryllium, diluted ....................... 0.316% 0.248% 0.224% 0.217% 0.224%
25. MANAGEMENT'S DISCUSSION AND ANALYSIS CRITICAL ACCOUNTING POLICIES The preparation of financial statements requires the inherent use of estimates and management's judgment in establishing those estimates. The following are the most significant accounting policies we use that rely upon management's judgment. ACCRUED LIABILITIES. We have various accruals on our balance sheet that are based in part upon management's judgment, including accruals for litigation, environmental remediation and workers' compensation costs. We establish accrual balances at the best estimate determined by a review of the available facts and trends by management and independent advisors and specialists as appropriate. Absent a best estimate, the accrual is established at the low end of the estimated reasonable range in accordance with Statement No. 5, "Accounting for Contingencies". Litigation and environmental accruals are only established for identified and/or asserted claims; future claims, therefore, could give rise to increases to the accruals. The accruals are adjusted as facts and circumstances change. The accruals may also be adjusted for changes in our strategies or regulatory requirements. Since these accruals are estimates, the ultimate resolution may be greater or less than the established accrual balance for a variety of reasons, including court decisions, additional discovery, inflation levels, cost control efforts and resolution of similar cases. Changes to the accruals would then result in an additional charge or credit to income. See Note J to the Consolidated Financial Statements. Certain legal claims are subject to partial or complete insurance recovery. The accrued liability is recorded at the gross amount of the estimated cost and the insurance recoverable, if any, is recorded as a separate asset and is not netted against the liability. The accrued legal liability includes the estimated indemnity cost only, if any, to resolve the claim through a settlement or court verdict. The legal defense costs are not included in the accrual and are expensed in the period incurred, with the level of expense in a given year affected by the number and types of claims we are actively defending. Portions of the legal defense costs may also be covered by insurance, in which case payments will be recorded as a prepaid expense on the balance sheet awaiting reimbursement from the insurance carrier. PENSIONS. We have a defined benefit pension plan that covers a large portion of our current and former domestic employees. We account for this plan in accordance with Statement No. 87, "Employers' Accounting for Pensions". Under this statement, the carrying values of the associated assets and liabilities are determined on an actuarial basis using numerous actuarial and financial assumptions. Differences between the assumptions and current period actual results may be deferred into the net pension asset or liability value and amortized against future income under established guidelines. The deferral process generally reduces the volatility of the recognized net pension asset or liability and current period income or expense. The actuaries adjust their assumptions to reflect changes in demographics and other factors, including mortality rates and employee turnover, as warranted. Management periodically reviews other key assumptions, including the expected return on plan assets, the discount rate and the average wage rate increase, against actual results, trends and industry standards and makes adjustments accordingly. These adjustments may then lead to a higher or lower expense in a future period. Our pension plan investment strategies are governed by a policy adopted by the Retirement Plan Review Committee of the Board of Directors. The future return on pension assets is dependent upon the plan's asset allocation, which changes from time to time, and the performance of the underlying investments. As a result of our review of various factors, we reduced the expected rate of return on plan asset assumption to 8.50% at December 31, 2005 from 8.75% at December 31, 2004. We believe that an 8.50% return over the long term is reasonable. Should the assets earn an average return less than 8.50% over time, in all likelihood the future pension expense would increase. Investment earnings in excess of 8.50% would tend to reduce the future expense. We establish the discount rate used to determine the present value of the projected and accumulated benefit obligation at the end of each year based upon the available market rates for high quality, fixed income investments. An increase to the discount rate would reduce the future pension expense and, conversely, a lower discount rate would raise the future pension expense. We elected to use a discount rate of 5.75% as of December 31, 2005 compared to 6.125% at December 31, 2004 and 5.875% as of the mid-year remeasurement. We estimate that the net expense from the domestic defined benefit pension plan will be $1.9 million higher in 2006 than 2005 as a result of the reduction in the expected rate of return and discount rate assumptions, changes in other assumptions and valuations, the amortization of prior differences between actual and expected results and other factors. If the expected rate of return assumption was changed by 50 basis points (0.50%) and all other pension assumptions remained constant, the 2006 projected pension expense would change by approximately $0.5 million. If the December 31, 2005 discount rate were reduced by 25 basis points (0.25%) and all other pension assumptions remained constant, then the 2006 projected pension expense would increase by approximately $0.4 million. The $27.7 million minimum pension liability for the domestic plan recorded as of December 31, 2005 does not by itself indicate that a cash contribution to the plan is required. This liability was recorded according to the requirements of Statement No. 87, while cash contributions and funding requirements are governed by ERISA and IRS guidelines. Based upon these guidelines, current assumptions and estimates and our pension plan objectives, we estimate a cash contribution of approximately $1.9 million will be required in 2006. The inter-relationship of the many factors affecting the plan assets and liabilities makes it difficult to project contributions beyond one year out; however, a contribution may be required in 2007 that is greater than the 2006 contribution. The minimum pension liability under Statement No. 87 will be recalculated at the measurement date (December 31 of each year) and any adjustments to this account and other comprehensive income within shareholders' equity will be recorded at that time accordingly. See Note I to the Consolidated Financial Statements for additional details on our pension plans. 26. The Financial Accounting Standards Board is currently reviewing and may recommend revising the accounting standards for pension and post-retirement benefit plans. The proposed revisions may be more reflective of international pension accounting standards. Potential changes may be the elimination of smoothing of actuarial gains and losses and revisions to the methods for calculating plan expenses. The revisions, if enacted, may be implemented in two phases beginning in 2006. At the present time, we cannot assess the potential impact these potential revisions may have on our results of operations or financial condition. LIFO INVENTORY. The prices of certain major raw materials, including copper, nickel, gold, silver and other precious metals, fluctuate during a given year. The cost of copper increased significantly in 2005 after a large increase in 2004 as well. Nickel prices have also climbed over the last two years. Where possible, such changes in costs are generally reflected in selling price adjustments. The prices of labor and other factors of production generally increase with inflation. Additions to capacity, while more expensive over time, usually result in greater productivity or improved yields. However, market factors, alternative materials and competitive pricing may limit our ability to offset cost increases with higher prices. This was evident in both 2005 and 2004; in 2005 alone we could not pass through an estimated $2.7 million of the increased raw material costs to our customers, which in turn reduced gross margins as compared to 2004. We use the last-in, first-out (LIFO) method for costing the majority of our domestic inventories. Under the LIFO method, inflationary cost increases are charged against the current cost of goods sold in order to more closely match the cost with the associated revenue. The carrying value of the inventory is based upon older costs and as a result, the LIFO cost of the inventory on the balance sheet is typically lower than it would be under most alternative costing methods. The LIFO inventory value also tends to be less volatile during years of fluctuating costs than the value would be using other costing methods. The LIFO impact on the income statement in a given year is dependent upon the inflation rate effect on raw material purchases and manufacturing conversion costs, the level of purchases in a given year and the inventory mix and balance. Assuming no change in the quantity or mix of inventory from the December 31, 2005 level, a 1% change in the annual inflation rate would cause a $0.4 million change in the LIFO inventory value. DEFERRED TAX ASSETS. We record deferred tax assets and liabilities in accordance with Statement No. 109, "Accounting For Income Taxes". The deferrals are determined based upon the temporary difference between the financial reporting and tax bases of assets and liabilities. We review the expiration dates of the deferrals against projected income levels to determine if the deferral will or can be realized. If it is determined that it is more likely than not that a deferral will not be realized, a valuation allowance would be established for that item. Certain deferrals, including the alternative minimum tax credit, do not have an expiration date. See Note O to the Consolidated Financial Statements for additional deferred tax details. In addition to reviewing the deferred tax assets against their expiration dates, we evaluated our deferred tax assets for impairment and, due to the operating losses in 2001 and 2002, we recorded a valuation allowance in December 2002. The valuation allowance was adjusted in each subsequent year, with amounts being charged or credited to income, including the use of net operating loss carryforwards, or other comprehensive income as appropriate. The deferred tax valuation allowance balance was $19.9 million as of December 31, 2005. In 2005, in addition to reversing amounts from the valuation allowance to offset the current year tax expense, we determined that it was more likely than not that, based upon recent earnings and projections of future taxable earnings, we would utilize an additional $5.9 million of our deferred tax assets and we reversed that amount against tax expense in 2005. Beginning in the first quarter 2006, we will record a tax expense based upon our estimated effective tax rate for all jurisdictions and without offset for the reversal of any valuation allowance. In the fourth quarter 2006, or earlier should a realization event occur, we will re-evaluate the deferred tax asset once again to determine if it is more likely than not that any additional portion or all of the asset may be realized. If so, the valuation allowance will be reduced and income tax expense will be credited at that time. Reversal of the allowance is dependent upon jurisdiction, as it is possible to reverse a portion of the allowance as a result of earnings in one country but retain an allowance as a result of a loss in another country. By recording tax expense in periods when we generate a pre-tax profit, the net income and earnings per share will be lower when compared to 2005 when we only recorded a net tax expense or benefit for those jurisdictions that did not have a valuation allowance. UNEARNED REVENUE. Billings under long-term sales contracts in advance of the shipment of the goods are recorded as unearned revenue, which is a liability on the balance sheet. Revenue and the related cost of sales and gross margin are only recognized for these transactions when the goods are shipped, title passes to the customer and all other revenue recognition criteria are met. The unearned revenue liability is reversed when the revenue is recognized. The related inventory also remains on our balance sheet until these criteria are met as well. Billings in advance of the shipments allow us to collect cash earlier than billing at the time of the shipment and, therefore, the collected cash can be used to help finance the underlying inventory. DERIVATIVES. We may use derivative financial instruments to hedge our foreign currency, commodity price and interest rate exposures. We apply hedge accounting when an effective hedge relationship can be documented and maintained. If a hedge is deemed effective, changes in its fair value are recorded in OCI until the underlying hedged item matures. If a hedge does not qualify as effective, changes in its fair value are recorded against income in the current period. We secure derivatives with the intention of hedging existing or forecasted transactions only and do not engage in speculative trading or holding derivatives for investment purposes. Our annual budget and quarterly forecasts serve as the basis for determining forecasted transactions. The use of derivatives is governed by policies established by the Board of Directors. The level of derivatives outstanding 27. MANAGEMENT'S DISCUSSION AND ANALYSIS may be limited by the availability of credit from financial institutions. See Note H to the Consolidated Financial Statements and the Market Risk Disclosures section in this Management's Discussion and Analysis for more information on derivatives. MARKET RISK DISCLOSURES We are exposed to precious metal and commodity price, interest rate and foreign exchange rate differences. While the degree of exposure varies from year to year, our methods and policies designed to manage these exposures have remained fairly consistent. We attempt to minimize the effects of these exposures through a combination of natural hedges and the use of derivatives. We use gold and other precious metals in manufacturing various products. To reduce the exposure to market price changes, precious metals are maintained on a consigned inventory basis. The metal is purchased out of consignment when it is ready to ship to a customer as a finished product. Our purchase price forms the basis for the price charged to the customer for the precious metal content and, therefore, the current cost is matched to the selling price and the price exposure is minimized. We maintain a certain amount of gold in our own inventory, which is typically balanced out by having a loan denominated in gold for the same number of ounces. Any change in the market price of gold, either higher or lower, will result in an equal change in the fair value of the asset and liability recorded on the balance sheet. We are charged a consignment fee by the financial institutions that actually own the precious metals. This fee, along with the interest charged on the gold-denominated loan, is partially a function of the market price of the metal. Because of market forces and competition, the fee, but not the interest on the loan, can be charged to customers on a case-by-case basis. To further limit price and financing rate exposures, under some circumstances we will require customers to furnish their own metal for processing. This practice is used more frequently when the rates are high and/or more volatile. Should the market price of precious metals that we use increase by 15% from the prices on December 31, 2005, the additional pre-tax cost to us on an annual basis would be approximately $0.2 million. This calculation assumes no changes in the quantity of inventory or the underlying fee and interest rates and that none of the additional fee is charged to customers. We also use base metals, including copper, in our production processes. When possible, fluctuations in the purchase price of copper are passed on to customers in the form of price adders or reductions. As previously indicated, copper prices increased significantly during 2005 and 2004 and we could not pass through all of this increase to customers in all cases. In 2005, we entered into derivative contracts to hedge portions of this price exposure and gains on the contracts that matured in 2005 helped to mitigate the negative margin impact of the higher copper prices. In the previous two years, credit availability from our banking group had limited our ability to secure copper hedge contracts. The notional value of the outstanding copper hedge contracts was $8.8 million as of December 31, 2005. Should the market prices of copper decline 20% from the year-end 2005 levels, the gain on these contracts and pre-tax income would be reduced by $1.5 million. This calculation does not take into account any change in sales volume as a result of changes in the copper prices or the margin benefit from selling products with a lower copper cost. We are exposed to changes in interest rates on our debt and cash balances. This interest rate exposure is managed by maintaining a combination of short-term and long-term debt and variable and fixed rate instruments. We also use interest rate swaps to fix the interest rate on variable debt obligations, as we deem appropriate. Excess cash is typically invested in high quality instruments that mature in 90 days or less. Investments are made in compliance with policies approved by the Board of Directors. We had $35.2 million in variable rate debt and a variable-to-fixed interest rate swap with a notional value of $37.0 million outstanding at December 31, 2005. If interest rates were to increase 200 basis points (2.0%) from the December 31, 2005 rates and assuming no changes in debt from the December 31, 2005 levels, the net interest expense would increase by $0.7 million; however this would be offset by a reduced loss and/or increased gain on the interest rate swap. Portions of our international operations sell products priced in foreign currencies, mainly the euro, yen and sterling, while the majority of these products' costs are incurred in U.S. dollars. We are exposed to currency movements in that if the U.S. dollar strengthens, the translated value of the foreign currency sale and the resulting margin on that sale will be reduced. We typically cannot increase the price of our products for short-term exchange rate movements because of local competition. To minimize this exposure, we may purchase foreign currency forward contracts, options and collars in compliance with approved policies. Should the dollar strengthen, the decline in the translated value of the margins should be offset by a gain on the hedge contract. A decrease in the value of the dollar would result in larger margins but potentially a loss on the contract, depending upon the method used to hedge the exposure. The notional value of the outstanding currency contracts was $32.1 million as of December 31, 2005. If the dollar weakened 10% against the currencies in which we sell from the December 31, 2005 exchange rates, the reduced gain and/or increased loss on the outstanding contracts as of December 31, 2005 would reduce pre-tax profits by approximately $2.5 million. This calculation does not take into account the increase in margins as a result of translating foreign currency sales at the more favorable exchange rates, any changes in margins from potential volume fluctuations caused by currency movements or the translation effects on any other foreign currency denominated income statement or balance sheet item. The fair values of derivatives, which are determined by financial institutions and represent the market price for the instrument between two willing parties, are recorded on the balance sheet. Changes in the fair value of outstanding derivatives are recorded in equity or against income as appropriate under the applicable guidelines. The fair value of the outstanding foreign currency contracts was an asset of $1.5 million at December 31, 2005, indicating that the average hedge rates were favorable compared to the actual year-end market exchange rates. The fair value of 28. the outstanding copper hedge contracts was an asset of $1.9 million as of December 31, 2005 indicating that the hedged rates were lower than the current price of copper. The year-end 2005 fair value of the interest rate swap was a loss of $1.2 million as the available interest rates were lower than the rates fixed under the swap contract. The net derivative income recorded in OCI was $4.0 million as of December 31, 2005 compared to a derivative loss of $4.0 million as of December 31, 2004. We are also exposed to the risk of fluctuating utility costs. The cost of natural gas in particular increased during the second half of 2005. Our total utility cost in 2005 was approximately $19.0 million. This cost may fluctuate in future periods based upon changes in rates as well as consumption levels. The consumption level in a given year is in turn dependent upon the level of production activity as well as the climate. Changes in the weather from year to year can impact the heating requirements as our larger facilities are in northern U.S. climates. OUTLOOK We entered 2006 with improving conditions in various portions of our major markets. Demand from the telecommunications and computer market has been strengthening while the magnetic and optical data storage market remains robust. We are also seeing growth in a number of our other markets and our new products continue to gain traction. Our sales in 2006 will include a full year's results from WAM's three recent acquisitions, which is estimated to be $37 to $39 million. We are planning on expanding the OMC business by opening a new operation in Eastern Europe in 2006. Demand for defense and government applications slowed down during 2005, but we believe this to be temporary and anticipate improvements in the latter portion of 2006. The financial condition of Delphi and its long-term effect on the automotive market in the U.S. is uncertain. The softening demand from the automotive market appeared to level off and perhaps improve slightly early in 2006, but this may be caused by planned downstream inventory builds in anticipation of a potential strike at Delphi. Sales order entry rates strengthened throughout the second half of 2005 and the backlog at the beginning of 2006 is 12% larger than it was at the beginning of 2005. While an improved backlog is not a guarantee that sales will be higher, based upon a combination of factors, we are estimating that sales in 2006 will be in the range of $580.0 to $600.0 million. Copper prices continued to increase in the early portion of 2006 and are at an all-time high, putting pressures on margins to the extent that these costs cannot be passed through to customers. We have a portion of our copper exposure hedged, but the hedges can only provide a temporary relief from the higher copper prices. Higher utility costs, particularly natural gas, may also negatively impact margins in future periods. We will continue to use our Lean Sigma techniques and other processes to improve efficiencies and yields in order to balance out these cost pressures. We will implement price increases and/or float copper prices to customers where possible. We also believe that we should see an improved product mix going forward with the increased demand. Competitive pressures and customer efforts to design out of our precious and beryllium-containing materials (which tend to be higher priced) require us to continually develop new applications and/or improve the properties of our products. We believe we are making progress in diversifying our product offerings with various new applications from each of our major businesses. Interest costs are anticipated to be lower in 2006 than 2005. With the payoff of the subordinated term loan, our average effective borrowing has been reduced. The amortization of the existing deferred financing costs will be $0.6 million lower in 2006 than in 2005 due to the costs written off in 2005. Profitability in 2005 was reduced by the one-time $4.4 million debt prepayment charges. As noted in the Critical Accounting Policies section of this Management's Discussion and Analysis, we will be recording income tax expense without regard to the deferred tax valuation allowance beginning in the first quarter 2006. As a result of the above, we are currently estimating that diluted earnings per share will be in the range of $0.80 to $0.95 in 2006. FORWARD-LOOKING STATEMENTS Portions of the narrative set forth in this document that are not statements of historical or current facts are forward-looking statements. Our actual future performance may materially differ from that contemplated by the forward-looking statements as a result of a variety of factors. These factors include, in addition to those mentioned elsewhere herein: - The global and domestic economies; - The condition of the markets which we serve, whether defined geographically or by segment, with the major market segments being telecommunications and computer, magnetic and optical data storage, aerospace and defense, automotive electronics, industrial components and appliance; - Changes in product mix and the financial condition of customers; - Our success in developing and introducing new products and applications; - Our success in integrating newly acquired businesses; - Our success in implementing our strategic plans and the timely and successful completion of any capital projects; - The availability of adequate lines of credit and the associated interest rates; - Other financial factors, including cost and availability of materials, tax rates, exchange rates, pension and other employee benefit costs, energy costs, regulatory compliance costs, and the cost and availability of insurance; - The uncertainties related to the impact of war and terrorist activities; - Changes in government regulatory requirements and the enactment of new legislation that impacts our obligations; and, - The conclusion of pending litigation matters in accordance with our expectation that there will be no material adverse effects. 29. REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM AND MANAGEMENT REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM THE BOARD OF DIRECTORS AND SHAREHOLDERS BRUSH ENGINEERED MATERIALS INC. We have audited the accompanying Consolidated Balance Sheets of Brush Engineered Materials Inc. and subsidiaries as of December 31, 2005 and 2004, and the related Consolidated Statements of Income, Shareholders' Equity, and Cash Flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Brush Engineered Materials Inc. and subsidiaries at December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Brush Engineered Materials Inc.'s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 3, 2006 expressed an unqualified opinion thereon. (ERNST & YOUNG LLP) Cleveland, Ohio March 3, 2006 REPORT OF MANAGEMENT The management of Brush Engineered Materials Inc. and subsidiaries is responsible for the contents of the financial statements, which are prepared in conformity with generally accepted accounting principles. The financial statements necessarily include amounts based on judgments and estimates. Financial information elsewhere in the annual report is consistent with that in the financial statements. The Company maintains a comprehensive accounting system, which includes controls designed to provide reasonable assurance as to the integrity and reliability of the financial records and the protection of assets. However, there are inherent limitations in the effectiveness of any system of internal controls and, therefore, it provides only reasonable assurance with respect to financial statement preparation. An internal audit staff is employed to regularly test and evaluate both internal accounting controls and operating procedures, including compliance with the Company's Statement of Policy regarding ethical and lawful conduct. The role of the independent registered public accounting firm is to provide an objective review of the financial statements and the underlying transactions in accordance with generally accepted auditing standards. The Audit Committee of the Board of Directors, comprised solely of Directors who are not members of management, meets regularly with management, the independent registered public accounting firm, and the internal auditors to ensure that their respective responsibilities are properly discharged. The independent registered public accounting firm and the internal audit staff have full and free access to the Audit Committee. /s/ John D. Grampa - -------------------------------------- John D. Grampa Vice President Finance and Chief Financial Officer 30. REPORTS ON INTERNAL CONTROL OVER FINANCIAL REPORTING MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The management of Brush Engineered Materials Inc. and subsidiaries is responsible for establishing and maintaining adequate internal controls over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Brush Engineered Materials Inc. and subsidiaries' internal control system was designed to provide reasonable assurance to the Company's management and Board of Directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. /s/ Gordon D. Harnett - ----------------------- Gordon D. Harnett Chairman and Chief Executive Officer Brush Engineered Materials Inc. and subsidiaries' management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2005. In making this assessment, it used the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria) in Internal Control-Integrated Framework. Based on our assessment, we believe that, as of December 31, 2005, the Company's internal control over financial reporting is effective. Management's assessment of the effectiveness of our internal control over financial reporting as of December 31, 2005 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report herein. /s/ John D. Grampa - -------------------- John D. Grampa Vice President Finance and Chief Financial Officer REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We have audited management's assessment, included in the accompanying Management's Report on Internal Control over Financial Reporting, that Brush Engineered Materials Inc. and subsidiaries maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Brush Engineered Materials Inc. and subsidiaries' management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that Brush Engineered Materials Inc. and subsidiaries maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Brush Engineered Materials Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Consolidated Balance Sheets of Brush Engineered Materials Inc. and subsidiaries as of December 31, 2005 and 2004, and the related Consolidated Statements of Income, Shareholders' Equity, and Cash Flows for each of the three years in the period ended December 31, 2005 and our report dated March 3, 2006 expressed an unqualified opinion thereon. (ERNST & YOUNG LLP) Cleveland, Ohio March 3, 2006 31. CONSOLIDATED STATEMENTS OF INCOME Brush Engineered Materials Inc. and Subsidiaries, Years ended December 31, 2005, 2004 and 2003 (Dollars in thousands except share and per share amounts)
2005 2004 2003 -------------- -------------- ------------- Net sales .................................................................. $ 541,267 $ 496,276 $ 401,046 Cost of sales ........................................................... 431,024 385,202 328,008 ------------- ------------- ------------ Gross profit ............................................................... 110,243 111,074 73,038 Selling, general and administrative expense ............................. 78,457 77,267 68,834 Research and development expense ........................................ 4,990 4,491 4,230 Other - net ............................................................. 7,287 4,282 8,918 ------------- ------------- ------------ Operating profit (loss) .................................................... 19,509 25,034 (8,944) Interest expense ........................................................ 6,372 8,377 3,751 ------------- ------------- ------------ INCOME (LOSS) BEFORE INCOME TAXES 13,137 16,657 (12,695) Minority interest .......................................................... - - (45) Income taxes (benefit): Currently payable ....................................................... 1,163 1,349 855 Deferred ................................................................ (5,851) (208) (279) ------------- ------------- ------------ (4,688) 1,141 576 ------------- ------------- ------------ NET INCOME (LOSS) $ 17,825 $ 15,516 $ (13,226) ============= ============= ============ Net income (loss) per share of common stock - basic ........................ $ 0.93 $ 0.87 $ (0.80) ============= ============= ============ Weighted-average number of shares of common stock outstanding - basic ...... 19,219,099 17,865,053 16,562,864 Net income (loss) per share of common stock - diluted ...................... $ 0.92 $ 0.85 $ (0.80) ============= ============= ============ Weighted-average number of shares of common stock outstanding - diluted .... 19,370,748 18,163,915 16,562,864
See Notes to Consolidated Financial Statements. 32. CONSOLIDATED STATEMENTS OF CASH FLOWS Brush Engineered Materials Inc. and Subsidiaries, Years ended December 31, 2005, 2004 and 2003 (Dollars in thousands)
2005 2004 2003 -------- --------- ---------- Cash flows from operating activities: Net income (loss) ............................................................................ $ 17,825 $ 15,516 $ (13,226) Adjustments to reconcile net income (loss) to net cash provided from operating activities: Depreciation, depletion and amortization .................................................. 21,675 21,173 19,107 Amortization of mine development .......................................................... - 1,188 1,228 Amortization of deferred financing costs in interest expense .............................. 1,115 1,465 396 Deferred financing cost write-off ......................................................... 2,738 - 99 Deferred tax (benefit) expense ............................................................ (5,851) (208) (279) Derivative financial instruments ineffectiveness .......................................... (801) 368 5,054 Decrease (increase) in accounts receivable ................................................ (10,032) (3,624) (6,590) Decrease (increase) in inventory .......................................................... (9,562) (6,830) 8,646 Decrease (increase) in prepaid and other current assets ................................... (386) (1,806) 4,871 Increase (decrease) in accounts payable and accrued expenses .............................. (5,516) 223 2,308 Increase (decrease) in unearned revenue ................................................... (7,535) 7,789 - Increase (decrease) in interest and taxes payable ......................................... (2,494) 2,101 1,221 Increase (decrease) in long-term liabilities .............................................. 1,921 (1,925) (443) Other - net ............................................................................... 368 3,490 3,920 -------- -------- --------- NET CASH PROVIDED FROM OPERATING ACTIVITIES 3,465 38,920 26,312 Cash flows from investing activities: Payments for purchase of property, plant and equipment .................................... (13,775) (9,093) (6,162) Payments for purchase of business less cash received ...................................... (11,497) - - Payments for mine development ............................................................. - (57) (157) Purchase of equipment previously held under operating lease ............................... (448) (880) (51,846) Proceeds from sale of property, plant and equipment ....................................... 60 711 203 Other investments - net ................................................................... (48) (62) - -------- -------- --------- NET CASH (USED IN) INVESTING ACTIVITIES (25,708) (9,381) (57,962) Cash flows from financing activities: Proceeds from issuance/(repayment) of short-term debt ..................................... 11,679 (274) (9,266) Proceeds from issuance of long-term debt .................................................. 22,000 2,881 72,000 Repayment of long-term debt ............................................................... (49,618) (29,346) (26,034) Debt issuance costs ....................................................................... (125) (250) (4,636) Issuance of common stock .................................................................. - 38,711 - Issuance of common stock under stock option plans ......................................... 372 3,236 25 -------- -------- --------- NET CASH PROVIDED FROM (USED IN) FINANCING ACTIVITIES (15,692) 14,958 32,089 Effects of exchange rate changes on cash and cash equivalents ................................ (1,066) 84 266 -------- -------- --------- NET CHANGE IN CASH AND CASH EQUIVALENTS (39,001) 44,581 705 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 49,643 5,062 4,357 -------- -------- --------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 10,642 $ 49,643 $ 5,062 ======== ======== =========
See Notes to Consolidated Financial Statements. 33. CONSOLIDATED BALANCE SHEETS Brush Engineered Materials Inc. and Subsidiaries, as of December 31, 2005 and 2004 (Dollars in thousands)
ASSETS 2005 2004 --------- ---------- CURRENT ASSETS Cash and cash equivalents ................................................................................ $ 10,642 $ 49,643 Accounts receivable (less allowance of $1,315 for 2005, and $1,555 for 2004) ............................. 69,938 59,229 Inventories .............................................................................................. 104,060 95,271 Prepaid expenses ......................................................................................... 14,417 8,348 Deferred income taxes .................................................................................... 1,118 275 --------- --------- TOTAL CURRENT ASSETS 200,175 212,766 OTHER ASSETS ................................................................................................ 8,252 14,518 RELATED-PARTY NOTES RECEIVABLE .............................................................................. 358 358 LONG-TERM DEFERRED INCOME TAXES ............................................................................. 4,109 928 PROPERTY, PLANT, AND EQUIPMENT .............................................................................. 540,420 540,937 LESS ALLOWANCES FOR DEPRECIATION, AMORTIZATION AND DEPLETION ................................................ (363,358) (363,318) --------- --------- PROPERTY, PLANT, AND EQUIPMENT - NET 177,062 177,619 GOODWILL .................................................................................................... 12,746 7,992 --------- --------- TOTAL ASSETS $ 402,702 $ 414,181 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Short-term debt .......................................................................................... $ 23,634 $ 11,692 Current portion of long-term debt ........................................................................ 636 19,209 Accounts payable ......................................................................................... 20,872 13,234 Salaries and wages ....................................................................................... 16,307 23,741 Taxes other than income taxes ............................................................................ 2,294 2,486 Other liabilities and accrued items ...................................................................... 19,921 24,225 Unearned revenue ......................................................................................... 254 7,789 Income taxes ............................................................................................. 726 1,591 --------- --------- TOTAL CURRENT LIABILITIES 84,644 103,967 OTHER LONG-TERM LIABILITIES ................................................................................. 8,202 10,798 RETIREMENT AND POST-EMPLOYMENT BENEFITS ..................................................................... 65,290 49,729 DEFERRED INCOME TAXES ....................................................................................... 172 - LONG-TERM DEBT .............................................................................................. 32,916 41,549 SHAREHOLDERS' EQUITY Serial preferred stock, no par value; 5,000,000 authorized shares, none issued ........................... - - Common stock, no par value; 60,000,000 authorized shares; 25,556,471 issued shares (25,526,516 in 2004) .. 137,665 137,247 Retained income .......................................................................................... 214,497 196,672 Common stock in treasury, 6,315,214 shares (6,307,009 in 2004) ........................................... (105,795) (105,675) Other comprehensive income (loss) ........................................................................ (35,037) (19,933) Other equity transactions ................................................................................ 148 (173) --------- --------- TOTAL SHAREHOLDERS' EQUITY 211,478 208,138 --------- --------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 402,702 $ 414,181 ========= =========
See Notes to Consolidated Financial Statements. 34. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Brush Engineered Materials Inc. and Subsidiaries, Years ended December 31, 2005, 2004 and 2003 (Dollars in thousands except for share amounts)
Other Common Comprehen- Common Retained Stock in sive Income Stock Warrants Income Treasury (loss) Other Total --------- -------- --------- --------- ----------- ------- ---------- BALANCES AT JANUARY 1, 2003 $ 93,311 $ - $ 194,382 $ (105,245) $ (22,859) $ (495) $ 159,094 Net loss .................................................. - - (13,226) - - - (13,226) Foreign currency translation adjustment ................... - - - - 475 - 475 Derivative and hedging activity ........................... - - - - 4,623 - 4,623 Minimum pension liability ................................. - - - - 967 - 967 --------- Comprehensive loss......................................... (7,161) Proceeds from sale of 1,900 shares under option plans ..... 21 - - - - - 21 Income tax benefit from employees' stock options .......... 4 - - - - - 4 Issuance of 115,000 warrants .............................. - 1,616 - - - - 1,616 Other equity transactions ................................. - - - (229) - 359 130 Forfeiture of restricted stock ............................ - - - (159) - 28 (131) --------- ------- --------- ---------- --------- ------ --------- BALANCES AT DECEMBER 31, 2003 93,336 1,616 181,156 (105,633) (16,794) (108) 153,573 Net income ................................................ - - 15,516 - - - 15,516 Foreign currency translation adjustment ................... - - - - 849 - 849 Derivative and hedging activity ........................... - - - - (809) - (809) Minimum pension liability ................................. - - - - (3,179) - (3,179) --------- Comprehensive income....................................... 12,377 Proceeds from sale of 228,298 shares under option plans ... 3,236 - - - - - 3,236 Proceeds from stock offering of 2,250,000 shares .......... 38,711 - - - - - 38,711 Exercise of 115,000 warrants .............................. 1,616 (1,616) - - - - - Other equity transactions ................................. 348 - - 141 - (131) 358 Forfeiture of restricted stock ............................ - - - (183) - 66 (117) --------- ------ --------- ---------- --------- ------ --------- BALANCES AT DECEMBER 31, 2004 137,247 - 196,672 (105,675) (19,933) (173) 208,138 Net income ................................................ - - 17,825 - - - 17,825 Foreign currency translation adjustment ................... - - - - (2,055) - (2,055) Derivative and hedging activity ........................... - - - - 8,006 - 8,006 Minimum pension liability ................................. - - - - (21,055) - (21,055) --------- Comprehensive income....................................... 2,721 Proceeds from sale of 29,955 shares under option plans .... 372 - - - - - 372 Other equity transactions ................................. 46 - - 27 - 321 394 Forfeiture of restricted stock ............................ - - - (147) - - (147) --------- ------- --------- ---------- --------- ------ --------- BALANCES AT DECEMBER 31, 2005 $ 137,665 $ - $ 214,497 $ (105,795) $ (35,037) $ 148 $ 211,478 ========= ======= ========= ========== ========= ====== =========
See Notes to Consolidated Financial Statements. 35. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Brush Engineered Materials Inc. and Subsidiaries, December 31, 2005 NOTE A - SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION: The Company is a holding company with subsidiaries that have operations in the United States, Europe and Asia. These operations manufacture engineered materials used in a variety of markets, including telecommunications and computer electronics, automotive electronics, magnetic and optical data storage, aerospace and defense, industrial components and appliance. The Company's operations are aggregated into two business segments - the Metal Systems Group and the Microelectronics Group - based upon the commonalities of their products, manufacturing processes, customers and other factors. The Metal Systems Group produces strip and bulk alloys (primarily copper beryllium), beryllium metal products and engineered material systems while the Microelectronics Group manufactures precious and non-precious vapor deposition targets, frame lid assemblies, other precious and non-precious metal products, ceramics, electronic packages and thick film circuits. The Company is vertically integrated and distributes its products through a combination of company-owned facilities and independent distributors and agents. USE OF ESTIMATES: The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results may differ from those estimates. CONSOLIDATION: The Consolidated Financial Statements include the accounts of Brush Engineered Materials Inc. and its subsidiaries. All of the Company's subsidiaries are wholly owned as of December 31, 2005. Intercompany accounts and transactions are eliminated in consolidation. CASH EQUIVALENTS: All highly liquid investments with a maturity of three months or less when purchased are considered to be cash equivalents. ACCOUNTS RECEIVABLE: An allowance for doubtful accounts is maintained for the estimated losses resulting from the inability of customers to pay the amounts due. The allowance is based upon identified delinquent accounts, customer payment patterns and other analyses of historical data and trends. The Company extends credit to customers based upon their financial condition and generally collateral is not required. INVENTORIES: Inventories are stated at the lower of cost or market. The cost of domestic inventories except ore and supplies is principally determined using the last-in, first-out (LIFO) method. The remaining inventories are stated principally at average cost. PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment is stated on the basis of cost. Depreciation is computed principally by the straight-line method, except certain facilities for which depreciation is computed by the sum-of-the-years digits or units-of-production method. Depreciable lives that are used in computing the annual provision for depreciation by class of asset are as follows:
Years ------------- Land improvements .................... 5 to 25 Buildings ............................ 10 to 40 Leasehold improvements ............... Life of lease Machinery and equipment .............. 3 to 15 Furniture and fixtures ............... 4 to 15 Automobiles and trucks ............... 2 to 8 Research equipment ................... 6 to 12 Computer hardware .................... 3 to 10 Computer software .................... 3 to 10
Leasehold improvements will be depreciated over the life of the improvement if it is shorter than the life of the lease. Repair and maintenance costs are expensed as incurred. MINERAL RESOURCES AND MINE DEVELOPMENT: Property acquisition costs are capitalized as mineral resources on the balance sheet and are depleted using the units-of-production method based upon recoverable proven reserves. Overburden, or waste rock, is removed prior to the extraction of the ore from a particular open pit. The removal cost is capitalized and amortized as the ore is extracted using the units-of-production method based upon the proven reserves in that particular pit. Exploration and development expenses, including development drilling, are charged to expense in the period in which they are incurred. INTANGIBLE ASSETS: Goodwill is not amortized, but instead reviewed annually at December 31, or more frequently under certain circumstances, for impairment. Goodwill is assigned to the lowest level reporting unit that the associated cash flows can be appropriately measured. Intangible assets with finite lives are amortized using the straight-line method or effective interest method, as applicable, over the periods estimated to be benefited, which is generally 20 years or less. Finite-lived intangible assets are also reviewed for impairment if facts and circumstances warrant. ASSET IMPAIRMENT: In the event that facts and circumstances indicate that the carrying value of long-lived and definite-lived intangible assets may be impaired, an evaluation of recoverability is performed. If an evaluation is required, the estimated future undiscounted cash flow associated with the asset or asset group would be compared to the carrying amount to determine if a write-down is required. DERIVATIVES: The Company recognizes all derivatives on the balance sheet at their fair values. If the derivative is a hedge, depending upon the nature of the hedge, changes in the fair value of the derivative are either offset against the change in fair value of the hedged asset, liability or firm commitment through earnings or recognized in other comprehensive income (loss) until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value, if any, is recognized in earnings immediately. If a derivative is not a hedge, changes in its fair value are adjusted through income. ASSET RETIREMENT OBLIGATION: The Company records a liability to recognize the legal obligation to remove an asset at the time the asset is acquired or when the legal liability arises. The liability is recorded for the present value of the ultimate obligation by discounting the estimated future cash flows using a credit-adjusted risk-free interest rate. The liability is accreted over time, with the accretion charged to expense. An asset equal to the fair value of the liability is recorded concurrent with the liability and depreciated over the life of the underlying asset. REVENUE RECOGNITION: The Company recognizes revenue when the goods are shipped and title passes to the customer. The Company requires persuasive evidence that a revenue arrangement exists, delivery of the product has occurred, the selling price is fixed or determinable and collectibility is reasonably assured before revenue is realized and earned. Billings under long-term sales contracts in advance of the shipment of the 36. goods are recorded as unearned revenue, which is a liability on the balance sheet. Revenue is only recognized for these transactions when the goods are shipped and all other revenue recognition criteria are met. SHIPPING AND HANDLING COSTS: The Company records shipping and handling costs for products sold to customers in cost of sales on the Consolidated Statements of Income. ADVERTISING COSTS: The Company expenses all advertising costs as incurred. Advertising costs were $0.8 million in 2005, $1.0 million in 2004 and $0.8 million in 2003. INCOME TAXES: The Company uses the liability method in measuring the provision for income taxes and recognizing deferred tax assets and liabilities on the balance sheet. The Company records a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not to be realized. NET INCOME PER SHARE: Basic earnings per share (EPS) is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the assumed conversion of all dilutive common stock equivalents as appropriate under the treasury stock method. RECLASSIFICATION: Certain amounts in prior years have been reclassified to conform to the 2005 consolidated financial statement presentation. VARIABLE INTEREST ENTITIES: The Financial Accounting Standards Board (FASB) issued Financial Interpretation (FIN) 46, "Consolidation of Variable Interest Entities" in January 2003 effective for periods ending subsequent to June 15, 2003 for variable entities for which an enterprise holds a variable interest that it acquired prior to February 1, 2003. The release clarified the application of Accounting Research Bulletin (ARB) No. 51, "Consolidated Financial Statements" to certain entities in which the equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from others. The Company adopted FIN 46 as proscribed and its adoption did not have a material impact on the Company's results of operations or financial position. STOCK OPTIONS: The Company provides a stock incentive plan for eligible employees. See Note K to the Consolidated Financial Statements for further details. The Company has adopted the disclosure-only provisions of Statement No. 123, "Accounting for Stock-Based Compensation" and applies the intrinsic value method in accordance with Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations in accounting for its stock incentive plan. If the Company had elected to recognize compensation expense for its stock incentive plan awards based on the estimated fair value of the awards on the grant dates, consistent with the method prescribed by Statement No. 123 by amortizing the expense over the options' vesting period, the pro forma net income (loss) and earnings per share (EPS) would have been as noted below:
2005 2004 2003 --------- --------- ---------- (Dollars in thousands, except per share data) Net income (loss) - as reported ............................... $ 17,825 $ 15,516 $ (13,226) Pro forma stock option expense ................................ (1,947) (1,882) (1,095) -------- -------- --------- Net income (loss) - pro forma ................................. $ 15,878 $ 13,634 $ (14,321) ======== ======== ========= Basic E.P.S. - as reported .................................... $ 0.93 $ 0.87 $ (0.80) Basic E.P.S. - pro forma ...................................... $ 0.83 $ 0.76 $ (0.86) Diluted E.P.S. - as reported .................................. $ 0.92 $ 0.85 $ (0.80) Diluted E.P.S. - pro forma .................................... $ 0.82 $ 0.75 $ (0.86)
Note: The pro forma disclosures shown are not representative of the effects on net income and earnings per share in future years. The weighted-average fair value of the Company's stock options used to compute the pro forma net income and earnings per share disclosures is $8.18, $7.72 and $2.79 for 2005, 2004 and 2003, respectively. The fair value is the estimated present value at grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions for the various grants in 2005, 2004 and 2003:
2005 2004 2003 ------- ------- ------- Risk-free interest rate ........ 4.72% 3.26% 3.63% Dividend yield ................. 0% 0% 0% Volatility of stock ............ 42.0% 41.8% 39.5% Expected life of option ........ 6 YEARS 6 years 8 years
NEW PRONOUNCEMENTS: The FASB issued Statement No. 151, "Inventory Costs", in November 2004, which amends ARB No. 43. The statement requires idle facility expense, excessive spoilage, double freight and rehandling costs to be treated as current period charges regardless of whether they meet the ARB No. 43 criteria of "so abnormal". The statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company adopted this statement effective in the first quarter 2006 and is currently assessing the impact of adoption on the results of operations and financial condition. The FASB issued FASB Staff Position (FSP) 109-1, "Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004" and FSP 109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004" in December 2004. These FSPs provide accounting and disclosure guidelines relative to the income tax deductions and repatriation provisions contained in the American Jobs Creation Act of 2004 (the Act). The FSPs were effective upon issuance. Adoption of these FSP's did not have a material impact on the Company's results of operations or financial condition. The FASB issued Statement No. 123 (Revised 2004), "Share-Based Payments", in December 2004 that revises Statement No. 123, "Accounting for Stock-Based Compensation", and supercedes APB Opinion No. 25, "Accounting for Stock Issued to Employees". The revised statement requires compensation cost for all share-based payments, including employee stock options, to be measured at fair value and charged against income. Compensation cost would be determined at the date of the award through 37. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Brush Engineered Materials Inc. and Subsidiaries, December 31, 2005 the use of a pricing model and charged against income over the vesting period for each award. The revised statement is effective for fiscal years beginning after June 15, 2005. The Company adopted this statement effective January 1, 2006. The Company has estimated, based upon the unvested options outstanding at December 31, 2005, that the stock option expense will be approximately $0.3 million in 2006. The pro forma effects on net income and income per share for 2005, 2004 and 2003 of using the Black-Scholes model to calculate the fair value of outstanding stock options had the provisions of Statement No. 123 been applied in those years are set forth earlier in this note. The FASB issued FIN 47, "Accounting for Conditional Asset Retirement Obligations", in March 2005. The interpretation clarified that the term "conditional asset retirement obligation", as used in Statement No. 143, "Accounting for Asset Retirement Obligations", refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. The interpretation also clarified when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The interpretation is effective no later than the end of fiscal years ending after December 31, 2005 for calendar-year enterprises. The adoption of this interpretation did not have a material impact on its results of operations or financial condition. The FASB issued Statement No. 154, "Accounting Changes and Error Corrections", which replaces APB Opinion No. 20, "Accounting Changes", and Statement No. 3. "Reporting Accounting Changes in Interim Financial Statements", in May 2005. The statement changes the requirements for the accounting and reporting of a change in accounting principle and is applicable to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement if that pronouncement does not include specific transition provisions. The statement requires retrospective application to prior periods' financial statements of changes in accounting principle, unless it is impractical to determine the period-specific effects or the cumulative effect of the change (in which case the statement provides additional guidance). The statement requires that retrospective application of a change in accounting principle be limited to the direct effect of the change. The correction of an error by the restatement of previously issued financial statements is also addressed by the statement. The statement is effective for accounting changes and correction of errors made in fiscal years commencing after December 31, 2005. The Company does not believe that adoption of this statement will have a material impact on its results of operations or financial condition. NOTE B - ACQUISITIONS In May 2005, Williams Advanced Materials Inc. (WAM), through its wholly owned subsidiary in the Netherlands, purchased the stock of OMC Scientific Holdings Limited (OMC) of Limerick, Ireland for $4.0 million in cash. OMC provides physical vapor deposition material cleaning and reconditioning services for customers in the magnetic media and data storage, semiconductor and other markets in Europe. In October 2005, WAM purchased the stock of Thin Film Technology, Inc. (TFT) of Buellton, California for $7.6 million in cash. An additional $0.5 million was placed in escrow pending final determination of the value of various assets and liabilities assumed. TFT manufactures precision optical coatings, photolithography, thin film hybrid circuits and specialized thin film coatings. TFT's products are used in the defense, medical and other commercial markets. The results of the above-acquired businesses were included in the Company's financial statements since their respective acquisition dates. Sales from OMC and TFT were immaterial to the total Company sales in 2005. The goodwill assigned and other intangible assets purchased as a result of these acquisitions are detailed in Note E to the Consolidated Financial Statements. NOTE C - INVENTORIES Inventories in the Consolidated Balance Sheets are summarized as follows:
December 31, --------------------- 2005 2004 --------- -------- (Dollars in thousands) Principally average cost: Raw materials and supplies ....................... $ 24,050 $ 22,705 Work in process .................................. 88,480 77,438 Finished goods ................................... 30,553 27,538 --------- -------- Gross inventories .............................. 143,083 127,681 Excess of average cost over LIFO inventory value .................................. 39,023 32,410 --------- -------- Net inventories ................................ $ 104,060 $ 95,271 ========= ========
Average cost approximates current cost. Gross inventories accounted for using the LIFO method totaled $97.0 million at December 31, 2005 and $85.7 million at December 31, 2004. The liquidation of LIFO inventory layers reduced cost of sales by $0.6 million in 2005 and $0.4 million in 2004. NOTE D - PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment on the Consolidated Balance Sheets is summarized as follows:
December 31, ------------------------ 2005 2004 ---------- ---------- (Dollars in thousands) Land ....................................................... $ 6,954 $ 7,305 Buildings .................................................. 101,074 98,905 Machinery and equipment .................................... 402,517 389,761 Software ................................................... 20,608 20,430 Construction in progress ................................... 4,238 5,122 Allowances for depreciation ................................ (361,308) (346,883) --------- --------- 174,083 174,640 Mineral resources .......................................... 5,029 5,029 Mine development ........................................... - 14,385 Allowances for amortization and depletion .................. (2,050) (16,435) --------- --------- 2,979 2,979 --------- --------- Property, plant and equipment - net ........................ $ 177,062 $ 177,619 ========= =========
38. Depreciation expense was $21.5 million in 2005, $21.1 million in 2004 and $18.6 million in 2003. Fully amortized mine development costs of $14.4 million were written off in 2005 as those mines were no longer in use. NOTE E - INTANGIBLE ASSETS ASSETS ACQUIRED The Company acquired the following intangible assets as part of the purchase of the OMC Scientific Holdings Limited and Thin Film Technology, Inc. businesses in 2005:
Weighted-average Amount Amortization Period ------- ------------------- (Dollars in thousands) Customer relationship ....................... $ 1,650 7.0 Years Technology .................................. 420 10.0 Years ------- Total assets subject to amortization ........ $ 2,070 7.6 Years ======= Goodwill .................................... $ 4,754 Not Applicable =======
See Note B to the Consolidated Financial Statements for additional information on the associated business acquisitions. ASSETS SUBJECT TO AMORTIZATION The cost, accumulated amortization and net book value of intangible assets subject to amortization as of December 31, 2005 and 2004 and the amortization expense for each year then ended is as follows:
2005 2004 -------- -------- (Dollars in thousands) Deferred financing costs Cost .................................... $ 3,284 $ 7,397 Accumulated amortization ................ (1,588) (2,250) ------- ------- Net book value .......................... 1,696 5,147 Customer relationship Cost .................................... 1,650 - Accumulated amortization ................ (157) - ------- ------- Net book value .......................... 1,493 - Technology Cost .................................... 420 - Accumulated amortization ................ (11) - ------- ------- Net book value .......................... 409 - Patents Cost .................................... 690 690 Accumulated amortization ................ (520) (471) ------- ------- Net book value .......................... 170 219 Total Cost .................................... $ 6,044 $ 8,087 Accumulated amortization ................ (2,276) (2,721) ------- ------- Net book value .......................... $ 3,768 $ 5,366 ======= ======= Aggregate amortization expense ............. $ 1,331 $ 1,514 ======= =======
The aggregate amortization expense is estimated to be $0.9 million in 2006, $0.7 million in 2007, $0.7 million in 2008, $0.6 million in 2009 and $0.3 million in 2010. Deferred financing costs with a net book value of $2.7 million in 2005 were expensed as a result of the prepayment of the associated debt instruments in that year. Intangible assets are included in other assets on the Consolidated Balance Sheets. ASSETS NOT SUBJECT TO AMORTIZATION The carrying value of intangible assets not subject to amortization as of December 31, 2005 and 2004 is as follows:
2005 2004 -------- --------- (Dollars in thousands) Goodwill .............................. $ 12,746 $ 7,992
The only change to goodwill in either of the years presented was as a result of the acquisitions of OMC and TFT in 2005. None of the goodwill acquired in 2005 was deductible for tax purposes. There were no goodwill impairments recorded in the years presented. All of the goodwill has been assigned to reporting units within the Microelectronics Group. NOTE F - DEBT A summary of long-term debt follows:
December 31, ---------------------- 2005 2004 --------- --------- (Dollars in thousands) Senior Credit Agreement: Revolving credit agreement .................... $ 22,000 $ - Senior five-year term note payable in installments beginning in 2004 .......... - 11,143 Senior five-year term note payable in installments beginning in 2004 .......... - 7,429 Variable rate demand bonds payable in installments beginning in 2005 ............... 2,400 3,000 Variable rate promissory note - Utah land purchase payable in 20 annual installments through 2021 ....................... 847 881 Variable rate industrial development revenue bonds payable in 2016 ................... 8,305 8,305 Subordinated five-year term note ................... - 30,000 -------- -------- 33,552 60,758 Current portion of long-term debt .................. (636) (19,209) -------- -------- Total .............................................. $ 32,916 $ 41,549 ======== ========
Maturities on long-term debt instruments as of December 31, 2005 are as follows: 2006 .......... $ 636 2007 .......... 638 2008 .......... 640 2009 .......... 22,642 2010 .......... 44 Thereafter .... 8,952 -------- Total ...... $ 33,552 ========
The Company has a senior secured credit agreement with five financial institutions that expires December 3, 2009. At December 31, 2005 maximum availability under this facility was $122.1 million. It consists of a $125.0 39. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Brush Engineered Materials Inc. and Subsidiaries, December 31, 2005 million revolving credit line secured by the Company's working capital, real estate, machinery and equipment and includes a total of $45.0 million availability on a declining basis to compensate for any shortfall in the basis of the collateral. Additionally, the facility is secured by a first lien on the stock of certain of the Company's direct and indirect subsidiaries. The credit agreement allows the Company to borrow money at a premium over LIBOR or prime rate and at varying maturities. The premium resets quarterly according to the terms and conditions available under the agreement. In October 2005, the credit facility was amended to revise certain items including pricing, definitions, reporting and allowable transactions. In December 2005, the facility was amended to, among other things, revise collateral amounts and increase the commitment from $105.0 million to $125.0 million. The credit agreement is subject to restrictive covenants including leverage, fixed charges, and capital expenditures. At December 31, 2005, long-term borrowings totaling $22.0 million were outstanding under the revolving credit line at an average rate of 5.33%. An additional $5.1 million of short-term borrowings was outstanding under the revolving credit agreement as of December 31, 2005. The Company pays a commitment fee of 0.25% on the unused borrowings under the revolving credit agreement. At December 31, 2004, the credit facility included two term notes secured by real estate and machinery and equipment that had outstanding borrowings of $18.6 million. The term notes were originally drawn at a total of $20.0 million in December of 2003 and were reduced by quarterly scheduled principal payments that began in July 2004. In December 2004, the credit agreement was amended to allow prepayment of the term loans and the re-borrowing of those funds under the revolver up to amounts limited by the original term loan amortization schedules. The Company exercised its right to prepay the term notes in full in January 2005. A line of credit from Exim that provided an available credit capacity of $7.5 million and which was secured by certain foreign accounts receivable was terminated in December 2004. There had been no borrowings under this facility. In December 2003, the Company refinanced its existing revolving line of credit and a synthetic operating lease with the credit agreement discussed above and a $35.0 million subordinated term note, that was secured by a second lien on the Company's working capital, real estate and machinery and equipment, and was payable in December 2008. The Company prepaid $5.0 million of this note in July 2004 as allowed without penalty. At December 2004, the Company had $30.0 million in long-term borrowings outstanding on this note at an average rate of 16.1%. The rate was based on variable prime plus a premium and reset quarterly. To hedge a portion of this variability, the Company entered into an interest rate swap, fixing the prime rate at 6.98% for a notional value of $10.0 million over the life of the note. The subordinated term note was subject to restrictive covenants including leverage, fixed charges, the issuance of dividends and capital expenditures. The subordinated term note was also secured by a second lien on the stock of certain of the Company's direct and indirect subsidiaries. In December 2005, the Company prepaid the $30.0 million remaining principal in addition to $1.6 million in prepayment penalty fees and incurred an expense of $2.2 million for the write-off of unamortized deferred finance costs. The interest rate swap was also monetized and terminated at that time. The following table summarizes the Company's short-term lines of credit. Amounts shown as outstanding are included in short-term debt on the Consolidated Balance Sheets.
DECEMBER 31, 2005 Total Outstanding Available -------- ----------- ---------- (Dollars in thousands) Domestic .................... $ 76,930 $ 5,123 $ 71,807 Foreign ..................... 9,932 6,204 3,728 Precious metal .............. 12,307 12,307 - -------- -------- -------- Total .................... $ 99,169 $ 23,634 $ 75,535 ======== ======== ========
December 31, 2004 Total Outstanding Available -------- ----------- ---------- (Dollars in thousands) Domestic ..................... $ 36,252 $ - $ 36,252 Foreign ...................... 5,084 1,202 3,882 Precious metal ............... 10,490 10,490 - -------- --------- -------- Total ..................... $ 51,826 $ 11,692 $ 40,134 ======== ========= ========
The domestic line is committed and included in the $125.0 million maximum borrowing under the revolving credit agreement. The Company has various foreign lines of credit, one of which is for 4 million Euros, committed and secured. The remaining foreign lines are uncommitted, unsecured and renewed annually. The precious metal facility (primarily gold) is secured and renewed annually. The average interest rate on short-term debt was 3.87% and 4.34% as of December 31, 2005 and 2004, respectively. In November 1996, the Company entered into an agreement with the Lorain Port Authority, Ohio to issue $8.3 million in variable rate industrial revenue bonds, maturing in 2016. The variable rate ranged from 1.74% to 3.80% in 2005 and from 1.15% to 2.25% in 2004. In 1994, the Company re-funded its $3.0 million industrial development revenue bonds into variable rate demand bonds. The variable rate ranged from 1.55% and 3.60% in 2005 and from 0.95% to 2.06% during 2004. NOTE G - LEASING ARRANGEMENTS The Company leases warehouse and manufacturing space, and manufacturing and computer equipment under operating leases with terms ranging up to 25 years. Rent expense amounted to $6.6 million, $7.6 million, and $16.2 million, during 2005, 2004, and 2003, respectively. The future estimated minimum lease payments under non-cancelable operating leases with initial lease terms in excess of one year at December 31, 2005, are as follows: 2006 - $5.1 million; 2007 - $4.8 million; 2008 - $4.2 million; 2009 - $4.1 million; 2010 - $3.4 million and thereafter - $4.1 million. The Company has an operating lease for one of its major production facilities. This facility is owned by a third party and cost approximately $20.3 million to build. Occupancy of the facility began in 1997. Lease payments for the facility continue through 2011 with options for renewal. The estimated minimum payments are included in the preceding paragraph. The facility lease is subject to certain restrictive covenants including leverage, fixed charges and annual capital expenditures. The 2003 rent expense of $16.2 million includes $9.3 million for equipment at the Elmore, Ohio facility that was purchased with a portion of the loan proceeds from the December 2003 refinancing. 40. NOTE H - DERIVATIVE FINANCIAL INSTRUMENTS AND FAIR VALUE INFORMATION The Company is exposed to interest rate, commodity price and foreign currency exchange rate differences and attempts to minimize the effects of these exposures through a combination of natural hedges and the use of derivative financial instruments. The Company has policies approved by the Board of Directors that establish the parameters for the allowable types of derivative instruments to be used, the maximum allowable contract periods, aggregate dollar limitations and other hedging guidelines. The Company will only secure a derivative if there is an identifiable underlying exposure that is not otherwise covered by a natural hedge. In general, derivatives will be held until maturity. The following table summarizes the fair value of the Company's outstanding derivatives and debt as of December 31, 2005 and 2004.
DECEMBER 31, 2005 December 31, 2004 ----------------------- ----------------------- Notional Carrying Notional Carrying Asset/(liability) Amount Amount Amount Amount -------- ---------- -------- ---------- (Dollars in thousands) FOREIGN CURRENCY CONTRACTS Forward contracts Yen ...................................... $ 7,720 $ 579 $ 16,622 $ (765) Euro ..................................... 9,473 658 27,842 (2,113) Sterling ................................. 1,803 116 5,189 (228) -------- --------- -------- --------- Total ................................. $ 18,996 $ 1,353 $ 49,653 $ (3,106) ======== ========= ======== ========= Options Yen ...................................... $ 1,743 $ 17 $ 3,366 $ (18) Euro ..................................... 11,381 106 9,200 (761) -------- --------- -------- --------- Total ................................. $ 13,124 $ 123 $ 12,566 $ (779) ======== ========= ======== ========= COPPER PRICE CONTRACTS Floating to fixed swaps .................... $ 6,983 $ 1,420 $ - $ - Floating to fixed options .................. 1,776 493 - - -------- --------- -------- --------- Total ................................. $ 8,759 $ 1,913 $ - $ - ======== ========= ======== ========= INTEREST RATE EXCHANGE CONTRACTS Floating to fixed .......................... $ 36,959 $ (1,241) $ 52,202 $ (3,256) SHORT- AND LONG-TERM DEBT ..................... $ - $ (57,186) $ - $ (72,450)
The fair values equal the carrying amounts in the Consolidated Balance Sheets as of December 31, 2005 and 2004. Statement No. 107 defines fair value as the amount at which an instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The fair values of the foreign currency, copper price and interest rate derivative contracts were calculated by third parties on behalf of the Company using the applicable market rates at December 31, 2005 and December 31, 2004. The fair value of the Company's debt was estimated using a discounted cash flow analysis based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. The Company records derivatives in its financial statements in accordance with Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" and Statement No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities", which amended Statement No. 133. Each of the Company's foreign currency, copper price and interest rate derivative contracts were designated as cash flow hedges at inception as defined under these statements. Statement No. 133 requires the fair value of outstanding derivative instruments to be recorded on the balance sheet. Accordingly, derivative fair values were included in the balance sheet line items as follows:
December 31, ----------------------- 2005 2004 -------- ----------- Debit/(credit) balance (Dollars in thousands) Prepaid expenses ............................ $ 3,389 $ - Other liabilities and accrued items ......... (414) (4,216) Other long-term liabilities ................. (827) (2,925) ------- ---------- Total .................................... $ 2,148 $ (7,141) ======= ==========
The balance sheet classification of the fair values is dependent upon the Company's rights and obligations under each derivative and the remaining term to maturity. Changes in fair values of derivatives are recorded in income or other comprehensive income (loss) (hereafter"OCI") as appropriate 41. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Brush Engineered Materials Inc. and Subsidiaries, December 31, 2005 under Statement No. 133 guidelines. A reconciliation of the changes in fair values and other derivative activity recorded in OCI for 2005 and 2004 is as follows:
2005 2004 -------- ----------- (Dollars in thousands) Balance in other comprehensive income (loss) at January 1............. $ (4,025) $ (3,216) Changes in fair values and other current period activity ............... 7,555 (3,336) Matured derivatives - charged to expense.. 631 2,527 Derivative ineffectiveness- (credited) to expense .................... (180) - -------- ----------- Balance in other comprehensive income (loss) at December 31........... $ 3,981 $ (4,025) ======== ===========
All of the outstanding foreign currency and copper price hedge contracts qualified for hedge accounting treatment as of December 31, 2005. The outstanding interest rate swap as of December 31, 2005 does not qualify for hedge accounting as the designated hedged item, the variable rate portion of an operating lease, was terminated as part of the refinancing in December 2003. The associated $4.6 million cumulative loss previously recorded in OCI was charged to expense on the Consolidated Statement of Income at the time of the refinancing. Changes in the swap's fair value subsequent to the refinancing are charged to income or expense in the current period. Hedge ineffectiveness, including amounts charged from OCI and other adjustments to the fair values of derivatives that did not flow through OCI, was income of $0.8 million in 2005 and an expense of $0.4 million in 2004 and $5.1 million in 2003 and was included in other-net expense on the Consolidated Statements of Income. Assuming no change from the applicable December 31, 2005 exchange rates or copper prices, the balance in OCI as of December 31, 2005 will be reversed to income in 2006 as the related hedged items are all scheduled to mature in 2006. The Company hedged a portion of its net investment in its Japanese subsidiary using yen-denominated debt until this loan was repaid in December 2003. A net loss of $0.6 million associated with translating this debt into dollars was recorded in the cumulative translation adjustment as of December 31, 2005 and 2004. This balance will remain in cumulative translation adjustment and will only be charged to income should the Company ever liquidate its investment. FOREIGN EXCHANGE HEDGE CONTRACTS The Company uses forward and option contracts to hedge anticipated foreign currency transactions, primarily foreign sales. The purpose of the program is to protect against the reduction in value of the foreign currency transactions from adverse exchange rate movements. Should the dollar strengthen significantly, the decrease in the translated value of the foreign currency transactions should be partially offset by gains on the hedge contracts. Depending upon the method used, the contract may limit the benefits from a weakening of the dollar. The Company's policy limits contracts to maturities of two years or less from the date of issuance. The outstanding contracts as of year-end 2005 all have maturities of one year or less while the outstanding contracts as of year-end 2004 had maturities ranging up to 18 months. Realized gains and losses on foreign exchange contracts are recorded in other-net on the Consolidated Statements of Income. The total exchange loss, which includes realized and unrealized losses, was $1.1 million in 2005, $1.8 million in 2004 and $0.9 million in 2003. COPPER PRICE CONTRACTS The Company purchases and manufactures products containing copper. Purchases are exposed to price fluctuations in the copper market. However, for a significant portion of its copper-based products, the Company will adjust its selling prices to customers to reflect the change in its copper purchase price. This program is designed to be profit neutral; i.e., any changes in copper prices, either up or down, will be directly passed on to the customer. The Company uses copper price contracts (i.e., swaps and options) to hedge the copper purchase price for those volumes where price fluctuations cannot be passed on to the customer. Under the swaps, which are purchased from financial institutions, the Company makes or receives payments based on a difference between a fixed price (as specified in each individual contract) and the market price of copper. These payments will offset the change in prices of the underlying purchases and effectively fix the price of copper at the swap rate for the contracted volume. Under the options, the Company will receive a payment if the market price exceeds the contract strike price at the maturity date. If the market price is below the strike price, the contract will expire worthless and the Company will not have to make a payment to the financial institution. The Company's policy limits commodity hedge contracts, including copper price contracts, to maturities of 27 months or less from the original date of issuance. Realized gains and losses on copper hedge contracts are deferred into OCI and then amortized to cost of sales on the Consolidated Statements of Income over the inventory turnover period. INTEREST RATE HEDGE CONTRACTS The Company attempts to minimize its exposure to interest rate variations by using combinations of fixed and variable rate instruments with varying lengths of maturities. Depending upon the interest rate yield curve, credit spreads, projected borrowing requirements and rates, cash flow considerations and other factors, the Company may elect to secure interest rate swaps, caps, collars, options or other related derivative instruments to hedge portions of its interest rate exposure. Both fixed-to-variable and variable-to-fixed interest rate instruments may be used. In December 2003, the Company entered into a five-year variable-to-fixed interest rate swap with a $10.0 million notional value designated as a hedge of a portion of its variable rate subordinated debt. The Company terminated this swap concurrent with the prepayment of the associated debt in December 2005. The termination resulted in a gain of $0.2 million, which was included in the hedge ineffectiveness total stated above. 42. While the remaining swap does not qualify for hedge accounting, cash payments made or received under this swap will tend to offset changes in the interest payments made on portions of its outstanding variable rate debt not otherwise hedged. The swap matures in 2008 and its notional value declines over time. Gains and losses on this swap were charged to cost of sales over its life until the underlying hedged item was terminated in December 2003. Gains and losses from that point forward are recorded as derivative ineffectiveness within other-net on the Consolidated Statements of Income. NOTE I - PENSIONS AND OTHER POST-RETIREMENT BENEFITS PART I: DOMESTIC PLANS The obligation and funded status of the Company's domestic pension and other post-retirement benefit plans are shown below. The Pension Benefits column includes the domestic defined benefit pension plan and unfunded supplemental retirement plan. The retiree medical and life insurance plan is shown in the Other Benefits column.
Pension Benefits Other Benefits -------------------------- ------------------------ 2005 2004 2005 2004 ----------- ------------- ---------- ----------- (Dollars in thousands) CHANGE IN BENEFIT OBLIGATION Benefit obligation at beginning of year............................... $ 122,520 $ 110,469 $ 42,890 $ 45,449 Service cost.......................................................... 4,747 4,242 299 280 Interest cost......................................................... 6,497 6,900 2,243 2,572 Amendments............................................................ (14,741) 119 697 - Actuarial (gain) loss................................................. 10,749 6,234 (8,710) (2,202) Benefit payments...................................................... (5,580) (5,444) (2,963) (3,209) ----------- ------------- ---------- ----------- Benefit obligation at end of year..................................... 124,192 122,520 34,456 42,890 CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year........................ 89,383 85,803 - - Actual return on plan assets.......................................... 5,865 8,955 - - Employer contributions................................................ 5,088 69 2,963 3,209 Benefit payments...................................................... (5,580) (5,444) (2,963) (3,209) ----------- ------------- ---------- ----------- Fair value of plan assets at end of year.............................. 94,756 89,383 - - ----------- ------------- ---------- ----------- Funded status......................................................... (29,436) (33,137) (34,456) (42,890) Unrecognized net actuarial (gain) loss................................ 45,551 33,189 (341) 8,369 Unrecognized prior service cost (benefit)............................. (9,080) 4,991 (15) (797) ----------- ------------- ---------- ----------- Net amount recognized................................................. $ 7,035 $ 5,043 $ (34,812) $ (35,318) =========== ============= ========== =========== AMOUNTS RECOGNIZED IN THE CONSOLIDATED BALANCE SHEETS CONSIST OF: Accrued benefit liability............................................. $ (28,415) $ (15,715) $ (34,812) $ (35,318) Intangible asset...................................................... - 4,983 - - Accumulated other comprehensive loss ................................. 35,450 15,775 - - ----------- ------------- ---------- ----------- Net amount recognized................................................. $ 7,035 $ 5,043 $ (34,812) $ (35,318) =========== ============= ========== =========== ADDITIONAL INFORMATION Increase in minimum liability included in other comprehensive loss.... $ 19,675 $ 3,179 Accumulated benefit obligation for all domestic pension plans......... $ 123,077 $ 104,949
43. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Brush Engineered Materials Inc. and Subsidiaries, December 31, 2005
Pension Benefits Other Benefits ---------------------------------- ---------------------------------- 2005 2004 2003 2005 2004 2003 ------- ---------- --------- -------- --------- ----------- (Dollars in thousands) COMPONENTS OF NET PERIODIC BENEFIT COST Service cost.......................................... $ 4,747 $ 4,242 $ 4,116 $ 299 $ 280 $ 274 Interest cost......................................... 6,497 6,900 6,668 2,243 2,572 2,818 Expected return on plan assets........................ (8,754) (9,069) (9,359) - - - Amortization of prior service cost (benefit).......... (670) 646 647 (85) (112) (112) Amortization of initial net (asset) obligation........ - (1) (361) - - - Recognized net actuarial (gain) loss.................. 1,276 (10) (26) - 255 333 Settlement (gain)..................................... - - (48) - - - ------- ---------- --------- -------- --------- ----------- Net periodic benefit cost............................. $ 3,096 $ 2,708 $ 1,637 $ 2,457 $ 2,995 $ 3,313 ======= ========== ========= ======== ========= ===========
Pension Benefits Other Benefits ---------------------------------- ---------------------------------- 2005 2004 2003 2005 2004 2003 ------- ---------- --------- -------- --------- ----------- ASSUMPTIONS WEIGHTED-AVERAGE ASSUMPTIONS USED TO DETERMINE BENEFIT OBLIGATIONS AT FISCAL YEAR END Discount rate......................................... 5.750% 6.125% 5.750% 6.125% Rate of compensation increase......................... 4.500% 3.500% 4.500% 3.500% WEIGHTED-AVERAGE ASSUMPTIONS USED TO DETERMINE NET COST FOR THE FISCAL YEAR Discount rate......................................... 6.125% 6.375% 6.750% 6.125% 6.375% 6.750% Expected long-term return on plan assets.............. 8.750% 9.000% 9.000% N/A N/A N/A Rate of compensation increase......................... 3.500% 2.750% 2.000% 3.500% 2.750% 2.000%
The Company uses a December 31 measurement date for the above plans. The Company amended the defined benefit plan during 2005. The amendment, among other items, revised the benefit payout formula for the majority of the plan participants. The plan amendment was deemed to be a significant event and the plan was remeasured accordingly during 2005. The discount rate assumption was changed at the time of the remeasurement. Therefore, a discount rate of 6.125% was used for part of the year and 5.875% was used for the remainder of the year to determine the net cost in 2005. The expected long-term rate of return on plan asset and the rate of compensation increase assumptions did not change for the remeasurement. Effective January 1, 2006, the Company revised the expected long-term rate of return assumption used in calculating the annual expense for its domestic pension plan in accordance with Statement No. 87, "Employers' Accounting for Pensions". The assumed expected long-term rate of return was decreased to 8.50% from 8.75%, with the impact being accounted for as a change in estimate. Effective January 1, 2005, the Company revised the expected long-term rate of return to 8.75% from 9.0%, with the impact being accounted for as a change in estimate. Management establishes the expected long-term rate of return assumption by reviewing its historical trends and analyzing the current and projected market conditions in relation to the plan's asset allocation and risk management objectives. Management consults with outside investment advisors and actuaries when establishing the rate and reviews their assumptions with the Retirement Plan Review Committee of the Board of Directors. The actual return on plan assets was 6.5% in 2005, 10.6% in 2004 and 19.7% in 2003. The 10-year average annualized return was 7.8% as of year-end 2005 and 9.0% as of year-end 2004. Management believes that the 8.50% expected long-term rate of return assumption is achievable and reasonable given current market conditions and forecasts, asset allocations, investment policies and investment risk objectives. The rate of compensation increase assumption was changed to a flat 4.5% as of January 1, 2006. Previously, a graded assumption was used, with the rate of increase beginning at 2% for the 2003 fiscal year and increasing 0.75% per year until it would have reached 5% for the 2007 fiscal year and later. 44.
2005 2004 ----- ------ ASSUMED HEALTH CARE TREND RATES AT FISCAL YEAR END Health care trend rate assumed for next year.. 9.00% 10.00% Rate that the trend rate gradually declines to (ultimate trend rate)...................... 5.00% 5.00% Year that the rate reaches the ultimate trend rate................................. 2010 2010
Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
1-Percentage-point 1-Percentage-point Increase Decrease ------------------ ------------------ 2005 2004 2005 2004 --------- ------- -------- ------- (Dollars in thousands) Effect on total of service and interest cost components... $ 84 $ 135 $ (74) $ (119) Effect on post-retirement benefit obligation......... 1,034 1,856 (907) (1,644)
PLAN ASSETS The Company's domestic defined benefit pension plan weighted-average asset allocation at fiscal year-end 2005 and 2004 and target allocation are as follows:
Percentage of Pension Plan Assets at Fiscal Year End Target --------------------- Allocation 2005 2004 ---------- ------- ------ ASSET CATEGORY Equity securities............... 35-75% 61% 67% Debt securities................. 10-25% 24% 18% Real estate..................... 0-5% 8% 7% Other........................... 0-15% 7% 8% ---------- ------- ------ Total........................ 100% 100% 100%
The Company's pension plan investment strategy, as approved by the Retirement Plan Review Committee, is to employ an allocation of investments that will generate returns equal to or better than the projected long-term growth of pension liabilities so that the plan will be self-funding. The return objective is to earn a real return (i.e., the actual return less inflation) of 6.0% as measured on a 10-year moving-average basis. The allocation of investments is designed to maximize the advantages of diversification while mitigating the risk to achieve the return objective. Risk is defined as the annual variability in value and is measured in terms of the standard deviation of investment return. Under the Company's investment policies, allowable investments include domestic equities, international equities, fixed income securities, alternative securities (which include real estate, private venture capital investments and hedge funds) and tactical allocation (a mix of equities and bonds). Ranges, in terms of a percentage of the total assets, are established for each allowable class of security. Derivatives may be used to hedge an existing security or as a risk reduction strategy. Management reviews the asset allocation on an annual or more frequent basis and makes revisions as deemed necessary. None of the plan assets noted above are invested in the Company's common stock. CASH FLOWS EMPLOYER CONTRIBUTIONS The Company expects to contribute $1.9 million to its domestic pension plans and $2.7 million to its other benefit plans in 2006. ESTIMATED FUTURE BENEFIT PAYMENTS The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
Pension Other DURING FISCAL YEARS Benefits Benefits -------- -------- (Dollars in thousands) 2006..................................... $ 4,829 $ 2,727 2007..................................... 5,051 2,747 2008..................................... 5,212 2,760 2009..................................... 5,568 2,790 2010..................................... 6,024 2,788 2011 through 2015........................ 37,830 13,171
PART II: FOREIGN PLAN The obligation and funded status of the Company's German defined benefit pension plan is as follows:
Pension Benefits ----------------------- 2005 2004 -------- ------------ (Dollars in thousands) CHANGE IN BENEFIT OBLIGATION Benefit obligation at beginning of year... $ 3,673 $ 2,617 Service cost.............................. 131 104 Interest cost............................. 162 142 Actuarial loss............................ 1,764 521 Benefit payments.......................... (34) (15) Translation changes....................... (564) 304 -------- ------------ Benefit obligation at end of year......... 5,132 3,673 Funded status............................. (5,132) (3,673) Unrecognized prior service cost........... 2,430 782 -------- ------------ Net amount recognized..................... $ (2,702) $ (2,891) ======== ============ AMOUNTS RECOGNIZED IN THE CONSOLIDATED BALANCE SHEETS CONSIST OF: Accrued benefit liability................. $ (4,082) $ (2,891) Accumulated other comprehensive loss...... 1,380 - -------- ------------ Net amount recognized..................... $ (2,702) $ (2,891) ======== ============ ADDITIONAL INFORMATION Increase in minimum liability included in other comprehensive loss............ $ 1,380 $ - Accumulated benefit obligation for the foreign pension plan................... $ 4,082 $ 2,891
45. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Brush Engineered Materials Inc. and Subsidiaries, December 31, 2005
2005 2004 2003 -------- -------- --------- (Dollars in thousands) COMPONENTS OF NET PERIODIC BENEFIT COST Service cost..................... $ 131 $ 104 $ 85 Interest cost ................... 162 142 121 Recognized net actuarial loss.... 26 2 - -------- -------- --------- Net periodic benefit cost........ $ 319 $ 248 $ 206 ======== ======== =========
ASSUMPTIONS 2005 2004 2003 -------- -------- --------- WEIGHTED-AVERAGE ASSUMPTIONS USED TO DETERMINE BENEFIT OBLIGATIONS AT FISCAL YEAR END Discount rate.................... 4.00% 5.00% Rate of compensation increase.... 3.00% 3.00% WEIGHTED-AVERAGE ASSUMPTIONS USED TO DETERMINE NET COST FOR THE FISCAL YEAR Discount rate.................... 5.00% 5.50% 5.75% Rate of compensation increase.... 3.00% 3.00% 2.50%
The Company uses a December 31 measurement date for the German defined benefit plan. The German plan does not have any assets, as the plan is unfunded. The discount rate assumption for the German plan is determined separately from the U.S. plan assumptions. The rate of compensation increase is also dependent upon assumptions for that operation separate from the U.S. ESTIMATED FUTURE BENEFIT PAYMENTS The following pension benefit payments, which reflect expected future service, as appropriate, are expected to be paid from the German plan: DURING FISCAL YEARS (Dollars in thousands) 2006................................................. $ 41 2007.................................................. 45 2008.................................................. 57 2009.................................................. 75 2010.................................................. 88 2011 through 2015..................................... 802
PART III: OTHER BENEFIT PLANS The Company also has accrued unfunded retirement arrangements for certain directors. The projected benefit obligation was $0.1 million at December 31, 2005 and $0.1 million at December 31, 2004. A corresponding accumulated benefit obligation of equal amounts has been recognized as a liability and is included in retirement and post-employment benefits as of the respective year ends. Certain foreign subsidiaries have funded and accrued unfunded pension and other post-employment arrangements. The liability for these plans was $2.6 million at December 31, 2005 and $2.4 million at December 31, 2004 and was included in retirement and post-employment benefits on the Consolidated Balance Sheets. The Company also sponsors a defined contribution plan available to substantially all U.S. employees. Company contributions to the plan are based on matching a percentage of employee savings up to a specified savings level. The Company's annual contributions were $2.3 million in 2005, $1.0 million in 2004 and $1.0 million in 2003. The Company doubled its matching percentage effective January 1, 2005. NOTE J - CONTINGENCIES AND COMMITMENTS CBD CLAIMS The Company is a defendant in proceedings in various state and federal courts by plaintiffs alleging that they have contracted chronic beryllium disease (CBD) or related ailments as a result of exposure to beryllium. Plaintiffs in CBD cases seek recovery under theories of negligence and various other legal theories and seek compensatory and punitive damages, in many cases of an unspecified sum. Spouses, if any, claim loss of consortium. Additional CBD claims may arise. Management believes the Company has substantial defenses in these cases and intends to contest the suits vigorously. Employee cases, in which plaintiffs have a high burden of proof, have historically involved relatively small losses to the Company. Third-party plaintiffs (typically employees of customers) face a lower burden of proof than do the Company's employees, but these cases are generally covered by varying levels of insurance. Although it is not possible to predict the outcome of the litigation pending against the Company and its subsidiaries, the Company provides for costs related to these matters when a loss is probable and the amount is reasonably estimable. Litigation is subject to many uncertainties, and it is possible that some of the actions could be decided unfavorably in amounts exceeding the Company's reserves. An unfavorable outcome or settlement of a pending CBD case or additional adverse media coverage could encourage the commencement of additional similar litigation. The Company is unable to estimate its potential exposure to unasserted claims. The Company recorded a reserve for CBD litigation of $2.1 million at December 31, 2005 and $1.9 million at December 31, 2004. The reserve is included in other long-term liabilities on the Consolidated Balance Sheets. An asset of $2.2 million was recorded in other assets on the Consolidated Balance Sheets at December 31, 2005 and $2.3 million at December 31, 2004 for recoveries from insurance carriers for outstanding insured claims and for prior settlements initially paid directly by the Company to the plaintiff on insured claims. An additional $0.4 million was reserved at December 31, 2005 and 2004 for insolvencies related to claims still outstanding as well as for claims for which partial payments have been received. While the Company is unable to predict the outcome of the current or future CBD proceedings, based upon currently known facts and assuming collectibility of insurance, the Company does not believe that resolution of these proceedings will have a material adverse effect on the financial condition or cash flow of the Company. However, the Company's results of operations could be materially affected by unfavorable results in one or more of these cases. 46. ENVIRONMENTAL PROCEEDINGS The Company has an active program for environmental compliance that includes the identification of environmental projects and estimating their impact on the Company's financial performance and available resources. Environmental expenditures that relate to current operations, such as waste-water treatment and control of airborne emissions, are either expensed or capitalized as appropriate. The Company records reserves for the probable costs for environmental remediation projects. The Company's environmental engineers perform routine ongoing analyses of the remediation sites and will use outside consultants to assist in their analyses from time to time. Accruals are based upon their analyses and are established at either the best estimate or, absent a best estimate, at the low end of the estimated range of costs. The accruals are revised for the results of ongoing studies and for differences between actual and projected costs. The accruals are also affected by rulings and negotiations with regulatory agencies. The timing of payments often lags the accrual, as environmental projects typically require a number of years to complete. The undiscounted reserve balances at December 31, 2005 and 2004 were as follows:
December 31, ---------------------- 2005 2004 -------- ----------- (Dollars in thousands) Current. . . . . . . . . . . . . . . . $ 656 $ 1,222 Long-term. . . . . . . . . . . . . . . 4,246 4,473 -------- ----------- Total reserve. . . . . . . . . . .. $ 4,902 $ 5,695 ======== ===========
These reserves cover existing or currently foreseen projects. It is possible that additional environmental losses may occur beyond the current reserve, the extent of which cannot be estimated. In 2005, the Company obtained updated detailed quotes on various remediation projects that estimated a lower remediation cost than previously reserved. In addition, the Company received notification that further remediation efforts on a particular project at the Elmore facility were no longer required. As a result of these and other minor factors, the Company reversed $0.5 million of the reserve to income in 2005. Payments against the reserve totaled $0.3 million in 2005. In 2004, the Company sold property that was subject to a Voluntary Action Plan. This property had been formerly used as a manufacturing site by one of the Company's subsidiaries. Under the terms of the sale, the buyer assumed the environmental remediation responsibilities and agreed to indemnify the Company against any environmental claims arising from this property. This transaction enabled the Company to reverse a previously recorded environmental remediation reserve associated with this property of $1.0 million to income. The reserve was also reduced in 2004 as a result of payments on various projects that totaled $0.2 million. The environmental reserve was reduced by $0.6 million in 2003 as a result of revised estimates of the required remediation work and related costs, primarily for RCRA projects, SWMU closure and other projects at the Elmore facility. LONG-TERM OBLIGATION The Company has a long-term supply arrangement with Ulba/ Kazatomprom of the Republic of Kazakhstan and their marketing representative, Nukem, Inc. of Connecticut. The agreement was signed in 2000 and amended from time to time. An amendment in 2003 reduced the previous purchase commitments for copper beryllium master alloy, added commitments to purchase beryllium vacuum cast billets and extended the contract period to 2012. All materials under the arrangement are sourced from Ulba/Kazatomprom. The annual base purchase commitments total approximately $5.8 million in 2006 and 2007. A new price will be renegotiated for the years 2008 through 2012. If a new price cannot be agreed to by December 31, 2007, then the material purchases will terminate with the 2008 delivery volumes. The contract allows for the Company to purchase additional quantities of copper beryllium master alloy up to an annual maximum of 150,000 pounds of beryllium contained in the master alloy. The purchase of beryllium vacuum cast billets can be plus or minus 10% of the annual base quantity. The contract was amended in 2005 to provide an additional quantity of 120,000 pounds for the years 2005 to 2007 above the existing quantities. Purchases of beryllium-containing materials from Nukem were $7.8 million in 2005, $5.9 million in 2004 and an immaterial amount in 2003. The Company has agreements to purchase stated quantities of beryl ore, beryllium metal and copper beryllium master alloy from the Defense Logistics Agency of the U.S. Government. The agreements expire in 2007. Annual purchase commitments total approximately $4.8 million in 2006 and $5.2 million in 2007. The beryllium component of the contract price is adjusted quarterly from these stated totals based upon fluctuations in the non-seasonally adjusted consumer price index. The Company may elect to take delivery of the materials in advance of the commitment dates. Purchases under these agreements totaled approximately $7.5 million in 2005, $6.6 million in 2004 and $5.9 million in 2003. The purchased material will serve as raw material input for operations within two of the Company's subsidiaries, Brush Wellman Inc. and Brush Resources Inc. OTHER One of the Company's subsidiaries, Williams Advanced Materials Inc. (WAM) is a defendant in a U.S. legal case where the plaintiff is alleging patent infringement by WAM and a small number of WAM's customers. WAM has provided an indemnity agreement to certain of those customers, under which WAM will pay any damages awarded by the court. WAM believes it has numerous and strong defenses applicable to both WAM and the indemnified customers and is contesting this action. WAM earlier filed suit against this plaintiff in the U.S. for wrongful intimidation of its customers and requested that certain of the plaintiff's patents be invalidated. WAM also filed a suit in Australia to revoke a corresponding patent. The Australian court has ruled in WAM's favor while the U.S. action is ongoing. WAM has not made any indemnification payments on behalf of any of its 47. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Brush Engineered Materials Inc. and Subsidiaries, December 31, 2005 customers as of December 31, 2005, nor have they recorded a reserve for losses under these indemnification agreements as of December 31, 2005. WAM does not believe a range of potential losses, if any, can be estimated at the present time. The Company is subject to various other legal or other proceedings that relate to the ordinary course of its business. The Company believes that the resolution of these proceedings, individually or in the aggregate, will not have a material adverse impact upon the Company's consolidated financial statements. The Company has outstanding letters of credit totaling $11.8 million related to workers' compensation, consigned precious metal arrangements and environmental remediation issues that expire in 2006. NOTE K - CAPITAL STOCK During the third quarter of 2004, the Company completed a common stock offering of 2,050,000 newly issued shares and 115,000 secondary shares of common stock sold by selling shareholders. In addition, pursuant to a partial exercise of an over allotment option by the underwriters, an additional 200,000 primary shares were issued bringing the total of primary shares of common stock issued under the offering to 2,250,000. The net proceeds from the offering after deducting fees was $38.7 million. The majority of proceeds from the offering was used to repay outstanding borrowings under the Company's revolving line of credit and $5.0 million of the proceeds was used to repay a portion of the Company's long-term subordinated debt. In connection with the Company's refinancing agreement dated December 4, 2003, 115,000 $0.01 common stock warrants were issued to the lenders as part of their fee. Holders of the warrants were entitled to exercise them for an equal number of shares of Company common stock. The warrants were recorded as a component of shareholders' equity at their fair value at the time of issuance. The holders of the warrants exercised them in the third quarter 2004 and sold their shares concurrent with the Company's new share offering. The Company has 5 million shares of Serial Preferred Stock authorized (no par value), none of which has been issued. Certain terms of the Serial Preferred Stock, including dividends, redemption and conversion, will be determined by the Board of Directors prior to issuance. On January 27, 1998 the Company's Board of Directors adopted a new share purchase rights plan and declared a dividend distribution of one right for each share of Common Stock outstanding as of the close of business on February 9, 1998. The plan allows for new shares issued after February 9, 1998 to receive one right subject to certain limitations and exceptions. Each right entitles the shareholder to buy one one-hundredth of a share of Serial Preferred Stock, Series A, at an initial exercise price of $110. A total of 450,000 unissued shares of Serial Preferred Stock will be designated as Series A Preferred Stock. Each share of Series A Preferred Stock will be entitled to participate in dividends on an equivalent basis with one hundred shares of common stock and will be entitled to one vote. The rights will not be exercisable and will not be evidenced by separate right certificates until a specified time after any person or group acquires beneficial ownership of 20% or more (or announces a tender offer for 20% or more) of common stock. The rights expire on January 27, 2008, and can be redeemed for 1 cent per right under certain circumstances. The amended 1995 Stock Incentive Plan authorizes the granting of five categories of incentive awards: option rights, performance restricted shares, performance shares, performance units and restricted shares. As of December 31, 2005, no performance units had been granted. Option rights under this plan entitled the optionee to purchase common shares at a price equal to or greater than market value on the date of grant. Option rights outstanding under the amended 1995 Stock Incentive Plan and previous plans generally became exercisable over a four-year period and expired 10 years from the date of the grant. In 1995, the Company's right to grant options on a total of 228,565 shares (under the Company's 1979, 1984 and 1989 stock option plans) was terminated upon shareholder approval of the amended 1995 Stock Incentive Plan upon terms providing that no further stock awards would be made under the Company's 1979, 1984 and 1989 stock option plans except to the extent that shares become available for grant under these plans by reason of termination of options previously granted. The amended 1995 Stock Incentive Plan expired in May 2005. Currently, there are stock options outstanding under the above plans. The 1990 Stock Option Plan for Non-employee Directors (the "1990 Plan") was terminated effective May 7, 1998. The 1997 Stock Incentive Plan for Non-employee Directors replaced the 1990 Plan and provided for a one-time grant of 5,000 options to up to six new non-employee directors who have not yet received options under the 1990 Plan at an option price equal to the fair market value of the shares at the date of the grant. Options are non-qualified and become exercisable six months after the date of grant. The options generally expire 10 years after the date they were granted. The 1997 Stock Incentive Plan for Non-employee Directors was amended on May 1, 2001. The amendment added an additional 100,000 shares to the Plan and established a grant of up to 2,000 options to each Director annually. 48. Stock option and restricted share award activities are summarized in the following table:
2005 2004 2003 ------------------------- --------------------------- ------------------------- Weighted- Weighted- Weighted- average average average Exercise Exercise Exercise Shares Price Shares Price Shares Price ---------- ------------ ---------- ------------ ---------- ----------- STOCK OPTIONS Outstanding at beginning of year............ 1,467,710 $ 16.19 1,474,943 $ 15.78 1,394,688 $ 17.82 Granted..................................... 174,200 17.12 242,650 17.01 262,800 5.62 Exercised................................... (29,955) 12.43 (228,298) 14.19 (1,900) 12.89 Cancelled................................... (103,695) 18.19 (21,585) 18.38 (180,645) 16.76 ---------- --------- ---------- Outstanding at end of year.................. 1,508,260 16.24 1,467,710 16.19 1,474,943 15.78 ========== ========= ========== Exercisable at end of year.................. 1,387,560 16.59 1,236,930 16.75 1,231,103 16.78 RESTRICTED AWARDS Awarded and restricted at beginning of year. 38,550 46,950 77,845 Awarded during the year..................... - 13,700 - Vested...................................... (25,250) (14,100) (26,845) Forfeited................................... - (8,000) (4,050) ---------- ---------- ---------- Awarded and restricted at end of year....... 13,300 38,550 46,950 ========== ========== ==========
The restricted awards are recorded as a component of shareholders' equity at their fair value as of the grant date. The fair value is subsequently amortized as deferred compensation expense over the vesting period. Amounts recorded against selling, general and administrative expense on the Consolidated Statements of Income totaled $0.1 million in 2005, $0.1 million in 2004 and $0.3 million in 2003. The following table provides additional information about stock options outstanding as of December 31, 2005:
Options Outstanding Options Exercisable ----------------------------------------- ---------------------- Weighted- average Weighted- Weighted- Remaining average average Range of Number Contract Exercise Number Exercise Option Prices Outstanding Life Price Exercisable Price - ----------------- ----------- --------- --------- ----------- --------- $ 5.55 - $ 8.10 213,820 7.15 $ 5.64 169,420 $ 5.66 $ 12.15 - $ 15.06 320,540 5.44 13.16 303,400 13.22 $ 15.97 - $ 18.13 625,500 6.34 17.12 566,340 17.13 $ 20.64 - $ 23.78 219,350 4.96 22.32 219,350 22.32 $ 26.44 - $ 26.72 129,050 2.34 26.72 129,050 26.72 ----------- --------- --------- ----------- --------- 1,508,260 5.68 $ 16.24 1,387,560 $ 16.59 =========== ========= ========= =========== =========
The weighted-average remaining contractual life of options outstanding at December 31, 2004 and 2003 is 5.93 years and 5.99 years, respectively. The number of shares available for future grants as of December 31, 2005, 2004 and 2003 was 95,460 shares, 245,566 shares and 472,331 shares, respectively. 49. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Brush Engineered Materials Inc. and Subsidiaries, December 31, 2005 NOTE L - OTHER COMPREHENSIVE INCOME The following table summarizes the cumulative net gain/(loss) by component within other comprehensive income as of December 31, 2005, 2004 and 2003:
December 31, ------------------------------------- 2005 2004 2003 ---------- ------------ ----------- (Dollars in thousands) Foreign currency translation adjustment............................... $ (2,188) $ (133) $ (982) Change in the fair value of derivative financial instruments.......... 3,981 (4,025) (3,216) Minimum pension liability............................................. (36,830) (15,775) (12,596) ---------- ------------ ----------- Total................................................................. $ (35,037) $ (19,933) $ (16,794) ========== ============ ===========
NOTE M - SEGMENT REPORTING AND GEOGRAPHIC INFORMATION Selected financial data by business segment for 2005, 2004 and 2003 is as follows:
Metal Micro- Total (Dollars in thousands) Systems electronics Segments All Other Total ------------- ----------- ------------- ------------- ------------- 2005 Revenues from external customers.................... $ 306,320 $ 234,947 $ 541,267 $ - $ 541,267 Intersegment revenues............................... 2,789 1,638 4,427 - 4,427 Depreciation, depletion and amortization............ 14,970 4,050 19,020 2,655 21,675 Profit (loss) before interest and taxes............. 6,258 18,958 25,216 (5,707) 19,509 Assets.............................................. 301,532 110,100 411,632 (8,930) 402,702 Expenditures for long-lived assets.................. 8,590 4,742 13,332 443 13,775 2004 Revenues from external customers.................... $ 300,711 $ 195,565 $ 496,276 $ - $ 496,276 Intersegment revenues............................... 3,513 1,149 4,662 - 4,662 Depreciation, depletion and amortization............ 16,100 3,870 19,970 2,391 22,361 Profit before interest and taxes.................... 4,463 18,540 23,003 2,031 25,034 Assets.............................................. 301,740 76,776 378,516 35,665 414,181 Expenditures for long-lived assets.................. 5,830 2,673 8,503 647 9,150 2003 Revenues from external customers.................... $ 243,723 $ 157,323 $ 401,046 $ - $ 401,046 Intersegment revenues............................... 2,414 1,119 3,533 - 3,533 Depreciation, depletion and amortization............ 13,710 4,020 17,730 2,605 20,335 Profit (loss) before interest and taxes............. (16,381) 12,618 (3,763) (5,181) (8,944) Assets.............................................. 293,933 74,137 368,070 3,546 371,616 Expenditures for long-lived assets.................. 3,320 2,930 6,250 69 6,319
Segments are evaluated using earnings before interest and taxes. Intersegment revenues are eliminated in consolidation. The revenues from external customer totals are presented net of the intersegment revenues. Effective January 1, 2005, the operating results of Brush Resources Inc. are included as part of the Metal Systems Group. Previously, the operating results of Brush Resources were included as part of All Other in the segment disclosures. Brush Resources sells beryllium hydroxide, produced through its Utah operations, to outside customers and to businesses within the Metal Systems Group. This change is more reflective of how the Company's businesses are evaluated. The 2004 and 2003 amounts presented have been reclassified to reflect this change. The "All Other" column includes the operating results of BEM Services, Inc., a wholly owned subsidiary of the Company, as well as the parent company's and other corporate expenses. BEM Services charges a management fee for the services provided to the other businesses within the Company on a cost-plus basis. Inventories for Metal Systems and Microelectronics are shown at their FIFO values with the LIFO reserve included in the All Other column. Assets shown in All Other include cash, computer hardware and software and capitalized interest. The change in All Other assets from December 31, 2004 to December 31, 2005 was primarily due to a $39.0 million decline in cash and a $6.6 million increase in the LIFO reserve. The All Other assets were a net credit balance as of December 31, 2005 as a result of the LIFO reserve being larger than the debit balances of the other items. 50. The Company's sales from U.S. operations to external customers, including exports, were $409.3 million in 2005, $376.5 million in 2004, and $311.5 million in 2003. Revenues attributed to countries based upon the location of customers and long-lived assets deployed by the Company by country are as follows:
2005 2004 2003 ----------- ---------- ----------- (Dollars in thousands) Revenues United States............... $ 362,160 $ 332,193 $ 276,668 All other................... 179,107 164,083 124,378 ----------- ---------- ----------- Total....................... $ 541,267 $ 496,276 $ 401,046 =========== ========== =========== Long-lived Assets United States............... $ 170,029 $ 171,188 $ 185,168 All other................... 7,033 6,431 5,678 ----------- ---------- ----------- Total....................... $ 177,062 $ 177,619 $ 190,846 =========== ========== ===========
No individual country, other than the United States, or customer accounted for 10% or more of the Company's revenues for the years presented. Revenues from outside the U.S. are primarily from Europe and Asia. NOTE N - INTEREST Interest expense associated with active construction and mine development projects is capitalized and amortized over the future useful lives of the related assets. The following chart summarizes the interest incurred, capitalized and paid, as well as the amortization of capitalized interest for 2005, 2004 and 2003.
2005 2004 2003 ----------- ---------- -------- (Dollars in thousands) Interest incurred.............. $ 6,631 $ 8,553 $ 3,665 Less capitalized interest...... 259 176 (86) ----------- ---------- -------- Total expense.................. $ 6,372 $ 8,377 $ 3,751 ----------- ---------- -------- Interest paid.................. $ 7,345 $ 6,103 $ 2,558 ----------- ---------- -------- Amortization of capitalized interest included in cost of sales........................ $ 587 $ 593 $ 623 =========== ========== ========
The difference in expense among 2005, 2004 and 2003 was due primarily to the changes in the level of outstanding debt. Amortization of deferred financing costs within interest expense was $1.1 million in 2005, $1.5 million in 2004 and $0.4 million in 2003. In 1986, the Company purchased company-owned life insurance policies insuring the lives of certain United States employees. The net contract (income) expense, including interest expense recorded in selling, general and administrative, was ($0.7) million in 2004 and $1.4 million in 2003. The related interest expense was $0.3 million in 2004 and $1.3 million in 2003. There was no contract (income) expense or related interest expense in 2005 as the program was terminated and the Company received back the net surrender value in 2004. The contracts had been recorded at cash surrender value, net of policy loans, in other assets on the Consolidated Balance Sheet. NOTE O - INCOME TAXES Income (loss) before income taxes and income taxes (benefit) are comprised of the following components, respectively:
2005 2004 2003 --------- --------- ----------- (Dollars in thousands) Income (loss) before income taxes: Domestic......................... $ 10,866 $ 14,030 $ (14,721) Foreign.......................... 2,271 2,627 2,071 --------- --------- ----------- Total before income taxes..... $ 13,137 $ 16,657 $ (12,650) ========= ========= =========== Income taxes (benefit): Current income taxes: Domestic......................... $ 720 $ 528 $ 158 Foreign.......................... 443 821 697 --------- --------- ----------- Total current................. 1,163 1,349 855 Deferred income taxes: Domestic......................... $ 2,213 $ 9,280 $ (5,291) Foreign.......................... 66 (208) (279) Valuation allowance.............. (8,130) (9,280) 5,291 --------- --------- ----------- Total deferred................ (5,851) (208) (279) --------- --------- ----------- Total income taxes (benefit).. $ (4,688) $ 1,141 $ 576 ========= ========= ===========
The reconciliation of the federal statutory and effective income tax rates follows:
2005 2004 2003 ------ ------ ------ Federal statutory rate (benefit).... 34.0% 34.0% (34.0)% State and local income taxes, net of federal tax effect............ 3.0 0.7 0.9 Effect of excess of percentage depletion over cost depletion.... (6.1) (4.7) (7.6) Company-owned life insurance........ (0.1) 34.1 3.6 Officers' compensation.............. 1.5 3.1 0.7 Stock warrants...................... 0.8 0.2 - Taxes on foreign source income...... (8.4) (7.2) (3.7) Valuation allowance................. (61.9) (55.7) 41.8 Other items......................... 1.5 2.4 2.8 ------ ------ ------ Effective tax rate (benefit)... (35.7)% 6.9% 4.5% ====== ====== ======
In accordance with the provisions of Statement No. 109, "Accounting for Income Taxes," the Company recorded an $8.1 million reversal of valuation allowance reflected as a reduction to tax expense in 2005. This amount is comprised of a $2.2 million current year utilization of net operating losses and a $5.9 million reversal of the valuation allowance associated with the Company's determination that it is more likely than not that this portion of the deferred tax asset will be realized. 51. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Brush Engineered Materials Inc. and Subsidiaries, December 31, 2005 The Company recorded a $4.5 million increase to the valuation allowance in 2005 as a component of OCI associated with the changes for the minimum pension liability and derivative and hedging activities. The Company intends to maintain a valuation allowance on certain deferred tax assets until a realization event occurs to support reversal of all or a portion of the allowance. Included in current domestic income taxes, as shown in the Consolidated Statements of Income, are $0.6 million, $0.2 million, and $0.2 million of state and local income taxes in 2005, 2004 and 2003, respectively. The Company had domestic and foreign income tax payments (refunds) of $2.1 million, $1.1 million and $(3.3) million in 2005, 2004 and 2003, respectively. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting bases and the tax bases of assets and liabilities. Deferred tax assets and (liabilities) recorded in the Consolidated Balance Sheets consist of the following at December 31, 2005 and 2004:
2005 2004 --------- ---------- (Dollars in thousands) Post-retirement benefits other than pensions................................ $ 11,827 $ 12,000 Alternative minimum tax credit............. 11,094 10,981 Other reserves............................. 2,205 2,591 Environmental reserves..................... 1,662 1,969 Pensions................................... 12,549 4,460 Derivative instruments and hedging activities.............................. - 2,476 Inventory.................................. - 20 Tax credit carryforward.................... 2,092 1,851 Net operating loss carryforward............ 20,758 23,385 Capitalized interest expense............... 351 237 --------- ---------- 62,538 59,970 Valuation allowance........................ (19,885) (23,175) --------- ---------- Total deferred tax assets.................. 42,653 36,795 Depreciation............................... (33,082) (33,148) Inventory.................................. (887) - Derivative instruments and hedging activities.............................. (264) - Mine development........................... (1,868) (1,858) Miscellaneous.............................. (1,497) (586) --------- ---------- Total deferred tax liabilities............. (37,598) (35,592) --------- ---------- Net deferred tax asset..................... $ 5,055 $ 1,203 ========= ==========
At December 31, 2005, for income tax purposes, the Company had domestic net operating loss carryforwards of $55.2 million, which are scheduled to expire in calendar years 2022 through 2025. The Company also had foreign net operating loss carryforwards for income tax purposes totaling $6.9 million that do not expire. At December 31, 2005, the Company had alternative minimum tax loss carryforwards of $20.9 million that do not expire. Utilization of these loss carryforwards is limited, on an annual basis, to 90% of alternative minimum taxable income. This limitation required the Company to record a $0.2 million tax liability in 2005. At December 31, 2005, the Company had research and experimentation tax credit and foreign tax credit carryforwards of $2.1 million that are scheduled to expire in calendar years 2008 through 2020. A provision has not been made with respect to $12.2 million of unremitted earnings at December 31, 2005 that have been invested by foreign subsidiaries. It is not practical to estimate the amount of unrecognized deferred tax liability for undistributed foreign earnings. NOTE P - EARNINGS PER SHARE The following table sets forth the computation of basic and diluted net earnings (loss) per share (E.P.S.):
2005 2004 2003 ------------ ----------- ------------- Numerator for basic and diluted E.P.S.: Net income (loss).............. $ 17,825 $ 15,516 $ (13,226) Denominator: Denominator for basic E.P.S.: Weighted-average shares outstanding............... 19,219,099 17,865,053 16,562,864 Effect of dilutive securities: Employee stock options...... 137,051 204,788 - Special restricted stock.... 14,598 36,574 - Warrants.................... - 57,500 - ------------ ----------- ------------- Diluted potential common shares.................... 151,649 298,862 - ------------ ----------- ------------- Denominator for diluted E.P.S.: Adjusted weighted-average shares outstanding........ 19,370,748 18,163,915 16,562,864 ============ =========== ============= Basic E.P.S......................... $ 0.93 $ 0.87 $ (0.80) ============ =========== ============= Diluted E.P.S....................... $ 0.92 $ 0.85 $ (0.80) ============ =========== =============
Under Statement No. 128, "Earnings per Share," no potential common shares shall be included in the computation of any diluted per-share amount when a loss from continuing operations exists. Accordingly, dilutive securities have been excluded from the diluted E.P.S. calculation of 109,052 for 2003. Options to purchase common stock with exercise prices in excess of the average share price totaling 817,000 at December 31, 2005, 361,475 at December 31, 2004 and 1,217,643 at December 31, 2003 were excluded from the diluted E.P.S. calculations as their effect would have been anti-dilutive. 52. NOTE Q - RELATED PARTY TRANSACTIONS The Company had outstanding loans of $0.4 million with six employees, including two executive officers, as of December 31, 2005 and December 31, 2004. The loans were made in the first quarter 2002 pursuant to life insurance agreements between the Company and the employees. The portion of the premiums paid by the Company is treated as a loan from the Company to the employees and the loans are secured by the insurance policies, which are owned by the employees. The agreements require each employee to maintain the insurance policy's cash surrender value in an amount at least equal to the outstanding loan balance. The loans are payable from the insurance proceeds upon the employee's death or at an earlier date due to the occurrence of specified events. The loans bear an interest rate equal to the applicable federal rate. There have been no modifications to the loan terms since the inception of the agreements. NOTE R - SUBSEQUENT EVENT In January 2006, Williams Advanced Materials Inc. acquired the stock of CERAC, incorporated for $26.2 million in cash, including advisor fees. CERAC provides physical vapor deposition and specialty inorganic materials for the precision optics, semiconductor and other industries. CERAC employs approximately 120 people at its Milwaukee, Wisconsin facility. Their sales were approximately $20.0 million in 2005. The purchase price included $3.8 million to be held in escrow pending resolution of various matters as detailed in the purchase agreement. NOTE S - QUARTERLY DATA (UNAUDITED) The following tables summarize selected quarterly financial data for the years ended December 31, 2005 and 2004:
2005 ------------------------------------------------------------------ First Second Third Fourth Quarter Quarter Quarter Quarter Total ----------- ----------- ----------- ----------- ------------ (Dollars in thousands except per share data) Net sales........................................ $ 130,372 $ 134,651 $ 135,614 $ 140,630 $ 541,267 Gross profit..................................... 28,577 29,106 25,940 26,620 110,243 Percent of sales.............................. 21.9% 21.6% 19.1% 18.9% 20.4% Net income....................................... 4,286 5,530 3,908 4,101 17,825 Net income per share of common stock: Basic......................................... 0.22 0.29 0.20 0.21 0.93 Diluted....................................... 0.22 0.29 0.20 0.21 0.92 Stock price range: High.......................................... 20.80 19.26 17.92 16.61 Low........................................... 16.11 13.11 14.60 14.83
2004 ------------------------------------------------------------------ First Second Third Fourth Quarter Quarter Quarter Quarter Total ----------- ----------- ----------- ----------- ------------ (Dollars in thousands except per share data) Net sales........................................ $ 125,862 $ 128,639 $ 125,766 $ 116,009 $ 496,276 Gross profit..................................... 29,577 29,441 26,584 25,472 111,074 Percent of sales.............................. 23.5% 22.9% 21.1% 22.0% 22.4% Net income....................................... 3,754 6,571 3,431 1,760 15,516 Net income per share of common stock: Basic......................................... 0.23 0.39 0.18 0.09 0.87 Diluted....................................... 0.22 0.38 0.18 0.09 0.85 Stock price range: High.......................................... 21.69 21.70 21.40 22.68 Low........................................... 14.95 15.43 17.43 15.60
Fourth quarter 2005 results include a $3.8 million pre-tax charge for costs related to the prepayment of subordinated debt and a $5.9 million benefit related to the reversal of a portion of the Company's domestic deferred tax valuation allowance. 53. SELECTED FINANCIAL DATA Brush Engineered Materials Inc. and Subsidiaries (Dollars in thousands except for share data)
2005 2004 2003 2002 2001 ----------- ----------- ----------- ----------- ------------ FOR THE YEAR Net sales............................................... $ 541,267 $ 496,276 $ 401,046 $ 372,829 $ 472,569 Cost of sales........................................... 431,024 385,202 328,008 324,932 404,574 Gross profit............................................ 110,243 111,074 73,038 47,897 67,995 Operating profit (loss)................................. 19,509 25,034 (8,944) (22,636) (14,069) Interest expense ....................................... 6,372 8,377 3,751 3,219 3,327 Income (loss) from continuing operations Before income taxes.................................. 13,137 16,657 (12,695) (25,855) (17,396) Income taxes (benefit).................................. (4,688) 1,141 576 9,749 (7,122) Net income (loss)....................................... 17,825 15,516 (13,226) (35,604) (10,274) Earnings per share of common stock: Basic net income (loss)............................ 0.93 0.87 (0.80) (2.15) (0.62) Diluted net income (loss).......................... 0.92 0.85 (0.80) (2.15) (0.62) Dividends per share of common stock..................... - - - - 0.24 Depreciation and amortization........................... 22,790 23,826 20,731 20,640 21,609 Capital expenditures.................................... 13,775 9,093 6,162 5,248 23,130 Mine development expenditures........................... - 57 157 166 154 YEAR-END POSITION Working capital......................................... 115,531 108,799 85,141 82,645 110,894 Ratio of current assets to current liabilities.......... 2.4 TO 1 2.0 to 1 2.2 to 1 2.1 to 1 2.4 to 1 Property and equipment: At cost............................................ 540,420 540,937 535,421 476,283 469,663 Cost less depreciation and impairment.............. 177,062 177,619 190,846 152,544 171,296 Total assets............................................ 402,702 414,181 371,616 334,879 403,653 Other long-term liabilities............................. 73,492 60,527 64,097 65,977 62,473 Long-term debt.......................................... 32,916 41,549 85,756 36,219 47,251 Shareholders' equity.................................... 211,478 208,138 153,573 159,094 214,350 Book value per share: Basic.............................................. 11.00 11.65 9.27 9.61 12.98 Diluted............................................ 10.92 11.46 9.21 9.58 12.87 Weighted-average number of shares of stock outstanding: Basic.............................................. 19,219,099 17,865,053 16,562,864 16,557,388 16,518,691 Diluted............................................ 19,370,748 18,163,915 16,671,916 16,608,725 16,650,587 Shareholders of record.................................. 1,572 1,683 1,791 1,864 1,981 Number of employees..................................... 1,970 1,912 1,833 1,862 1,946
Minority interest of $45,000 decreased the net loss for 2003. In addition to the capital expenditures shown above, the Company purchased $0.4 million of assets in 2005, $0.9 million of assets in 2004 and $51.8 million of assets in 2003 that were previously held under operating leases and used by the Company. Changes in deferred tax valuation allowances decreased income tax expense by $8.1 million and $9.3 million in 2005 and 2004, respectively, and increased income tax expense by $5.3 million and $19.9 million in 2003 and 2002, respectively. A special charge reduced net income by $16.5 million in 1998. See Notes to Consolidated Financial Statements. 54.
2000 1999 1998 1997 1996 1995 - ------------- ----------- ----------- ------------ ------------ -------------- $ 563,690 $ 455,707 $ 409,892 $ 433,801 $ 376,279 $ 369,618 444,951 363,773 325,173 324,463 271,149 268,732 118,739 91,934 84,719 109,338 105,130 100,886 22,986 10,558 (10,313) 36,024 34,305 29,086 4,652 4,173 1,249 553 1,128 1,653 18,334 6,385 (11,562) 35,471 33,177 27,433 4,169 (54) (4,430) 9,874 8,686 6,744 14,165 6,439 (7,132) 25,597 24,491 20,689 0.87 0.40 (0.44) 1.58 1.55 1.28 0.86 0.40 (0.44) 1.56 1.53 1.27 0.48 0.48 0.48 0.46 0.42 0.36 22,664 27,037 24,589 19,329 22,954 20,911 21,306 16,758 36,732 53,155 26,825 24,244 332 288 433 9,526 3,663 787 143,387 124,831 100,992 100,599 128,172 125,156 2.3 to 1 2.3 to 1 2.1 to 1 2.3 to 1 2.9 to 1 2.9 to 1 449,697 440,234 421,467 463,689 404,127 374,367 170,460 170,939 164,469 173,622 130,220 121,194 452,506 428,406 403,690 383,852 355,779 331,853 55,454 53,837 49,955 48,025 47,271 45,445 43,305 42,305 32,105 17,905 18,860 16,996 229,907 220,638 221,811 236,813 219,257 200,302 14.11 13.62 13.63 14.60 13.84 12.40 13.98 13.55 13.50 14.41 13.72 12.30 16,292,431 16,198,885 16,267,804 16,214,718 15,846,358 16,159,508 16,448,667 16,279,591 16,424,747 16,429,468 15,980,481 16,289,795 2,101 2,330 2,313 2,329 2,407 2,351 2,500 2,257 2,167 2,160 1,926 1,856
55. BRUSH ENGINEERED MATERIALS INC. DIRECTORS, OFFICERS, FACILITIES AND SUBSIDIARIES BOARD OF DIRECTORS AND COMMITTEES OF THE BOARD ALBERT C. BERSTICKER (2, 3, 4) Retired Chairman and CEO Ferro Corporation GORDON D. HARNETT (2) Chairman and CEO Brush Engineered Materials Inc. JOSEPH P. KEITHLEY (2, 3, 4, 5) Chairman, President and CEO Keithley Instruments, Inc. WILLIAM B. LAWRENCE (1, 4) Former Executive Vice President, General Counsel & Secretary TRW, Inc. WILLIAM P. MADAR (2, 3, 4) Retired Chairman and Former (CEO) Nordson Corporation WILLIAM G. PRYOR (3, 4, 5) Retired President Van Dorn Demag Corporation Former President and CEO Van Dorn Corporation N. MOHAN REDDY (1, 4) Professor The Weatherhead School of Management Case Western Reserve University WILLIAM R. ROBERTSON (1, 4, 5) Consulting Partner Kirtland Capital Partners JOHN SHERWIN, JR. (1, 2, 4, 5) Lead Director President Mid-Continent Ventures, Inc. - ----------------- 1 Audit Committee 2 Executive Committee 3 Governance Committee 4 Organization and Compensation Committee 5 Retirement Plan Review Committee CHARLES F. BRUSH, III Director Emeritus CORPORATE AND EXECUTIVE OFFICERS GORDON D. HARNETT (1, 2) Chairman and CEO RICHARD J. HIPPLE (1, 2) President and COO JOHN D. GRAMPA (1, 2) Vice President Finance and Chief Financial Officer DANIEL A. SKOCH (1, 2) Senior Vice President Administration MICHAEL C. HASYCHAK (1) Vice President, Treasurer and Secretary JAMES P. MARROTTE (1) Vice President, Controller JOHN J. PALLAM (1) Vice President, General Counsel GARY W. SCHIAVONI (1) Assistant Treasurer and Assistant Secretary - ----------------- 1 Corporate Officers 2 Executive Officers OPERATING GROUPS ALLOY PRODUCTS DONALD G. KLIMKOWICZ, PRESIDENT BERYLLIUM PRODUCTS MICHAEL D. ANDERSON, PRESIDENT BRUSH INTERNATIONAL, INC. MARK M. COMERFORD, PRESIDENT BRUSH RESOURCES INC. ALEX C. BOULTON, PRESIDENT TECHNICAL MATERIALS, INC. ALFONSO T. LUBRANO, PRESIDENT WILLIAMS ADVANCED MATERIALS INC. RICHARD W. SAGER, PRESIDENT OFFICES AND FACILITIES MANUFACTURING FACILITIES Brewster, New York Buellton, California Buffalo, New York Delta, Utah Elmore, Ohio Fremont, California Limerick, Ireland Lincoln, Rhode Island Lorain, Ohio Milwaukee, Wisconsin Newburyport, Massachusetts Oceanside, California Reading, Pennsylvania Santa Clara, California Singapore Subic Bay, Philippines Taipei, Taiwan Tucson, Arizona Wheatfield, New York CORPORATE OFFICES Cleveland, Ohio DOMESTIC SERVICE CENTERS Elmhurst, Illinois Fairfield, New Jersey Warren, Michigan INTERNATIONAL SERVICE CENTERS AND SALES OFFICES Fukaya, Japan Singapore Stuttgart, Germany Theale, England Tokyo, Japan INTERNATIONAL REPRESENTATIVE OFFICES Hong Kong Shanghai, China Taipei, Taiwan KyunGi-Do, Korea 56. EX-21 3 l17862aexv21.txt EX-21 SUBSIDIARIES EXHIBIT 21 Subsidiaries of Registrant The Company has the following subsidiaries, all of which are wholly owned and included in the consolidated financial statements. State or Country Name of Subsidiary of Incorporation - ------------------ ---------------- BEM Services, Inc. Ohio Brush Ceramic Products Inc. Arizona Brush Wellman Inc. Ohio Brush International, Inc. Ohio Brush Resources Inc. Utah Brush Wellman GmbH Germany Brush Wellman (Japan), Ltd. Japan Brush Wellman Limited England Brush Wellman (Singapore) Pte Ltd. Singapore CERAC incorporated Wisconsin Circuits Processing Technology, Inc. California OMC Scientific Holding Limited Ireland Technical Materials, Inc. Ohio Thin Film Technology, Inc. California Williams Advanced Materials Inc. New York Williams Advanced Materials Pte Ltd. Singapore Williams Advanced Materials (Netherlands) B.V. Netherlands Zentrix Technologies Inc. Arizona EX-23 4 l17862aexv23.txt EX-23 CONSENT - E & Y Exhibit 23 Consent of Independent Registered Public Accounting Firm We consent to the incorporation by reference in this Annual Report (Form 10-K) of Brush Engineered Materials Inc. and subsidiaries of our reports dated March 3, 2006, with respect to the consolidated financial statements of Brush Engineered Materials Inc. and subsidiaries, Brush Engineered Materials Inc. and subsidiaries' management's assessment of the effectiveness of internal control over financial reporting, and the effectiveness of internal control over financial reporting of Brush Engineered Materials Inc. and subsidiaries, included in the 2005 Annual Report to Shareholders of Brush Engineered Materials Inc. Our audits also included the financial statement schedule of Brush Engineered Materials Inc. and subsidiaries listed in Item 15(a). This schedule is the responsibility of Brush Engineered Materials Inc.'s management. Our responsibility is to express an opinion based on our audits. In our opinion, as to which the date is March 16, 2006, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We consent to the incorporation by reference in the following Registration Statements: (1) Registration Statement Number 333-88994 on Form S-8 dated May 24, 2002; (2) Post-Effective Amendment Number 1 to Registration Statement Number 333-74296 on Form S-8 dated November 30, 2001; (3) Post-Effective Amendment Number 5 to Registration Statement Number 2-64080 on Form S-8 dated May 17, 2000; (4) Post-Effective Amendment Number 1 to Registration Statement Number 333-63355 on Form S-8 dated May 17, 2000; (5) Post-Effective Amendment Number 1 to Registration Statement Number 33-28605 on Form S-8 dated May 17, 2000; (6) Post-Effective Amendment Number 1 to Registration Statement Number 333-63353 on Form S-8 dated May 17, 2000; (7) Post-Effective Amendment Number 1 to Registration Statement Number 333-63357 on Form S-8 dated May 17, 2000; (8) Post-Effective Amendment Number 1 to Registration Statement Number 333-52141 on Form S-8 dated May 17, 2000; (9) Post-Effective Amendment Number 1 to Registration Statement Number 2-90724 on Form S-8 dated May 17, 2000; (10) Registration Statement Number 333-63353 on Form S-8 dated September 14, 1998; (11) Registration Statement Number 333-63355 on Form S-8 dated September 14, 1998; (12) Registration Statement Number 333-63357 on Form S-8 dated September 14, 1998; (13) Registration Statement Number 333-52141 on Form S-8 dated May 5, 1998; (14) Registration Statement Number 33-28605 on Form S-8 dated May 5, 1989; (15) Registration Statement Number 2-90724 on Form S-8 dated April 27, 1984; (16) Post-Effective Amendment Number 3 to Registration Statement Number 2-64080 on Form S-8 dated April 22, 1983; (17) Registration Statement Number 333-114147 on Form S-3 dated July 1, 2004; and (18) Registration Statement Number 333-127130 on Form S-8 dated August 3, 2005. Cleveland, Ohio March 16, 2006 EX-24 5 l17862aexv24.txt EX-24 POWER OF ATTORNEY EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned directors and officers of BRUSH ENGINEERED MATERIALS INC., an Ohio corporation (the "Corporation"), hereby constitutes and appoints Gordon D. Harnett, John D. Grampa, Michael C. Hasychak and David P. Porter, and each of them, their true and lawful attorney or attorneys-in-fact, with full power of substitution and revocation, for them and in their names, place and stead, to sign on their behalf as a director or officer, or both, as the case may be, of the Corporation, an Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 on Form 10-K for the fiscal year ended December 31, 2005, and to sign any and all amendments to such Annual Report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission granting unto said attorney or attorneys-in-fact, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as they might or could do in person, hereby ratifying and confirming all that said attorney or attorneys-in-fact or any of them or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof. IN WITNESS WHEREOF, the undersigned have hereunto set their hands as of the 7th day of March, 2006. /s/ Gordon D. Harnett /s/ William P. Madar - ------------------------------------ ------------------------------ Gordon D. Harnett, Chairman, William P. Madar, Director Chief Executive Officer and Director (Principal Executive Officer) /s/ John D. Grampa /s/ William G. Pryor - ------------------------------------ ------------------------------ John D. Grampa, Vice President William G. Pryor, Director Chief Financial Officer (Principal Financial Officer) /s/ Albert C. Bersticker /s/ N. Mohan Reddy - ------------------------------------ ------------------------------ Albert C. Bersticker, Director N. Mohan Reddy, Director /s/ Joseph P. Keithley /s/ William R. Robertson - ------------------------------------ ------------------------------ Joseph P. Keithley, Director William R. Robertson, Director /s/ William B. Lawrence /s/ John Sherwin, Jr. - ------------------------------------ ------------------------------ William B. Lawrence, Director John Sherwin, Jr., Director EX-31.1 6 l17862aexv31w1.txt EX-31.1 CERTIFICATION 302 - CEO Exhibit 31.1 CERTIFICATIONS I, Gordon D. Harnett, certify that: 1) I have reviewed this annual report on Form 10-K of Brush Engineered Materials Inc. (the "Company"); 2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this report; 4) The Company's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Company and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the Company's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the Company's internal control over financial reporting that occurred during the Company's most recent fiscal quarter (the Company's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting; and 5) The Company's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Company's auditors and the audit committee of the Company's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Company's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Company's internal control over financial reporting. /s/ Gordon D. Harnett Dated: March 16, 2006 Gordon D. Harnett Chairman and Chief Executive Officer EX-31.2 7 l17862aexv31w2.txt EX-31.2 CERTIFICATION 302 - CFO Exhibit 31.2 CERTIFICATIONS I, John D. Grampa, certify that: 1) I have reviewed this annual report on Form 10-K of Brush Engineered Materials Inc. (the "Company"); 2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this report; 4) The Company's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Company and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the Company's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the Company's internal control over financial reporting that occurred during the Company's most recent fiscal quarter (the Company's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting; and 5) The Company's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Company's auditors and the audit committee of the Company's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Company's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Company's internal control over financial reporting. /s/ John D. Grampa Dated: March 16, 2006 John D. Grampa Vice President Finance and Chief Financial Officer EX-32.1 8 l17862aexv32w1.txt EX-32.1 CERTIFICATIONS 906 - CEO AND CFO Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, in connection with the filing of the Annual Report on Form 10-K of Brush Engineered Materials Inc. (the "Company") for the year ended December 31, 2005, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), each of the undersigned officers of the Company certifies, that, to such officer's knowledge: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)), and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and for the periods expressed in the Report. Dated: March 16, 2006 /s/ Gordon D. Harnett ------------------------------------------ Gordon D. Harnett Chairman of the Board and Chief Executive Officer /s/ John D. Grampa ------------------------------------------ John D. Grampa Vice President Finance and Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----