X annual report pursuant to section 13 or 15(d) of the securities exchange act of 1934


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Commercial Aerospace:  Net sales to the commercial aerospace market segment increased by $74.5 million or 13.6% to $621.8 million for 2007 as compared to net sales of $547.3 million for 2006.  Net sales of the Composite Materials segment were $45.7 million higher, up 11.2% from 2006.  Net sales of the  Engineered Products segment increased by $28.8 million or 20.9% to $166.6 million in 2007.  In constant currency, net sales to the commercial aerospace market segment increased $63.8 million, or 11.4%.

 

Our overall year-over-year improvement was driven by increases in aircraft production in 2007 by Boeing, Airbus, their subcontractors and other aircraft manufacturers, as well as the resultant growth in demand by aircraft engine and nacelle manufacturers.  For the year, Boeing and its subcontractors, manufacturers of engines and nacelles, and regional aircraft producers as a group were up over 25% as compared to 2006.  Airbus and its subcontractor sales ended down about 5% from the prior year, as the comparisons for the first half of 2007 were significantly impacted by the June 2006 announcement of the A380 delay.

 

We continue to pursue the increased use of advanced composite materials in each new generation of aircraft.  Boeing and Airbus are currently developing the 787 and A350XWB aircraft, respectively, each of which employ higher percentage of advanced composite materials than any previous large commercial aircraft.

 

Industrial:  Net sales of $293.6 million for 2007 increased by $13.4 million, or 4.8%, compared to net sales of $280.2 million in 2006.  In constant currency, net sales to the industrial market segment decreased $5.2 million or 1.7%. This decrease was primarily due to lower revenues from recreation and automotive applications offset in part by strong growth in sales of composite materials used in wind energy applications.

 

Sales of composite materials used to manufacture wind turbine blades produced mid-teens percentage growth compared to 2006, and represents the largest contributor within our Industrial market segment.  Sales to recreation and other industrial markets for the year were down 9.2% due to capacity constraints, selective portfolio pruning and a weak winter sports market.

 

Space & Defense:  Net sales of $255.7 million increased $33.7 million, or 15.2%,for 2007 as compared to net sales of $222.0 million for 2006. In constant currency, net sales increased $28.4 million, or 12.5%.  Rotocraft sales across all geographic areas was the primary contributor to the sales growth and included a benefit from a change in recognition of tooling revenue 2007 in the amount of approximately $5 million.  The revenues that we derive from military and space programs tend to vary period to period based on customer ordering patterns and manufacturing campaigns.  We continue to benefit from our ability to supply composite materials and, in some cases, composite structures to a broad range of military aircraft and helicopter programs, including the F/A-18E/F (Hornet), the F-22 (Raptor), the European Fighter Aircraft (Typhoon), the C-17, the V-22 (Osprey) tilt rotor aircraft, and the Blackhawk, the Tiger and the NH90 helicopters.  In addition, the EADS A400M military transport aircraft and the F-35 (joint strike fighter or JSF) are currently under development and should enter low rate initial production later in the decade .

 

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Gross Margin: Gross margin for 2007 was $283.0 million, or 24.2% of net sales, compared to gross margin of $248.5 million, or 23.7% of net sales, in 2006.  The improvement reflects primarily the contribution of higher net sales from Commercial Aerospace, Space & Defense and Wind Energy end markets, the product mix of those markets and improved operating effeciencies somewhat offset by higher maintenance, labor, freight and depreciation expenses.

 

Selling, General and Administrative (“SG&A”) Expenses: SG&A expenses were $114.0 million, or 9.7% of net sales, for 2007 compared with $105.5 million, or 10.1% of net sales, for 2006.  The $8.5 million increase in SG&A expenses reflects, among other factors, $3.9 million attributed to changes in foreign exchange rates, an increase of $2.1 million for share-based compensation primarily from grants issued at the beginning of the year.  The remaining is primarily due to general increases in incentive compensation, salaries and benefits and costs related to personnel changes.

 

Research and Technology Expenses: R&T expenses for 2007 were $34.2 million, or 2.9% of net sales, compared with $29.7 million, or 2.8% of net sales, for 2006.  The $4.5 million increase was due to qualification costs (i.e. costs associated with certifying our products and processes to customer specifications) associated with the acceleration of opportunities for composites on new commercial aircraft programs including the Boeing 787 and investment in the development of new products and applications.

 

Business Consolidation and Restructuring Expenses: Business consolidation and restructuring expenses for 2007 were $7.3 million, compared with $9.9 million for 2006.  The decrease is primarily attributable to the establishment of a $7.4 million accrual in the fourth quarter of 2006 related to our organizational realignment.  The 2007 expense related to this program was $2.8 million.  This decrease was offset by an increase of $2.9 million during 2007, related to our Livermore program.

 

Other Expense, Net:  Other operating expense of $12.6 million during 2007 consists a $9.4 million pension settlement charge related to previously disclosed termination of our U.S. defined benefit plan, and a $3.2 million impairment charge related to certain purchased technology and fixed assets related to our portfolio realignment.  We did not incur any costs classified as other operating expense in 2006.

 

Operating Income: Operating income for 2007 was $114.9 million compared with operating income of $103.4 million for 2006.  Operating income as a percent of sales was 9.8% and 9.9% for 2007 and 2006 respectively.  The $11.5 million increase in operating income is due in part to greater sales for 2007 and product mix of those sales resulting in an increase in gross margin, partially offset by other expense of $12.6 million in 2007 where there was no such expense in 2006, and increased SG&A and R&T expenses.  One of the Company’s performance measures is operating income adjusted for non-recurring operating expenses and business consolidation and restructuring expenses, which is a non-GAAP measure.  Adjusted operating income for the years ended December 31, 2007 and 2006 was $134.8 million and $114.5 million or 11.5% and 10.9% as a percentage of net sales, respectively.  A reconciliation to adjusted operating income is provided on page 25.

 

Operating income for the Composite Materials segment increased $23.7 million or 19.9% to $142.8 million, as compared to $119.1 million for 2006.  The increase in operating income is the result of an additional $83.7 million of segment revenue, slightly offset by a $3.2 million impairment charge from the write-off of previously acquired technology and certain related fixed assets.  Operating income for the Engineered Products segment decreased by $0.5 million compared with 2006 to $21.3 million.

 

We did not allocate corporate operating expenses of $49.2 million and $35.8 million to segments in 2007 and 2006, respectively.  The year-on-year increase in corporate operating expenses of $13.4 million is primarily attributable to the pension settlement expense of $9.4 million and inceased SG&A of $4.0 million from the higher stock and incentive compensation costs and the costs related to personnel changes.

 

Interest Expense:  Interest expense for 2007 was $21.4 million compared to $23.6 million for 2006.  The $2.2 million decrease primarily due to lower average outstanding debt under our senior secured credit facility resulting in a $2.8 million decrease in expense and lower bank fees of $0.7 million.  This decrease was partially offset by a $0.5 million increase in expense related to uncertain tax positions and a $0.7 million decrease in capitalized interest.

 

Non-Operating Expense, Net:  Non-operating expense for 2007 was $1.1 million and in 2006 it was $0.1 million.  Amounts reflect the accelerated amortization of deferred financing costs as a result of prepayments of the Company’s bank term loan with the net proceeds from asset sales.

 

Provision (Benefit) for Income Taxes:  During 2007, we recorded a tax provision $33.4 million or 36.1% of pre-tax income.  During the fourth quarter of 2007, we recorded a $1.9 million benefit, which includes an adjustment of $2.3 million to certain prior period balances to primarily record additional deferred tax assets arising from state net operating loss carryforwards, offset by other discrete items of $0.4 million. Excluding this benefit the effective tax rate for the year was 38.2%.  The 2006 provision included a $4.5 million benefit for the reversal of a valuation allowance against our U.S. deferred tax assets related to capital losses.

 

As of December 31, 2007, there is a $7.7 million valuation allowance related to current and prior year net operating losses generated by our Belgian and certain UK subsidiaries.  Consistent with prior years, we continue to adjust our tax provision rate through the establishment, or release, of a non-cash valuation allowance attributable to current Belgian and certain UK net operating income (losses).  This practice will continue until such time as  the Belgian and UK operations have evidenced the ability to consistently generate sufficient taxable income such that in future years management can reasonably expect that the deferred tax assets can be utilized.

 

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Equity in Earnings from and Gain on Sale of Investments in Affiliated Companies: Equity in earnings from and gain on sale of investments in affiliated companies during 2007 of $4.3 million decreased by $15.6 million from 2006 due to the inclusion of a pre-tax gain of $15.7 million from the sale of our interest in TechFab LLC during 2006 to our joint venture partner for $22.0 million in cash.  For additional information, see Note 6 to the accompanying consolidated financial statements of this Annual Report on Form 10-K.

 

Income from Continuing Operations: Net income from continuing operations was $63.3 million, or $0.66 per diluted share for the year ended December 31, 2007 compared to $64.9 million, or $0.68 per diluted common share for the year ended December 31, 2006.  The decrease reflects the results discussed above.

 

Income (Loss) from Discontinued Operations, Net:  Net loss from discontinued operations was $2.0 million, or $0.02 per diluted common share for the year ended December 31, 2007, which includes a net gain of $3.1 million related to the sales of the U.S. EBGI product lines and the European Architectural business.  For the year ended December 31, 2006, our discontinued operations resulted in net income of $1.0 million, or $0.01 per diluted common share.  The change in results from discontinued operations, excluding the 2007 gain on sales, was $6.1 million, primarily resulting from an after-tax charge of $9.7 million recognized during 2007 related to a litigation settlement.  Our net gain on the sales of discontinued businesses consists of a $6.5 million gain on the sale our Architectural business and a $3.4 million loss on the sale of our U.S. EBGI product lines.  For additional information, see Note 2 to the accompanying consolidated financial statements of this Annual Report on Form 10-K.

 

2006 Compared to 2005

 

Net Sales:  Consolidated net sales of $1,049.5 million for 2006 were $91.9 million, or 9.6% higher than the $957.6 million of net sales for 2005. The increase was primarily attributable to sales growth within Commercial Aerospace.  Had the same U.S. dollar, British Pound Sterling and Euro exchange rates applied in 2006 as in 2005 (“in constant currency”), consolidated net sales for 2006 would have been $88.8 million higher than the 2005 net sales of $957.6 million at $1,046.4 million.

 

The following table summarizes net sales to third-party customers by segment and end market segment in 2006 and 2005:

 

(In millions)

 

Commercial

Aerospace

 

Industrial

 

Space &

Defense

 

Total

 

2006 Net Sales

 

 

 

 

 

 

 

 

 

Composite Materials

 

$

409.5

 

$

275.8

 

$

172.9

 

$

858.2

 

Engineered Products

 

137.8

 

4.4

 

49.1

 

191.3

 

Total

 

$

547.3

 

$

280.2

 

$

222.0

 

$

1,049.5

 

 

 

52

%

27

%

21

%

100

%

2005 Net Sales

 

 

 

 

 

 

 

 

 

Composite Materials

 

$

356.7

 

$

261.4

 

$

173.5

 

$

791.6

 

Engineered Products

 

113.8

 

5.8

 

46.4

 

166.0

 

Total

 

$

470.5

 

$

267.2

 

$

219.9

 

$

957.6

 

 

 

49

%

28

%

23

%

100

%

 

Commercial Aerospace:  Net sales to the commercial aerospace market segment increased by $76.8 million or 16.3% to $547.3 million for 2006 as compared to net sales of $470.5 million for 2005. Net sales of the Composite Materials segment were $52.8 million higher, up 14.8% from 2005.  Net sales of the Engineered Products segment were higher by $24.0 million, up 21.1% from 2005.  In constant currency, net sales to the commercial aerospace market segment increased $75.7 million, or 16.1%, to $546.2 million.  Our overall year-over-year improvement was driven by increases in aircraft production in 2006 by Boeing, Airbus and other aircraft manufacturers, as well as the resultant growth in demand by aircraft engine and nacelle manufacturers.

 

Industrial:  Net sales of $280.2 million for 2006 reflected an increase of $13.0 million, or 4.9%, compared to net sales of $267.2 million in 2005.  In constant currency, net sales to the industrial market segment increased $11.8 million or 4.4%, to $279.0 million.  The industrial market consists primarily of wind, recreation, auto and other industrial sub-markets. Sales of composite materials used to manufacture wind turbine blades grew 18% compared to 2005, and  represents the largest contributor within our Industrial market segment.  These results reflect the underlying growth in global wind turbine installations.  Strong sales performance in wind and other industrial sub-markets was offset by weaker sales from recreation due to common volatility in the recreation equipment markets and automotive markets due to certain programs ending.

 

Space & Defense:  Net sales of $222.0 million increased $2.1 million, or 1.0%,for 2006 as compared to net sales of $219.9 million for 2005. In constant currency, net sales increased $1.3 million to $221.2 million.  Some inventory corrections at certain of our rotorcraft customers during 2006 constrained revenue growth compared to 2005.  The revenues that we derive from military and space programs tend to vary period  to period based on customer ordering patterns and manufacturing campaigns.  We continue to benefit from our ability to supply composite materials and, in some cases, composite structures to a broad range of military aircraft and helicopter programs, including the F/A-18E/F (Hornet), the F-22 (Raptor), the European Fighter Aircraft (Typhoon), the C-17, the V-22 (Osprey) tilt rotor aircraft, and the Blackhawk, the Tiger and the NH90 helicopters.

 

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Gross Margin: Gross margin for 2006 was $248.5 million, or 23.7% of net sales, compared to gross margin of $224.2 million, or 23.4% of net sales, in 2005.  The improvement reflects primarily the contribution of higher net sales from Commercial Aerospace and our continued focus on cost containment.

 

Selling, General and Administrative (“SG&A”) Expenses: SG&A expenses were $105.5 million, or 10.1% of net sales, for 2006 compared with $97.1. million, or 10.1% of net sales, for 2005.  The $8.4 million increase in SG&A expenses reflects, among other factors, an increase of $6.3 million for share-based compensation expense following our adoption of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment (“ FAS 123(R)”) and $1.1 million of disposition costs associated with divestures.

 

Research and Technology Expenses: R&T expenses for 2006 were $29.7 million, or 2.8% of net sales, compared with $24.8 million, or 2.6% of net sales, for 2005.  The $4.9 million increase was due to, among other factors, increased spending in support of new products and new commercial aircraft qualification activities (i.e. costs associated with certifying our products and processes to customer specifications).

 

Other Expense, Net:  We did not incur any costs classified as other operating expense in 2006.  Other expense, net for 2005 was $15.1 million, which included an accrual of $16.5 million for the settlement of litigation matters, offset partially by a $1.4 million gain on the sale of surplus land at one of our manufacturing facilities.

 

Operating Income: Operating income for 2006 was $103.4 million compared with operating income of $84.3 million for 2005.  Operating income as a percent of sales was 9.9% for  2006 and 8.8% for 2005.  The $19.1 million increase in operating income is due in part to greater sales for 2006 resulting in an increase in gross margin, and the fact that we incurred other expense, net, of $15.1 million in 2005 and there was no such expense in 2006.  As previously mentioned, during 2006 we incurred increased SG&A expenses of $6.3 million primarily due to the adoption of FAS 123(R) and increased R&T expenses of $4.9 million, primarily attributable to an increase in qualification activities.  In addition, business consolidation and restructuring expenses increased $7.0 million over the prior year to $9.9 million.  The increase in business consolidation and restructuring expenses result primarily from our organizational realignment and reduction of stranded costs that will result from divestures associated with our portfolio review, as well as the continuing costs associated with the closure of our Livermore, California facility.

 

Operating income for the Composite Materials segment increased  $0.9 million or 1% to $119.1 million, as compared to $118.2 million for 2005.  Operating income for the Composite materials segment includes $9.9 million of business consolidation and restructuring expenses and $2.6 million in share-based compensation expense in 2006.  Operating income for the Engineered Products segment increased $8.3 million, resulting primarily from higher sales volumes.

 

We did not allocate corporate operating expenses of $35.8 million and $47.7 million to segments in 2006 and 2005, respectively.  The year-on-year decrease in corporate operating expenses of $10.0 million is primarily attributable to expense of $16.5 million associated with litigation settlements in 2005, offset by increased share-based compensation expense of $3.9 million.

 

Interest Expense:  Interest expense for 2006 was $23.6 million compared to $29.6 million for 2005.  The $6.0 million decline in interest expense primarily reflects a $3.5 million increase in interest expense capitalized in 2006 as a result of our carbon fiber capacity expansion.  Refer to Note 9 to the accompanying consolidated financial statements in this Annual Report on Form 10-K for additional information.

 

Non-Operating Expense, Net:  Non-operating expense for 2006 was $0.1 million compared to $40.9 million in 2005.  During 2005, we recognized $40.9 million in losses on the early retirement of debt, $40.3 million resulting from the first quarter’s debt refinancing.  Refer to Note 22 to the accompanying consolidated financial statements in this Annual Report on Form 10-K for additional information.

 

Provision (Benefit) for Income Taxes:  During 2006, we recorded a tax provision $34.7 million or 43.5 % of pre-tax income.  The full year tax provision included a $4.5 million benefit of the reversal of the valuation allowance against our U.S. deferred tax assets related to capital losses.  During the fourth quarter of 2005, we recorded a $119.2 million benefit from the reversal of the majority of the previously recorded valuation allowance established on our U.S. federal, state and local deferred tax assets except for that portion where the evidence did not yet support a reversal.

 

As of December 31, 2006, no evidence exists to support the reversal of the $6.2 million valuation allowance related to our Belgian subsidiary.  Consistent with prior years, we continue to adjust our tax provision rate through the establishment, or release, of a non-cash valuation allowance attributable to currently generated Belgian net operating income (losses).  This practice will continue until such time as the Belgian operations have evidenced the ability to consistently generate sufficient taxable income such that in future years management can reasonably expect that the deferred tax assets can be utilized.

 

Equity in Earnings from and Gain on Sale of Investments in Affiliated Companies: Equity in earnings from and gain on sale of investments in affiliated companies was $19.9 million in 2006 compared to $3.6 million in 2005.  During 2006, we completed the sale of our interest in TechFab to our joint venture partner for $22.0 million in cash.  As a result of the sale we recognized a gain of $15.7 million in the fourth quarter of 2006.  We recorded equity in earnings of affiliated companies of $1.9 million and $3.0 million during 2006 and 2005, respectively, related to the joint venture interests sold or dissolved during 2006. Equity in earnings of affiliated

 

 

 

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companies does not affect our cash flows.  For additional information, see Note 6 to the accompanying consolidated financial statements of this Annual Report on Form 10-K.

 

Income from Continuing Operations: Net income from continuing operations was $64.9 million, or $0.68 per diluted share for the year ended December 31, 2006 compared to $131.2 million, or $1.40 per diluted common share for the year ended December 31, 2005.  The decrease reflects the results discussed above, primarily driven by the $119.2 million tax benefit from the reversal of the majority of the previously recorded valuation allowance established on our U.S. federal, state and local deferred tax assets.

 

Income from Discontinued Operations, Net:  Income from discontinued operations was $1.0 million, or $0.01 per diluted common share for the year ended December 31, 2006 compared to $10.1 million, or $0.11 per diluted common share for the year ended December 31, 2005.   During the fiscal year ending December 31, 2007 we completed the sale of our European Architectural business and U.S. electronics, ballistics and general industrial products lines (“EBGI”).  In accordance with the provisions of FAS 144 the results of operations for both business has been reported as discontinued operations.   For additional information, see Note 2 to the accompanying consolidated financial statements of this Annual Report on Form 10-K.

 

Deemed Preferred Dividends and Accretion: We recognized deemed preferred dividends and accretion of $30.8 million for 2005.  Included in deemed preferred dividends and accretion for 2005 are accelerated charges of $23.2 million resulting from the conversions of mandatorily redeemable convertible preferred stock into common stock.  For additional information, see Note 11 to the accompanying consolidated financial statements of this Annual Report on Form 10-K.

 
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