5

---

 

Synalloy Corporation

Notes To Condensed Consolidated Financial Statements

(Unaudited)

September 29, 2007

 

NOTE 1-- BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine-month period ended September 29, 2007, are not necessarily indicative of the results that may be expected for the year ending December 29, 2007. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the period ended December 30, 2006.

 

 

NOTE 2--INVENTORIES

 

Inventories are stated at the lower of cost (first-in, first-out method) or market.

 

 

NOTE 3--STOCK OPTIONS AND EMPLOYEE STOCK GRANTS

 

The Company has three stock option plans in effect at September 29, 2007. A summary of plan activity for 2007 is as follows:

 

		Weighted								Weighted
		Average								Average				Intrinsic
		Exercise				Options				Contractual				Value of				Options
		Price				Outstanding				Term				Options				Available
Outstanding at										(in years)
December 30, 2006		$	9.64				282,150				4.1			$	2,512,000				207,100
Third quarter:
Exercised			7.95				(13,800	)							339,152
Nine Months:
Exercised			10.39				(132,407	)							2,400,000
Expired			12.14				(19,000	)							369,730
Outstanding at
September 29, 2007		$	8.51				130,743				4.9			$	1,646,085				207,100
Exercisable options		$	7.79				87,289				3.7			$	1,162,007
Options expected to vest		$	9.96				43,454				7.4			$	484,078

 

 

6

---

 

 

Synalloy Corporation

Notes To Condensed Consolidated Financial Statements (Unaudited)

September 29, 2007

 

During the third quarter and first nine months of 2007, options for 13,800 and 132,407 shares were exercised by employees and directors for an aggregate exercise price of $110,000 and $1,375,000.  For the first nine months of 2007, proceeds generated from the repurchase of 32,614 shares from employees and directors totaled $825,000.  There were no share repurchases during the third quarter of 2007.  As a result of stock option transactions during the third quarter and first nine months of 2007, the Company received cash of approximately $110,000 and $550,000, respectively. Stock option compensation cost has been charged against income before taxes for the unvested options of approximately $19,000 and $57,000 for the three and nine months ended September 29, 2007, respectively, and the three and nine months ended September 30, 2006, respectively. As of September 29, 2007, there was $177,000 of total unrecognized compensation cost related to non-vested stock options granted under the Company's stock option plans which is expected to be recognized over a period of 2.25 years.

 

On February 8, 2007, the Board of Directors of the Company approved stock grants under the Company’s 2005 Stock Awards Plan, which was approved by shareholders at the April 28, 2005 Annual Meeting. On February 12, 2007, 22,510 shares were granted under the Plan to certain management employees of the Company. The stock awards vest in 20 percent increments annually on a cumulative basis, beginning one year after the date of grant. In order for the awards to vest, the employee must be in the continuous employment of the Company since the date of the award. Any portion of an award that has not vested will be forfeited upon termination of employment. The Company may terminate any portion of the award that has not vested upon an employee’s failure to comply with all conditions of the award or the Plan. Shares representing awards that have not yet vested will be held in escrow by the Company. An employee is not entitled to any voting rights with respect to any shares not yet vested, and the shares are not transferable. Compensation expense totaling $563,000, before income taxes of approximately $203,000, is being recorded against earnings equally over the following 60 months from the date of grant with the offset recorded in Shareholders’ Equity. Approximately $28,000 and $71,000 of compensation cost has been charged against income before taxes for the three and nine months ended September 29, 2007, respectively. As of September 29, 2007, there was $492,000 of total unrecognized compensation cost related to non-vested stock grants which is expected to be recognized over a period of 4.25 years.

 

 

NOTE 4--INCOME TAXES

 

The Company has adopted FASB Interpretation 48, “Accounting for Uncertainty in Income Taxes”, at the beginning of fiscal year 2007. As a result of the implementation the Company recognized a $995,000 decrease to reserves for uncertain tax positions. This decrease was accounted for as an adjustment to the beginning balance of retained earnings on the Balance Sheet. Including the cumulative effect decrease, at the beginning of 2007, the Company had approximately $350,000 of total gross unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in any future periods. During the third quarter of 2007, the Company recognized $172,000 of these benefits or $.03 per share, leaving $178,000 accrued at September 29, 2007. The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of multiple state jurisdictions. The Company has substantially concluded all U.S. federal income tax matters and substantially all material state and local income tax matters for years through 2002. The Company’s continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company had $76,000 accrued for interest and $0 accrued for penalties at September 29, 2007. The Company provided income taxes at an effective tax rate of 34.7 percent in the first nine months of 2007 compared to 36.6 percent in the same period last year.  The lower income tax rate resulted from recognizing tax benefits and an increase in permanent differences which reduced taxable income in 2007 compared to taxable income for 2006.

 

 

7

---

 

Synalloy Corporation

Notes To Condensed Consolidated Financial Statements (Unaudited)

September 29, 2007

 

NOTE 5--PAYMENT OF DIVIDENDS

 

On February 8, 2007, the Board of Directors of the Company voted to pay an annual dividend of $.15 per share payable on March 15, 2007 to holders of record on February 23, 2007, for a total cash payment of $927,000. The Board presently plans to review at the end of each fiscal year the financial performance and capital needed to support future growth to determine the amount of cash dividend, if any, which is appropriate.

 

 

NOTE 6--SEGMENT INFORMATION

		THREE MONTHS ENDED								NINE MONTHS ENDED
		Sep 29, 2007				Sep 30, 2006				Sep 29, 2007				Sep 30, 2006
Net sales
Specialty Chemicals Segment		$	14,982,000			$	12,725,000			$	39,045,000			$	38,158,000
Metals Segment			36,533,000				26,372,000				100,809,000				73,831,000
		$	51,515,000			$	39,097,000			$	139,854,000			$	111,989,000
Operating income
Specialty Chemicals Segment		$	1,106,000			$	647,000			$	2,239,000			$	2,235,000
Metals Segment			3,477,000				3,308,000				14,451,000				6,720,000
			4,583,000				3,955,000				16,690,000				8,955,000
Unallocated expenses
Corporate			648,000				556,000				2,109,000				1,545,000
Plant relocation costs			-				-				-				213,000
Gain from sale of plant & property			-				(596,000	)			-				(596,000	)
Interest and debt expense			364,000				183,000				835,000				529,000
Other income			-				-				(2,000	)			(1,000	)
Income before income taxes		$	3,571,000			$	3,812,000			$	13,748,000			$	7,265,000

NOTE 7--SALE OF ASSETS

 

The Company completed the movement of Organic Pigments’ operations from Greensboro, NC to Spartanburg, SC in the first quarter of 2006, recording plant relocation costs of $213,000 in administrative expense in the first quarter of 2006. The Greensboro plant was closed at the end of the first quarter of 2006 and sold for a pre-tax gain of approximately $596,000 in the third quarter of 2006.

 

 

 

8

---

 

 

Synalloy Corporation

Notes To Condensed Consolidated Financial Statements (Unaudited)

September 29, 2007

 

NOTE 8—RECENT ACCOUNTING PRONOUNCEMENTS

 

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Liabilities (SFAS 159). SFAS 159 is effective as of the beginning of the first fiscal year beginning after November 15, 2007, and is effective for the Company on December 30, 2007. SFAS 159 provides companies with an option to report selected financial assets and liabilities at fair value that are not currently required to be measured at fair value. Accordingly, companies would then be required to report unrealized gains and losses on these items in earnings at each subsequent reporting date. The objective is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for the Company beginning in fiscal year 2008 and is not expected to have a significant impact on the Company’s financial statements.

 

 

9

---

 

Synalloy Corporation

Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations

 

The following is management's discussion of certain significant factors that affected the Company during the three and nine months ended September 29, 2007.

Consolidated sales for the third quarter were $51,515,000, increasing 32 percent compared to the same period one year ago.  The Company’s consolidated net income for the third quarter of 2007 decreased six percent to $2,260,000, or $.36 per share compared to net earnings of $2,409,000, or $.39 per share on sales of $39,097,000 in 2006. The Company generated a 95 percent increase in net earnings for the first nine months of 2007 of $8,980,000, or $1.42 per share, on a 25 percent sales increase to $139,854,000, compared to net earnings of $4,605,000, or $.74 per share on sales of $111,989,000 in the first nine months of 2006. Included in net earnings in the third quarter and first nine months of 2006 was an after tax gain from the sale of property and plant of $378,000, or $.06 per share. Without the gain, the Company experienced 11 percent and 112 percent increases in net earnings for the quarter and first nine months, respectively, over the same periods last year.

The Specialty Chemicals Segment achieved increases in sales and operating income of 18 percent and 71 percent, respectively, in the third quarter of 2007 compared to the third quarter of 2006. For the first nine months of 2007, the Segment experienced an increase in sales of two percent and operating income was up slightly over the same period last year. The majority of the increases in third quarter revenues and profits came from contract manufacturing. In addition, the Segment’s basic manufacturing operations performed well for the quarter resulting from a much improved demand for most of the Segment’s products. The new line of fire retardant products continued to show progress but remains below expected levels. The combination of poor consumer demand for mattresses reflecting the decline in the housing industry, coupled with some mattress manufacturers utilizing fiber solutions with inherent fire retardant properties instead of chemical treatment to comply with the fire retardant regulations has led to the slow sales growth.

The Metals Segment achieved outstanding sales increases of 39 percent and 37 percent for the third quarter and first nine months of 2007, respectively, from the same periods a year earlier. The increases resulted from a 70 percent and 65 percent increase in average selling prices for the quarter and nine months, respectively, partially offset by a 19 percent and 17 percent decline in unit volumes, respectively, compared to the same periods last year. Operating income increased five percent in the third quarter and 115 percent for the first nine months of 2007 compared to the same periods last year. The decrease in Segment unit volumes during the third quarter resulted from a 41 percent decline in pipe sales partially offset by much higher piping systems unit volume compared to a year earlier. The big unit volume decrease in pipe sales resulted primarily from significant declines in stainless steel surcharges in August, September and October which caused distributors to delay purchases as much as possible to get the lower prices. There also was evidence of somewhat weaker end use demand for commodity pipe as the third quarter progressed. The unit volume decline in the nine months was also the result of lower pipe sales partially offset by higher piping systems sales. The huge increases in average selling prices in the three and nine months resulted partly from higher stainless steel surcharges in 2007 compared to 2006. Importantly, also contributing to the increase was accomplishing our objective of expanding into markets that require larger pipe sizes, higher-priced alloys, larger proportions of non-commodity products, and products fabricated by piping systems’ operations, allowing us to be less dependent on commodity pipe sales. The change in product mix includes the successful development of business from LNG, waste water and water treatment, biofuels and electric utility scrubber projects. Many of the products produced for these markets are subject to more stringent specifications including 100 percent x-ray of the weld seams. In addition, some of these non-commodity products are made from expensive alloys and are more

 

10

---

 

 

Synalloy Corporation

 

Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations – Continued

 

difficult to produce. Accordingly, their cost and sales price are much higher than commodity products. Increased sales of these products led to improved operating income in the quarter and nine months despite the unusually weak commodity pipe results in the latest quarter. Profits resulting from higher stainless steel prices including surcharges made a significant contribution to the increase in operating income in the nine months but only a modest contribution in the quarter compared to comparable periods last year. Piping systems continued to experience the favorable impact of its strong backlog as operating income more than tripled in both the third quarter and nine months of 2007 compared to a year earlier. Piping systems’ backlog continued to grow, reaching another record level of $66,800,000 at the end of the third quarter of 2007 compared to $34,200,000 at the end of the third quarter of 2006.

Consolidated selling and administrative expense for the third quarter and first nine months of 2007 increased $232,000, or eight percent, and $1,249,000, or 15 percent, respectively, from the same periods of 2006.  This expense category was six percent of sales for the third quarter of 2007 and seven percent of sales for the third quarter of 2006.  For the first nine months, these expenses were seven percent of sales for both 2007 and 2006.  The third quarter increase was comprised of higher salaries and wages, including related employee benefits, bad debt expense and stock grant compensation costs.  In addition to these items, selling and administrative expenses increased for the first nine months of 2007 when compared to 2006 due primarily to higher profit-based incentives for management partially offset by a $213,000 loss on the relocation of Organic Pigment’s operations to Spartanburg which was recorded during the first quarter of 2006.

The Company completed the relocation of Organic Pigments’ operations from Greensboro, NC to Spartanburg in the first quarter of 2006. The Greensboro plant was sold in August of 2006 for a sales price of $811,000 and a pre-tax gain of approximately $596,000 was recorded in the third quarter of 2006. Interest expense for the three and nine months ending September 29, 2007 increased $181,000 and $305,000, respectively, from the same periods in the prior year due to higher average debt levels for 2007 compared to 2006.

The Company provided income taxes at an effective tax rate of 34.7 percent in the first nine months of 2007 compared to 36.6 percent in the same period last year.  The lower income tax rate resulted from recognizing tax benefits and an increase in permanent differences which reduced taxable income in 2007 compared to taxable income for 2006.

Cash provided from operations was $3,869,000 for the first nine months of 2007.  This amount, combined with proceeds from the exercise of stock options of $550,000, was almost entirely offset by $3,547,000 in purchases of property, plant and equipment and the payment of a $927,000 cash dividend.  The Company expects that cash flows for the remainder of the year and available borrowings will be sufficient to make debt payments, and fund estimated capital expenditures and normal operating requirements anticipated over the last three months of 2007.

Demand during the third quarter of 2007 for many of the Specialty Chemicals Segment’s products continued the improvement experienced over the last half of the second quarter as market conditions continue to be favorable, and the Segment is experiencing positive results from several new products developed earlier this year. In addition, management is anticipating the continuation of orders in the fourth quarter that began in the third quarter from a significant contract customer after experiencing lower than normal activity in the first six months. Management continues to believe that we have a low-cost fire retardant product line and with the price of inherent fire retardant fibers escalating, chemical solutions should become more attractive; however, revenues are growing at a slower rate than originally expected.

 

 

11

---

 

Synalloy Corporation

Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations – Continued

 

All of these factors provide the opportunity for the Segment to improve profits in the fourth quarter of 2007 over the fourth quarter of 2006, and provide positive momentum into the first half of 2008.

 

The significant decline in nickel prices that led to lower surcharges on stainless steel in the third quarter of 2007 ended, at least temporarily, as nickel prices have increased more than 20 percent from the lows in mid August. Stainless steel surcharges, which are determined two months in advance of when they become effective, increased in November from the lows in October and based on current nickel prices will increase again in December. Although the volatility of nickel prices over the past few months continues to negatively impact commodity pipe sales, the recent price increases should improve distributor demand before the end of the year. However, the volatility of nickel prices makes it impossible to know whether the positive trend in surcharges will continue. These factors add uncertainty to the performance of commodity pipe during the fourth quarter of 2007. The favorable experience realized by our non-commodity business in the third quarter leads us to believe that the negative impact on profitability from commodity pipe will be mitigated because of our significant project business, larger diameter and higher-priced alloy pipe business, most of which are subject to fixed pricing. Piping systems’ record backlog, of which management expects about 80 percent to be completed over the next 12 months, should continue to provide a much higher level of sales and profits for piping systems in the fourth quarter of 2007 compared to the same period last year. Management continues to be optimistic about the piping systems business due to the large dollar amount of projects we expect to bid during future months. With over 90 percent of the backlog coming from energy and water and wastewater treatment projects, management is confident that it has positioned the Metals Segment to benefit from the long-term growth of these areas.

 

 

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995

 

This Form 10-Q includes and incorporates by reference "forward-looking statements" within the meaning of the securities laws. All statements that are not historical facts are "forward-looking statements." The words "estimate," "project," "intend," "expect," "believe," "anticipate," "plan" and similar expressions identify forward-looking statements. The forward-looking statements are subject to certain risks and uncertainties, including without limitation those identified below, which could cause actual results to differ materially from historical results or those anticipated. Readers are cautioned not to place undue reliance on these forward-looking statements. The following factors could cause actual results to differ materially from historical results or those anticipated: adverse economic conditions, the impact of competitive products and pricing, product demand and acceptance risks, raw material and other increased costs, customer delays or difficulties in the production of products, unavailability of debt financing on acceptable terms and exposure to increased market interest rate risk, inability to comply with covenants and ratios required by our debt financing arrangements and other risks detailed from time-to-time in Synalloy's Securities and Exchange Commission filings. Synalloy Corporation assumes no obligation to update the information included in this Form 10-Q.

 

 

 

12

---

 

Synalloy Corporation

 

Item 3. Market Risk

 

Information about the Company’s exposure to market risk was disclosed in its Annual Report on Form 10-K for the year ended December 30, 2006, which was filed with the Securities and Exchange Commission on March 29, 2007. There have been no material quantitative or qualitative changes in market risk exposure since the date of that filing.

 

 

Item 4. Controls and Procedures

 

Based on the evaluation required by 17 C.F.R. Section 240.13a-15(b) or 240.15d-15(b) of the Company's disclosure controls and procedures (as defined in 17 C.F.R. Sections 240.13a-15(e) and 240.15d-15(e)), the Company's chief executive officer and chief financial officer concluded that such controls and procedures, as of the end of the period covered by this quarterly report, were effective.

 

There has been no change in the registrant's internal control over financial reporting during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting.

 

 

13

---

 

 

Synalloy Corporation

 

PART II: OTHER INFORMATION

 

Item 1A. Risk Factors

 

There has been no material change in the risk factors as previously disclosed in the Company’s Form 10-K filed for the period ended December 30, 2006.

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

During the third quarter ended September 29, 2007, the Registrant issued shares of common stock to the following classes of persons upon the exercise of options issued pursuant to the Registrant's 1998 Stock Option Plan. Issuance of these shares was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933 because the issuance did not involve a public offering.

 

			Number of Shares				Aggregate Exercise
Date Issued	Class of Purchasers		Issued				Price
7/2/2007	Officers and employees			9,000			$	87,430
7/16/2007	Officers and employees			4,800				22,320
				13,800			$	109,750

Item 6. Exhibits
The following exhibits are included herein:
31	Rule 13a-14(a)/15d-14(a) Certifications of Chief Executive Officer and Chief Financial Officer
32	Certifications Pursuant to 18 U.S.C. Section 1350

 

 

 

14

---

 

 

Synalloy Corporation

 

 

SIGNATURES

 

 

Pursuant to the requirements 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.

 

	SYNALLOY CORPORATION
		(Registrant)
Date: November 12, 2007	By:	/s/ Ronald H. Braam
		Ronald H. Braam
		President and Chief Executive Officer
Date:  November 12, 2007	By:	/s/ Gregory M. Bowie
		Gregory M. Bowie
		Vice President Finance and Chief Financial Officer

 

 

 

15

---