UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

 

 

Commission File Number 1-15885

BRUSH ENGINEERED MATERIALS INC.

(Exact name of Registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code

216-486-4200

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

 

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 Securities 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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     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. o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange 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 3, 2009 was $314,026,839.

 

As of February 22, 2010, there were 20,277,083 common shares, no par value, outstanding.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

 

 

Portions of the proxy statement for the annual meeting of shareholders to be held on May 5, 2010 are incorporated by reference into Part III.

 

 

BRUSH ENGINEERED MATERIALS INC.

 

Index to Annual Report
On Form 10-K for
Year Ended December 31, 2009

 

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:

 

 

 

Brush Engineered Materials Inc., through its wholly owned subsidiaries, is a manufacturer of advanced engineered materials serving the global telecommunications and computer, aerospace and defense, medical, industrial components, data storage, automotive electronics and appliance markets. As of December 31, 2009, we had 2,196 employees.

 

Our businesses are organized under four reportable segments: Advanced Material Technologies and Services (AMTS), Specialty Engineered Alloys (SEA), Beryllium and Beryllium Composites and Engineered Material Systems. AMTS consists of Williams Advanced Materials Inc. (WAM) and, beginning in the first quarter 2009, Zentrix Technologies Inc. (Zentrix). Previously, Zentrix had been included with the corporate office as part of All Other. We made this change because the Advanced Material Technologies and Services segment management is now responsible for Zentrix and this structure is consistent with our internal reporting and how the Chairman of the

Board evaluates the operations. The results for the prior years have been recast to reflect this change. SEA consists of Alloy Products, which includes bulk and strip form products, and beryllium hydroxide produced by Brush Resources Inc. (BRI). The Beryllium and Beryllium Composites segment consists of Beryllium Products and Brush Ceramic Products Inc., while the Engineered Material Systems segment consists of Technical Materials, Inc. (TMI).

 

All Other includes our parent company expenses, other corporate charges and the operating results of BEM Services, Inc., a wholly owned subsidiary that provides administrative and financial oversight services to our other businesses on a cost-plus basis. Corporate employees not covered as part of a reportable segment totaled 98 as of December 31, 2009.

 

We use our Investor Relations web site, www.beminc.com, as a channel for routine distribution of important information, including news releases, analyst presentations, and financial information. We post filings as soon as reasonably practicable after they are electronically filed with, or furnished to, the SEC, including our annual, quarterly, and current reports on Forms 10-K, 10-Q, and 8-K; our proxy statements; and any amendments to those reports or statements. All such postings and filings are available on our Investor Relations web site free of charge. In addition, this web site allows investors and other interested persons to sign up to automatically receive e-mail alerts when we post news releases and financial information on our web site. The SEC also maintains a web site, www.sec.gov, that contains reports, proxy and information statements, and other information regarding issuers who file electronically with the SEC. The content on any web site referred to in this Annual Report on Form 10-K is not incorporated by reference into this Annual Report unless expressly noted.

 

ADVANCED MATERIAL TECHNOLOGIES AND SERVICES

 

Sales for this segment were $460.8 million, or 64% of total sales, in 2009, $480.3 million, or 53% of total sales, in 2008 and $533.5 million, or 56% of total sales, in 2007. As of December 31, 2009, AMTS had 963 employees.

 

AMTS manufactures precious, non-precious and specialty metal products, including vapor deposition targets, frame lid assemblies, clad and precious metal preforms, high temperature braze materials, ultra-fine wire, specialty inorganic materials, optics, performance coatings and electronic packages. These products are used in wireless, semiconductor, photonic, hybrid and other micro-electronic applications within the telecommunications and computer market. Other key markets for these products include medical, data storage, defense, security and solar energy. An in-house refinery and metal cleaning operations allow for the reclaim of precious metals from internally generated or customers’ scrap. In October 2009, we purchased Barr Associates, Inc., based in Westford, Massachusetts, which supplies optical filters, optical reflectors and high-end coated products and devices in support of defense, space and commercial applications for detection devices to aid in analysis and soldier protection. In January 2010, we purchased Academy Corporation, based in Albuquerque, New Mexico, which supplies precious metal targets to the architectural glass, solar energy, medical and microelectronics industries and has refining capabilities for reclaim of precious metals from secondary scrap markets.

 

AMTS’ products are sold directly from its facilities throughout the U.S., Asia and Europe, as well as through direct sales offices and independent sales representatives throughout the world. Principal competition includes companies such as Sumitomo Metals, Heraeus Inc., Praxair, Inc., Honeywell International Inc., Solar Applied Materials Technology Corp. and a number of smaller regional and national suppliers.

 

Advanced Material Technologies and Services — Sales and Backlog

 

The backlog of unshipped orders for AMTS as of December 31, 2009, 2008 and 2007 was $51.3 million, $34.6 million and $29.5 million, respectively. 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, 2009 will be filled during 2010.

 

Sales are made to over 2,800 customers. Government sales, principally subcontracts, accounted for less than 1% of the sales volume in 2009, 2008 and 2007. Sales outside the United States, principally to Europe and Asia, accounted for approximately 29% of sales in 2009, 28% of sales in 2008 and 41% of sales in 2007. Other segment reporting and geographic information is contained in Note M of Notes to Consolidated Financial Statements, which can be found in Part II, Item 8 of this Form 10-K and which is incorporated herein by reference.

Advanced Material Technologies and Services — 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 AMTS amounted to $3.2 million in 2009, $2.9 million in 2008 and $2.1 million in 2007. A staff of 22 scientists, engineers and technicians was employed in this effort as of year-end 2009.

 

SPECIALTY ENGINEERED ALLOYS

 

Sales for this segment were $172.5 million, or 24% of total sales, in 2009, $299.9 million, or 33% of total sales, in 2008 and $290.0 million, or 30% of total sales, in 2007. As of December 31, 2009, SEA had 767 employees.

 

SEA manufactures and sells three main product families: strip products, bulk products and beryllium hydroxide. Strip products, the larger of the product families, include thin gauge precision strip and thin diameter rod and wire. These copper and nickel beryllium alloys 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, appliance and medical. SEA’s primary direct competitor in strip form beryllium alloys is NGK Insulators, Ltd. of Nagoya, Japan, with subsidiaries in the United States and Europe. SEA also competes with alloy systems manufactured by Global Brass and Copper, Inc., Wieland Electric, Inc., Stolberger Metallwerke GmbH, Nippon Mining, PMX Industries, Inc. 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.

 

Bulk products are copper and nickel-based alloys manufactured in plate, rod, bar, tube and other customized forms that, depending upon the application, may provide superior strength, corrosion or wear resistance, thermal conductivity or lubricity. While the majority of bulk products contain beryllium, a growing portion of bulk products’ sales is from non-beryllium-containing alloys as a result of product diversification efforts. Applications for bulk products include oil and gas drilling components, bearings, bushings, welding rods, plastic mold tooling and undersea telecommunications housing equipment. In the area of bulk products, in addition to NGK Insulators, Ltd., SEA competes with several smaller regional producers such as International Beryllium Corp., LaBronze Industriel in Europe and Young II in Asia.

 

Beryllium hydroxide is produced by Brush Resources Inc., a wholly owned subsidiary, at its milling operations in Utah from its bertrandite mine and purchased beryl ore. The hydroxide is used primarily as a raw material input for strip and bulk products and, to a lesser extent, by the Beryllium and Beryllium Composites segment. External sales of hydroxide from the Utah operations were less than 4% of Specialty Engineered Alloys’ total sales in each of the three most recent years. BRI sells beryllium hydroxide externally to NGK Insulators, Ltd.

 

Strip and bulk products are manufactured at facilities in Ohio and Pennsylvania and are distributed internationally through a network of company-owned service centers and outside distributors and agents.

 

Specialty Engineered Alloys — Sales and Backlog

 

The backlog of unshipped orders for SEA as of December 31, 2009, 2008 and 2007 was $68.6 million, $55.5 million and $71.5 million, respectively. Backlog is generally represented by purchase orders that may be terminated under certain conditions. We expect that substantially all the backlog of orders for this segment as of December 31, 2009 will be filled during 2010.

 

Sales are made to over 2,100 customers. SEA had government sales, principally subcontracts, accounting for less than 1% of segment sales in 2009 and 2007 and none in 2008. Sales outside the United States, principally to Europe and Asia, accounted for approximately 57% of sales in 2009 and 2008, and 58% of sales in 2007. Other segment reporting and geographic information is contained in Note M of Notes to Consolidated Financial Statements, which can be found in Part II, Item 8 of this Form 10-K and which is incorporated herein by reference.

Specialty Engineered Alloys — Research and Development

 

Active research and development programs seek new product compositions and designs as well as process innovations. Expenditures for research and development amounted to $2.2 million in 2009, $2.3 million in 2008 and $1.9 million in 2007. A staff of seven scientists, engineers and technicians was employed in this effort as of year-end 2009.

 

BERYLLIUM AND BERYLLIUM COMPOSITES

 

Sales for this segment were $47.0 million, or 7% of total sales, in 2009, $63.6 million, or 7% of total sales, in 2008 and $60.5 million, or 6% of total sales, in 2007. As of December 31, 2009, Beryllium and Beryllium Composites had 211 employees.

 

Beryllium and Beryllium Composites manufactures beryllium-based metals and metal matrix composites in rod, 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 and Beryllium Composites, while other markets served include medical, telecommunications and computer, electronics (including acoustics), optical scanning and general industrial. In June 2008, we announced that Brush Wellman Inc. had entered into an agreement with the Department of Defense to construct a $90.3 million primary beryllium facility. This facility will produce primary beryllium, the feedstock material used to produce beryllium metal products. Construction of this facility is on schedule for completion in the second half of 2010. Beryllium-containing products are sold throughout the world through a direct sales organization and through company-owned and independent distribution centers. While Beryllium and Beryllium Composites is the only domestic producer of metallic beryllium, it competes primarily with designs utilizing other materials including metals, metal matrix and organic composites.

 

This segment also manufactures beryllia ceramics through Brush Ceramic Products Inc., a wholly owned subsidiary in Tucson, Arizona. Electronic components utilizing beryllia are used in the telecommunications, medical, industrial and defense markets. These products are distributed through direct sales and independent sales agents. Direct competitors include American Beryllia Inc. and CBL Ceramics Limited.

 

Beryllium and Beryllium Composites — Sales and Backlog

 

The backlog of unshipped orders for Beryllium and Beryllium Composites as of December 31, 2009, 2008 and 2007 was $38.1 million, $28.7 million and $23.9 million, respectively. 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, 2009 will be filled during 2010.

 

Sales are made to over 300 customers. Government sales, principally subcontracts, accounted for less than 2% of Beryllium and Beryllium Composites’ sales in 2009, less than 1% of segment sales in 2008 and 1% of segment sales in 2007. Sales outside the United States, principally to Europe and Asia, accounted for approximately 22% of sales in 2009, 23% of sales in 2008 and 22% of sales in 2007. Other segment reporting and geographic information is contained in Note M of Notes to Consolidated Financial Statements, which can be found in Part II, Item 8 of this Form 10-K and which is incorporated herein by reference.

 

Beryllium and Beryllium Composites — Research and Development

 

Active research and development programs seek new product compositions and designs as well as process innovations. Expenditures for research and development amounted to $1.4 million in 2009, $1.3 million in 2008 and $1.0 million in 2007. A staff of seven scientists, engineers and technicians was employed in this effort as of year-end 2009. Some research and development projects, expenditures for which are not material, were externally sponsored and funded.

ENGINEERED MATERIAL SYSTEMS

 

Sales for this segment were $34.7 million, or 5% of total sales, in 2009, $65.9 million, or 7% of total sales, in 2008 and $70.9 million, or 7% of total sales, in 2007. As of December 31, 2009, Engineered Material Systems had 157 employees.

 

Engineered Material Systems include 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. Our 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 these products include connectors, contacts and semiconductors while the largest markets are automotive electronics, telecommunications and computer and data storage. The energy and defense and medical electronic markets are smaller but offer further growth opportunities. Engineered Material Systems’ products are manufactured at our Lincoln, Rhode Island facility. Engineered Material Systems’ products are sold directly and through its sales representatives. Engineered Material Systems has limited competition in the United States and several European manufacturers are competitors for the sale of inlay strip.

 

Engineered Material Systems — Sales and Backlog

 

The backlog of unshipped orders for Engineered Material Systems as of December 31, 2009, 2008 and 2007 was $7.6 million, $7.6 million and $12.2 million, respectively. 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, 2009 will be filled during 2010.

 

Sales are made to over 100 customers. Engineered Material Systems did not have any sales to the government for 2009, 2008 or 2007. Sales outside the United States, principally to Europe and Asia, accounted for approximately 21% of Engineered Material Systems’ sales in 2009, 17% of sales in 2008 and 13% of sales in 2007. Other segment reporting and geographic information is contained in Note M of Notes to Consolidated Financial Statements, which can be found in Part II, Item 8 of this Form 10-K and which is incorporated herein by reference.

 

Engineered Material Systems — 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 Engineered Material Systems were nominal in 2009, 2008 and 2007.

 

GENERAL

 

Availability of Raw Materials

 

The principal raw materials we use are beryllium (extracted from both imported beryl ore and bertrandite ore mined from our Utah properties), copper, gold, silver, nickel, platinum, palladium, aluminum and ruthenium. Ore reserve data can be found in Part II, Item 7 of this Form 10-K. The availability of these raw materials, as well as other materials used by us, 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 inplant and outplant 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 U.S. Occupational Safety and Health Administration (OSHA) and by other governmental and private standard-setting organizations. One result of these reviews will likely be more stringent worker safety standards. Some organizations, such as the California Occupational Health and Safety Administration and the American Conference of Governmental Industrial Hygienists, have adopted standards that are more stringent than the current standards of OSHA. The development, proposal or adoption of more stringent standards may affect buying decisions by the users of beryllium-containing products. If the standards are made more stringent and/or our customers or other downstream users decide to reduce their use of beryllium- containing products, our results of operations, liquidity and financial condition could be materially adversely affected. The impact of this potential 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. The magnitude of this potential adverse effect cannot be estimated.

 

Executive Officers of the Registrant

 

 

 

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 this 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.

 

Health issues, litigation and government regulation relating to our beryllium operations could significantly reduce demand for our products, limit our ability to operate and adversely affect our profitability.

 

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. This scrutiny includes regulatory decisions relating to the approval or prohibition of the use of beryllium-containing material for various uses. 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. 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.

 

Our bertrandite ore mining and beryllium-related manufacturing operations and some of 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.

 

Our customers and we are subject to laws regulating worker exposure to beryllium. Standards for exposure to beryllium are under review by OSHA and by other governmental and private standard-setting organizations. One result of these reviews will likely be more stringent worker safety standards. Some organizations, such as the California Occupational Health and Safety Administration and the American Conference of Governmental Industrial Hygienists, have adopted standards that are more stringent than the current standards of OSHA. The development, proposal or adoption of more stringent standards may affect buying decisions by the users of beryllium-containing products. If the standards are made more stringent and/or our customers or other downstream users decide to reduce their use of beryllium-containing products, our results of operations, liquidity and financial condition could be materially adversely affected. The impact of this potential 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. The magnitude of this potential adverse effect cannot be estimated.

 

Our bertrandite ore mining and 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 non-compliance. 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. These environmental laws and regulations could also require us to acquire costly equipment, obtain additional financial assurance, or 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, copper beryllium has long been used for high reliability contacts in mobile handheld devices. Mobile device designers may justify using lower-performance materials in some of the less-critical components of mobile phones. 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.

 

We are dependent on the successful scheduled completion of a new primary beryllium facility for our future supply of pure beryllium.

 

We have partnered with the Department of Defense to share in the cost of a new beryllium plant for primary beryllium feedstock. We may experience construction delays and quality and/or production issues in start-up of this new facility. Any prolonged delays of pure beryllium production from the new plant could negatively impact our Company.

 

We are exposed to lawsuits in the normal course of business, which could harm our business.

 

We are currently involved in certain legal proceedings, including those involving product liability claims, and third-party lawsuits relating to exposure to beryllium as well as claims against us of infringement of intellectual property rights of third parties and other claims arising out of the ordinary conduct of our business. Due to the uncertainties of litigation, we can give no assurance that we will prevail on claims made against us in the lawsuits that we currently face or that additional claims will not be made against us in the future. Certain of these matters involve types of claims, that, if they result in an adverse ruling to us, could give rise to substantial liability which could have a material adverse effect on our business, operating results or financial condition.

 

We are presently uninsured for beryllium-related claims where the claimants’ first exposure to beryllium occurred on or after January 1, 2008, and we have not undertaken to estimate the impact of such claims, which have yet to be asserted. In addition, some jurisdictions preclude insurance coverage for punitive damage awards. Accordingly, our profitability could be adversely affected if any current or future claimants obtain judgments for any uninsured compensatory or punitive damages. Further, an unfavorable outcome or settlement of a pending

beryllium case or additional adverse media coverage could encourage the commencement of additional similar litigation.

 

A portion of our revenue is derived from the sale of defense-related products through various contracts and subcontracts. These contracts may be suspended or canceled, which could have an adverse impact on the Company’s revenues.

 

In 2009, 8% of our revenue was derived from sales to customers in the aerospace and defense market. A portion of these customers operate under contracts with the U.S. government, which are vulnerable to termination at any time, for convenience or default. Some of the reasons for cancellation include, but are not limited to: budgetary constraints or re-appropriation of government funds, timing of contract awards, violations of legal or regulatory requirements, and changes in political agenda. If these cancellations were to occur, it would result in a reduction to Company revenues. For example, various projects including the F-22 fighter aircraft have been canceled, which had and will have a negative impact on our sales.

 

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 our customers, end users or to us. 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.

 

Many of 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 and profitability.

 

A substantial number of our customers are in the telecommunications and computer, aerospace and defense, industrial components, data storage, automotive electronics and appliance 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 U.S. dollar, the strength of the consumer electronics, automotive electronics and computer industries and the rate of construction of telecommunications infrastructure equipment and government spending on defense.

 

Also, in times when growth rates in our markets slow down, there may be temporary inventory adjustments by our customers that may negatively affect our business.

 

The global economic crisis is having a negative impact on our financial performance.

 

The global economic crisis continues to adversely affect the global economy. Some customers are experiencing difficulty in obtaining adequate financing due to the current disruption in the credit markets, which has impacted our sales. Our exposure to bad debt losses may also increase if customers are unable to pay for products previously ordered. The severe recession has also caused higher unemployment rates globally which could have an adverse affect on demand for consumer electronics, which comprised over 55% of our sales in 2009. Continuation or further deterioration of these financial and macroeconomic conditions may have a significant adverse effect on our sales, profitability and results of operations.

We may not be able to complete our acquisition strategy or successfully integrate acquired businesses.

 

We have been active over the last several years 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 and routinely review acquisition opportunities. 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 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.

 

In addition, there may be liabilities that we fail, or are unable, to discover in the course of performing due diligence investigations on the assets or companies we have already acquired or may acquire in the future. We cannot assure that rights to indemnification by the sellers of these assets or companies to us, even if obtained, will be enforceable, collectible or sufficient in amount, scope or duration to fully offset the possible liabilities associated with the business or property acquired. Any such liabilities, individually or in the aggregate, could have a materially adverse effect on our business, financial condition and results of operations.

 

The terms of our indebtedness may restrict our operations, including our ability to pursue our growth and acquisition strategies.

 

The terms of our credit facilities contain a number of restrictive covenants, including restrictions in our ability to, among other things, borrow and make investments, acquire other businesses and consign additional precious metals. These covenants could adversely affect us by limiting our ability to plan for or react to market conditions or to meet our capital needs, as well as adversely affect our ability to pursue our growth, acquisition strategies and other strategic initiatives.

 

Our failure to comply with the covenants contained in the terms of our indebtedness could result in an event of default which could materially and adversely affect our operating results and our financial condition.

 

The terms of our credit facilities require us to comply with various covenants, including financial covenants. If the global economic crisis is prolonged, it could have a material adverse impact on our earnings and cash flow which could adversely affect our ability to comply with our financial covenants and could limit our borrowing capacity. Our ability to comply with these covenants depends, in part, on factors over which we may have no control. A breach of any of these covenants could result in an event of default under one or more of the agreements governing our indebtedness which, if not cured or waived, could give the holders of the defaulted indebtedness the right to terminate commitments to lend and cause all amounts outstanding with respect to the indebtedness to be due and payable immediately. Acceleration of any of our indebtedness could result in cross defaults under our other debt instruments. Our assets and cash flow may be insufficient to fully repay borrowings under all of our outstanding debt instruments if some or all of these instruments are accelerated upon an event of default, 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 35% of our sales in 2009, 37% in 2008 and 43% in 2007. We anticipate that international shipments will account for a significant portion of our sales for the foreseeable future. Revenue from international operations (principally Europe and Asia) amounted to approximately 24% of our sales in 2009 and 2008 and 25% in 2007. There are a number of risks associated with international business activities, including:

 

 

 

Additionally, foreign and international regulations have also impacted our sales, margins and profitability in the past. See also “— Health issues, litigation and government regulation relating to machining and manufacturing of beryllium-containing products could significantly reduce demand for our products, limit our ability to operate and adversely affect our profitability”, and “— Our bertrandite ore mining and beryllium-related manufacturing operations and some of 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”. 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 substantially all of our assets (other than non-mining real property and certain other assets). 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 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. Additional information regarding our market risks is contained in Part II, Item 7A of this Form 10-K.

 

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 advanced engineered materials using various precious and non-precious metals, including gold, silver, palladium, platinum, ruthenium, 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 U.S. 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 been very volatile in recent months due to global demand and market conditions. Further, we maintain some precious metals on a consigned inventory basis. 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.

 

We expect seasonal patterns to continue, which causes our quarterly results to fluctuate. For example, the Christmas season generates increased demand from our customers that manufacture consumer products. 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 results of operations.

 

Natural disasters, equipment failures, work stoppages, bankruptcies 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, bankruptcies, work stoppages due to strikes or lockouts, including those affecting the automotive industry, one of

our major markets, and other unexpected events. For example, Delphi Corporation, a customer of three of our business units and the largest United States supplier of automotive parts, filed for bankruptcy protection in 2005. Delphi Corporation emerged from bankruptcy reorganization in 2009. Similar events could also affect other suppliers to our customers. In either case, such 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.

 

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, 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 numerous milling and manufacturing facilities and a mining operation, which depend on electrical power, fuel or other energy sources. See “Item 2. — Properties,” of this Form 10-K. 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, such as those increases which may occur from climate change legislation or other environmental mandates, 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 Reading, Pennsylvania, Fremont, California and Tucson, Arizona manufacturing facilities are dependent on materials produced by our Elmore, Ohio manufacturing facility and our Wheatfield, New York manufacturing facility is dependent on our Buffalo, New York manufacturing facility. See “Item 2 — Properties”, of this Form 10-K. 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 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. In particular, the substantial volatility in world capital markets due to the global economic crisis has had a significant negative impact on the global financial markets.

 

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:

 

 

 

All of these factors have adversely impacted our access to the financial markets at various times over the last five years. The global economic crisis may make it difficult for us to access the credit market and to obtain financing or refinancing, as the case may be, to the extent necessary, on satisfactory terms or at all.

 

Low investment performance by our domestic pension plan assets may require us to increase our pension liability and expense, which may require us to fund a portion of 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. As of December 31, 2009, for pension accounting purposes, we assumed an 8.25% 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 pension asset return fall below our expectations, it is likely that future pension expenses would increase. The actual return on our plan assets for the twelve months ending December 31, 2009 was a gain of approximately 16%.

 

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 $8 million to our pension plan in 2010. If our current assumptions and estimates are not correct, a contribution in years beyond 2010 may be greater than the projected 2010 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 maintained the assumed rate at which health care costs will increase for the next year at 8% for both December 31, 2009 and December 31, 2008. In addition, we have assumed that this health care cost increase trend rate will decline to 5% by 2016. 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 one percentage point increase in assumed health care cost trend rates would have increased the post-employment benefits included among the liabilities in our balance sheet by $0.6 million at December 31, 2009.

 

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 U.S. dollar. Revenues from customers outside of the United States (principally Europe and Asia) amounted to 35% of sales in 2009, 37% in 2008 and 43% in 2007. 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 U.S. dollar may negatively affect our financial performance. In the past, fluctuations in currency exchange rates, particularly for the euro and the yen, have impacted our sales, margins and profitability. The fair value of our net asset relating to outstanding foreign currency contracts was $0.1 million at December 31, 2009, indicating that the average hedge rates were slightly favorable compared to the actual year-end market exchange rates. 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.

 

Our financial results are likely to be negatively impacted by an impairment of goodwill should our shareholder equity exceed our market capitalization for a number of quarters.

 

A goodwill impairment charge may be triggered by a reduction in actual and projected cash flows, which could be negatively impacted by the market price of our common shares. Our goodwill balance at December 31, 2009 was $67.0 million. Any required non-cash impairment charge could significantly reduce this balance and have a material impact on our reported financial position and results of operations.

 

 

None.

 

We operate manufacturing plants, service and other facilities throughout the world. During 2009, we made effective use of our productive capacities at our principal facilities. We believe that the quality and production capacity of our facilities is sufficient to maintain our competitive position for the foreseeable future. Information as of December 31, 2009, with respect to our significant facilities that are owned or leased, and the respective segments in which they are included, is set forth below.

 

 

 

 

In addition to the above, the Company holds certain mineral rights on 7,500 acres in Juab County, Utah from which the beryllium-bearing ore, bertrandite, is mined by the open pit method. A portion of these mineral rights are held under lease. Ore reserve data can be found in Part II, Item 7 of this Form 10-K.

 

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, 2009, our subsidiary, Brush Wellman Inc., was a defendant in four proceedings in various state and federal courts brought by plaintiffs alleging that they have contracted, or have been placed at risk of contracting, beryllium sensitization or 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.

 

As of December 31, 2008, there were nine beryllium cases (involving 36 plaintiffs) and as of December 31, 2009, there were four beryllium cases (involving eight plaintiffs). During 2009:

 

 

The four pending beryllium cases as of December 31, 2009 fall into two categories: three cases involving five individual plaintiffs, plus two spouses with consortium claims, and one purported class action, involving one named plaintiff, as discussed more fully below. These cases are covered by insurance, subject to an annual deductible.

 

The first purported class action is Gary Anthony v. Small Tube Manufacturing Corporation d/b/a Small Tube Products Corporation, Inc., et al., filed in the Court of Common Pleas of Philadelphia County, Pennsylvania, case number 000525, on September 7, 2006. The case was removed to the U.S. District Court for the Eastern District of Pennsylvania, case number 06-CV-4419, on October 4, 2006. The only named plaintiff is Gary Anthony. The defendants are Small Tube Manufacturing Corporation, d/b/a Small Tube Products Corporation, Inc.; Admiral Metals Inc.; Tube Methods, Inc.; and Cabot Corporation. 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. Defendant Tube Methods, Inc. filed a third-party complaint against Brush Wellman Inc. in that action on November 15, 2006. Tube Methods alleges that Brush supplied beryllium-containing products to U.S. Gauge, and that Tube Methods worked on those products, but that Brush is liable to Tube Methods for indemnification and contribution. Brush moved to dismiss the Tube Methods complaint on December 22, 2006. On January 12, 2007, Tube Methods filed an amended third-party complaint, which Brush moved to dismiss on January 26, 2007; however, the Court denied the motion on September 28, 2007. Brush filed its answer to the amended third-party complaint on October 19, 2007. On November 14, 2007, two of the defendants filed a joint motion for an order permitting discovery to make the threshold determination of whether plaintiff is sensitized to beryllium. On February 29, 2008, Brush filed a motion for summary judgment based on plaintiff’s lack of any substantially increased risk of CBD. Oral argument on this motion took place on June 13, 2008. On September 30, 2008, the court granted the motion for summary judgment in favor of all of the defendants and dismissed plaintiff’s class action complaint. On October 29, 2008, plaintiff filed a notice of appeal. The Court of Appeals had granted a motion to stay

the appeal due to the bankruptcy of one of the appellees, Millennium Petrochemicals. On April 3, 2009, Small Tube Manufacturing filed a motion for relief in bankruptcy court from the automatic stay, asking that the bankruptcy court modify the stay to allow Small Tube Manufacturing’s indemnification claim against Millennium Petrochemicals and the Anthony case to proceed to final judgment, including all appeals. On May 14, 2009, the bankruptcy court approved a stipulation and order modifying the automatic stay to permit Millennium Petrochemicals and Small Tube Manufacturing to participate in the appeal. On May 27, 2009, Small Tube Manufacturing filed an unopposed motion with the Court of Appeals to lift the stay, which the court granted on June 22, 2009. On July 29, 2009, the Company and the other appellees filed their brief in the Court of Appeals.

 

As reported above, the Company had one purported class action that is now proceeding as an individual claim. The second purported class action was 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 were Manuel Marin, Lisa Marin, Garfield Perry and Susan Perry. The defendants were 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 were Robert Thomas, Darnell White, Leonard Joffrion, James Jones and John Kesselring. The plaintiffs alleged that they had been sensitized to beryllium while employed at the Boeing Company. The plaintiffs’ wives claimed loss of consortium. The plaintiffs purported to represent two classes of approximately 250 members each, one consisting of workers who worked at Boeing or its predecessors and were beryllium sensitized and the other consisting of their spouses. They 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 sought 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 represented current and past employees of Boeing in California; and Ms. Marin and Ms. Perry were spouses. Defendant Appanaitis Enterprises, Inc. was dismissed on May 5, 2005. Plaintiffs’ motion for class certification, which the Company opposed, was heard by the court on February 8, 2008, and the motion was denied by the court on May 7, 2008. Plaintiffs filed a notice of appeal on May 20, 2008. Oral argument took place on July 22, 2009. On August 24, 2009, the Court of Appeals issued a decision affirming the denial of class certification. Messrs. Thomas and White were dismissed as plaintiffs due to their deaths. Plaintiffs did not appeal the decision of the Court of Appeals. The case is now proceeding as an individual claim involving five plaintiffs (Messrs. Marin, Perry and Kesselring and the spouses of Messrs. Marin and Perry). Messrs. Jones and Joffrion were dismissed from this case because they already had individual claims pending. The Marin case has been stayed pending the trials of the Jones and Joffrion cases, which are scheduled for March 30, 2010.

 

Subsequent Events

 

From January 1, 2010 to March 8, 2010, the following subsequent events took place. In the Anthony case, the Court of Appeals heard oral arguments on January 11, 2010, and the matter is now under submission.

 

Other Claims

 

One of our subsidiaries, Williams Advanced Materials Inc. (WAM), is a party to patent litigation in the U.S. involving Target Technology Company, LLC of Irvine, California (Target). The litigation involves patents directed to technology used in the production of DVD-9s, which are high storage capacity DVDs, and other optical recording media. The patents at issue primarily concern certain silver alloys used to make the semi-reflective layer in DVD-9s, a thin metal film that is applied to a DVD-9 through a process known as sputtering. The raw material used in the sputtering process is called a target. Target alleges that WAM manufactures and sells infringing sputtering targets to DVD manufacturers.

 

In the first action, filed in April 2003 by WAM against Target in the U.S. District Court, Western District of New York (case no. 03-CV-0276A (SR)) (the NY Action), WAM had asked the Court for a judgment declaring certain Target patents invalid and/or unenforceable and awarding WAM damages. Target counterclaimed alleging infringement of those patents and seeking a judgment for infringement, an injunction against further infringement and damages for past infringement. Following certain proceedings in which WAM was denied an injunction to prevent Target from suing and threatening to sue WAM’s customers, Target filed an amended counterclaim and a

third-party complaint naming certain of WAM’s customers and other entities as parties to the case and adding related other patents to the NY Action. The action temporarily was stayed pending resolution of the ownership issue in the CA Action (defined below), as discussed more fully below. On January 26, 2009, the Court in the CA Action ordered that the case and remaining issues be transferred to the Court in the NY Action. As a result, the stay in the NY Action has been lifted, and the Court in the NY Action has consolidated the CA Action with the NY Action. With the parties having resumed pre-trial proceedings, Target had moved the Court to further amend its counts for infringement to include only certain claims of six of the patents claimed to be owned by Target. If granted, Target’s counts for infringement of other claims in those patents and six other patents claimed to be owned by Target would be removed from the NY Action. WAM had opposed the motion to the extent Target seeks dismissal without prejudice of the counts for infringement of the other claims and other patents. Following a Court hearing on Target’s motion to amend its pleadings and upon agreement of the parties, Target further amended its counts for infringement to include a total of nine U.S. patents and withdrawing four other patents. In response to Target’s amendment of its pleadings, WAM moved for (a) dismissal of Target’s counts for lack of jurisdiction on the basis that Target did not own the patents, (b) terminating sanctions on the basis of litigation misconduct by Target, and (c) a stay of discovery pending a decision by the Court on the first two WAM motions, all of which motions are pending. WAM continues to dispute Target’s claims of ownership of all of the patents and denies both validity and infringement of the patent claims. Following a September 11, 2009 oral argument on WAM’s motions, the Magistrate Judge reserved decision and pending the Court’s action on the motions effectively stayed further discovery. On October 28, 2009, the Magistrate Judge recommended to the District Court Judge that the Court deny WAM’s motion for dismissal of Target’s counts for lack of jurisdiction on the basis of WAM’s claim that Target did not own the patents. The Magistrate Judge reasoned that, in view of the earlier reported November 2008 settlement agreement between the Sony companies and Target, any lack of jurisdiction was cured when in July 2009, Target filed an amended answer. The Magistrate Judge further deferred until trial WAM’s motion for terminating sanctions because of Target’s litigation misconduct, but reopened discovery. Both WAM and Target objected to the Magistrate Judge’s report, and their objections are yet to be heard by the District Court Judge before he may rule on the recommendation. Nothwithstanding the Magistrate Judge’s recommendation, WAM continues to dispute Target’s claims of ownership of the patents remaining in the Action, and to deny both validity and infringement of the patents. The Magistrate Judge by separate order and with the consent of the parties referred the case to a mediator for consideration under the Court’s alternate dispute resolution plan, which mediation is ongoing. No deadline to complete discovery has yet been set, nor has a trial date been scheduled.

 

Target in September 2004 filed in the U.S. District Court, Central District of California (case no. SAC04-1083 DOC (MLGx)), a separate action for infringement of one of the same patents named in the NY Action (the CA Action), naming as defendants WAM and certain of WAM’s customers who purchase certain WAM sputtering targets. Target sought a judgment that the patent is valid and infringed by the defendants, a permanent injunction, a judgment on ownership of certain Target patents, damages adequate to compensate Target for the infringement, treble damages and attorneys’ fees and costs. In April 2007, Sony DADC U.S., Inc. among other Sony companies (Sony) had intervened in the CA Action claiming ownership of that patent and others of the patents that Target is seeking to enforce in the NY Action. Sony’s claim was based on its prior employment of the patentee and Target’s founder, Han H. Nee (Nee), and had included a demand for damages against both Target and Nee. WAM on behalf of itself and its customers has a paid-up license from Sony under any rights that Sony has in those patents. Although trial of the CA Action had been scheduled for March 2009, in December 2008, a confidential settlement agreement was reached between Target and Sony, as well as a partial settlement agreement between Target and WAM releasing WAM and its customers from infringement of the one named patent. As a result, the issues not subject to any settlement were (1) a remaining count in which the Target parties had requested a judgment declaring that Target is the owner of certain of the Target patents and (2) WAM’s request for sanctions against Target. Pursuant to various stipulations filed by the parties, the Court on January 6, 2009 ordered a dismissal with prejudice of all of the respective intervention claims and counterclaims between the Target parties and the Sony companies, and a dismissal without prejudice of the counterclaims by WAM and its defendant customers, the exception being the remaining declaratory judgment count on patent ownership. Following motions filed by the parties, the Court on January 26, 2009 ordered that the case and remaining issues be transferred to the Court in the NY Action.

 

 

Market Information and Dividends

 

The Company’s common shares are listed on the New York Stock Exchange under the symbol “BW”. As of February 22, 2010, there were 1,444 shareholders of record. The table below is a summary of the range of market prices with respect to common shares during each quarter of fiscal years 2009 and 2008. We did not pay any dividends in 2009 or 2008. We have no current intention to declare dividends on our common shares in the near term. Our current policy is to retain all funds and earnings for the use in the operation and expansion of our business.

 

Performance Graph

 

The following graph sets forth the cumulative shareholder return on our common shares as compared to the cumulative total return of the S&P SmallCap 600 Index and the Russell 2000 Index as Brush Engineered Materials Inc. is a component company of these indices.

 

 

 

The above graph assumes that the value of our common shares and each index was $100 on December 31, 2004 and that all dividends, if paid, were reinvested.

 

Brush Engineered Materials Inc. and Subsidiaries

 

 

Capital expenditures shown above include amounts spent under government contracts for which reimbursements were received from the government in the amounts of $28.2 million in 2009, $8.0 million in 2008 and $3.5 million in 2007. The reimbursements are recorded within long-term liabilities.

 

Changes in deferred tax valuation allowances decreased income tax expense by $21.8 million in 2006 and $8.1 million in 2005.

 

See Notes to Consolidated Financial Statements.

 

OVERVIEW

 

We are an integrated producer of high performance advanced engineered materials used in a variety of electrical, electronic, thermal and structural applications. Our products are sold into numerous markets, including telecommunications and computer, aerospace and defense, medical, industrial components, data storage, automotive electronics and appliance.

 

Sales of $715.2 million were 21% lower in 2009 than in 2008 largely as a result of the global economic crisis as demand from various key markets declined significantly beginning in the fourth quarter 2008 and continued to remain at very low levels into 2009. We believe that there was excess inventory in the supply chain that needed to be worked down when the crisis hit and therefore the demand from our customers on us initially fell further than the decline in consumer spending. Conditions improved in portions of various markets as 2009 progressed, but this improvement was tempered by a softening of defense and medical market sales in the second half of the year. After reaching a near-term low point in the first quarter 2009, order entry and sales grew in each subsequent quarter of the year. Shipping levels in the fourth quarter 2009, however, still remained below the shipping levels in 2008 before the crisis began.

 

Gross margin and profitability declined significantly in 2009 largely as a result of the fall-off in sales. In response to the decline in sales, we implemented various cost-saving initiatives that helped offset a portion of the negative margin impact of the lower sales volume. Manpower levels were reduced, compensation and benefits were frozen and/or cut and various discretionary spending items were eliminated.

 

The operating loss was $19.5 million in 2009 compared to an operating profit of $28.1 million in 2008. In addition to the impact from the changes in sales volumes and the cost-saving initiatives, profitability in 2009 was affected by an unfavorable non-cash $4.9 million mark-to-market valuation on a derivative and $2.1 million of severance and restructuring costs.

 

In October 2009, we purchased the outstanding stock of Barr Associates, Inc. (Barr) for $55.2 million in cash. Barr produces precision thin film optical filters used in defense, medical, telecommunications and other markets. The acquisition of Barr, coupled with our existing operations, allows us to provide a broad array of optical filters across a wide band of wavelengths.

 

We reduced our working capital investments in light of the reduced sales and profitability and, as a result, we generated cash flow from operations of $41.5 million in 2009. We also limited our capital spending to high priority items; capital spending, excluding amounts reimbursed by the Department of Defense under a government contract, was below the level of depreciation.

 

Debt totaled $64.5 million at year-end 2009, an increase of $22.7 million during the year. The debt-to-debt-plus-capital-ratio was 16% at December, 31, 2009. The increase in debt plus the cash flow from operations and excess cash were used to fund the Barr acquisition and capital expenditures.

 

RESULTS OF OPERATIONS

 

 

Sales of $715.2 million in 2009 were $194.5 million, or 21%, lower than sales of $909.7 million in 2008, while sales in 2008 were $46.0 million, or 5%, lower than sales of $955.7 million in 2007.

Domestic sales declined 19% in 2009 from 2008 after growing 6% in 2008 over 2007. International sales were 25% lower in 2009 than 2008 and 19% lower in 2008 than in 2007.

 

Sales to all major markets were lower in 2009 than in 2008. Demand from various markets declined significantly as a result of the global economic crisis and the related impact on consumer spending. We believe that the demand level in certain markets initially fell further than the actual decline in consumer spending levels as a result of excess inventory levels in the downstream supply chain. Sales to certain markets also were affected by government spending levels, energy prices and other factors in 2009.

 

Sales to the telecommunications and computer market, our largest market, declined 16% in 2009 from 2008 after growing 19% in 2008 over 2007. Demand levels started to soften in the fourth quarter 2008 and then fell significantly in the first quarter 2009 due to the global economic crisis. By the fourth quarter 2009, demand had improved over the levels from the first quarter 2009 but had not yet returned to the levels prior to the start of the crisis. Demand from the appliance market was also severely affected by the economic crisis and our sales into this market declined by over 40% in 2009.

 

Automotive electronic sales declined at a double digit rate in both 2009 and 2008 from the respective prior years. Shipments into Europe, partially spurred by the lower value of the U.S. dollar, helped offset a portion of the weakness in the U.S. market.

 

Sales for defense applications, which had grown in 2008 over 2007, initially were not affected by the global economic crisis and remained solid for the first half of 2009. However, program funding delays, push outs of orders and other factors reduced demand in the second half of the year and defense sales in 2009 fell below the 2008 level.

 

Medical market sales were higher in the first half of 2009 than the first half of 2008, but a combination of softer demand and a manufacturing quality issue, which has been resolved, reduced sales in the second half of the year. Medical sales had grown in 2008 over 2007 in part due to the acquisition of Techni-Met in the first quarter 2008.

 

Sales for oil and gas applications within the industrial components market grew in the first three quarters of 2008 over 2007, but then declined in the fourth quarter 2008 due to temporary disruptions to drilling operations in the southern U.S. caused by Hurricane Ike and a decline in energy prices. Demand remained soft in 2009 as a result of the relatively low energy prices and excess inventories in the supply chain.

 

Sales into the data storage market were lower in 2009 from 2008 after declining significantly in 2008 from the very high levels in 2007. See “Segment Disclosures” below for further discussion.

 

Offsetting a portion of the weakness in our traditional markets was the continued development of various new products and applications for our existing and new markets. One of the key new markets we are targeting for growth is the energy market. Each of our major businesses is developing solar and/or alternative energy applications for this growing market and, while still relatively minor, sales into this market improved in 2009 over the 2008 level.

 

Sales are affected by metal prices as changes in precious metal and a portion of the changes in base metal prices, primarily copper, are passed on to our customers. Copper prices have been volatile and, while market prices by year-end 2009 were quite high, the average price for 2009 was lower than the average price for 2008. The average price for copper in 2008 was higher than the 2007 average price. Prices for gold and other precious metals increased in the second half of 2009 and for the year were higher on average than in 2008. Precious metal prices were higher in 2008 than in 2007 as well. Ruthenium prices have fallen over the last two years. We estimate that the net metal price impact decreased sales $9.1 million in 2009 as compared to 2008 and increased sales $50.7 million in 2008 as compared to 2007.

 

We implemented various cost-saving initiatives beginning late in the fourth quarter 2008 and throughout the first nine months of 2009 in response to the weakening order entry rate at that time. By the end of 2009, excluding the impact of the Barr acquisition in the fourth quarter 2009, total manpower was reduced by 14% from year-end 2008 levels and 17% from the end of the third quarter 2008. Overtime in the plants was eliminated and regular work hours were reduced in many cases. The Company match for the 401(k) savings plan was first reduced in half and then suspended altogether for the majority of employees. Discretionary spending was reduced and various projects and initiatives were cancelled or delayed. Compensation levels were frozen and then reduced for the majority of

employees; by year-end 2009, the pay reductions were reinstated. These cost-saving initiatives favorably impacted gross margins and selling, general and administrative expenses in 2009. Severance and related costs associated with the headcount reductions totaled $2.1 million in 2009 and were included in selling, general and administrative expenses on the Consolidated Statement of Income.

 

We estimate that spending on certain operating costs (excluding materials) and other manufacturing overhead and administrative costs was reduced by approximately 21% in 2009 from the 2008 level.

 

Gross margin of $91.4 million was 13% of sales in 2009 compared to $151.9 million, or 17% of sales, in 2008 and $196.7 million, or 21% of sales, in 2007. The lower sales volume in 2009 reduced margins by an estimated $69.5 million from 2008 and was the cause for the overall decline in margins in 2009 from 2008. Production levels were reduced in 2009 (due to the lower sales and a reduction in inventory) which resulted in operating inefficiencies at various facilities that negatively affected margins. The change in product mix was unfavorable in 2009 as compared to 2008 partially due to lower sales of higher margin generating beryllium-containing products in 2009. The 2009 gross margin was also reduced by the cost of a manufacturing quality return, unplanned downtime on a key piece of equipment and inventory valuation adjustments.

 

The cost-reduction efforts offset a portion of the negative impact of the above items on gross margin in 2009 as operating and overhead manufacturing costs were lower in 2009 than in 2008.

 

The market price of ruthenium declined from a high of over $800 per troy ounce in the first quarter 2007 to a low of below $100 per troy ounce in 2009. Accounting regulations require inventory to be carried at the lower of its cost or market. As a result of the generally falling prices over this time period, we recorded lower of cost or market charges of $0.7 million in 2009, $15.2 million in 2008 and $4.5 million in 2007.

 

After a rapid increase in the market price of ruthenium late in 2006 and early 2007, we sold products at prices significantly higher than their original material cost, generating an additional $22.9 million of margin, primarily in the first half of 2007. This benefit did not repeat in 2008 and 2009 as we changed our pricing practices so that our purchase price for ruthenium forms the basis for the price charged to our customers.

 

In addition to the above items that affected the comparison between the 2008 and 2007 gross margin, the lower sales volume in 2008 reduced margins by an estimated $21.0 million as compared to 2007. Manufacturing overhead costs were higher in 2008 than in 2007 due to increases in utilities, freight and other items. The margin generated by Techni-Met, improved pricing in portions of the business and a favorable foreign currency translation effect offset a portion of the impact of the decline in volume, changes in product mix and higher overhead costs. Margins were reduced $5.7 million in 2007 as a result of quality returns from a key customer and related rework and scrap costs.

 

In the first quarter 2009, we determined that the domestic defined benefit pension plan was curtailed due to the significant reduction in force. As a result of the curtailment and the associated remeasurement, we recorded a $1.1 million one-time benefit during the first quarter 2009, $0.8 million of which was recorded against cost of sales and $0.3 million recorded against selling, general and administrative expenses on the Consolidated Statement of Income. In addition to the one-time benefit, the 2009 annual expense under the plan was reduced by $1.0 million from the initial projected expense had the plan not been curtailed. The all-in expense on this plan was $3.2 million in 2009 compared to $4.8 million in 2008. See “Critical Accounting Policies” below.

 

Selling, general and administrative expenses (SG&A) were $89.8 million in 2009 (13% of sales), $104.5 million in 2008 (11% of sales) and $110.1 million in 2007 (12% of sales). SG&A expenses declined 14% in 2009 from 2008 after having declined 5% in 2008 from 2007. The lower expense in 2009 as compared to 2008 was mainly due to the cost reduction efforts in light of the sales decline as manpower levels and costs and discretionary spending were cut in 2009. Sales and distribution-related expenses were lower in 2009 than in 2008 as well.

 

The incentive compensation expense on plans designed to pay in cash was $1.2 million lower in 2009 than in 2008 and $8.2 million lower in 2008 than in 2007. The changes in the annual expense between years were caused by the performance of the individual businesses relative to their plans’ objectives. Stock-based compensation expense, including the expense for performance restricted shares, stock options, stock appreciation rights and restricted stock, was $3.5 million in 2009, $2.6 million in 2008 and $3.9 million in 2007. The comparison of stock-based

compensation expense between years is affected by changes in plan design, actual performance relative to the plans’ objectives, movement in our stock price and other factors.

 

International SG&A expenses, excluding incentive compensation, were approximately 19% lower in 2009 than in 2008 largely due to the cost reductions efforts and a decline in sales-related expenses. International expenses had increased modestly in 2008 over 2007, mainly as a result of translation rate differences.

 

Acquisition-related expenses for legal, accounting and due diligence services totaled $0.7 million in 2009. As a result of a change in accounting regulations effective January 1, 2009, acquisition-related expenses must be charged against income as incurred. Previously, these expenses would have been capitalized as part of the cost of the acquisition.

 

Other corporate administrative expenses were down $5.6 million in 2009 from 2008 in part due to the cost-reduction efforts and the related impact on compensation and benefits. Information technology costs were also lower as were costs for various outside services. In 2008, corporate administrative expenses increased $3.0 million over 2007 largely due to higher legal, compliance and information technology costs.

 

In addition to the items noted above, the comparison of the total SG&A expenses between 2008 and 2007 was affected by the inclusion of Techni-Met beginning in the first quarter 2008 and higher retirement costs in 2008.

 

Research and development expenses (R&D) totaled $6.8 million in 2009, $6.5 million in 2008 and $5.0 million in 2007. R&D expenses were below 1% of sales in each of the last three years, although despite the corporate-wide cost reduction efforts in light of the lower sales volume, we increased our R&D spending slightly in 2009. R&D efforts are focused on developing new products and applications as well as continuing improvements in our existing products.

 

The litigation settlement gain of $1.1 million in 2008 represents the favorable settlement of a lawsuit, net of legal fees, in which we sought recovery of our rights under a previously signed indemnity agreement.

 

The litigation gain of $8.7 million in 2007 resulted from the settlement of a lawsuit against our former insurers in the fourth quarter of that year. We originally filed the lawsuit in order to resolve a dispute over how insurance coverage should be applied to incurred indemnity losses and defense costs. The court previously had issued a summary judgment in our favor in the third quarter 2006 and awarded us damages of $7.8 million. The defendants did not pay the award at that time and, due to the uncertainty of the appeal process, we did not record the benefits of that award in our Consolidated Financial Statements. Under the terms of the settlement, the insurers agreed to pay us $17.5 million and to provide enhanced insurance coverage. This enhanced insurance includes occurrence-based coverage for years up to the date of the settlement, including years when we did not have any beryllium-related product liability insurance. We agreed to dismiss our bad faith claim against the insurers, which was scheduled to go to trial in the first quarter 2008, as well as the prior damage award of $7.8 million.

 

We applied $1.1 million of the settlement against amounts recorded on our Consolidated Balance Sheet as recoverable amounts for previously incurred indemnity and defense costs. The remaining $16.4 million was credited to income on the Consolidated Statement of Income. We incurred $7.7 million of legal fees pursuing the lawsuit and negotiating the settlement agreement in 2007, yielding a net pre-tax benefit to income of $8.7 million.

 

There were no litigation settlement gains in 2009.

 

Derivative ineffectiveness expense of $4.9 million was recorded in 2009 on a copper derivative embedded in a debt obligation secured during the year. The derivative serves as an economic hedge to changes in the value of our copper inventories. However, the derivative does not qualify as a hedge for accounting purposes and changes in its fair value must be recorded against income as ineffectiveness. The derivative was in a loss position as of year-end 2009 as a result of an increase in the market price of copper since the derivative’s inception. The $4.9 million was a non-cash expense in 2009.

 

Derivative ineffectiveness expense of $0.2 million in 2008 and $0.1 million in 2007 was due to changes in the fair value of an interest rate swap that did not qualify as a hedge for accounting purposes. This swap was terminated in the fourth quarter 2008.

Other-net expense for each of the last three years is summarized in the following table:

 

 

Foreign currency exchange gains and losses result from movements in value of the U.S. dollar against the euro, yen and sterling and the maturity of hedge contracts.

 

The amortization of intangible assets increased in 2009 over 2008 primarily as a result of the intangible assets acquired with Barr in the fourth quarter 2009 and a full year of amortization of the Techni-Met intangible assets. The increased amortization in 2008 over 2007 was due to the intangible assets purchased as part of the Techni-Met acquisition in the first quarter 2008. See Note E to the Consolidated Financial Statements.

 

Metal financing fees are a function of the quantity and market price of precious metals held on consignment and the consignment fee rate. The fee was lower in 2009 than in 2008 as a result of a reduction in the quantities of metal on hand. The fee increased in 2008 over 2007 due to the inclusion of Techni-Met’s metal requirements under our existing lines beginning in the first quarter 2008.

 

The income or expense on the directors’ deferred compensation plan was a function of the outstanding shares in the plan and movements in the market price of our stock. In the first quarter 2009, the Board of Directors amended the deferred compensation plan, eliminating the directors’ ability to transfer their deferral balance between stock and other investment options allowable under the plan. As a result of the amendment, effective with the beginning of the second quarter 2009, the shares being held are no longer marked-to-market against the income statement in accordance with accounting guidelines. Prior to this change, in 2008, the share price decreased, which reduced our liability and created income. In 2007, the share price increased, increasing our liability to the plan and resulting in an expense.

 

In the first quarter of 2007, we sold substantially all of the operating assets and liabilities of Circuits Processing Technology, Inc. (CPT), a wholly owned subsidiary that manufactures thick film circuits, for $2.2 million. CPT, which was acquired in 1996, was a small operation with limited growth opportunities. The loss on the sale was approximately $0.3 million.

 

Other-net expense also includes bad debt expense, cash discounts, gains and losses on the sale of fixed assets and other non-operating items.

 

The operating loss in 2009 was $19.5 million compared to an operating profit of $28.1 million in 2008. This $47.6 million reduction in profitability was primarily a result of the lower gross margin due to the decline in sales and other factors along with the derivative ineffectiveness loss offset in part by the operating and overhead spending savings from the cost reduction efforts, lower foreign currency exchange losses and other items.

 

The 2008 operating profit was $56.4 million less than the record-high operating profit of $84.5 million generated in 2007. The lower of cost or market charge in 2008 compared to the ruthenium pricing benefit net of the lower of cost or market charge and quality return charge in 2007 and the differences in litigation settlement gain between years accounted for $35.5 million of the decline in profit. The remaining $20.9 million decline in profit was due to the margin impact from the lower sales volumes in 2008, increased manufacturing overhead costs, higher amortization expense, foreign currency exchange losses and other factors. Operating profit was 3% of sales in 2008 and 9% of sales in 2007.

 

Interest expense was $1.3 million in 2009, $2.0 million in 2008 and $1.8 million in 2007. While debt levels and the associated interest expense increased in the fourth quarter 2009 mainly as a result of the acquisition of Barr,

average debt levels for the full year 2009 were lower than in 2008. The average borrowing rate was lower in 2009 than in 2008 as well. The average debt level was higher throughout 2008 than in 2007, primarily due to the Techni-Met acquisition, but the average borrowing rate was lower.

 

The (loss) income before income taxes and the income tax (benefit) expense for each of the past three years were as follows:

 

 

The effects of percentage depletion (a tax benefit that results from our mining operations), the production deduction and foreign source income and deductions were major causes of the differences between the effective and statutory rates for all three years. The effect of executive compensation was also a major cause for the difference between the effective and statutory rates in 2008 and 2007.

 

In 2009, the effective rate was affected by a net $0.7 million reduction in the tax reserves that was recorded in accordance with accounting guidelines. In 2008, tax reserves were reduced a net $1.3 million while tax reserves were reduced by an immaterial amount in 2007.

 

See Note P to the Consolidated Financial Statements for a reconciliation of the statutory and effective tax rates.

 

The net loss was $12.4 million, or $0.61 per share diluted, in 2009 compared to net income of $18.4 million, or $0.89 per share diluted, in 2008 and $53.3 million, or $2.59 per share diluted, in 2007.

 

Segment Disclosures

 

The Company has four reportable segments — Advanced Material Technologies and Services, Specialty Engineered Alloys, Beryllium and Beryllium Composites and Engineered Material Systems.

 

Beginning in the first quarter 2009, the operating results for Zentrix Technologies Inc. (Zentrix), a small, wholly owned subsidiary, are included in the Advanced Material Technologies and Services segment. Previously, Zentrix had been included with the corporate office as part of All Other. We made this change because the Advanced Material Technologies and Services segment management is now responsible for Zentrix and this structure is consistent with our internal reporting and how the Chairman of the Board evaluates the operations. The results for the prior years have been recast to reflect this change. Results by segment are shown in Note M to the Consolidated Financial Statements.

 

The All Other column in Note M includes our parent company expenses, other corporate charges and the operating results of BEM Services, Inc., a wholly owned subsidiary that provides administrative and financial oversight services to our other businesses on a cost-plus basis.

 

The All Other column shows an operating loss of $9.4 million in 2009 and $2.9 million in 2008 and an operating profit of $3.9 million in 2007. The increased loss in 2009 as compared to 2008 was due primarily to the $4.9 million derivative ineffectiveness expense recorded in 2009, the $1.1 million litigation settlement gain recorded in 2008, the difference in the directors’ deferred compensation between years and differences in the level of costs charged to the other units offset in part by lower corporate spending and other factors.

 

The change in profitability between 2008 and 2007 was due to a combination of the difference in litigation settlement gains between periods, increased corporate costs, lower charges out to the business units and other factors offset in part by reduced incentive compensation and the difference in the directors’ deferred compensation expense.

Advanced Material Technologies and Services

 

 

Advanced Material Technologies and Services manufactures precious, non-precious and specialty metal products, including vapor deposition targets, frame lid assemblies, clad and precious metal preforms, high temperature braze materials, ultra-fine wire, specialty inorganic materials, optics, performance coatings and electronic packages. These products are used in wireless, semiconductor, photonic, hybrid and other microelectronic applications within the telecommunications and computer market. Other key markets for these products include medical, data storage, defense, security and solar energy. An in-house refinery and metal cleaning operations allow for the reclaim of precious metals from internally generated or customers’ scrap. Due to the high cost of precious metal products, we emphasize quality, delivery performance and customer service in order to attract and maintain applications. Development of new products and new technologies is key for long-term growth. This segment has domestic facilities in New York, Connecticut, Wisconsin, Massachusetts and California and international facilities in Asia and Europe.

 

Sales from Advanced Material Technologies and Services of $460.8 million in 2009 were $19.5 million, or 4%, lower than sales of $480.3 million in 2008. Sales in 2008 were 10% lower than sales of $533.5 million in 2007.

 

We adjust our selling prices daily to reflect the current cost of the precious and various non-precious metals sold. The cost of the metal is generally a pass-through to the customer and we generate a margin on our 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 margin dollars generated by those sales. On average, metal prices were higher in 2009 and 2008 than the respective prior years. We estimate that the higher metal prices increased sales by $5.0 million in 2009 as compared to 2008 and $45.8 million in 2008 as compared to 2007. This higher metal price pass-through offset a portion of the decline in sales due to lower underlying volumes in both 2009 and 2008.

 

After a weak first quarter 2009, sales of vapor deposition targets, lids and wire products manufactured at the Buffalo, New York facility for wireless and semiconductor applications improved and were solid the last three quarters of the year. Sales of these products had grown significantly in 2008 over 2007, but were adversely affected by the global economic crisis beginning late in 2008 as key customers pushed orders out in response to the slowdown in consumer spending.

 

Sales of lids from Thin Film Technology, Inc. (TFT), a wholly owned subsidiary, grew 6% in 2009 over 2008 after growing over 50% in 2008 over 2007. The growth in sales in 2008 was fueled by strong demand from the defense and medical markets and this high level of growth from both markets continued into the first half of 2009. However, a key defense customer lost a major application for its product, resulting in significantly reduced demand for lids from TFT in the second half of 2009. Sales for medical applications remained solid throughout 2009.

 

Sales of inorganic chemicals and other materials from CERAC, a wholly owned subsidiary, declined in 2009 as demand softened due to the global economic crisis. Demand levels started to improve in the fourth quarter 2009. Sales from CERAC had grown at a double digit rate in 2008 over 2007. CERAC’s products are used in optics, security, solar energy and other applications.

 

Sales of precision precious metal polymer films for the medical market from Techni-Met grew in the first half of 2009 over the first half of the prior year. However, a slight softening of demand coupled with a manufacturing quality issue late in the third quarter resulted in reduced shipments in the fourth quarter and sales for the year being lower than 2008. The manufacturing issue has been resolved and we anticipate that shipments will ramp back up to the level prior to this issue during the first quarter 2010. Techni-Met was acquired in early 2008 and contributed to the growth in sales to the medical market in 2008 over 2007.

 

Sales of targets manufactured at the Brewster, New York facility for media applications within the data storage market declined by $3.2 million in 2009 from 2008 after declining $141.9 million in 2008 from 2007. Media sales grew significantly and quickly in 2007 as a result of our product development efforts allowing us to capture a share of this growing market, particularly as customers were converting over to the perpendicular magnetic recording

technology. However, after a quality issue and a change in material specifications, sales declined in the second half of 2007 from the first half of that year. The ramifications of these and other material supply issues continued and, along with weaker market demand in the second half of 2008 and falling prices, caused sales to decline in 2008. Sales remained soft throughout 2009, although there was some improvement in the fourth quarter.

 

While the dollar value of media sales was lower in 2009 than in 2008, volumes processed and shipped were actually higher as the sales value was affected by lower metal prices, changes in the metal composition and a shift in material supply arrangements (i.e., the use of customer supplied metal as opposed to metal that we own). The volume decline in 2008 relative to 2007 was also less than the sales decline.

 

Sales of electronic packages from Zentrix increased 8% in 2009 over 2008 after increasing 2% in 2008 over 2007. Demand levels from Asia improved in the second half of 2009.

 

The acquisition of Barr added to the sales from Advanced Material Technologies and Services in the fourth quarter 2009. Barr produces thin film optical filters that enable complex technologies in a variety of markets. Barr’s products are complementary to the segment’s existing product lines, particularly the products manufactured by TFT. Barr and TFT together offer a variety of solutions for optical applications over a wide spectrum of wavelengths.

 

Advanced Material Technologies and Services generated gross margins of $68.1 million (15% of sales) in 2009, $59.6 million (12% of sales) in 2008 and $103.1 million (19% of sales) in 2007.

 

Margins grew in 2009 on the lower sales volume largely due to lower of cost or market charges of $0.7 million in 2009 compared to $15.2 million in 2008. This $14.5 million benefit between years was partially offset by an estimated $8.0 million margin impact from the lower sales volume. The negative volume impact on margins was net of an improvement in margin contribution from TFT and Zentrix in 2009 from 2008. The manufacturing issue in the third quarter and various inventory valuation adjustments reduced margins by an estimated $1.1 million in 2009. The change in product mix was slightly unfavorable in 2009. Manufacturing overhead costs at the existing facilities were reduced in 2009, but these savings were partially offset by the inclusion of Barr beginning in the fourth quarter. A $2.6 million sales correction in the first quarter 2008 of an error from 2007 affected the margin comparison between 2009 and 2008 as well.

 

The $43.5 million decline in gross margin in 2008 from 2007 was caused largely by the lower sales volumes from the Brewster facility to the data storage market and the $15.2 million of lower of cost or market charges on ruthenium inventories. Margins were also lower in 2008 as a result of the previously discussed net $12.7 million benefit (the $22.9 million benefit from the sale of the low cost ruthenium inventory at higher market prices, the $4.5 million lower of cost or market charge and the $5.7 million quality charge) that flowed through this segment’s margins in 2007. Manufacturing overhead costs increased $12.7 million in 2008 over 2007 as a result of the expansion of several facilities, the addition of Techni-Met and other factors. Offsetting a portion of these unfavorable movements was a growth in margins from various portions of the business, including CERAC, TFT and the Buffalo operations. The acquisition of Techni-Met provided a margin benefit in 2008 as well.

 

SG&A, R&D and other-net expenses from Advanced Material Technologies and Services totaled $45.5 million (10% of sales) in 2009, $48.7 million (10% of sales) in 2008 and $42.6 million (8% of sales) in 2007. Expenses were reduced in 2009 mainly in response to the lower sales volumes. Manpower levels and costs and discretionary spending items were reduced at various facilities during the year.

 

The comparison of expenses between years was affected by the acquisitions. The decline in expenses in 2009 was net of the $1.9 million in SG&A expenses incurred by Barr since its acquisition in the fourth quarter 2009. The increase in expenses in 2008 over 2007 was partially due to the $2.1 million of SG&A and R&D expenses incurred by Techni-Met in 2008 since its acquisition in the first quarter of that year.

 

Incentive compensation expense increased $0.1 million in 2009 over 2008 after declining $1.8 million in 2008 from 2007. R&D costs increased in each of the last two years in order to support the current business and future growth. International SG&A expenses declined $1.3 million in 2009 over 2008. In 2008, international SG&A expenses grew $0.5 million over 2007. Corporate charges were lower in 2009 than in 2008 after increasing in 2008 over 2007.

Amortization of intangible assets increased $0.5 million in 2009 over 2008 largely due to the acquisition of Barr in the fourth quarter 2009. Amortization was $2.4 million higher in 2008 than 2007 as a result of the intangible assets purchased as part of the Techni-Met acquisition.

 

Metal financing fees were $1.2 million lower in 2009 than in 2008 primarily due to a reduction in the average quantity of metal on hand. Metal financing fees increased $2.5 million in 2008 due to the inclusion of Techni-Met and changes in the market value of the metal.

 

Operating profit from Advanced Material Technologies and Services was $22.6 million in 2009, more than double the profit of $10.8 million in 2008 as a result of the margin improvement and lower expenses. Profit in 2008 was $49.6 million lower than the profit of $60.4 million in 2007. The lower profit in 2008 resulted primarily from the fall-off in data storage market sales and the related ruthenium inventory issues. Operating profit was 5% of sales in 2009, 2% in 2008 and 11% in 2007.

 

Specialty Engineered Alloys

 

 

Specialty Engineered Alloys manufactures and sells three main product families:

 

Strip products, the larger of the product families, include thin gauge precision strip and thin diameter rod and wire. These copper and nickel beryllium alloys 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, appliance and medical;

 

Bulk products are copper and nickel-based alloys manufactured in plate, rod, bar, tube and other customized forms that, depending upon the application, may provide superior strength, corrosion or wear resistance, thermal conductivity or lubricity. While the majority of bulk products contain beryllium, a growing portion of bulk products’ sales is from non-beryllium-containing alloys as a result of product diversification efforts. Applications for bulk products include oil and gas drilling components, bearings, bushings, welding rods, plastic mold tooling and undersea telecommunications housing equipment; and

 

Beryllium hydroxide is produced by Brush Resources Inc., a wholly owned subsidiary, at its milling operations in Utah from its bertrandite mine and purchased beryl ore. The hydroxide is used primarily as a raw material input for strip and bulk products and, to a lesser extent, by the Beryllium and Beryllium Composites segment. External sales of hydroxide from the Utah operations were less than 4% of Specialty Engineered Alloys’ total sales in each of the three most recent years.

 

Strip and bulk products are manufactured at facilities in Ohio and Pennsylvania and are distributed internationally through a network of company-owned service centers and outside distributors and agents.

 

Sales from Specialty Engineered Alloys of $172.5 million in 2009 were $127.4 million, or 42%, lower than sales of $299.9 million in 2008 primarily due to the impact of the global economic crisis on shipments of both strip and bulk products. Sales to all major markets declined at double digit rates in 2009 from the 2008 levels. Sales in 2008 were 3% higher than sales of $290.0 million in 2007 as a result of improved pricing and mix, the translation effect on foreign currency denominated sales and the pass-through of higher metal prices.

 

Sales of strip products declined in 2009 and 2008 from the respective prior year while sales of bulk products declined in 2009 from 2008 after increasing in 2008 over 2007.

 

Demand for strip products from the telecommunications and computer and automotive electronic markets, which was relatively soft during the first three quarters of 2008, declined severely in the fourth quarter 2008 and the first half of 2009 as a result of low consumer spending and excess inventories in the supply chain. As this inventory was worked off and overall market conditions started to improve, demand for strip products increased in the second half of 2009 over the first half of the year. This improvement in demand in the second half of the year was largely for telecommunications applications in Asia and automotive and appliance applications in Europe.

Initially, bulk product volumes were not affected as severely by the global economic crisis as strip products. However, a fall-off in demand from the oil and gas and aerospace markets coupled with high downstream inventory positions within the supply chain led to a significant decline in volumes in 2009. Bulk product sales into the oil and gas market were weak as a result of the soft demand for energy which is keeping the price of oil below the level that would spur significant exploration and production increases. The growth in bulk product sales in 2008 over 2007 was partially due to increased sales for oil and gas applications as a result of higher energy prices during that year. After growing in 2008 over 2007, sales for aerospace applications softened in 2009 due to ongoing deferrals of new aircraft builds and decreased repair and maintenance activities. Some improvement in demand was seen in the second half of 2009 for military and heavy equipment applications as well as plastic mold tooling for the appliance and automotive markets. Bulk products remained well positioned in its markets and we believe sales should grow once market conditions improve.

 

Strip product volumes (i.e., pounds shipped) were 32% lower in 2009 than 2008 and 13% lower in 2008 than in 2007. Bulk product volumes declined 45% in 2009 from 2008 after growing 6% in 2008 over 2007. Copper prices were lower on average in 2009 than in 2008 and were responsible for an estimated $14.1 million of the sales decline in 2009 from 2008. Higher copper prices accounted for an estimated $4.8 million of the sales increase in 2008 over 2007.

 

The order entry rate was extremely weak in the first half of 2009. However, the rate improved in the second half of 2009, primarily due to increased demand for strip products, and the order entry rate in the fourth quarter 2009 exceeded the rate in the fourth quarter 2008 (although it was still below the rate from the first nine months of 2008). The improvement in the order entry rate continued into the early portion of 2010.

 

In response to the lower sales level, Alloy Products implemented numerous cost-reduction efforts beginning in the fourth quarter 2008 and continuing into 2009. These efforts included a reduction in force of approximately 200 people in manufacturing, sales and administration by December 2009 from the September 2008 level.

 

The gross margin on sales by Specialty Engineered Alloys was $9.0 million in 2009 compared to $59.3 million in 2008 and $58.2 million in 2007. The gross margin was 5% of sales in 2009 and 20% of sales in both 2008 and 2007.

 

The $50.3 million margin decline in 2009 was primarily due to the $127.4 million reduction in sales. Production volumes were even lower than sales in 2009 as inventories were worked down throughout the year. The lower production volumes, however, negatively affected margins as a result of increased manufacturing inefficiencies and lower machine utilization rates. In addition, unplanned downtime on a key piece of equipment in the fourth quarter 2009 reduced margins by an estimated $1.3 million. The change in product mix was unfavorable in 2009 as well. Manufacturing overhead spending, including manpower and utilities, was lower in 2009 than 2008 and helped to mitigate a portion of the negative impact the above items had on margins. Pricing improvements implemented during 2009 also provided a small benefit to margins in the year.

 

The margin growth in 2008 over 2007 was due to the benefits of improved pricing and mix offset in part by the margin loss on the lower sales volume, higher costs of utilities, freight and certain chemicals and lower production volumes.

 

Total SG&A, R&D and net-other expenses of $41.3 million in 2009 were $12.2 million lower than expenses of $53.5 million in 2008. Expenses in 2007 totaled $50.7 million. Expenses were 24% of sales in 2009, 18% of sales in 2008 and 17% of sales in 2007.

 

The lower expenses in 2009 as compared to 2008 were largely due to the aforementioned cost reduction efforts offset in part by severance costs. Sales-related expenses, including commissions and advertising, were also lower in 2009 than in 2008. Lower incentive compensation and foreign currency exchanges losses contributed to the decline in expenses in 2009 as well.

 

In the fourth quarter 2009, we implemented a plan to realign the distribution of Alloy Products in the United Kingdom. The plan included the use of an independent distributor and should result in lower overhead costs and improved profitability from that operation in future periods.

The $2.8 million growth in expenses in 2008 was primarily due to higher foreign currency exchange losses, increased incentive compensation accruals and a higher bad debt expense. R&D efforts and expenses increased slightly as well. These higher costs were partially offset by lower corporate charges in 2008.

 

Specialty Engineered Alloys generated an operating loss of $32.3 million in 2009 as a result of the margin decline due to the lower sales volume and other factors offset in part by the cost saving efforts and other expense reductions. Operating profit was $5.8 million in 2008, down $1.8 million from the profit of $7.6 million earned in 2007.

 

While we did see benefits from a growing order entry rate and from the cost reduction efforts late in the year, we will continue to investigate alternatives to further reduce costs and/or restructure this business in order to improve profitability.

 

Beryllium and Beryllium Composites

 

 

Beryllium and Beryllium Composites manufactures beryllium-based metals and metal matrix composites in rod, 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. This segment also manufactures beryllia ceramics through Brush Ceramic Products Inc., a wholly owned subsidiary in Tucson, Arizona. Defense and government-related applications, including aerospace, is the largest market for Beryllium and Beryllium Composites, while other markets served include medical, telecommunications and computer, electronics (including acoustics), optical scanning and general industrial markets.

 

Sales from Beryllium and Beryllium Composites of $47.0 million in 2009 declined 26% from sales of $63.6 million in 2008. Sales in 2008 were $3.1 million, or 5%, higher than sales of $60.5 million in 2007.

 

The fall-off in sales in 2009 was largely due to softer demand from the defense market, mainly in the second half of the year. The primary defense platforms for beryllium products are aerospace and missile systems and we began to experience delays in orders for these applications in the third quarter. Funding for orders for various projects was delayed while other orders were pushed out into future periods. We do not believe the decline in defense sales was due to any significant applications being lost to competing materials or technologies. Demand for defense applications has shown improvement in the first quarter of 2010.

 

Sales from the Fremont facility were 19% lower in 2009 than in 2008, largely due to weaker demand for medical and industrial x-ray window assemblies although sales for assemblies and other beryllium foil products improved modestly in the fourth quarter 2009 over the previous quarters in 2009. We continued our application development work on high-end speaker domes, which is a potential niche market for beryllium materials, during 2009. This product has been well-received thus far and we anticipate slow but steady growth in this market in 2010.

 

Sales of ceramics declined 42% in 2009 from 2008 as the global economic crisis had a major impact on a key ceramic customer’s business. We anticipate that business levels at this customer will ramp up at modest rates in the first half of 2010.

 

Shipments for defense applications improved in the last three quarters of 2008 after a sluggish first quarter and were the primary cause for the increase in Beryllium and Beryllium Composites’ sales in 2008 over 2007. Sales for medical and industrial x-ray applications were down slightly in 2008 from 2007 while sales for acoustic applications grew modestly in 2008. Sales of new products, including applications using near net shape technologies, also contributed to the sales improvement in 2008 over 2007. Ceramic sales grew 3% in 2008 over 2007.

 

Sales from Beryllium and Beryllium Composites during 2007 included shipments under two distinct, non-repeating programs — the James Webb Space Telescope (JWST) for NASA and the Joint European Torus (JET), a nuclear fusion experimental reactor, totaling $3.1 million. These projects were completed in 2007 and shipments did not repeat in subsequent years.

Beryllium and Beryllium Composites generated a gross margin of $11.1 million (24% of sales) in 2009, $19.6 million (31% of sales) in 2008 and $20.1 million (33% of sales) in 2007. The main cause of the decline in the gross margin dollars and rate in 2009 was the significant fall-off in sales. The margin impact of the lower volumes was partially mitigated by a reduction in direct and overhead manufacturing costs, including manpower, supplies and utility costs. Material input costs increased in 2009 over 2008 and had a negative impact on margins. The change in product mix was slightly unfavorable in 2009.

 

The $0.5 million decline in margins in 2008 as compared to 2007 resulted from an unfavorable product mix shift (which resulted from the completion of the JWST and JET projects and increased sales for applications that typically carry lower margins), higher metal feedstock costs and an increase in manufacturing overhead costs partially offset by the margin benefit of the higher sales volume.

 

SG&A, R&D and other-net expenses were $9.0 million (19% of sales) in 2009, $11.2 million (18% of sales) in 2008 and $12.2 million (20% of sales) in 2007. The lower expense in 2009 was due to the cost-reduction initiatives and reduced incentive compensation. These benefits were partially offset by an increase in R&D expenses.

 

The $1.0 million decline in expenses in 2008 was due to lower incentive expense and corporate charges. Selling and other administrative costs were unchanged while R&D increased slightly as a result of higher activity levels.

 

Operating profit from Beryllium and Beryllium Composites declined $6.3 million, from $8.4 million in 2008 to $2.1 million in 2009. The reduction in profit in 2009 resulted from the margin impact from the lower sales volume offset in part by the cost reductions. The operating profit in 2008 was a 7% improvement over the $7.8 million operating profit generated in 2007 as the reduction in incentive compensation and other expenses more than offset the lower gross margin. Operating profit was 5% of sales in 2009 and 13% of sales in 2008 and 2007.

 

Engineered Material Systems

 

 

Engineered Material Systems include 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. Our 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 these products include connectors, contacts and semiconductors while the largest markets are automotive electronics, telecommunications and computer and data storage. The energy and defense and medical electronic markets are smaller but offer further growth opportunities. Engineered Material Systems are manufactured at our Lincoln, Rhode Island facility.

 

Sales from Engineered Material Systems totaled $34.7 million in 2009, a decline of 47% from sales of $65.9 million in 2008. Sales from all major product lines were lower in 2009 than in 2008. Sales declined 7% in 2008 from sales of $70.9 million in 2007.

 

The significant decline in sales in 2009 was caused by the global economic crisis as demand from all of this segment’s key markets dropped quickly and severely beginning in the fourth quarter 2008. Sales reached their near-term low point in the first quarter 2009, having declined to less than one-third of sales in the first quarter 2008. Sales slowly began to recover, growing each quarter in 2009 and sales in the fourth quarter 2009 were more than double sales from the first quarter.

 

Sales of materials for disk drive applications, a new product that had grown into a sizable portion of Engineered Material Systems’ total sales in 2008 and 2007, fell to an immaterial level in the first quarter 2009. Shipment levels then grew over the balance of the year helping to fuel the quarter-to-quarter improvement in 2009. The improvement during 2009 also resulted from increased shipments to the automotive electronics market, particularly to Europe which was partially due to the weaker dollar, as well as the development of new products and applications.

The lower sales in 2008 as compared to 2007 were primarily due to weak demand from the automotive electronics market. Improved demand from the European automotive market in the first half of 2008 had helped to offset a portion of the weakness in the U.S. market, but the European market weakened in the second half of that year.

 

The order entry rate improved over the last three quarters of 2009 from the extremely low levels from the first quarter of the year. By the fourth quarter 2009 and into early first quarter 2010, demand had strengthened across all major markets and order entry had stabilized at a level above the total 2009 sales but still below the 2008 sales level.

 

The gross margin on Engineered Material Systems’ sales totaled $3.5 million in 2009, $13.5 million in 2008 and $13.0 million in 2007. As a percent of sales, gross margin fell to 10% of sales in 2009 after improving to 21% of sales in 2008 from 18% in 2007.

 

The lower margin dollars and rate in 2009 were due to the severe decline in sales during the year. The change in product mix was also unfavorable in 2009. In response to the lower sales, labor and other direct manufacturing costs were reduced approximately 26% in 2009 from the 2008 level. Production schedules were revised to allow for manufacturing to be campaigned on various equipment lines in order to offset a portion of the inefficiencies created by the low production volumes. Manufacturing overhead costs, including manpower, maintenance and utilities, were also reduced by $1.6 million in 2009 from the 2008 level.

 

The margin grew in 2008 despite the lower sales due to reduced manufacturing and commodity costs. In addition, yields and other manufacturing efficiencies improved beginning in the fourth quarter 2007 and continued during 2008. A portion of these manufacturing improvements resulted from capital investments completed at that time.

 

SG&A, R&D and other-net expenses of $6.0 million from Engineered Material Systems were $1.6 million lower than in 2008. In addition to the spending reductions, the savings resulted from lower incentive expense and corporate charges. In 2008, these expenses were $0.7 million lower than in 2007 due to a reduction in incentive expense and corporate charges.

 

Engineered Material Systems generated an operating loss of $2.5 million in 2009 compared to an operating profit of $5.9 million (9% of sales) in 2008 and $4.7 million (7% of sales) in 2007. The segment was profitable in the second half of 2009.

 

International Sales and Operations

 

We operate in worldwide markets and our international customer base continues to expand geographically 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.

 

The Advanced Material Technologies and Services segment has operations in Singapore, Taiwan, the Philippines, China, Ireland and the Czech Republic. These facilities provide a combination of light manufacturing, finishing operations and distribution services.

 

Brush International has service centers in Germany, Japan and Singapore that primarily focus on the finishing and distribution of materials from Specialty Engineered Alloys while also providing additional local support to portions of our other businesses.

 

We realigned the operating activities at Brush International’s service center in England in the fourth quarter 2009. A portion of the distribution of products into England has been outsourced while the balance will be managed by other Company facilities.

 

We also have branch sales offices and other operations in various countries, including China, Korea and Taiwan, and we utilize an established network of independent distributors and agents throughout the world. Approximately 11% of our workforce is based overseas.

The following chart summarizes total international sales by region for the last three years:

 

 

International sales include sales from international operations and direct exports from the U.S. The international sales in the above chart are included in the individual segment sales previously discussed.

 

The lower international sales in 2009 were primarily due to the global economic crisis and the resulting fall-off in demand, particularly from the telecommunications and computer market. Sales to Asia declined 17% in 2009 from the 2008 levels while sales to Europe fell 36%. The decline in international sales in 2008 from the high level in 2007 was primarily due to the previously discussed decline in sales of ruthenium targets to the data storage market in Asia. Asian sales declined 30% while European sales grew 4% in 2008.

 

Telecommunications and computer, automotive electronics, appliance (primarily in Europe) and data storage are the largest international markets for our products. 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 Asia.

 

Sales from the European and certain Asian operations are denominated in the local currency. Exports from the U.S. and the balance of the sales from the Asian operations are typically denominated in U.S. dollars. Local competition generally limits our ability to adjust selling prices upwards to compensate for short-term unfavorable exchange rate movements.

 

We have a hedge program with the objective of minimizing the impact of fluctuating currency values on our consolidated operating profit. See “Critical Accounting Policies” below.

 

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.

 

 

Settlement payment and dismissal for a single case may not occur in the same period.

 

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.

 

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.

 

Based upon currently known facts and assuming collectibility of insurance, we do not believe that resolution of the current and future beryllium 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, 2009, one purported class action was pending.

 

The balances recorded on the Consolidated Balance Sheets associated with beryllium litigation were as follows:

 

 

The reserve and the recoverable changed by equal amounts in 2009 due to changes in the outstanding cases. The $0.9 million payment to settle three cases in 2009 was fully insured.

 

Regulatory Matters.  Standards for exposure to beryllium are under review by the United States Occupational Safety and Health Administration (OSHA) and by other governmental and private standard-setting organizations. One result of these reviews will likely be more stringent worker safety standards. Some organizations, such as the California Occupational Health and Safety Administration and the American Conference of Governmental Industrial Hygienists, have adopted standards that are more stringent than the current standards of OSHA. The development, proposal or adoption of more stringent standards may affect the buying decisions by the users of beryllium-containing products. If the standards are made more stringent and/or our customers or other downstream users decide to reduce their use of beryllium-containing products, our results of operations, liquidity and financial condition could be materially adversely affected. The impact of this potential 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. The magnitude of this potential adverse effect cannot be estimated.

 

FINANCIAL POSITION

 

Net cash from operations of $41.5 million generated in 2009 was $35.3 million lower than the cash flow from operations of $76.8 million in 2008. The decline was primarily due to the net loss in 2009 plus differences in the change in various working capital balances, including receivables and inventory, and deferred taxes. Cash flow from operations in 2008 improved $25.9 million from the cash flow from operations of $50.9 million in 2007 despite the decline in net income in that year as a result of changes in working capital levels and the benefits of depreciation and amortization.

 

As previously noted, changes in the cost of precious and base metals are essentially passed on to customers. Therefore, while sudden movements in the price of metals can cause a temporary imbalance in our cash receipts and payments in either direction, once prices stabilize our cash flow tends to stabilize as well.

 

Working Capital

 

Cash balances totaled $12.3 million at year-end 2009 compared to $18.5 million at year-end 2008. A portion of the cash on hand, increased debt and the cash flow from operations were used to fund the acquisition of Barr and

capital expenditures during the year. Cash declined $13.2 million during 2008. Cash was used along with additional borrowings and the cash flow from operations to fund the acquisition of Techni-Met, capital expenditures and the repurchase of shares during that year.

 

Accounts receivable of $84.0 million at December 31, 2009 was $3.9 million, or 4%, lower than the receivable balance of $87.9 million at December 31, 2008. The receivable balance declined despite sales in the fourth quarter 2009 being higher than sales in the fourth quarter 2008 due to an improvement in collections. The days sales outstanding (DSO), a measure of the average time period to collect receivables, improved by approximately five days as of the end of 2009 from the end of 2008.

 

Accounts written off to bad debts were lower in 2009 than in 2008 and were relatively minor. Bad debts had increased by a modest amount in 2008 over 2007 due to the bankruptcy filing of a customer who purchased scrap from one of our operations. We have procedures in place to closely monitor our accounts receivable aging and to follow-up on past due accounts. We evaluate the credit position of new customers in advance of the initial sale and we evaluate our existing customers’ credit positions on an ongoing basis. We will revise credit terms offered to our customers as conditions warrant in order to minimize our exposures.

 

Accounts receivable declined $9.5 million, or 10%, in 2008 as a result of lower sales volumes offset in part by a slow down in the DSO.

 

Other receivables of $11.1 million were outstanding as of year-end 2009 compared to $3.4 million from year-end 2008. The majority of the amounts due at both year ends were for reimbursement for equipment purchased under a government contract. These billings are typically paid by the government on a current basis. The 2009 receivable also included a $0.9 million advance of a legal settlement for which we were reimbursed in full by our insurance provider in the first quarter 2010. The 2008 receivable included $1.4 million for the final purchase price adjustment on the Techni-Met acquisition; we received this payment in the first quarter 2009.

 

Inventories totaled $130.1 million as of December 31, 2009, a decline of $26.6 million, or 17%, from inventories of $156.7 million as of year-end 2008. Inventory turns, a measure of how efficiently inventory is utilized, improved as of year-end 2009 as compared to year-end 2008. This improvement occurred primarily in the second half of the year as inventory positions were held fairly constant while sales increased.

 

The majority of the inventory reduction in 2009 was within the Specialty Engineered Alloys segment as inventory was adjusted to the lower business levels. Total pounds in inventory were down 24% from 2008 year-end, with the finished goods inventories being reduced further than raw materials and work-in-process due in part to mild changes in distribution channels. Inventories within Engineered Material Systems declined over the course of 2009, but started to climb in the fourth quarter in response to the improved order entry. Their 2009 year-end inventory was down approximately 10% from year-end 2008.

 

Inventories as of year-end 2009 within Advanced Material Technologies and Services were essentially unchanged from the prior year-end as various reductions from the existing facilities were offset by the inventory acquired with Barr. Beryllium and Beryllium Composites’ inventory was also relatively unchanged in 2009.

 

Total inventories were $8.5 million, or 5%, lower at year-end 2008 than year-end 2007. Inventories at the Brewster facility within the Advanced Material Technologies and Services segment declined in response to the lower sales volumes and as a result of the $15.2 million lower of cost or market adjustment. This decline was partially offset by an increase in inventories within the Specialty Engineered Alloys segment. Those inventories grew approximately 13% in 2008 due to increased mining activity at the Utah operations and as a result of additional purchases of copper late in the fourth quarter to allow for portions of the production activity at the Elmore facility to be campaigned for scheduling and efficiency purposes in the fourth quarter 2008 and first quarter 2009. Inventory turns were approximately 10% slower at year-end 2008 than at year-end 2007.

 

The price of gold and copper increased significantly during the fourth quarter 2009. The price of these and other metals we use, including nickel, can be quite volatile. Changes in market prices can lead to changes in the value of our inventory on a first-in, first-out method (FIFO). The impact of the changing metal prices was partially offset by the use of the last-in, first-out (LIFO) valuation method for these metals, limiting the impact on the

fluctuation in inventory carrying value on the balance sheet as the LIFO process will result in the current prices being charged to the income statement. See “Critical Accounting Policies” below.

 

Prepaid expenses, including insurance, income taxes, property taxes, rent, manufacturing supplies and other items, were $28.0 million as of year-end 2009 compared to $23.7 million as of year-end 2008. The 2009 change was due to differences in the timing of payments and a variety of other factors. Prepaid expenses increased $6.0 million in 2008, primarily due to an increase in prepaid income taxes.

 

Other assets of $42.0 million as of December 31, 2009 were $7.6 million higher than the balance of $34.4 million as of December 31, 2008. Intangible assets acquired as part of the Barr purchase totaled $12.2 million while the amortization of existing and acquired intangible assets totaled $4.5 million in 2009. The insurance recoverable account declined $1.4 million as a result of the resolution of various cases in 2009.

 

Other assets increased $22.6 million in 2008 primarily due to the intangible assets acquired with Techni-Met as well as an increase to the insurance recoverable account offset in part by the amortization of the existing and acquired intangible assets.

 

Accounts payable totaling $36.6 million as December 31, 2009 was $8.6 million higher than the $28.0 million balance as of December 31, 2008. The increase was due to the timing of payments, the inclusion of Barr and a higher level of operating activities. The 2008 year-end balance was $0.9 million higher than the prior year-end balance of $27.1 million.

 

Accrued salaries and wages of $16.3 million at year-end 2009 were $6.3 million lower than at year-end 2008. Accrued salaries and wages declined $11.6 million during 2008. The changes in the balance in both years were due to changes in the incentive compensation accruals, manpower levels and other related factors.

 

Unearned revenue, which is a liability representing billings to customers in advance of the shipment of product, was $0.4 million as of December 31, 2009 and $0.1 million as of December 31, 2008.

 

Other Long-term Liabilities

 

Other long-term liabilities of $49.3 million as of year-end 2009 were $29.9 million higher than the $19.4 million balance at year-end 2008. Other long-term liabilities totaled $11.6 million as of year-end 2007. Long-term unearned income increased $28.2 million during 2009 and $8.0 million during 2008 for reimbursements received under a government funded capital expenditure program. See “Critical Accounting Policies” below. Other long-term liabilities also increased $1.9 million in 2009 for the estimated fair value of the earn-out liability for the potential payments to be made to the sellers of Barr based upon Barr’s future performance. The legal reserve declined $1.3 million in 2009 as a result of a settlement and other changes to the outstanding cases.

 

Other increases in 2008, including a growth in the legal reserve and rent accruals, were offset by a reduction to the long-term portion of the incentive compensation accrual in that year.

 

Retirement and Post-employment Benefits

 

The liability for retirement and post-employment benefits was $82.4 million at December 31, 2009, a decrease of $14.8 million from the balance of $97.2 million at December 31, 2008.

 

Included within these balances is the recorded liability for the domestic defined benefit pension of $44.2 million as of December 31, 2009 and $58.7 million as of December 31, 2008. The projected benefit obligation for this plan, which covers the majority of our domestic employees, was $149.9 million as of year-end 2009 versus $137.5 million at year-end 2008. The market value of the plan assets grew from $78.8 million as of year-end 2008 to $105.7 million as of year-end 2009. This $26.9 million growth was due to actual investment gains of $15.4 million and Company contributions of $18.3 million offset in part by benefit and expense payments totaling $6.8 million. In 2009, we increased the pension liability and recorded a net $0.4 million pre-tax charge to other comprehensive income (OCI), a component of shareholders’ equity, as a net result of a change in the discount rate, the plan performance during the year, the curtailment recorded in the first quarter and other factors.

A portion of our domestic retirees and current employees are eligible to participate in a retiree medical benefit plan. The liability for this unfunded plan was $30.9 million as of December 31, 2009 and $32.8 million at December 31, 2008. The plan expense was $2.2 million in 2009 and $2.4 million in 2008.

 

Brush International’s subsidiary in Germany has an unfunded retirement plan for its employees while its subsidiary in England has a funded retirement plan.

 

See Note I to the Consolidated Financial Statements for additional details on our retirement obligations.

 

Depreciation and Amortization

 

Depreciation, depletion and amortization was $31.9 million in 2009, $33.8 million in 2008 and $23.9 million in 2007. The decline in 2009 from 2008 was due to reduced mine amortization at our Utah operations offset in part by an increase in the intangible asset amortization due to the Barr acquisition. The increase in expense in 2008 was due in part to additional mine activity in that year and the acquisition of intangible assets as part of the Techni-Met purchase.

 

Capital Expenditures

 

A summary of capital expenditures over the past three years is as follows:

 

 

We have a contract with the U.S. Department of Defense (DoD) for the design and development of a new facility for the production of primary beryllium. The total cost of the project is estimated to be approximately $90.3 million; we will contribute land, buildings, research and development, technology and ongoing operations valued at approximately $23.2 million to the project. The DoD will reimburse us for the balance of the project cost. All of the funds required to complete the project are in the President’s approved defense budget, but are still subject to final House and Senate appropriations approvals. Reimbursements from the DoD are recorded as unearned income and included in other long-term liabilities on the Consolidated Balance Sheets. We began construction of the facility early in the third quarter 2008 and we anticipate it will be completed in the second half of 2010. Since 2000, all of our metallic beryllium requirements have been supplied from materials purchased from the National Defense Stockpile and international vendors. Successful completion of this project will allow for the creation of the only domestic facility capable of producing primary beryllium.

 

We reduced the level of capital spending, net of the reimbursements from the DoD, by approximately 40% of the spending rate in 2008 and 44% from the 2007 spending rate due to the decline in profitability in 2009. The net capital spending was below the level of depreciation in both 2009 and 2008.

 

Capital spending by Advanced Material Technologies and Services was $4.5 million in 2009 and $7.9 million in 2008. Spending in 2009 included a micro-slitter, clean room and other investments into the Techni-Met facility designed to expand our capabilities in order to further penetrate the medical and solar energy markets. Capital spending in 2008 included the completion of the new facility in China and the expansion of the Brewster facility. Spending in both years included the implementation of new software systems.

 

Specialty Engineered Alloys’ capital spending totaled $3.8 million in 2009 compared to $9.1 million in 2008 as spending was reduced in 2009 due to the operating loss within this segment. Spending in both years was primarily to replace or upgrade discrete pieces of equipment at the Ohio and Pennsylvania facilities. Included in the capital spending totals for this segment were mine development costs of $0.8 million in 2009 and $0.4 million in 2008. We anticipate that mine development spending will increase significantly in 2010 as we will be opening a new bertrandite mine pit in Utah.

In addition to the new beryllium plant, capital spending within the Beryllium and Beryllium Composites segment included an investment in new coating technologies and expenditures to support the development of acoustic applications.

 

Capital spending within Engineered Material Systems was $0.4 million in 2009 and $1.1 million in 2008. Spending was limited to high priority items in 2009 due to the decline in profitability. The installation of a new efficient high technology work center at the Lincoln facility was completed in 2008.

 

Approximately 79% of the capital spending in 2009 was for capacity expansions, largely the new beryllium facility. Maintenance capital items accounted for an estimated 15% of the spending while new technology projects accounted for the remaining 6%.

 

In addition to the above capital expenditure totals, we acquired the outstanding capital stock of Barr for $55.2 million in cash in the fourth quarter 2009. Preliminary goodwill assigned to the transaction totaled $31.3 million. The purchase price is subject to final adjustment based upon resolution of matters defined in the purchase agreement. The sellers also have an opportunity to earn additional payments based upon Barr’s performance over the next five years.

 

In the first quarter 2008, we acquired the operating assets of Techni-Met for $87.5 million. We received $1.4 million from escrow in the first quarter 2009 as the final purchase adjustment under the terms of the agreement. Subsequent to the acquisition, we transferred the precious metal portion of Techni-Met’s inventory to our existing consignment lines and received its fair value of $22.9 million back from the financial institution. Goodwill assigned to the transaction totaled $13.9 million.

 

Debt

 

Outstanding debt totaled $64.5 million as of December 31, 2009, an increase of $22.7 million over the prior year end. Total debt had declined $2.8 million over the first three quarters of 2009 as a result of the cash flow from operations, but then increased $25.5 million in the fourth quarter in order to partially fund the acquisition of Barr. Short-term debt, which included U.S. dollar, metal and foreign currency denominated borrowings, totaled $56.2 million while long-term debt totaled $8.3 million as of year-end 2009.

 

We have a $240.0 million revolving credit agreement that matures in the fourth quarter 2012. It is a committed facility and is comprised of sub-facilities for revolving loans, swing line loans, letters of credit and foreign currency denominated borrowings. The agreement is subject to a maximum availability calculation. We were in compliance with all of our debt covenants as of December 31, 2009.

 

Total outstanding debt of $41.8 million as of year-end 2008 was $6.3 million higher than the outstanding debt as of year-end 2007. Short-term debt of $30.6 million increased $5.7 million during 2008. Long-term debt grew $0.6 million during 2008 and stood at $11.2 million as of year-end 2008. Debt increased in the first quarter 2008 primarily due to the acquisition of Techni-Met and then decreased each quarter over the balance of the year as a result of the cash flow from operations.

 

Shareholders’ Equity

 

Shareholders’ equity decreased $7.2 million from $347.1 million as of year-end 2008 to $339.9 million as of year-end 2009. Equity decreased by $6.6 million in 2008. The comprehensive loss, which includes net income (loss), changes in derivative fair values and the pension liability that are charged directly to equity and the change in the cumulative translation adjustment, was $11.2 million in 2009 and $4.9 million in 2008. See Note L to the Consolidated Financial Statements.

 

Proceeds from the exercise of approximately 32,000 options totaled $0.5 million in 2009. In 2008, we received $0.2 million of cash for the exercise of approximately 12,000 options.

 

In the third quarter 2008, our Board of Directors adopted a share buyback program authorizing the repurchase of up to one million shares of stock. The primary purpose of the program is to offset the dilution caused by stock-based compensation plans. In 2008, we had repurchased 300,000 shares at a cost of $5.0 million under this plan. There were no repurchases under this plan in 2009.

 

Equity was also affected by stock-based compensation expense, the tax benefits on the exercise of options and other factors in both 2009 and 2008.

 

Off-balance Sheet Obligations

 

We maintain the majority of the precious metals we use in production on a consignment basis in order to reduce our exposure to metal price movements and to reduce our working capital investment. See Item 7A, “Quantitative and Qualitative Disclosures about Market Risk”. The notional value of the off-balance sheet inventory was $98.7 million at December 31, 2009, a decrease of $5.5 million from the $104.2 million outstanding at December 31, 2008. The decline was due to a reduction in the ounces on hand offset in part by an increase in metal prices.

 

Contractual Obligations

 

A summary of payments to be made under long-term debt agreements and operating leases, pension plan contributions and material purchase commitments by year is as follows:

 

 

Consistent with our prior practice, we anticipate that we will renegotiate a new debt agreement prior to the maturation of the current revolving credit agreement in 2012; however, we cannot guarantee that we will be able to enter into a replacement facility with similar terms as the existing facility. Outstanding borrowings under the revolving credit agreement classified as short-term debt totaled $11.4 million as of December 31, 2009. 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, 2009. See Note G to the Consolidated Financial Statements for further leasing details.

 

The pension plan contribution of $8.1 million in the above table refers to the domestic defined benefit plan. Contributions to the plan are designed to comply with ERISA guidelines and are based upon the plan’s funded ratio, which is affected by actuarial assumptions, investment performance, benefit payouts, plan expenses, amendments and other factors. Therefore, it is not practical to estimate contributions to the plan beyond one year. The amount shown in the table represents our best estimate of the 2010 contribution as of early in 2010.

 

The purchase commitments of $1.8 million are for capital equipment to be acquired in 2010.

 

Liquidity

 

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 strategic acquisitions.

 

The cumulative cash flow from operations totaled $169.2 million in 2007 through 2009 while capital expenditures, net of amounts reimbursed by the government, totaled $74.7 million.

 

A summary of the outstanding debt, cash balances and available borrowing capacity as of the end of each of the last three years is as follows:

 

 

Debt net of cash is a non-GAAP measure. We are providing this information because we believe it is more indicative of our financial position. It is also a measure our management uses to assess investment and other decisions.

 

As the chart indicates, debt net of cash increased $48.4 million from the end of 2007 to the end of 2009. During this time period, we acquired Barr for $55.2 million and Techni-Met for a net outlay of $63.1 million (the purchase price less the cash received for the reimbursement of their gold against the consignment line). The increase in debt was less than the net outlay for these two acquisitions as a result of the cash flow from operations being in excess of capital spending.

 

The available borrowing capacity in the chart represents the amounts that could be borrowed under the revolving credit agreement and other secured lines existing as of December 31 of each year depicted. The applicable debt covenants have been taken into account when determining the available borrowing capacity. One of these covenants restricts the borrowing capacity to a multiple of the twelve-month trailing earnings before interest, income taxes, depreciation and amortization and other adjustments. The available borrowing capacity is lower as of year-end 2009 than it was at year-end 2008 because of the effect the lower earnings in 2009 had on this covenant. We had an operating loss of $11.4 million in the first quarter 2009. By the end of the first quarter 2010, the first quarter 2009 results will not be included in the covenant calculation. All else equal, our borrowing capacity will increase in the first quarter 2010 to the extent that our earnings in the first quarter 2010 improve over the first quarter 2009 loss. The available unused capacity is also lower at year-end 2009 due to the higher level of outstanding borrowings.

 

The debt-to-total-debt-plus-equity ratio, a measure of balance sheet leverage, increased to 16% as of December 31, 2009 from 11% as of December 31, 2008 and 9% as of December 31, 2007. The increase in 2009 was largely due to the additional borrowings to finance the Barr acquisition. Management believes that this level of leverage is within the long-term average for the Company. There are no mandatory long-term debt repayments due in 2010.

 

The unused and available capacity under the consignment lines totaled approximately $57.2 million as of year-end 2009.

 

The working capital ratio, which compares current assets excluding cash to current liabilities excluding debt, was 3.2 to 1.0 as of year-end 2009 compared to 3.8 to 1.0 as of year-end 2008.

 

Cash on hand does not affect the covenants or the borrowing capacity. Portions of the cash balances may be invested in high quality, highly liquid investments with maturities of three months or less.

 

After acquiring Barr in the fourth quarter 2009, we acquired all of the outstanding capital stock of Academy Corporation (Academy) for $22.7 million in cash in the first quarter 2010. Academy provides precious and non-precious metals and refining services to a number of technically demanding end-use applications, including architectural glass, solar energy, medical and electronics. The acquisition was financed with a combination of cash on hand and borrowings under the revolving credit agreement. Immediately after the acquisition, we transferred Academy’s precious metals onto our existing consignment lines and received its estimated market value of $7.2 million back from the financial institution.

 

ENVIRONMENTAL

 

We have an active environmental compliance program. We estimate the probable cost of identified environmental remediation projects and establish reserves accordingly. The environmental remediation reserve balance was $5.6 million at December 31, 2009 and $6.3 million at December 31, 2008. Spending against the reserve, primarily for clean-up costs for the Company’s former headquarters building that previously was also used to house light manufacturing operations and R&D laboratories, totaled $1.0 million in 2009. Payments against the reserve totaled $0.3 million in 2008. The reserve balance was adjusted in 2009 for the addition of a small project and changes in estimates on existing projects. 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 over time. 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. The ore is processed at Brush Resources’ extraction facility in Utah. Approximately 87% of the 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 the Utah 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. 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 same time period. 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 over one hundred years. Ore reserves classified as possible are excluded from the following table.

 

 

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 accounting guidelines. Litigation and environmental accruals are established only 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 an 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.

Non-employee claims for beryllium disease made prior to 2022 where any of the alleged exposure period is prior to year-end 2007 are covered by insurance. The insurance covers defense costs and indemnity payments (resulting from settlements or court verdicts) and is subject to a $1.0 million annual deductible. In 2009, defense and indemnity costs exceeded the deductible.

 

Pensions.  We have a defined benefit pension plan that covers a large portion of our current and former domestic employees. Carrying values of the associated pension 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. Unrealized gains or losses are recorded in OCI. The actuaries adjust certain assumptions to reflect changes in demographics and other factors, including mortality rates and employee turnover, as warranted. Management annually reviews other key assumptions, including the expected return on plan assets, the discount rate and the average wage rate increase, against actual results, trends, Company strategies, the current and projected investment environment and industry standards and makes adjustments accordingly. These adjustments may then lead to a higher or lower expense in a future period.

 

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 present value of the projected benefit obligation and future pension expense and, conversely, a lower discount rate would raise the benefit obligation and future pension expense. We elected to use a discount rate of 5.875% as of December 31, 2009 and 6.15% as of December 31, 2008.

 

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 maintained the expected rate of return on plan asset assumption at 8.25% as of December 31, 2009, unchanged from December 31, 2008. After generating a loss in 2008, the pension plan investments generated a return in excess of the 8.25% assumption in 2009. The expected rate of return assumption relates to the long term and we believe that an 8.25% return over the long term is reasonable. Should the assets earn an average return less than 8.25% over time, in all likelihood the future pension expense would increase. Investment earnings in excess of 8.25% would tend to reduce the future expense.

 

If the expected rate of return assumption was changed by 25 basis points (0.25%) and all other pension assumptions remained constant, the 2010 projected pension expense would change by approximately $0.3 million. If the December 31, 2009 discount rate were reduced by 25 basis points and all other pension assumptions remained constant, then the 2010 projected pension expense would increase by approximately $0.4 million.

 

Cash contributions and funding requirements are governed by ERISA and IRS guidelines and not by accounting standards. These guidelines are subject to change from time to time. As previously indicated, based upon these guidelines, current assumptions and estimates and our pension plan objectives, we estimate a cash contribution of approximately $8.1 million will be made in 2010.

 

The pension liability is 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 and other retirement plans.

 

LIFO Inventory.  The prices of certain major raw materials that we use, including copper, nickel, gold, silver and other precious metals, fluctuate during a given year. Copper prices, after reaching very high levels in the second quarter 2008, declined significantly and quickly in the second half of that year, only to steadily increase throughout 2009. Gold prices increased significantly in the fourth quarter 2009. The year-end price for gold has increased over the respective prior year-end price for three straight years. The prices for nickel and other precious metals we use have been quite volatile in recent years as well.

 

Where possible, such changes in material costs are generally reflected in selling price adjustments. The prices of labor and other factors of production, including supplies and utilities, generally increase with inflation. From

time to time, we will revise our billing practices to include an energy surcharge in attempts to recover a portion of our higher energy costs from our customers. However, market factors, alternative materials and competitive pricing may limit our ability to offset all cost increases with higher prices.

 

We use the 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, but not always, lower than it would be under most alternative costing methods. The LIFO cost may also be lower than the current replacement cost of the inventory. The LIFO inventory value tends to be less volatile during years of fluctuating costs than the inventory 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 changes in the inventory mix and quantities. Assuming no change in the quantity or mix of inventory from the December 31, 2009 level, a 100 basis point change in the annual inflation rate would cause a $0.5 million change in the LIFO inventory value.

 

Deferred Tax Assets.  We record deferred tax assets and liabilities 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. We will also evaluate deferred tax assets for impairment due to cumulative operating losses and record a valuation allowance as warranted. A valuation allowance may increase tax expense and reduce net income in the period it is recorded. If a valuation allowance is no longer required, it will reduce tax expense and increase net income in the period that it is reversed.

 

A deferred tax valuation allowance of $0.2 million associated with a foreign subsidiary was reversed back to income in 2009. We had valuation allowances of $1.7 million associated with state deferrals and $2.0 million associated with foreign deferrals (primarily net operating loss carryforwards) recorded against our net deferred tax assets of $19.5 million as of December 31, 2009.

 

See Note P to the Consolidated Financial Statements for additional deferred tax details.

 

Unearned revenue.  Billings under long-term sales contracts in advance of the shipment of the goods are initially recorded as unearned revenue, which is a liability on the balance sheet. This liability is subsequently reversed when the revenue is recognized. 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 satisfied. The related inventory also remains on our balance sheet until these criteria are met. 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.

 

Long-term unearned income.  Expenditures for capital equipment to be reimbursed under government contracts are recorded in construction in process. Reimbursements for those expenditures are recorded in unearned income, a liability on the balance sheet. The total cost of the assets to be constructed may include costs reimbursed by the government as well as costs borne by us. When the assets are placed in service and capitalized, this total cost will be depreciated over the useful life of the assets. The unearned income liability will be reduced and credited to income ratably with the annual depreciation expense. This benefit in effect reduces the net expense charged to the income statement to an amount equal to the depreciation on the portion of the cost of the assets borne by us.

 

Capital expenditures subject to reimbursement from the government under the current Title III project and the related unearned income balance totaled $39.7 million as of December 31, 2009. This total could rise to between $65.0 and $70.0 million when the project is completed depending upon the actual cost of the facility to be constructed, government approval of the project funding, the timing of the construction of the facility and the portion of the cost to be retained by us. The plant is expected to be completed and placed in service during 2010.

Derivatives.  We may use derivative financial instruments to hedge our foreign currency, commodity and precious metal price and interest rate exposures. We apply hedge accounting when an effective hedge relationship can be documented and maintained. If a cash flow 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. If a derivative is deemed to be a hedge of the fair value of a balance sheet item, the change in the derivative’s value will be recorded in income and will offset the change in the fair value of the hedged item to the extent that the hedge is effective.

 

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, quarterly forecasts and other analyses serve as the basis for determining forecasted transactions. The use of derivatives is governed by policies established by the Board of Directors. Hedge contracts are secured and approved by senior financial managers at our corporate office. The level of derivatives outstanding may be limited by the availability of credit from financial institutions.

 

Our practice has been to secure hedge contracts denominated in the same manner as the underlying exposure; for example, a yen exposure will only be hedged with a yen contract and not with a surrogate currency. We also secure contracts through financial institutions that are already part of our bank group.

 

See Note H to the Consolidated Financial Statements and Item 7A, “Quantitative and Qualitative Disclosures About Market Risk”.

 

OUTLOOK

 

We entered 2010 with mixed economic signals. We had an improving order entry trend from portions of our key markets, including telecommunications and computer, but we remained concerned that the high unemployment rate in the U.S. will have a negative impact on consumer spending levels and our order entry rate going forward. Portions of certain other markets, including the oil and gas and aerospace sectors of the industrial components market, were starting to show signs of recovery as of early in the first quarter 2010. Medical sales, after a relatively soft first quarter 2010, should improve during the balance of 2010. Demand for defense applications has shown improvement in the first quarter of 2010.

 

Sales in 2010 will benefit from a full year of owning Barr, which was acquired in the fourth quarter 2009, as well as the acquisition of Academy in the first quarter 2010. These two operations complement and expand the products offered by our Advanced Material Technologies and Services segment and should offer a variety of synergies as we progress through 2010 and 2011. Due to the product mix in these businesses and the high metal content in sales, the gross margin as a percent of sales from these acquisitions may be lower than our historic gross margin percent.

 

In addition to growing sales, our cost control efforts will be key to improving profitability in 2010. While resources will need to be added back to some degree depending upon the increase in production requirements, our challenge will be to limit those additions and to leverage the existing resources and investments through improved efficiencies.

 

The new beryllium facility is scheduled to be completed in 2010 with product testing and qualification to occur in the second half of the year. While qualifying a facility of this size can be a difficult endeavor, once operational, the facility will provide a long-term stable source of high-quality beryllium metal.

 

Capital investments will continue to be closely managed in 2010. We will concentrate our spending on high-return and high priority projects. Total spending in 2010 should be higher than 2009, with the amount of the increase somewhat dependent upon the level of cash flow generated from operations and the available debt capacity under our existing bank lines.

 

 

While the global credit crisis and the resulting economic downturn affected our sales and margins in 2009, it has not had a significant impact on our credit lines, our ability to conduct financial transactions or the valuation of financial instruments as of early in the first quarter 2010. However, this can potentially change quickly as there have been sudden and dramatic changes in the financial standing of a number of firms during this crisis. We have a program in place to closely monitor the credit worthiness and financial condition of our key providers of financial services, including our bank group and insurance carriers, as well as the credit worthiness of customers and vendors and have been developing contingency plans accordingly.

 

Our credit lines are with banks that thus far have remained solvent throughout the crisis. While there were minor changes to the participants in some of our credit lines during 2009, these changes did not materially affect the cost or availability of our credit. Our total borrowing capacity under secured lines, that cannot be terminated prior to maturity as long as we continue to meet our debt covenants, was in excess of current needs as of December 31, 2009. The availability of credit for foreign currency hedging purposes thus far has been unaffected by the crisis.

 

The financial statement impact from the risk of one or more of the banks in our bank group becoming insolvent cannot be estimated at the present time.

 

The only financial instruments subject to fair value considerations on our December 31, 2009 balance sheet are:

 

 

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 the use of natural hedges, which include pricing strategies, borrowings denominated in the same terms as the exposed asset, off-balance sheet arrangements and other methods. Where we cannot use a natural hedge, we may use derivative financial instruments to minimize the effects of these exposures when practical and cost efficient. The use of derivatives is subject to policies approved by the Board of Directors with oversight provided by a group of senior financial managers at our corporate office.

 

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. We purchase the metal out of consignment from our suppliers 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. The use of precious metal consignment arrangements is governed by a policy approved by the Board of Directors.

 

We are charged a consignment fee by the financial institutions that own the precious metals. This fee is partially a function of the market price of the metal. Because of market forces and competition, the fee can only 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. Customers may also elect to provide their own material for us to process as opposed to purchasing our material. Should the market price of precious metals that we use increase by 20% from the prices on December 31, 2009, the additional pre-tax cost to us as a result of an increase in the consignment fee would be approximately $0.5 million on an annual basis. This calculation assumes no changes in the quantity of inventory or the underlying fee and that none of the additional fees are charged to customers.

 

The available capacity of our existing credit lines to consign precious metals is a function of the quantity and price of the metals on hand. As prices increase, a given quantity of metal will use a larger proportion of the credit line. A significant prolonged increase in metal prices could result in our credit lines being fully utilized, and, absent

securing additional credit line capacity from a financial institution, could require us to purchase precious metals rather than consign them, require customers to supply their own metal and/or force us to turn down additional business opportunities. If we were in a significant precious metal ownership position, we might elect to use derivative financial instruments to hedge the potential price exposure. The cost to finance the purchased inventory may also be higher than the consignment fee. The financial statement impact of the risk from rising metal prices impacting our credit availability cannot be estimated at the present time.

 

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. While over time our price exposure to copper is generally in balance, there can be a lag between the change in cost and the pass-through to our customers, resulting in higher or lower margins in a given period.

 

We use ruthenium in the manufacture of one of our family of products. Ruthenium is not a widely used or traded metal and, therefore, there is no established efficient market for derivative financial instruments that could be used to effectively hedge the ruthenium price exposure. Generally, our pricing practice with respect to ruthenium products is to establish the selling price on our cost to purchase the material, limiting our price exposure. However, the inventory carrying value may be exposed to market fluctuations. The inventory value is maintained at the lower of cost or market and if the market value were to drop below the carrying value, the inventory would have to be reduced accordingly and a charge taken against cost of sales. This risk is mainly associated with sludges and scrap materials, which generally have longer processing times to be refined into a usable form for further manufacturing and are typically not covered by specific sales orders from customers. As a result of market price fluctuations, we recorded lower of cost or market charges totaling $0.7 million in 2009 and $15.2 million in 2008 on portions of our inventory. The market price of ruthenium increased in the fourth quarter 2009 and the carrying cost of our inventory was approximately 46% lower than the market price at year-end 2009.

 

We are exposed to changes in interest rates on portions of 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 may also use interest rate swaps to fix the interest rate on variable rate obligations, as we deem appropriate; we did not have any derivatives in place to hedge the interest rate exposure as of December 31, 2009. Excess cash is typically invested in high quality instruments that mature in ninety days or less. Investments are made in compliance with policies approved by the Board of Directors. Assuming no change in amount or make-up of the outstanding debt as of December 31, 2009, a 200 basis point movement upwards in the interest rates would increase our annual interest expense by $0.9 million.

 

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. If the dollar strengthened, the decline in the translated value of our margins would be at least partially 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 $13.1 million as of December 31, 2009. If the dollar weakened 10% against the currencies we have hedged from the December 31, 2009 exchange rates, the reduced gain and/or increased loss on the outstanding contracts as of December 31, 2009 would reduce pre-tax profits by approximately $1.3 million in 2010. 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 value of the outstanding foreign currency contracts was a net asset of $0.1 million at December 31, 2009, indicating that the average hedge rates were slightly favorable compared to the actual year-end market exchange rates.

 

 

The management of Brush Engineered Materials Inc. and subsidiaries are 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.

 

Brush Engineered Materials Inc. and subsidiaries’ management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009. 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, 2009, the Company’s internal control over financial reporting is effective.

 

Management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include an assessment of the internal control over financial reporting of Barr Associates, Inc., which is included in the 2009 consolidated financial statements of the Company. We did not assess the effectiveness of internal control over financial reporting at Barr Associates, Inc. because we did not believe we had adequate time to conduct an assessment of the internal control over financial reporting in the period between the consummation date of the acquisition and the date of management’s assessment. Barr Associates, Inc. constituted $65.8 million of total assets as of December 31, 2009 and approximately $6.4 million and $0.2 million of net sales and net loss, respectively, for the year ended December 31, 2009.

 

The effectiveness of our internal control over financial reporting as of December 31, 2009 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report.

 

Richard J. Hipple

Chairman, President and Chief Executive Officer

 

John D. Grampa

Senior Vice President Finance and

Chief Financial Officer

 

The Board of Directors and Shareholders of Brush Engineered Materials Inc.

 

We have audited Brush Engineered Materials Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2009, 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 included in the Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on 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, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, 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.

 

As indicated in the accompanying Management’s Report on Internal Control Over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Barr Associates, Inc. which is included in the 2009 consolidated financial statements of Brush Engineered Materials Inc. and subsidiaries and constituted $65.8 million of total assets as of December 31, 2009 and approximately $6.4 million and $0.2 million of net sales and net loss, respectively, for the year ended December 31, 2009. Our audit of internal control over financial reporting of Brush Engineered Materials Inc. and subsidiaries also did not include an evaluation of the internal control over financial reporting of Barr Associates, Inc.

 

In our opinion, Brush Engineered Materials Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, 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 as of December 31, 2009 and 2008, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009 of Brush Engineered Materials Inc. and subsidiaries and our report dated March 5, 2010 expressed an unqualified opinion thereon.

 

 

Cleveland, Ohio

March 5, 2010

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Shareholders of Brush Engineered Materials Inc.

 

We have audited the accompanying consolidated balance sheets of Brush Engineered Materials Inc. and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule 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, 2009 and 2008, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

 

As discussed in Note A to the consolidated financial statements, the Company changed its method of accounting for business combinations with the adoption of the guidance originally issued in FASB Statement No. 141(R), Business Combinations (codified in FASB ASC Topic 805, Business Combinations) effective January 1, 2009. Also, as discussed in Note P to the consolidated financial statements, the Company changed its method of accounting for uncertain tax positions with the adoption of the guidance originally issued in FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109 (codified in FASB ASC Topic 740, Income Taxes).

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Brush Engineered Material Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2009, 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 5, 2010 expressed an unqualified opinion thereon.

 

 

Cleveland, Ohio

March 5, 2010

Brush Engineered Materials Inc. and Subsidiaries
Years Ended December 31, 2009, 2008 and 2007

Consolidated Statements of Income

 

 

See Notes to Consolidated Financial Statements.

Brush Engineered Materials Inc. and Subsidiaries
Years Ended December 31, 2009, 2008 and 2007

Consolidated Statements of Cash Flows

 

 

See Notes to Consolidated Financial Statements.

Brush Engineered Materials Inc. and Subsidiaries
December 31, 2009 and 2008

Consolidated Balance Sheets

 

 

See Notes to Consolidated Financial Statements.

Brush Engineered Materials Inc. and Subsidiaries
Years Ended December 31, 2009, 2008 and 2007

Consolidated Statements of Shareholders’ Equity