Seemingly, FIFO accounting helps explain the 74% gross margin despite the increasing price of Ir.
Inventories: Inventories consist of raw materials, work-in-process and finished goods, including inventory consigned to customers, and are stated at the lower of cost, determined on a first-in, first-out basis, or net realizable value. Inventory valuation and firm committed purchase order assessments are performed on a quarterly basis and those items that are identified to be obsolete or in excess of forecasted usage are written down to their estimated realizable value. Estimates of realizable value are based upon management’s analyses and assumptions, including, but not limited to, forecasted sales levels by product, expected product lifecycle, product development plans and future demand requirements. A 12-month rolling forecast based on factors, including, but not limited to, production cycles, anticipated product orders, marketing forecasts, backlog, and shipment activities is used in the inventory analysis. If market conditions are less favorable than forecasts or actual demand from customers is lower than estimates, additional inventory write-downs may be required. If demand is higher than expected, inventories that had previously been written down may be sold.
Management did speak about Ir pricing and margins, but the questions did not lead to a direct answer. Sid
did note that they have been actively managing their Ir inventory. He separately noted that they still expect a 65-70% gross margin for the year. Given the Q1 is at 74%, the idea of dipping as low as 65% for the full year is pretty big clue that margin pressure is coming, and Ir is the likely source.
As noted above, Raw materials fall under the "Inventory" line. Those materials are stated at cost, and used on a FIFO basis. Accordingly it is easy to see that the margins this quarter were achieved in part because the Ir used was purchased before the Ir price skyrocket which really started in December.
Inventory on the books is up by $10 million from 12/31 to 3/31. There is no way to know how much of that is due to raw material cost basis increases, but I'm guessing it's not a trivial amount. It is unclear how UDC has been "managing" their Ir supply. Perhaps they have some futures contracts in place that have hedged the risk, but nobody asked about their degree of hedging.
My bottom line take-away is that Ir will be a margin squeezer coming up soon. There may be some hedges in place to temper the impact, but the increase in inventory (at cost acquired) and management's commentary that they expect 65-70% gross margins for the full year both lead me to believe that the Ir price increase will be pretty easy to see by next quarter.