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Howard Industries has proposed a floating surcharge to replace the fixed surcharges now in effect for existing transformer contracts. The floating surcharge will be indexed to the cost of specific raw materials and will track these costs as they increase or decrease over time. A floating surcharge is considered to be a more fair and equitable price relief method that can better address the continued increase in costs that have occurred since fixed surcharges were imposed. A floating surcharge will also begin to drive prices lower as soon as aggregate material costs start decreasing.
It had been hoped that a modest fixed surcharge would be sufficient to see us through this abnormal situation. Unfortunately, it is apparent now that the amount of fixed price relief requested in February of this year is not going to be adequate to offset the cost levels already encountered and the levels anticipated for the near term. Another justification for a floating surcharge is that during times of rapidly changing costs such as seen now, a fixed surcharge is appropriate only for an instant. At other times it is either insufficient or produces more relief than is needed.
The cost of key materials used in the manufacture of distribution and power transformers continues to increase. These materials, including carbon steel, stainless steel, silicon core steel, copper, aluminum, and oil, represent about sixty percent of a transformer's total material content. Although each of these individual commodities has experienced elevated price levels at some time in the past, it is unprecedented that they have all spiked together. These escalating costs are placing a greater and greater burden on our business.
The forces driving these cost increases continue to plague the market. Industry experts cite the weak U.S. dollar, high global demand for metals (particularly extreme in China and other Asian countries) a shortage of domestic coke used in steel production, low metals inventories, high energy costs, and escalating Mid-East oil prices as the primary causes. Some analysts believe that price levels may begin to decline toward the end of 2004 or early in 2005, but there is no consensus. There have been some recent indications that the cost of metals may be leveling out for the moment. Although this is encouraging, it is far too early to assume that conditions are beginning to return to normal. It is just as likely that the situation could worsen. The steel industry continues to warn of sustained high cost and the potential for extended lead-times and shortages. In addition to concerns about steel and other metals, the cost of petroleum products (including transformer oil) continues to escalate.
Howard Industries is doing everything possible to minimize the impact of these cost increases and to ensure an uninterrupted supply of our transformer products. Over the years we have forged exceptionally strong relationships with our suppliers, including the development of long-term supply alliances with our key suppliers. Our suppliers have told us they are doing everything they can to ease the situation and have assured us of a continued supply of material.
Howard Industries sales representatives will soon be contacting current customers to explain the floating surcharge proposal and discuss its implementation.
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