Summary of AMERICAN PACIFIC CORP

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Dollars in Thousands)
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the safe harbor created by those sections. These forward-looking statements include, but are not limited to: our expectation that our working capital may vary in the future, our potential incurrence of additional debt in the future, our belief that our cash flows will be adequate for the foreseeable future to satisfy the needs of our operations, our expectations regarding anticipated contributions to our defined benefit pension plans and supplemental executive retirement plan, our expectation regarding anticipated cash expenditures for environmental remediation at our former Henderson, Nevada site, statements regarding our beliefs about future demand for Grade I ammonium perchlorate, our statement regarding one of the significant factors that will affect our consolidated gross margins in the future, our expectations regarding Fine Chemicals segment revenue, and related effect on gross margin and operating income, for the remainder of the current fiscal year, our expectations regarding fulfillment of existing backlog within the next twelve months, and all plans, objectives, expectations and intentions contained in this report that are not historical facts. We usually use words such as "may," "can," "will," "could," "should," "expect," "anticipate," "believe," "estimate," or "future," or the negative of these terms or similar expressions to identify forward-looking statements. Discussions containing such forward-looking statements may be found throughout this document. These forward-looking statements involve certain risks and uncertainties that could cause actual results to differ materially from future results or outcomes expressed or implied in such forward-looking statements. Please see the section titled "Risk Factors" in Part II, Item 1A of this Quarterly Report on Form 10-Q for further discussion of these and other factors that could affect future results. All forward-looking statements in this document are made as of the date hereof, based on information available to us as of the date hereof, and we assume no obligation to update any forward-looking statement, unless otherwise required by law. Any business risks discussed later in this Item 2, among other things, should be considered in evaluating our prospects and future financial performance.
The terms "Company," "AMPAC," "we," "us," and "our" are used herein to refer to American Pacific Corporation and, where the context requires, one or more of the direct and indirect subsidiaries or divisions of American Pacific Corporation. The following discussion and analysis is intended to provide a narrative discussion of our financial results and an evaluation of our financial condition and results of operations with respect to the first fiscal quarter of the year ending September 30, 2009 ("fiscal 2009") as compared to the first fiscal quarter of the year ended September 30, 2008 ("fiscal 2008"). The discussion should be read in conjunction with our Annual Report on Form 10-K for the year ended September 30, 2008 filed with the Securities and Exchange Commission (the "SEC") and the condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q. A summary of our significant accounting policies is included in Note 1 to our consolidated financial statements in our Annual Report on Form 10-K for the year ended September 30, 2008.
OUR COMPANY We are a leading manufacturer of fine and specialty chemicals within our focused markets. Our fine chemicals products are used by our customers to make drugs, primarily those with anti-viral, oncology and central nervous system indications. Our specialty chemicals and aerospace equipment products are utilized in national defense programs and provide access to, and movement in, space, via solid and liquid propellant rockets and propulsion thrusters. Our technical and manufacturing expertise and customer service focus has gained us a reputation for quality, reliability, technical performance and innovation. Given the mission critical nature of our products, we maintain long-standing strategic customer relationships. We work collaboratively with our customers to develop customized solutions that meet rigorous federal and other international regulatory standards. We generally sell our products through long-term contracts under which we are the sole-source or limited-source supplier.

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                             OUR BUSINESS SEGMENTS
Our operations comprise four reportable business segments: (i) Fine Chemicals,
(ii) Specialty Chemicals, (iii) Aerospace Equipment and (iv) Other Businesses.
The following table reflects the revenue contribution percentage from our
business segments and each of their major product lines:

                                               Three Months Ended
                                                  December 31,
                                                2008          2007

                Fine Chemicals                     45 %            57 %

                Specialty Chemicals:
                Perchlorates                       35 %            31 %
                Sodium Azide                        1 %             0 %*
                Halotron                            2 %             2 %

                Total Specialty Chemicals          38 %            33 %

                Aerospace Equipment                13 %             8 %

                Other Businesses:
                Real Estate                         1 %             1 %
                Water Treatment Equipment           3 %             1 %

                Total Other Businesses              4 %             2 %

                Total Revenues                    100 %           100 %

* less than 1%

FINE CHEMICALS. On November 30, 2005, we acquired the fine chemicals business of GenCorp Inc. (the "AFC Business") through our newly-formed, wholly-owned subsidiary Ampac Fine Chemicals LLC ("AFC"). Our Fine Chemicals segment is a custom manufacturer of active pharmaceutical ingredients ("APIs") and registered intermediates. The pharmaceutical ingredients that we manufacture are used by our customers in drugs with applications in three primary areas: anti-viral, oncology, and central nervous system. We generate nearly all of our Fine Chemicals sales from manufacturing chemical compounds that are proprietary to our customers. We operate in compliance with the U.S. Food and Drug Administration's (the "FDA") current Good Manufacturing Practices or "cGMP" and other regulatory agencies such as the European Union's European Medicines Agency ("EMEA"). Our Fine Chemicals segment's strategy is to focus on high growth markets where our technological position, combined with our chemical process, development and engineering expertise, leads to strong customer allegiances and limited competition.
We have distinctive competencies and specialized engineering capabilities in performing chiral separations, manufacturing highly potent (including cytotoxic) products, and performing energetic and nucleoside/nucleotide chemistries at commercial scale. We have invested significant resources in our facilities and technology base. We believe we are the U.S. leader in performing chiral separations using commercial-scale simulated moving bed ("SMB") technology and own and operate two large-scale SMB machines, both of which are among the largest in the world operating under cGMP. We have distinctive competency in handling highly toxic chemicals using our specialized high containment facilities in applications such as drugs used for oncology. We have significant experience and specially engineered facilities for energetic chemistry on a commercial-scale under cGMP. We use this capability in development and production of products such as those used in anti-viral drugs, including HIV-related and influenza-combating drugs.
We have established long-term, sole-source and limited-source contracts, which help provide us with earnings stability and visibility. In addition, the inherent nature of custom pharmaceutical fine chemicals manufacturing encourages stable, long-term customer relationships. We work collaboratively with our customers to develop reliable, safe and cost-effective, custom solutions. Once a custom manufacturer has been qualified as a supplier on a cGMP product, there are several potential barriers that discourage transferring the manufacturing method to an alternative supplier, including the following:

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• Alternative Supply May Not Be Readily Available. We are currently the sole-source supplier on several of our fine chemicals products.

• Regulatory Approval. Applications to and approvals from the FDA and other regulatory authorities generally require the chemical contractor to be named. Switching contractors may require additional regulatory approval and could take as long as six months to two years.

• Significant Financial Costs. Switching contractors and amending various filings can result in significant costs associated with technology transfer, process validation and re-filing with the FDA and other regulatory authorities.

SPECIALTY CHEMICALS. Our Specialty Chemicals segment is principally engaged in the production of ammonium perchlorate ("AP"). We are the only North American producer of AP, which is the predominant oxidizing agent for solid propellant rockets, booster motors and missiles used in space exploration, commercial satellite transportation and national defense programs. In addition, we produce and sell sodium azide, a chemical used in pharmaceutical manufacturing, and Halotron, a series of clean fire extinguishing agents used in fire extinguishing products ranging from portable fire extinguishers to total flooding systems. We have supplied AP for use in space and defense programs for over 50 years and we have been the only AP supplier in North America since 1998. A significant number of existing and planned space launch vehicles use solid propellant and thus depend, in part, upon our AP. Many of the rockets and missiles used in national defense programs are also powered by solid propellants.
Alliant Techsystems Inc. or "ATK" is our largest AP customer. We sell Grade I AP to ATK under a long-term contract that requires us to maintain a ready and qualified capacity for Grade I AP and that requires ATK to purchase its Grade I AP requirements from us, subject to certain terms and conditions. The contract, which expires in 2013, provides fixed pricing in the form of a price volume matrix for annual Grade I AP volumes ranging from 3 million to 20 million pounds. Pricing varies inversely to volume and includes annual escalations. AEROSPACE EQUIPMENT. On October 1, 2004, we acquired the former Atlantic Research Corporation's liquid in-space propulsion business from Aerojet-General Corporation," which is now our Aerospace Equipment segment. Our Aerospace Equipment segment is one of two major North American manufacturers of monopropellant and bipropellant liquid propulsion systems and thrusters for satellites, launch vehicles, and interceptors. Our products are utilized on various satellite and launch vehicle programs such as Space Systems/Loral's 1300 series geostationary satellites.
Effective October 1, 2008, our Aerospace Equipment segment completed the acquisition of Marotta Holdings Limited (subsequently renamed Ampac ISP Holdings Limited) and its wholly-owned subsidiaries (collectively "AMPAC ISP Holdings") for a cash purchase price, including direct expenses and net of cash acquired, of $6,653. AMPAC ISP Holdings is included in our consolidated financial statements beginning on October 1, 2008. We are accounting for this acquisition using the purchase method of accounting. The allocation of the purchase price among the fair values of assets acquired and liabilities assumed is preliminary as of December 31, 2008.
AMPAC ISP Holdings designs, develops and manufactures high performance valves, pressure regulators, cold-gas propulsion systems, and precision structures for space applications, especially in the European space market. These products are used on various satellites and spacecraft, as well as on the Ariane 5 launch vehicle. The business has two locations, Dublin, Ireland and Cheltenham, U.K. OTHER BUSINESSES. Our Other Businesses segment contains our water treatment equipment and real estate activities. Our water treatment equipment business designs, manufactures and markets systems for the control of noxious odors, the disinfection of water streams and the treatment of seawater. Our real estate activities are not material.

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                             RESULTS OF OPERATIONS
REVENUES

                                    December 31,           Increase       Percentage
                                  2008         2007       (Decrease)        Change

         Three Months Ended:
         Fine Chemicals        $ 20,384     $ 26,762      $   (6,378 )        (24 %)
         Specialty Chemicals     17,359       15,549           1,810           12 %
         Aerospace Equipment      5,756        3,735           2,021           54 %
         Other Businesses         2,130          844           1,286          152 %

         Total Revenues        $ 45,629     $ 46,890      $   (1,261 )         (3 %)

Fine Chemicals. The decrease in Fine Chemicals segment revenues for the fiscal 2009 first quarter compared to the prior fiscal year period is due to a decline in revenues from our anti-viral products offset partially by revenue increases from our oncology and central nervous system products.
Consistent with our prior disclosures, Fine Chemicals segment revenues are anticipated to decline in fiscal 2009, as compared to fiscal 2008, reflecting an approximately 85% reduction in volume for the anti-viral product that was our largest product in fiscal 2008. We recorded no revenues from this product during the fiscal 2009 first quarter. We believe the fiscal 2009 decline in volume for this product is due to our customer's supply chain strategy and their desire to reduce their current levels of inventory. The decline in revenues from this product is expected to be only partially offset by increases in revenues from other existing and new business.
Specialty Chemicals. Our Specialty Chemicals segment revenues include the operating results from our perchlorate, sodium azide and Halotron product lines, with perchlorates comprising 92% and 95% of Specialty Chemicals revenues in the fiscal 2009 and 2008 first quarters, respectively.
The variances in Specialty Chemicals revenues reflect the following factors:
• A 7% decrease in perchlorate volume and a 17% increase in the related average price per pound.

• Sodium azide revenues increased $210.

• Halotron revenues increased $358.

The decline in perchlorate volume is primarily due to lower volume on our non-Grade I perchlorate products. The average price per pound of perchlorate product increased because lower-priced, non-Grade I products comprised a smaller percentage of revenues in the fiscal 2009 first quarter than in the comparable prior year quarter.
For the fiscal 2009 first quarter, the greatest contribution to segment revenue was product for the Space Shuttle Reusable Solid Rocket Motor ("RSRM") program. We currently expect annual demand for Grade I AP in fiscal 2009 to be consistent with fiscal 2008. Increases in demand in fiscal 2009 for the Space Shuttle RSRM program, the Atlas V Solid Rocket Booster (SRB) program and the Guided Multiple Launch Rocket System ("MLRS") program should offset declines from the completion in fiscal 2008 of the three-year Minuteman III propulsion replacement program. Over the longer term, we expect annual demand for Grade I AP to be within the range of 6 million to 9 million pounds based on current NASA and U.S. Department of Defense production programs. However, Grade I AP demand could increase if there is an extension of the Space Shuttle program and/or an acceleration of the Ares program.
Aerospace Equipment. Our Aerospace Equipment segment reflects the operating results of our wholly-owned subsidiary Ampac-ISP Corp. ("ISP") and its wholly-owned subsidiaries, which include the recently acquired AMPAC ISP Holdings beginning on October 1, 2008.

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Aerospace Equipment segment revenues increased $2,021 due to organic growth and through the AMPAC ISP Holdings acquisition. AMPAC ISP Holdings contributed $1,372 in revenues. The remainder of the revenue increase is primarily attributed to this segment's U.S. operations which experienced success in the latter part of fiscal 2008 with new contract awards. This improvement in backlog resulted in revenue increases in the fiscal 2009 first quarter.
Other Businesses. The increase in our Other Businesses segment revenues for the fiscal 2009 first quarter is due to an increase in water treatment equipment sales.

COST OF REVENUES AND GROSS MARGIN

                                      December 31,           Increase       Percentage
                                    2008         2007       (Decrease)        Change

       Three Months Ended:
       Revenues                  $ 45,629     $ 46,890      $   (1,261 )         (3 %)
       Cost of Revenues            30,895       29,461           1,434            5 %

       Gross Margin                14,734       17,429          (2,695 )        (15 %)

       Gross Margin Percentage         32 %         37 %

For our fiscal 2009 first quarter, cost of revenues was $30,895 compared to $29,461 for the prior fiscal year first quarter. The consolidated gross margin percentage was 32% and 37% for our fiscal 2009 and 2008 first quarters, respectively.
One of the most significant factors that affects, and should continue to affect, the comparison of our consolidated gross margins from period to period is the change in revenue mix between our two largest segments. The revenue contribution by each of our segments is indicated in the table above under the heading "Our Business Segments".
In addition, consolidated gross margins for our fiscal 2009 first quarter reflect:
• A decrease in the gross margin percentage of approximately nineteen points for our Fine Chemicals segment. Factors that contributed to this decline in gross margin percentage include:

o During the fourth quarter of fiscal 2008, we implemented a new process for a large-volume anti-viral product and experienced start-up difficulties that negatively impacted margins for this product. During the fiscal 2009 first quarter, gross margins for this product improved somewhat as we continued to strive to improve the production process. However, despite progress, gross margins for this product remain significantly below historical levels.

o During the fiscal 2008 first quarter, an atypical mix of starting materials resulted in unusually high gross margin for our central nervous system products. In the fiscal 2009 first quarter, gross margins for these products were at a more normalized level. As a result, the quarter over quarter comparison reflects a decline.

• Specialty Chemicals segment gross margin percentage improved five points for the fiscal 2009 first quarter primarily due to a reduction in amortization expense from $975 for the fiscal 2008 first quarter to zero for the fiscal 2009 first quarter. In mid-fiscal 2008 second quarter, the Specialty Chemicals segment completed the amortization of the value assigned to the perchlorate customer list acquired in fiscal 1998.

OPERATING EXPENSES

                                      December 31,           Increase       Percentage
                                    2008         2007       (Decrease)        Change

        Three Months Ended:
        Operating Expenses       $ 11,309     $ 10,205       $   1,104            11 %
        Percentage of Revenues         25 %         22 %

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For our fiscal 2009 first quarter, operating expenses increased $1,104 to $11,309 from $10,205 in the first quarter of the prior fiscal year primarily due to:
• A $265 decrease in Fine Chemicals segment operating expenses reflecting a reduction in incentive compensation.

• A $649 increase in Aerospace Equipment segment operating expenses primarily due to the acquisition of AMPAC ISP Holdings.

• A $641 increase in corporate operating expenses, including increases in rent of $220, consulting and professional services of $135, and stock-based compensation expense of $103. The remaining increases in corporate expenses are individually insignificant.

SEGMENT OPERATING INCOME (LOSS)

                                       December 31,           Increase       Percentage
                                     2008         2007       (Decrease)        Change

       Three Months Ended:
       Fine Chemicals             $ (1,024 )   $  4,661      $   (5,685 )        (122 %)
       Specialty Chemicals           7,606        5,879           1,727            29 %
       Aerospace Equipment             410          173             237           137 %
       Other Businesses                545          (18 )           563          NM

       Segment Operating Income      7,537       10,695          (3,158 )         (30 %)
       Corporate Expenses           (4,112 )     (3,471 )          (641 )          18 %

       Operating Income           $  3,425     $  7,224      $   (3,799 )         (53 %)

NM = Not Meaningful

Segment operating income includes all sales and expenses directly associated with each segment. Environmental remediation charges, corporate general and administrative costs and interest are not allocated to segment operating results. Fluctuations in segment operating income or loss are driven by changes in segment revenues, gross margins and operating expenses, each of which is discussed in greater detail above.
In addition, Fine Chemicals segment revenue was lower in the fiscal 2009 first quarter than we are expecting for subsequent quarters in fiscal 2009. This lower revenue level provides less gross margin contribution in the fiscal 2009 first quarter to cover Fine Chemicals segment general and administrative expenses which tend to occur more evenly between quarters. We anticipate that Fine Chemicals segment quarterly gross margins and quarterly operating income will improve for the remaining quarters in fiscal 2009, as compared to the fiscal 2009 first quarter, due to the expected increases in quarterly revenues and the related improvements in absorption of fixed costs.
BACKLOG
Agreements with our Fine Chemicals segment customers typically include multi-year supply agreements. These agreements may contain provisional order volumes, minimum order quantities, take-or-pay provisions, termination fees and other customary terms and conditions, which we do not include in our computation of backlog. Fine Chemicals segment backlog includes unfulfilled firm purchase orders received from a customer, including both purchase orders which are issued against a related supply agreement and stand-alone purchase orders. Fine Chemicals segment backlog was $34,952 and $84,496 as of December 31, 2008 and 2007, respectively. We anticipate backlog as of December 31, 2008 to be substantially filled during the next twelve months.
The decrease in Fine Chemicals segment backlog at December 31, 2008 as compared to December 31, 2007 generally reflects the timing of customer purchase orders against related supply agreements, as well as the previously mentioned expected decline in demand in fiscal 2009 for one of our anti-viral products.

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Our Aerospace Equipment segment is a government contractor, and accordingly, total backlog includes both funded backlog (contracts for which funding is contractually obligated by the customer) and unfunded backlog (contracts for which funding is not currently contractually obligated by the customer). We compute backlog as the total contract value less revenues that have been recognized under the percentage-of-completion method of accounting. Aerospace Equipment segment total backlog and funded backlog were $30,772 and $24,513, respectively, as of December 31, 2008 compared to both total and funded backlog of $14,222 as of December 31, 2007. We anticipate funded backlog as of December 31, 2008 to be substantially filled during the next twelve months. The acquisition of AMPAC ISP Holdings contributed approximately $7,000 to total and funded backlog.
Backlog is not a meaningful measure for our other business lines.

                        LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS

                                                    Three Months Ended December 31,                                Percentage
                                                      2008                    2007                Change             Change

Cash Provided (Used) By:
Operating activities                             $       6,950           $      18,219         $  (11,269 )             (62 %)
Investing activities                                    (8,462 )                (1,500 )           (6,962 )            (464 %)
Financing activities                                       (73 )                    15                (88 )             587 %

Net change in cash for period                    $      (1,585 )         $      16,734         $  (18,319 )            (109 %)

Operating Activities. Operating activities provided cash of $6,950 for our fiscal 2009 first quarter compared to $18,219 for the prior fiscal year first quarter, resulting in a decrease of $11,269 from the prior fiscal year first quarter.
Significant components of the change in cash flow from operating activities include:
• A decrease in cash due to less profit from our operations of $4,859.

• A decrease in cash provided by working capital accounts of $7,131, excluding the effects of interest and income taxes.

• An increase in cash taxes paid of $158.

• A decrease in cash paid for interest of $75.

• An increase in cash used for environmental remediation of $74.

• Other increases in cash provided by operating activities of $878.

The decrease in cash provided by working capital accounts is primarily due to the timing of accounts receivable invoicing and collections. Reductions in accounts receivable provided cash of $11,238 in the first quarter of fiscal 2008 compared to $6,661 for the first quarter of fiscal 2009. Our Specialty Chemicals segment began fiscal 2008 with significant accounts receivable balances which . . .