Note
1 - Basis of Presentation
The
unaudited condensed consolidated financial statements of Engelhard Corporation
and subsidiaries (the “Company”) contain all adjustments, consisting only of
normal recurring adjustments, which, in the opinion of management, are necessary
for a fair presentation of the results for the interim periods presented.
The
financial statement results for interim periods are not necessarily indicative
of financial results for the full year. These financial statements should
be
read in conjunction with the consolidated financial statements and notes
thereto
included in the Company’s 2004 Form 10-K. The unaudited condensed consolidated
financial statements include the accounts of the Company and its subsidiaries.
All significant intercompany transactions and balances have been eliminated
in
consolidation.
The
prior
year presentation of the “Condensed Consolidated Statements of Cash Flows” has
been changed to conform to the current year presentation. Specifically,
“Decrease in hedged metal obligations” has been reclassified from “Net cash used
in financing activities” to “Net cash provided by operating activities,” and is
included in the “Materials Services related” line. The net effect of this
reclassification is a decrease to “Net cash provided by operating activities” of
$3.8 million and a decrease to “Net cash used in financing activities” of an
equivalent amount.
Note
2 - Special Charges
In
the
second quarter of 2005, the Company committed to a plan to discontinue
manufacturing operations at its Carteret, New Jersey facility, which
manufactures specialty precious metal products. The Company recorded
charges
totaling $10.4 million related to this action within the Environmental
Technologies segment during the second quarter. The special charge consists
of
$4.8 million related to severance and other employee related expenses,
$3.2
million related to the impairment of machinery and equipment, $1.3 million
related to the impairment of goodwill and $1.1 million related to
work-in-process inventory not expected to be completed or sold. These
charges
are included in the “Special charge” line in the “Condensed Consolidated
Statements of Earnings.” The above impairment values are based upon management’s
estimate of fair value. The amount ultimately realized from the disposition
of
these assets is subject to change. The Company expects to incur additional
pre-tax expenses of approximately $1 million related to this action in
the
quarter ending September 30, 2005.
Operations
at the Carteret, New Jersey facility are expected to cease on or about
August
23, 2005. At that point in time, the Company will classify this manufacturing
operation as a discontinued
operation in accordance with SFAS No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets.”
Note
3 - Acquisitions
In
June
2005, the Company acquired the syngas catalyst business of Nanjing Chemical
Industry Corporation (NCIC), a wholly owned subsidiary of SINOPEC, one
of
China’s largest integrated energy and chemical companies, for approximately $20
million. As of June 30th, the Company has paid approximately 70% of
the purchase price with the remaining 30% recorded in accounts payable
and
expected to be paid in the third quarter of 2005. The Company acquired
NCIC’s
syngas business operations, catalyst technology and Nanjing-based manufacturing
assets. The acquisition supports the Company’s growth strategy and broadens the
competencies in surface and material sciences as it expands the Company’s
portfolio of served markets and applications. The results of operations
of this
acquisition, integrated into the Process Technologies segment, are included
in
the accompanying consolidated financial statements from the date of acquisition.
A portion of the purchase price has been allocated to assets acquired based
on
their fair values, while the remaining balance was recorded as goodwill.
The
Company is completing its review and determination of these fair values,
and
thus the allocation of the purchase price is subject to revision. Pro forma
information is not provided as the impact of the acquisition does not have
a
material effect on the Company’s results of operations, cash flow, or financial
position.
In
March
2005, the Company acquired a majority stake in Coletica, S.A., a French company
that develops performance-based, skin-care compounds and related technologies
for the cosmetic and personal care industry. The Company purchased 77.87%
of
Coletica’s outstanding shares for approximately €50 million ($65 million). In
the second quarter of 2005, the Company made a tender offer and acquired
the
remaining publicly held shares. The
total
purchase price of shares amounted to €65.5 million ($86 million) for 100%
ownership. This acquisition further strengthens the Company’s position as a
leading global supplier of materials technology to the cosmetic and personal
care industries. Coletica has two facilities in Lyon, France and sales
offices
in Paris, New York and Tokyo. A portion of the purchase price has been
allocated
to assets acquired based on their fair values, while the remaining balance
was
recorded as goodwill. The Company is completing its review and determination
of
these fair values, and thus the allocation of the purchase price is subject
to
revision. Pro forma information is not provided as the impact of the acquisition
does not have a material effect on the Company’s results of operations, cash
flows or financial position.
During
the first quarter of 2005, the Company exchanged a 7.5% interest in its Chinese
automotive catalyst operations for approximately 2.6% of N.E. Chemcat (NECC),
a
publicly-traded joint venture. This transaction was recorded as an exchange
of
similar productive assets in accordance with APB 29, “Accounting of Nonmonetary
Transactions.” The Company also acquired an additional 0.7% of NECC through a
public tender offer. These transactions increase the Company’s ownership
percentage in NECC from 38.8% to 42.1%.
Note
4
- Accounting for Asset Retirement Obligations
The
Company’s asset retirement obligations primarily relate to kaolin mining
operations of its Appearance and Performance Technologies segment. In order
to
provide kaolin-based products to the Company’s customers and the Process
Technologies segment, the Company engages in kaolin mining operations. The
kaolin mining process includes exploration, topsoil and overburden removal,
extraction of kaolin and the subsequent reclamation of mined areas. The Company
has a legal obligation to reclaim mined areas under state regulations.
The
following table represents the change in the Company’s asset retirement
obligation liability (in millions):
|
|
June
30, 2005
|
|
June
30, 2004
|
|
Balance
at beginning of year
|
|
$
|
10.8
|
|
$
|
10.5
|
|
Accretion
expense
|
|
|
0.3
|
|
|
0.3
|
|
Payments
|
|
|
(0.5
|
)
|
|
(0.6
|
)
|
Asset
retirement obligation at end of period
|
|
$
|
10.6
|
|
$
|
10.2
|
|
Note
5 - Inventories
Inventories
consist of the following (in millions):
|
|
June
30, 2005
|
|
December
31, 2004
|
|
Raw
materials
|
|
$
|
165.3
|
|
$
|
137.5
|
|
Work
in process
|
|
|
51.2
|
|
|
49.3
|
|
Finished
goods
|
|
|
257.9
|
|
|
255.1
|
|
Precious
metals
|
|
|
16.4
|
|
|
17.7
|
|
Total
inventories
|
|
$
|
490.8
|
|
$
|
459.6
|
|
The
majority of the Company’s physical metal is carried in the committed metal
positions line on the balance sheet at fair value with the remainder carried
in
the inventory line at historical cost. The inventory portion of precious
metals
is stated at LIFO cost. The market value of the precious metals recorded
at LIFO
exceeded cost by $91.2 million and $73.1 million at June 30, 2005 and December
31, 2004, respectively.
In
the
normal course of business, certain customers and suppliers deposit significant
quantities of precious metals with the Company under a variety of arrangements.
Equivalent quantities of precious metals are returnable as product or in
other
forms. Metals held for the accounts of customers and suppliers are not reflected
in the Company’s financial statements.
Note
6 - Comprehensive Income
Comprehensive
income is summarized as follows (in millions):
|
|
Three
Months Ended
June
30,
|
|
Six
Months Ended
June
30,
|
|
|
|
2005
|
|
2004
|
|
2005
|
|
2004
|
|
Net
earnings
|
|
$
|
57.9
|
|
$
|
68.0
|
|
$
|
115.9
|
|
$
|
118.3
|
|
Other
comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation adjustment
|
|
|
(40.4
|
)
|
|
0.1
|
|
|
(41.8
|
)
|
|
0.6
|
|
Cash
flow derivative adjustment, net of tax
|
|
|
(1.9
|
)
|
|
(0.2
|
)
|
|
6.6
|
|
|
1.2
|
|
Investment
adjustment, net of tax
|
|
|
—
|
|
|
(0.1
|
)
|
|
—
|
|
|
(0.4
|
)
|
Minimum
pension liability adjustment, net of tax
|
|
|
0.4
|
|
|
—
|
|
|
0.6
|
|
|
—
|
|
Comprehensive
income
|
|
$
|
16.0
|
|
$
|
67.8
|
|
$
|
81.3
|
|
$
|
119.7
|
|
The
foreign currency translation adjustments are not currently adjusted for income
taxes as they relate to permanent investments in non-U.S. entities.
Note
7 - Earnings Per Share
SFAS
No.
128 “Earnings Per Share” specifies the computation, presentation and disclosure
requirements for basic and diluted earnings per share (EPS). The following
table
represents the computation of basic and diluted EPS as required by SFAS No.
128:
|
|
Three
Months Ended
June
30,
|
|
Six
Months Ended
June
30,
|
|
(in
millions, except per-share data):
|
|
2005
|
|
2004
|
|
2005
|
|
2004
|
|
Basic
EPS Computation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
earnings applicable to common shares
|
|
$
|
57.9
|
|
$
|
68.0
|
|
$
|
115.9
|
|
$
|
118.3
|
|
Average
number of shares outstanding - basic
|
|
|
120.2
|
|
|
123.7
|
|
|
120.9
|
|
|
123.9
|
|
Basic
earnings per share
|
|
$
|
0.48
|
|
$
|
0.55
|
|
$
|
0.96
|
|
$
|
0.96
|
|
Diluted
EPS Computation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
earnings applicable to common shares
|
|
$
|
57.9
|
|
$
|
68.0
|
|
$
|
115.9
|
|
$
|
118.3
|
|
Average
number of shares outstanding - basic
|
|
|
120.2
|
|
|
123.7
|
|
|
120.9
|
|
|
123.9
|
|
Effect
of dilutive stock options and other incentives
|
|
|
2.1
|
|
|
2.3
|
|
|
2.2
|
|
|
2.3
|
|
Average
number of shares outstanding - diluted
|
|
|
122.3
|
|
|
126.0
|
|
|
123.1
|
|
|
126.2
|
|
Diluted
earnings per share
|
|
$
|
0.47
|
|
$
|
0.54
|
|
$
|
0.94
|
|
$
|
0.94
|
|
Note
8 - Derivatives and Hedging
The
Company reports all derivative instruments on the balance sheet at their
fair
value. Foreign exchange contracts, commodity contracts and interest rate
derivatives are recorded within the “Other current assets” and “Other current
liabilities” lines on the Company’s “Condensed Consolidated Balance Sheets.”
Changes in the fair value of derivatives designated as cash flow hedges are
initially recorded in accumulated other comprehensive income and are
reclassified to earnings in the period the hedged item is reflected in earnings.
Changes in the fair value of derivatives that are not designated as cash
flow
hedges are reported immediately in earnings. Cash flows resulting from
derivatives accounted for as cash flow or fair value hedges are classified
in
the same category as the cash flows from the underlying
transactions.
In
order
to manage in a manner consistent with historical processes, procedures and
systems and to achieve operating economies, certain economic hedge transactions
are not designated as hedges for accounting purposes. In those cases, which
primarily relate to precious and base metals, the Company will continue to
mark-to-market both the hedge instrument and the related position constituting
the risk hedged, recognizing the net effect in current earnings.
The
Company documents all relationships between derivative instruments designated
as
hedging instruments and the hedged items at inception of the hedges, as well
as
its risk-management strategies for the hedges. For the three- and six-month
periods ended June 30, 2005 and 2004, there was no gain or loss recognized
in
earnings resulting from hedge ineffectiveness.
Foreign
Exchange Contracts
The
Company designates as cash flow hedges certain foreign currency derivative
contracts which hedge the exposure to the foreign exchange rate variability
of
the functional-currency equivalent of foreign-currency denominated cash flows
associated with forecasted sales or forecasted purchases. The ultimate
maturities of the contracts are timed to coincide with the expected occurrence
of the underlying forecasted transaction.
For
the
six-month periods ended June 30, 2005 and 2004, the Company reported an
after-tax gain of $1.2 million and an after-tax loss of $0.8 million,
respectively, in accumulated other comprehensive income relating to the change
in the fair value of derivatives designated as foreign exchange cash flow
hedges. It is expected that cumulative gains of $1.2 million as of June 30,
2005
will be reclassified into earnings within the next 12 months. There was no
gain
or loss reclassified from accumulated other comprehensive income into earnings
as a result of the discontinuance of cash flow hedges due to the probability
of
the original forecasted transactions not occurring or hedge ineffectiveness.
As
of June 30, 2005, the maximum length of time over which the Company has hedged
its exposure to movements in foreign exchange rates for forecasted transactions
is 12 months.
A
second
group of forward contracts entered into to hedge the exposure to foreign
currency fluctuations associated with certain monetary assets and liabilities
is
not designated as hedging instruments for accounting purposes. Changes in
the
fair value of these items are recorded in earnings offsetting the foreign
exchange gains and losses arising from the effect of changes in exchange
rates
used to measure related monetary assets and liabilities.
Commodity
Contracts
The
Company enters into contracts that are designated as cash flow hedges to
protect
a portion of its exposure to movements in certain commodity prices. These
contracts primarily relate to derivatives designated as natural gas and nickel
cash flow hedges. The ultimate maturities of the contracts are timed to coincide
with the expected usage of these commodities.
For
the
six-month periods ended June 30, 2005 and 2004, the Company reported after-tax
gains of $3.8 million and $1.7 million, respectively, in accumulated other
comprehensive income relating to the change in the fair value of derivatives
designated as cash flow commodity hedges. It is expected that the cumulative
gain of $3.8 million as of June 30, 2005 will be reclassified into earnings
within the next 18 months. There was no gain or loss reclassified from
accumulated other comprehensive income into earnings as a result of the
discontinuance of cash flow commodity hedges due to the probability of the
original forecasted transactions not occurring or hedge ineffectiveness.
As of
June 30, 2005, the maximum length of time over which the Company has hedged
its
exposure to movements in commodity prices for forecasted transactions is
18
months.
Interest
Rate Derivatives
The
Company uses interest rate derivatives that are designated as fair value
hedges
to help achieve its fixed and floating rate debt objectives. The Company
currently has two interest rate swap agreements with a total notional value
of
$100 million maturing in August 2006 and three interest rate swap agreements
with a total notional value of $150 million maturing in May 2013. These
agreements effectively change fixed rate debt obligations into floating rate
debt obligations. The total notional values and maturity dates of these
agreements are equal to the face values and the maturity dates of the related
debt instruments. For these fair value hedges, there was no gain or loss
recognized
from hedged firm commitments no longer qualifying as fair value hedges
for the
three- and six-month periods ended June 30, 2005 and 2004.
In
June
2005, the Company terminated two interest rate swap agreements, with a total
notional value of $120 million maturing in June 2028, that were designated
as
fair value hedges. The termination of these two interest rate swap agreements
resulted in a cash receipt of $20.1 million that will be amortized to earnings
over the remaining term of the underlying debt instrument.
In
March
2004, the Company entered into an interest rate derivative contract. This
derivative, referred to as a Forward Rate Agreement (FRA), economically hedged
the Company’s interest rate exposure for the May 15, 2004 LIBOR rate reset under
a pre-existing interest rate swap agreement. In June 2004, the Company entered
into two additional FRA contracts, which economically hedged the Company’s
interest rate exposure for the December 1, 2004 LIBOR rate reset under a
pre-existing interest rate swap agreement. These FRAs have been marked-to-market
with the gain/loss being reflected in earnings.
In
January 2005, the Company entered into two additional FRA contracts, which
economically hedged the Company’s interest rate exposure for the May 16, 2005
and the June 1, 2005 LIBOR rate reset under two pre-existing interest rate
swap
agreements. The FRA contracts were terminated in March 2005 due to favorable
market conditions, and the gain was reflected in earnings.
In
January 2005, the Company entered into a derivative agreement with a total
notional value of $74.7 million maturing in January 2012. This agreement
effectively changes a rental obligation that varies directly with short-term
commercial paper rates to a fixed payment obligation. The total notional
value
and other terms of this agreement are equal to the rental payments and other
terms of an operating lease for machinery and equipment used in the Process
Technologies segment that was renewed in January 2005. This derivative is
designated as a cash flow hedge, and as such, it is marked-to-market with
the
gain/loss reflected in other comprehensive income. For the six-month period
ended June 30, 2005, the Company reported an after-tax loss of $0.2 million
in
accumulated other comprehensive income. There was no gain or loss reclassified
from accumulated comprehensive income into earnings as a result of the
discontinuance of cash flow hedges due to the probability of the original
forecasted transactions not occurring or hedge ineffectiveness.
Net
Investment Hedges
The
Company issued two tranches (one in April 2004 and one in August 2004) of
five-year term, 5.5 billion Japanese yen notes (approximately $50 million
each)
with a coupon rate of 1.1%. These notes are designated as an effective net
investment hedge of a portion of the Company’s yen-denominated investments. As
such, any foreign currency gains and losses resulting from these notes are
accounted for as a component of accumulated other comprehensive income. For
the
six-month period ended June 30, 2005, the Company reported an after-tax loss
of
$2.8 million in accumulated other comprehensive income, relating to the
mark-to-market of these notes. The Company intends to issue a third tranche
of
5.5 billion Japanese yen-denominated notes in August 2005. As with the previous
issues, these new notes will be designated as an effective net investment
hedge
of an additional portion of the Company’s yen-denominated assets.
Note
9 - Guarantees and Warranties
In
the
normal course of business, the Company incurs obligations with regard to
contract completion, regulatory compliance and product performance. Under
certain circumstances, these obligations are supported through the issuance
of
letters of credit. At June 30, 2005, the aggregate outstanding amount of
letters
of credit supporting such obligations amounted to $87.5 million, of which
$86.3
million will expire in less than one year, $1.0 million will expire in two
to
three years, $0.1 million will expire in four to five years and $0.1 million
will expire after five years. In the opinion of management, such obligations
will not significantly affect the Company’s financial position or results of
operations as the Company anticipates fulfilling its performance
obligations.
The
Company accrues for anticipated product warranty expenses on certain products.
Accruals for anticipated warranty liabilities are recorded based upon a review
of historical warranty claims experience. Adjustments are made to accruals
as
claim data and historical experience warrant. The Company’s accrual is
primarily
comprised of warranty liabilities within the non-automotive business of
the
Environmental Technologies segment.
The
change in the Company’s product warranty reserves is as follows (in
millions):
|
|
June
30, 2005
|
|
June
30, 2004
|
|
Balance
at beginning of year
|
|
$
|
8.7
|
|
$
|
10.0
|
|
Payments
|
|
|
(1.7
|
)
|
|
(2.7
|
)
|
Provision
|
|
|
0.1
|
|
|
3.2
|
|
Reversal
of reserve (a)
|
|
|
(1.3
|
)
|
|
—
|
|
Balance
at end of period
|
|
$
|
5.8
|
|
$
|
10.5
|
|
(a) |
In
2005, the Company reversed a $1.3 million warranty accrual ($0.8
million
due to favorable experience related to the Environmental Technologies
segment and $0.5 million due to expiration of
warranties).
|
Note
10 - Goodwill and Other Intangible Assets
Identifiable
intangible assets, such as patents and trademarks, are amortized using the
straight-line method over their estimated useful lives. Goodwill and other
intangible assets that have indefinite useful lives are not amortized, but
are
tested for impairment based on the specific guidance of SFAS No. 142, “Goodwill
and Other Intangible Assets.”
The
following information relates to acquired amortizable intangible assets (in
millions):
|
|
As
of June 30, 2005
|
|
As
of December 31, 2004
|
|
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Acquired
Amortizable Intangible Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Usage
rights
|
|
$
|
19.9
|
|
$
|
6.3
|
|
$
|
22.2
|
|
$
|
6.3
|
|
Supply
agreements
|
|
|
17.3
|
|
|
6.4
|
|
|
19.0
|
|
|
6.3
|
|
Technology
licenses
|
|
|
16.1
|
|
|
4.2
|
|
|
9.1
|
|
|
3.5
|
|
Other
|
|
|
5.6
|
|
|
3.2
|
|
|
3.7
|
|
|
2.3
|
|
Total
|
|
$
|
58.9
|
|
$
|
20.1
|
|
$
|
54.0
|
|
$
|
18.4
|
|
Amortization
expense for the six-month period ended June 30, 2005 exceeds the increase
in
accumulated amortization due to the impact of foreign exchange rate
changes. Intangible
assets with indefinite useful lives, and thus not subject to amortization,
are
$1.9 million as of June 30, 2005 and December 31, 2004. Total accumulated
amortization for goodwill and other intangible assets amounted to $86.3 million
and $83.9 million at June 30, 2005 and December 31, 2004, respectively. As
of
June 30, 2005, the estimated aggregate amortization expense for each of the
five
succeeding years is as follows (in millions):
Estimated
Annual Amortization Expense:
|
|
|
|
2005
|
|
$
|
4.5
|
|
2006
|
|
|
4.4
|
|
2007
|
|
|
4.3
|
|
2008
|
|
|
4.3
|
|
2009
|
|
|
4.2
|
|
The
following table represents the changes in the carrying amount of goodwill
for
the six-month period ended June 30, 2005 (in millions):
|
|
Environmental
Technologies
|
|
Process
Technologies
|
|
Appearance
& Performance Technologies
|
|
All
Other
|
|
Total
|
|
Balance
as of January 1, 2005
|
|
$
|
20.4
|
|
$
|
108.1
|
|
$
|
201.8
|
|
$
|
0.5
|
|
$
|
330.8
|
|
Goodwill
additions (a)
|
|
|
—
|
|
|
1.5
|
|
|
63.8
|
|
|
—
|
|
|
65.3
|
|
Purchase
accounting adjustments (b)
|
|
|
—
|
|
|
—
|
|
|
(4.5
|
)
|
|
—
|
|
|
(4.5
|
)
|
Foreign
currency translation adjustment
|
|
|
(1.4
|
)
|
|
—
|
|
|
(4.4
|
)
|
|
—
|
|
|
(5.8
|
)
|
Goodwill
impairment (c)
|
|
|
(1.3
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(1.3
|
)
|
Balance
as of June 30, 2005
|
|
$
|
17.7
|
|
$
|
109.6
|
|
$
|
256.7
|
|
$
|
0.5
|
|
$
|
384.5
|
|
(a) |
Goodwill
additions amount includes $63.8 million related to the Company’s
acquisition of Coletica, S.A. during the first quarter of 2005
and $1.5
million related to the acquisition of the catalyst business of
Nanjing
Chemical Industry Corporation during the second quarter of 2005.
These
amounts represent the excess of the purchase price paid over the
fair
market value of the net assets acquired. The Company is completing
its
review and determination of these fair values, and thus the allocation
of
the purchase price is subject to
revision.
|
(b) |
Purchase
accounting adjustment of $4.5 million relates to a revision of
the
allocation of the purchase price of The Collaborative Group, Ltd.,
including its wholly owned subsidiary Collaborative Laboratories,
Inc.,
acquired by the Company in the third quarter of 2004, in accordance
with
SFAS No. 141, “Business
Combinations.”
|
(c) |
Goodwill
impairment charge of $1.3 million was recorded by the Company in
the
second quarter of 2005, in accordance with SFAS No. 142, “Goodwill and
Other Intangible Assets,” related to the Company’s plan to discontinue
manufacturing operations at its Carteret, New Jersey
facility.
|
Note
11 - Committed Metal Positions and Hedged Metal
Obligations
|
|
June
30, 2005
|
|
December
31, 2004
|
|
Committed
Metal Positions were comprised of the following (in
millions):
|
|
|
|
|
|
Metals
in a net spot long position economically hedged with derivatives
(primarily forward sales)
|
|
$
|
446.9
|
|
$
|
324.2
|
|
Fair
value of hedging derivatives in a “gain” position
|
|
|
9.9
|
|
|
14.2
|
|
Unhedged
metal positions, net (see analysis below)
|
|
|
23.8
|
|
|
19.3
|
|
Fair
value of metals received with prices to be determined, net of hedged
spot
sales
|
|
|
7.9
|
|
|
99.9
|
|
Total
committed metal positions
|
|
$
|
488.5
|
|
$
|
457.6
|
|
Both
spot
metal positions and derivative instruments are stated at fair value. Fair
value
is based on relevant published market prices. The following table sets forth
the
Company’s unhedged metal positions included in the committed metal positions
line on the Company’s “Condensed Consolidated Balance Sheets”:
Metal
Positions Information (in millions):
|
|
June
30, 2005
|
|
December
31, 2004
|
|
|
|
Net
Position
|
|
Value
|
|
Net
Position
|
|
Value
|
|
Platinum
group metals
|
|
|
Long
|
|
$
|
27.9
|
|
|
Long
|
|
$
|
19.4
|
|
Gold
|
|
|
Short
|
|
|
(2.2
|
)
|
|
Flat
|
|
|
—
|
|
Silver
|
|
|
Flat
|
|
|
—
|
|
|
Short
|
|
|
(0.9
|
)
|
Base
metals
|
|
|
Short
|
|
|
(1.9
|
)
|
|
Long
|
|
|
0.8
|
|
Total
unhedged metal positions
|
|
|
|
|
$
|
23.8
|
|
|
|
|
$
|
19.3
|
|
Committed
metal positions may include significant advances made for the purchase of
precious metals that have been delivered to the Company, but for which the
final
purchase price has not yet been determined. As of June 30, 2005 and December
31,
2004, the aggregate market value of the metals purchased under a contract
for
which a provisional price has been paid was in excess of the amounts advanced
by
a total of $7.6 million and $49.9 million, respectively, which is recorded
as a
current liability.
|
|
June
30, 2005
|
|
December
31, 2004
|
|
Hedged
Metal Obligations were comprised of the following (in
millions):
|
|
|
|
|
|
|
|
Metals
in a net spot short position economically hedged with derivatives
(primarily forward purchases) - represents a payable for the return
of
spot metal to counterparties
|
|
$
|
378.8
|
|
$
|
265.1
|
|
Fair
value of hedging derivatives in a “loss” position
|
|
|
23.1
|
|
|
27.8
|
|
Total
hedged metal obligations
|
|
$
|
401.9
|
|
$
|
292.9
|
|
At
June
30, 2005 and December 31, 2004, hedged metal obligations relating to 875,484
and
603,330 troy ounces of gold, respectively, were outstanding. These quantities
were sold short on a spot basis generating cash approximating $384 million
and
$266 million, respectively. These spot sales were hedged with forward purchases
for the same number of ounces at an average price of $438.06 at June 30,
2005
and $441.23 at December 31, 2004. Unless a forward counterparty failed to
perform, there was no risk of loss in the event prices rose. All counterparties
for such transactions are investment grade.
Derivative
metal and foreign currency instruments are used to hedge metal positions
and
obligations. As of June 30, 2005, 98% of these instruments have settlement
terms
of less than one year, with the remaining instruments expected to settle
within
42 months. These derivative metal and foreign currency instruments consist
of
the following:
Metal
Hedging Instruments (in millions):
|
|
June
30, 2005
|
|
December
31, 2004
|
|
|
|
Buy
|
|
Sell
|
|
Buy
|
|
Sell
|
|
Metal
forwards/futures
|
|
$
|
697.7
|
|
$
|
645.9
|
|
$
|
625.2
|
|
$
|
662.6
|
|
Eurodollar
futures
|
|
|
72.8
|
|
|
52.0
|
|
|
11.2
|
|
|
136.6
|
|
Swaps
|
|
|
38.0
|
|
|
6.5
|
|
|
31.2
|
|
|
9.8
|
|
Options
|
|
|
22.9
|
|
|
—
|
|
|
3.9
|
|
|
—
|
|
Foreign
exchange forwards/futures - Japanese yen
|
|
|
—
|
|
|
81.8
|
|
|
—
|
|
|
130.8
|
|
Foreign
exchange forwards/futures - Euro
|
|
|
—
|
|
|
23.4
|
|
|
—
|
|
|
23.4
|
|
Foreign
exchange forwards/futures - Other
|
|
|
3.5
|
|
|
—
|
|
|
5.5
|
|
|
—
|
|
Note
12 - New Accounting Pronouncements
In
May
2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,”
which replaces APB Opinion No. 20, “Accounting Changes” and FASB Statement No.
3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS No. 154
requires retrospective application to prior periods’ financial statements for
voluntary changes in accounting principle unless it is impracticable. SFAS
No.
154 is effective for accounting changes and corrections of errors made in
fiscal
years beginning after June 1, 2005.
At
the
March 17, 2005 EITF (Emerging Issues Task Force) meeting, the Task Force
reached
a consensus on Issue No. 04-06, “Accounting for Stripping Costs Incurred during
Production in the Mining Industry.” In the mining industry, companies may be
required to remove overburden and other mine waste materials to access mineral
deposits. The costs of removing overburden and waste materials are referred
to
as stripping costs. During the development of a mine (before production begins),
it is generally accepted in practice that stripping costs are capitalized
as part of the depreciable cost of building, developing, and constructing
the
mine. Those capitalized costs are typically amortized over the productive
life
of the mine using the units of production method. A mining company may continue
to remove overburden and waste materials, and therefore incur stripping costs,
during the production phase of the mine. The EITF has reached a consensus
that
stripping costs incurred during the production phase of a mine are variable
production costs that should be included in the costs of the inventory produced
during the period that the stripping costs are incurred. The Board ratified
this
consensus at its March 30, 2005 meeting. The guidance in this consensus will
be
effective for financial statements issued for fiscal years beginning after
December 15, 2005. The Company is in the process of assessing the impact
of this
consensus on its financial statements.
In
December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment,” which
replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes
APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS No. 123(R)
requires compensation costs relating to share-based payment transactions,
including grants of employee stock options, be recognized in the financial
statements based on their fair values. The pro forma disclosure previously
permitted under SFAS No. 123 will no longer be an acceptable alternative
to
recognition of expenses in the financial statements. In April 2005, the
Securities and Exchange Commission issued a new rule that amends the effective
date of SFAS No. 123(R) to the beginning of the next fiscal year. As a result,
the Company will adopt this statement on January 1, 2006. The Company currently
measures compensation costs related to share-based payments under APB No.
25, as
allowed by SFAS No. 123, and provides disclosure in the notes to financial
statements as required by SFAS No. 123. SFAS No. 123(R) provides for two
transition alternatives: Modified-Prospective transition and
Modified-Retrospective transition. The Company is currently evaluating the
transition alternatives and the impact on the Company’s financial
statements.
In
December 2004, the FASB issued FASB Staff Position (FSP) No. 109-1 to provide
guidance on the application of SFAS No. 109, “Accounting for Income Taxes” to
the provision within the American Jobs Creation Act of 2004, enacted on October
22, 2004, that provides tax relief to U.S. domestic manufacturers. The FSP
states that the manufacturers’ deduction provided for under the Act should be
accounted for as a special deduction in accordance with SFAS No. 109 and
not as
a tax rate reduction.
In
December 2004, FASB Staff Position (FSP) No. 109-2, “Accounting and Disclosure
Guidance for the Foreign Earnings Repatriation Provision within the American
Jobs Creation Act of 2004” was issued, providing guidance under SFAS No. 109,
“Accounting for Income Taxes” for recording the potential impact of the
repatriation provisions of the American Jobs Creation Act of 2004, enacted
on
October 22, 2004. FSP No. 109-2 allows time beyond the financial reporting
period of enactment to evaluate the effects of the Act before applying the
requirements of FSP No. 109-2. Accordingly, the Company continues to assess
the
new tax rules relating to the repatriation of offshore earnings from its
foreign
subsidiaries and it will take appropriate measures in the second half of
2005.
Due to the uncertainty of the direction the Company will take in this regard,
it
cannot reasonably predict the impact to the Company’s financial statements in
2005.
Note
13 - Stock Option and Bonus Plans
The
Company has several long-term incentive compensation plans that allow for
the
granting of stock options to employees. Had compensation cost for the Company’s
stock option plans been determined based on the fair value at grant date
consistent with the provisions of SFAS No. 123, “Accounting for Stock-Based
Compensation,”
as amended by SFAS No. 148, “Accounting for Stock-Based Compensation —
Transition and Disclosure,” the Company’s net earnings and earnings per share
would have been as follows:
Pro
Forma Information
|
|
Three
Months Ended
June
30,
|
|
Six
Months Ended
June
30,
|
|
(in
millions, except per share-data):
|
|
2005
|
|
2004
|
|
2005
|
|
2004
|
|
Net
earnings - as reported
|
|
$
|
57.9
|
|
$
|
68.0
|
|
$
|
115.9
|
|
$
|
118.3
|
|
Deduct:
Total stock-based employee compensation expense determined under
fair
value based method for all awards, net of tax
|
|
|
(0.8
|
)
|
|
(0.8
|
)
|
|
(3.1
|
)
|
|
(3.6
|
)
|
Net
earnings - pro forma
|
|
$
|
57.1
|
|
$
|
67.2
|
|
$
|
112.8
|
|
$
|
114.7
|
|
Earnings
Per Share:
|
|
|
|
|
|
|
|
|
|
Basic
earnings per share - as reported
|
|
$
|
0.48
|
|
$
|
0.55
|
|
$
|
0.96
|
|
$
|
0.96
|
|
Basic
earnings per share - pro forma
|
|
|
0.48
|
|
|
0.54
|
|
|
0.93
|
|
|
0.93
|
|
Diluted
earnings per share - as reported
|
|
|
0.47
|
|
|
0.54
|
|
|
0.94
|
|
|
0.94
|
|
Diluted
earnings per share - pro forma
|
|
|
0.47
|
|
|
0.53
|
|
|
0.92
|
|
|
0.91
|
|
In
December 2004, the FASB issued SFAS No. 123(R), “Share Based Payment.” This
standard, although not yet effective, clarifies guidance relating to stock
options granted to employees that are eligible to retire. This guidance states
that options granted to employees eligible to retire should be expensed on
the
date of grant versus over the vesting period. As a result, the Company has
revised its pro forma stock option disclosures to reflect the change. Full
year
pro forma diluted EPS for 2003 and 2004 will remain unchanged at $1.79 and
$1.82, respectively. Revised quarterly pro forma diluted EPS will be $0.38,
$0.53, $0.47, and $0.44 for the quarters ended March 31, 2004, June 30, 2004,
September 30, 2004, and December 31, 2004, respectively. Reported amounts
for
those same periods were $0.38, $0.53, $0.46, and $0.46.
Note
14 - Benefits
The
Company has domestic and foreign pension plans covering substantially all
employees. The Company also provides post-employment and postretirement benefits
to certain eligible employees. The components of net periodic benefit cost
for
the six-month periods ended June 30, 2005 and 2004 are shown in the following
table:
Net
Periodic Benefit Cost (in millions):
|
|
Pension
Benefits
|
|
Other
Benefits
|
|
|
|
2005
|
|
2004
|
|
2005
|
|
2004
|
|
Service
cost
|
|
$
|
12.0
|
|
$
|
11.1
|
|
$
|
2.1
|
|
$
|
1.9
|
|
Interest
cost
|
|
|
20.3
|
|
|
19.0
|
|
|
3.9
|
|
|
4.4
|
|
Expected
return on plan assets
|
|
|
(24.5
|
)
|
|
(24.1
|
)
|
|
—
|
|
|
—
|
|
Amortization
of prior service cost
|
|
|
1.2
|
|
|
1.6
|
|
|
(1.1
|
)
|
|
(1.1
|
)
|
Recognized
actuarial loss
|
|
|
7.2
|
|
|
5.4
|
|
|
0.5
|
|
|
0.7
|
|
Net
periodic benefit cost
|
|
$
|
16.2
|
|
$
|
13.0
|
|
$
|
5.4
|
|
$
|
5.9
|
|
The
Company does not anticipate any changes to the 2005 required contributions
previously disclosed in the Company's 2004 Form 10K; however, the Company
is
evaluating whether to make a discretionary contribution or accelerate 2006
required contributions. The Company is in the process of forecasting 2006
pension expense. Final pension expense numbers for the 2006 fiscal year
cannot
be calculated until the September 30, 2005 measurement date. The measurement
date is used to value the Plan assets and set the applicable rates used
in
determining the projected benefit obligation and 2006 pension expense.
Based
upon current economic conditions, the Company may be required, on the
measurement date, to lower the domestic discount rate by approximately
50 basis
points and foreign discount rates by approximately 50 to 150 basis points.
This
would increase 2006 pension
expense
by approximately $7 million. Other factors including asset returns and
plan
experience will additionally increase pension expense by approximately
$7
million in 2006.
On
December 8, 2003, the President of the United States signed into law the
Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the
Act).
This Act introduces a prescription drug benefit under Medicare (Medicare
Part
D), as well as a federal subsidy to sponsors of retiree health care benefit
plans that provide a benefit that is at least actuarially equivalent to Medicare
Part D. After a review of the Company’s plan design, the Company and its
consulting actuaries believe the Company’s plan is actuarially equivalent to
Medicare Part D. In accordance with FASB Staff Position (FSP) No. 106-2,
“Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003,” the Company revalued the
benefit obligation and determined that the reduction in the accumulated
postretirement benefit obligation for the subsidy related to the benefits
attributed to past service is $15 million. The effects of this act will reduce
the net periodic benefit cost by $2.0 million for the year ended December
31,
2005.
The
Company incurred benefit payments of $5.8 million for the six-month period
ended
June 30, 2005. Expected future benefit payments, including prescription drug
benefits, are as follows (in millions):
Year
|
|
|
|
2005
(July 1 through December 31)
|
|
$
|
5.9
|
|
2006
|
|
|
11.2
|
|
2007
|
|
|
10.6
|
|
2008
|
|
|
10.0
|
|
2009
|
|
|
9.4
|
|
2010
through 2014
|
|
|
44.0
|
|
The
Company expects the following reimbursements under the subsidy portion of
the
Medicare Prescription Drug, Improvement and Modernization Act of 2003 (in
millions):
Year
|
|
|
|
2005
(July 1 through December 31)
|
|
$
|
-
|
|
2006
|
|
|
1.7
|
|
2007
|
|
|
1.9
|
|
2008
|
|
|
1.9
|
|
2009
|
|
|
2.0
|
|
2010
through 2014
|
|
|
8.3
|
|
Note
15 -
Supplemental Information
The
following table presents certain supplementary information to the Company’s
“Condensed Consolidated Statements of Cash Flows”:
Supplementary
Cash Flow Information (in millions):
|
|
Six
Months Ended June 30,
|
|
|
|
2005
|
|
2004
|
|
Materials
Services related:
|
|
|
|
|
|
Change
in assets and liabilities - source (use):
|
|
|
|
|
|
|
|
Receivables
|
|
$
|
(4.1
|
)
|
$
|
(10.8
|
)
|
Committed
metal positions
|
|
|
(78.0
|
)
|
|
(65.4
|
)
|
Inventories
|
|
|
0.6
|
|
|
-
|
|
Other
current assets
|
|
|
(1.1
|
)
|
|
0.4
|
|
Accounts
payable
|
|
|
(28.5
|
)
|
|
104.5
|
|
Hedged
metal obligations
|
|
|
113.8
|
|
|
(3.8
|
)
|
Other
current liabilities
|
|
|
1.1
|
|
|
(3.7
|
)
|
Net
cash flows from changes in assets and liabilities
|
|
$
|
3.8
|
|
$
|
21.2
|
|
All
Other:
|
|
|
|
|
|
Change
in assets and liabilities - source (use):
|
|
|
|
|
|
|
|
Receivables
|
|
$
|
(74.8
|
)
|
$
|
(23.9
|
)
|
Inventories
|
|
|
(40.0
|
)
|
|
(2.5
|
)
|
Other
current assets
|
|
|
14.3
|
|
|
1.8
|
|
Other
noncurrent assets
|
|
|
13.8
|
|
|
5.5
|
|
Accounts
payable
|
|
|
31.7
|
|
|
0.4
|
|
Other
current liabilities
|
|
|
41.8
|
|
|
(9.5
|
)
|
Noncurrent
liabilities
|
|
|
(25.2
|
)
|
|
(2.3
|
)
|
Net
cash flows from changes in assets and liabilities
|
|
$
|
(38.4
|
)
|
$
|
(30.5
|
)
|
Note
16 - Other Matters
The
Company is involved in a value-added tax dispute in Peru. Management believes
the Company was targeted by corrupt officials within a former Peruvian
government. On December 2, 1999, Engelhard Peru, S.A., a wholly owned
subsidiary, was denied refund claims of approximately $28 million. The Peruvian
tax authority also determined that Engelhard Peru, S.A. is liable for
approximately $63 million in refunds previously paid, fines and interest
as of
December 31, 1999. Interest and fines continue to accrue at rates established
by
Peruvian law. The Peruvian Tax Court ruled on February 11, 2003 that Engelhard
Peru, S.A. was liable for these amounts, overruling precedent to apply a
“form
over substance” theory without any determination of fraudulent participation by
Engelhard Peru, S.A. As part of its efforts to vigorously contest this
determination, Engelhard Peru, S.A. filed a constitutional action against
the
Peruvian Tax agency and Tax Court. On May 3, 2004, the judge in this action
ruled that none of the findings of the Peruvian tax authorities were properly
applicable to Engelhard Peru, S.A. based on several grounds, including improper
use of a presumption of guilt with no actual proof of irregularity in the
transactions of Engelhard Peru, S.A. The government of Peru has appealed
this
decision. Management believes, based on consultation with counsel, that
Engelhard Peru, S.A. is entitled to all refunds claimed and is not liable
for
any additional taxes, fines or interest. In late October 2000, a criminal
proceeding alleging tax fraud and forgery related to this value-added tax
dispute was initiated against two Lima-based officials of Engelhard Peru,
S.A.
Although Engelhard Peru, S.A. is not a defendant, it may be civilly liable
in
Peru if its representatives are found responsible for criminal conduct. In
its
own investigation, and in detailed review of the materials presented in Peru,
management has not seen any evidence of tax fraud by these officials.
Accordingly, Engelhard Peru, S.A. is
assisting
in the vigorous defense of this proceeding. Management believes the maximum
economic exposure is limited to the aggregate value of all assets of Engelhard
Peru, S.A. That amount, which is approximately $30 million, including unpaid
refunds, has been fully provided for in the accounts of the
Company.
Note
17
- Income Taxes
In
2004,
the Internal Revenue Service (“IRS”) concluded their audit of the Company’s tax
returns for the years 1998 through 2000. Accordingly, as a result of an
agreement reached with the Company, the Company recorded an $8 million benefit
in the second quarter of 2004. In the first quarter of 2005, the Company
recorded a $2.7 million reduction of tax expense resulting from an agreement
with the IRS relating to the audit of the Company’s tax return for 2001. The
Company is currently under examination for the 2002 and 2003 tax periods
with
the IRS, and the Company also seeks resolution with tax authorities in foreign
jurisdictions in which the Company operates. In the current quarter, the
Company
recorded a benefit of $5.7 million related to prior tax periods in the
Netherlands and a tax expense of $3.3 million related to prior periods in
Germany, due to changes in estimates based upon information obtained during
the
resolution process.
The
Company’s effective tax rate (“ETR”) as it relates to net income, is dependent
upon the enacted tax laws in jurisdictions in which the Company operates,
the
amount and jurisdictional mixture of earnings, the amount of percentage
depletion deductions related to mining activity, foreign tax credit valuation
allowances and changes in estimate, the ability to utilize tax credits,
extraterritorial income and domestic production related benefits and other
factors. Based upon the Company’s assessment of the above factors, the ETR for
the full year ending December 31, 2005 is estimated to be approximately 22%.
In
the current quarter, the Company’s ETR is 18.1%. This is substantially
lower than the estimated full year ETR due to the aforementioned changes
in
estimate for Germany and the Netherlands and $3.9 million of tax benefits
related to the closure of the Carteret, NJ manufacturing facility (see Note
2,
“Special Charges”).
Item
2. Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
Unless
otherwise indicated, all per-share amounts are presented as diluted earnings
per
share, as calculated under SFAS No. 128, “Earnings per Share.”
Overview
The
Company develops, manufactures and markets value-adding technologies based
on
surface and materials science for a wide spectrum of served markets. The
Company
also provides its technology segments, their customers and others with
precious
and base metals and related services. The Company’s businesses are organized
into four reportable segments that are discussed individually below. Additional
detailed descriptive material is included in “ITEM 1. BUSINESS” and NOTE 19,
“BUSINESS SEGMENT AND GEOGRAPHIC AREA DATA” in the Company’s 2004 Form 10-K.
Comparative financial data is also given in Note 19 of the Company’s 2004 Form
10-K and on page 5 of this Form 10-Q.
One
of
the strengths of the Company is that its segments serve diverse markets,
which
is important for assessing the variability of future cash flows. The following
economic comments also provide a useful context for evaluating the Company’s
performance: (1) worldwide auto builds continue to be relatively flat,
albeit at
fairly high levels - industry growth for auto-emission catalysts will benefit
from tougher environmental regulation throughout the world over the next
5-10
years as well as developing economies, especially new Asian production;
(2) more
stringent diesel-emission regulations are being phased in, affording the
Company
additional opportunities for catalyst solutions; (3) worldwide petroleum
refineries are operating close to capacity generating demand for the extra
yields provided by Engelhard’s advanced fluid cracking catalysts and performance
additives; (4) markets for effect pigments, colors and active ingredients
in
cosmetics, auto finishes and coatings have remained positive during the
recent
economic downturns and tend to be less cyclical; however, the Company is
currently experiencing growing competition from Asian producers; (5) the
coated,
free-sheet paper market has strengthened, but pricing and related market
share
loss continue to negatively impact the Company; and (6) margins related
to the
supply of metal to industrial customers have been lower in recent years
because
of changes in pricing and supply arrangements.
Results
of Operations
The
information in the discussion of each segment’s results discussed below is
derived directly from the internal financial reporting system used for
management purposes. Items allocated to each segment’s results include the
majority of corporate operating expenses. Unallocated items include interest
expense, interest income, royalty income, sale of precious metals accounted
for
under the last-in, first-out (LIFO) method, certain special charges and
credits,
income taxes, certain information technology development costs and other
miscellaneous corporate items.
Comparison
of the Second Quarter of 2005 with the Second Quarter of
2004
Net
earnings in the second quarter of 2005 included an after-tax special charge
of
$6.4 million related to the closure of the Company’s Carteret, NJ manufacturing
facility (see Note 2, “Special Charges”). Net earnings decreased to $57.9
million in the second quarter of 2005 compared with $68.0 million in the
second
quarter of 2004, which included an $8 million tax benefit, discussed below.
Operating earnings decreased to $69.8 million in the second quarter compared
with $73.1 million in the same period last year, primarily due to the
above-mentioned special charge ($10.4 million, pre-tax) and decreased earnings
in the Appearance and Performance Technologies segment, partially offset
by
higher earnings from mobile-source markets served by the Environmental
Technologies segment and improved performance by the Materials Services
segment.
Earnings from equity method joint ventures decreased in the quarter due
to the
lack of earnings associated with the divestiture of Engelhard CLAL. This
was
partially offset by modestly improved earnings from the Company’s Asian equity
method joint ventures. These Asian joint ventures are an integral component
of
the Company’s growth strategy, and serve as the Company’s presence in the
Japanese and Korean automotive markets.
In
2004,
the Internal Revenue Service (“IRS”) concluded their audit of the Company’s tax
returns for the years 1998 through 2000. Accordingly, as a result of an
agreement reached with the Company, the Company recorded an $8 million
benefit
in the second quarter of 2004. In the first quarter of 2005, the Company
recorded a $2.7 million reduction of tax expense resulting from an agreement
with the IRS relating to the audit of the Company’s tax return for 2001. The
Company is currently under examination for the 2002 and 2003 tax
periods
with
the
IRS, and the Company also seeks resolution with tax authorities in foreign
jurisdictions in which the Company operates. In the current quarter,
the Company
recorded a benefit of $5.7 million related to prior tax periods in the
Netherlands and a tax expense of $3.3 million related to prior periods
in
Germany, due to changes in estimates based upon information obtained
during the
resolution process.
The
Company’s effective tax rate (“ETR”) as it relates to net income, is dependent
upon the enacted tax laws in jurisdictions in which the Company operates,
the
amount and jurisdictional mixture of earnings, the amount of percentage
depletion deductions related to mining activity, foreign tax credit valuation
allowances and changes in estimate, the ability to utilize tax credits,
extraterritorial income and domestic production related benefits and other
factors. Based upon the Company’s assessment of the above factors, the ETR for
the full year ending December 31, 2005 is estimated to be approximately
22%. In
the current quarter, the Company’s ETR is 18.1%. This is substantially lower
than the estimated full year ETR due to the aforementioned changes in estimate
for Germany and the Netherlands and $3.9 million of tax benefits related
to the
closure of the Carteret, NJ manufacturing facility (see Note 2, “Special
Charges”).
In
connection with the recent tax law changes, the Company continues to assess
the
new tax rules relating to the repatriation of offshore earnings from its
foreign
subsidiaries and it will take appropriate measures in the second half of
2005.
Due to the uncertainty of the direction the Company will take in this regard,
it
cannot reasonably predict the impact to the Company’s financial statements in
2005.
The
Company’s share of equity earnings from affiliates was $7.4 million in the
second quarter of 2005 compared with $8.4 million in the same period last
year.
In the second quarter of 2004, the Company recognized $1.1 million in equity
earnings associated with the divestiture of Engelhard CLAL. The Company
has not
recognized, and does not expect to recognize any equity earnings from the
former
Engelhard CLAL joint venture in 2005. Worldwide automobile builds were
flat in
the second quarter, but automobile builds in Asia were higher compared
with the
same period last year. The Company serves the Japanese and Korean mobile-source
emissions control markets through its Asian joint ventures NECC and Heesung,
respectively. The Company expects these operations to produce earnings
near
current levels for the remainder of 2005. It should be noted that growth
in Asia
is primarily driven by the expanding China economy, which the Company serves
through consolidated subsidiaries included in the Environmental Technologies
segment.
Interest
expense increased to $9.4 million in the second quarter of 2005 compared
with
$5.9 million in the second quarter of 2004 due to both higher short-term
borrowing rates and higher average debt levels. Interest income increased
to
$2.9 million in the second quarter of 2005 compared with $1.4 million in
the
second quarter of 2004. In 2002, the Company established a cash-pooling
program,
which has been expanded significantly over the past year. While this program
allows for the efficient and cost effective funding of the Company’s foreign
subsidiaries, primarily in Europe, it has the effect of increasing both
interest
income and interest expense in proportion to the changes in the underlying
cash
and short-term debt balances.
Environmental
Technologies
The
majority of this segment’s sales is derived from technologies to control harmful
emissions from mobile sources, including gasoline- and diesel-powered passenger
cars, sport-utility vehicles, trucks, buses and motorcycles. This segment’s
customers are driven by increasingly stringent environmental regulations,
for
which the Company provides sophisticated emission-control technologies.
The
remainder of this segment’s sales is derived from products sold into a variety
of industrial markets, including aerospace, power generation, process industries
and utility engines. The Company supplies these industrial markets with
sophisticated emission-control technologies, high-value material products
made
primarily from platinum group metals and thermal spray and coating
technologies.
Results
of Operations (in
millions)
|
|
Q2
2005
|
|
Q2
2004
|
|
%
change
|
|
Sales
|
|
$
|
250.5
|
|
$
|
224.2
|
|
|
11.7%
|
|
Operating
earnings before special items
|
|
|
38.4
|
|
|
32.8
|
|
|
17.1%
|
|
Special
charge
|
|
|
10.4
|
|
|
0.0
|
|
|
|
|
Operating
earnings
|
|
|
28.0
|
|
|
32.8
|
|
|
-14.6%
|
|
Discussion
Results
from this segment were good. Although the Company incurred previously disclosed
charges related to the closure of the Carteret, NJ facility, results from
mobile-sourced markets were good.
Revenues
from mobile-source markets increased 11% in the second quarter of 2005
compared
with the same period in 2004. The majority of this increase was due to
increased
pass-through substrate costs. Substrate costs were higher primarily due
to
increased demand for catalyzed soot filters (CSF) to the light duty diesel
market. This also increased the segment’s working capital requirements. The
Company serves a wide customer base, and changes in the mix of sales to
these
markets are common. In the second quarter of 2005 compared with the second
quarter of 2004, sales to North American automotive customers decreased,
while
sales to European, Asian and emerging market automotive customers increased.
Sales to the motorcycle, diesel OEM, diesel retrofit and other niche markets
increased modestly compared with the year ago quarter.
Operating
earnings from mobile-source markets increased 7% in the second quarter
of 2005
compared with the second quarter of 2004. Profits from automotive markets
increased, driven by the above-mentioned increased demand for light duty
diesel
applications, partially offset by decreased demand for gasoline applications.
The Company does not expect any near term improved demand for gasoline
applications, as previously disclosed. Worldwide automobile builds varied
by
region, with increases in Asia offsetting decreases in North America. The
Company serves the large Asian markets of Japan and Korea through joint
ventures
accounted for under the equity method. Accordingly, the positive results
of
those operations, reflecting continued strength in the Asian markets, are
included on the equity earnings line. Operating earnings from diesel OEM
markets
decreased against a strong year ago quarter. Diesel OEM volumes are expected
to
remain at or below current levels until the latter half of 2006, when new
regulations begin to impact the market. Profits from motorcycle and other
niche
markets improved, as the Company continues to diversify its served market
base.
Sales
to
industrial product markets increased in the second quarter of 2005 compared
with
the second quarter of 2004. Sales to power-generation customers increased
in the
period, but are not indicative of a rebound in the power-generation market.
Sales to all other industrial markets were modestly higher compared with
the
same quarter last year.
Operating
earnings from industrial product markets decreased in the second quarter
of 2005
compared with the second quarter of 2004, due to the previously disclosed
plan
to discontinue manufacturing operations at the Company’s Carteret, NJ facility.
Asset impairment, severance and other charges related to this action totaled
$10.4 million (see Note 2, “Special Charges”). Earnings from the
power-generation market improved versus the prior year, commensurate with
the
above-mentioned increased sales. The temperature-sensing market, while
relatively small, represents a niche growth area for the Company, and earnings
improved modestly. The Company expects modest near-term improvement in
earnings
from industrial product markets, but continues to evaluate the long-term
viability of these operations.
Process
Technologies
The
Process Technologies segment enables customers to make their processes
more
productive, efficient, environmentally sound and safer through the supply
of
advanced chemical-process catalysts, additives and sorbents.
Results
of Operations (in
millions)
|
|
Q2
2005
|
|
Q2
2004
|
|
%
change
|
|
Sales
|
|
$
|
172.6
|
|
$
|
159.2
|
|
|
8.4%
|
|
Operating
earnings
|
|
|
23.3
|
|
|
23.1
|
|
|
0.9%
|
|
Discussion
This
segment experienced mixed results in the second quarter of 2005 compared
with
the same period last year, as improved revenues did not translate to improved
earnings.
Sales
to
the petroleum-refining market increased modestly in the second quarter
of 2005
compared with the second quarter of 2004. Higher volumes of petroleum-refining
additives drove the improvement. Demand remains strong for catalyst based
on the
Company’s Distributed Matrix Structure (DMS) technology platform. DMS technology
allows refiners to increase yields, and accordingly, these products sell
at
premium prices. The Company recently announced additional price increases
for
these products. The Company also experienced some increased demand in the
quarter for certain older product offerings. Demand for these older product
offerings is not expected to grow.
Operating
earnings from products sold to petroleum-refining markets increased in
the
second quarter of 2005 compared with the second quarter of 2004, primarily
due
to the aforementioned increase in sales of additives. These improvements
were
offset by higher natural gas costs of approximately $1 million and other
raw
material costs. During 2004, strong demand for DMS technology began to
exceed
existing capacity at the operating facilities that produce these products.
The
Company recently completed a project to reduce costs and increase capacity
at
these facilities, but experienced implementation difficulties resulting
in
higher than expected manufacturing costs in the quarter. These implementation
difficulties are substantially resolved. The Company plans to maintain
an asset
utilization rate of approximately 90% for DMS offerings for the foreseeable
future.
Sales
of
catalysts to the chemical-process markets increased significantly in the
second
quarter of 2005 compared with the second quarter of 2004. The increase
in
revenues came from most served markets including the oleochemical, petrochemical
and polyolefin markets. Volumes of Lynx
1000
polypropylene catalysts increased in the second quarter of 2005 compared
with
the same period in 2004 as market acceptance continued, and expanded capacity
at
the Company’s facility in Tarragona, Spain is now fully operational. This was
partially offset by decreased demand for older product offerings. Price
increases initiated in 2004 and 2005 accounted for approximately $1 million
of
higher revenues from the chemical-process markets.
Operating
earnings from products sold to chemical-process markets decreased in the
second
quarter of 2005 compared with the second quarter of 2004 due to decreased
sales
of higher margin products, partially offset by increased sales of lower
margin
products. Notably, the Company experienced increased demand for low margin
clays
to the oleochemical market compared with the year ago quarter, while seeing
decreased demand for fats and oils catalysts. The Company continues to
invest in
assets and technologies to broaden the product offerings to this market,
and to
increase its global presence. In the quarter, the Company completed the
acquisition of the catalyst business of Nanjing Chemical Industry Corporation
(see Note 3, “Acquisitions”). Results for the quarter were also negatively
impacted by higher SG&A spending of approximately $1 million, and higher raw
material costs of approximately $2 million compared with the same period
last
year.
Appearance
and Performance Technologies
The
Appearance and Performance Technologies segment provides pigments, effect
materials, personal care active ingredients and performance additives that
enable its customers to market enhanced image and functionality in their
products. This segment serves a broad array of end markets, including cosmetics
and personal care, coatings, plastics, automotive, construction and paper.
The
segment’s products help customers improve the look, functionality, performance
and overall cost of their products. In addition, the segment is the internal
supply source of precursors for most of the Company’s advanced
petroleum-refining catalysts.
Results
of Operations (in
millions)
|
|
Q2
2005
|
|
Q2
2004
|
|
%
change
|
|
Sales
|
|
$
|
186.6
|
|
$
|
185.2
|
|
|
0.8%
|
|
Operating
earnings
|
|
|
20.5
|
|
|
23.8
|
|
|
-13.9%
|
|
Discussion
Results
from this segment were disappointing, as decreased earnings from sales
to the
paper and other served markets were partially offset by increased earnings
from
the Company’s acquisitions within the personal care market.
Sales
from the Company’s mineral-based operations decreased 8% in the second quarter
of 2005 compared with the second quarter of 2004. This decrease is due
to lower
volumes of kaolin-based products to the paper market, partially offset
by an
increase in sales of kaolin- and attapulgite-based products to specialty
markets. Lower sales to the paper market were partially attributable to
industry
strikes in Finland and Canada during the quarter, somewhat offset by higher
prices. Although the strike in Finland is over, the Company does not expect
to
compensate for the lost second quarter paper sales. The Company
continues
to focus on non-paper kaolin markets to maximize cash flows from these
operations. These markets include plastics, construction, automotive,
agriculture, coatings and refining catalysts.
Operating
earnings from mineral-based products decreased significantly in the second
quarter of 2005 compared with the same period of 2004. Despite increased
sales
of kaolin- and attapulgite-based products to specialty markets, earnings
decreased as a result of higher manufacturing costs. Earnings from kaolin-based
products to the paper market decreased as a result of the aforementioned
strike-related negative impact on volumes of approximately $2 million in
the
quarter, as well as a negative impact from natural gas prices of approximately
$2 million in the quarter. Natural gas prices are expected to remain
high
for the remainder of 2005, and will negatively impact these businesses
by as
much as $10 million for the full year, despite a successful hedging strategy.
Cash flows from kaolin-based operations remain substantial, and these assets
continue to be monitored with respect to SFAS No. 144, “Accounting for the
Impairment or Disposal of Long-Lived Assets.”
Sales
of
effect materials, colors and personal care actives increased 9% in the
second
quarter of 2005 compared with the same period in 2004. Earlier in the year,
the
Company strengthened its position in the personal care market by acquiring
Coletica, S.A., a European high-growth company that develops performance-based,
skin-care compounds and related technologies. In 2004, the Company acquired
The
Collaborative Group, a domestic company serving similar markets. These
operations, along with previously existing operations, serve the cosmetics
and
personal care markets. These operations, with second quarter sales of $17
million, accounted for all of the increase in sales in the second quarter
of
2005 compared with the second quarter of 2004, offset by lower sales of
effect
materials and colorants. Decrease in colorant sales in the second quarter
was
due to decreased demand for the Company’s customers’ products.
Operating
earnings from effect materials, colors and personal care actives increased
6% in
the second quarter of 2005 compared with the second quarter of 2004, primarily
due to the above-mentioned acquisitions, offset by somewhat decreased earnings
from effect materials and colorants. Earnings from colorant markets are
expected
to decrease for the full year 2005 compared with 2004 due to 2004 customer
inventory builds, and decreased demand for the Company’s customers’ products.
Increased competition from Asian producers of effect pigments continues
to
negatively impact the Company’s margins and volumes.
Materials
Services
The
Materials Services segment serves the Company’s technology segments, their
customers and others with precious and base metals and related services.
This is
a distribution and materials services business that purchases and sells
precious
metals, base metals, other commodities and related products and services.
It
does so under a variety of pricing and delivery arrangements structured
to meet
the logistical, financial and price-risk management requirements of the
Company,
its customers and suppliers. Additionally, it offers the related services
of
precious-metal refining and storage, and produces precious-metal salts
and
solutions.
Results
of Operations (in
millions)
|
|
Q2
2005
|
|
Q2
2004
|
|
%
change
|
|
Sales
|
|
$
|
480.2
|
|
$
|
525.2
|
|
|
-8.6%
|
|
Operating
earnings
|
|
|
5.9
|
|
|
2.8
|
|
|
110.7%
|
|
Discussion
Sales
for
this segment include substantially all the Company’s sales of metals to
industrial customers of all segments. Sales also include fees invoiced
for
services rendered (e.g.
refining
charges). Because of the logistical and hedging nature of much of this
business
and the significant precious metal values included in both sales and cost
of
sales, gross margins tend to be low in relation to the Company’s technology
segments, as does capital employed. This effect also dampens the gross
margin
percentages of the Company as a whole, but improves the return on
investment.
While
many customers of the Company’s platinum-group-metal catalysts purchase the
metal from Materials Services, some choose to deliver metal from other
sources
prior to manufacture. In such cases, precious metal values are not included
in
sales. The mix of such arrangements and extent of market price fluctuations
can
significantly affect the reported level of sales and cost of sales.
Consequently, there is no necessary direct correlation between year-to-year
changes in reported sales and operating earnings. Revenues in the second
quarter
of 2005 decreased compared with the second quarter of 2004 due to lower
volumes
of precious metal sales.
Earnings
from metal sourcing operations improved in the second quarter of 2005 compared
with the second quarter of 2004. Refining and related service operations
were
improved compared with the same period last year, as the Company’s domestic
refinery experienced improved volumes and operating efficiencies.
Comparison
of the First Half of 2005 with the First Half of 2004
Net
earnings in the first half of 2005 included an after-tax special charge
of $6.4
million related to the closure of the Company’s Carteret, NJ manufacturing
facility (see Note 2, “Special Charges”). Net earnings in the first half of 2004
included an $8 million tax benefit resulting from resolution of the Company’s
1998, 1999 and 2000 federal tax returns. Net earnings decreased to $115.9
million in the first half of 2005 compared with $118.3 million in the first
half
of 2004. Operating earnings increased to $139.2 million in the first half
compared with $137.7 million in the same period last year, primarily due
to
higher earnings from the Materials Services segment, the Process Technologies
segment and the mobile-source markets served by the Environmental Technologies
segment, partially offset by the above-mentioned special charge ($10.4
million,
pre-tax). Earnings from equity method joint ventures increased to $15.5
million
in the first half of 2005 compared with $13.3 million in the same period
last
year, due to improved earnings from the Company’s Asian joint
ventures.
Environmental
Technologies
Results
of Operations (in
millions)
|
|
First
Half 2005
|
|
First
Half 2004
|
|
%
change
|
|
Sales
|
|
$
|
491.9
|
|
$
|
462.6
|
|
|
6.3%
|
|
Operating
earnings before special items
|
|
|
74.9
|
|
|
69.7
|
|
|
7.5%
|
|
Special
Charge
|
|
|
10.4
|
|
|
0.0
|
|
|
|
|
Operating
earnings
|
|
|
64.5
|
|
|
69.7
|
|
|
-7.5%
|
|
Discussion
Revenues
from mobile-source markets increased in the first half of 2005 compared
with the
same period in 2004, as increased sales of light duty diesel automotive
applications outpaced decreased sales of domestic gasoline applications.
The
majority of this increase was due to increased pass-through substrate costs.
Substrate costs were higher primarily due to increased demand for catalyzed
soot
filters (CSF) to the light duty diesel market. Sales to the motorcycle
and
diesel OEM markets increased in the half compared with last year, while
sales to
the diesel retrofit market decreased in the half.
Operating
earnings from mobile-source markets were flat in the first half of 2005
compared
with the first half of 2004. Profits from automotive markets increased,
driven
by the above-mentioned increased demand for light duty diesel applications,
partially offset by the decreased demand for gasoline applications. Earnings
from non-
automotive
diesel applications declined against a strong year ago half, while earnings
from
the motorcycle market improved.
Sales
to
industrial product markets increased in the first half of 2005 compared
with the
first half of 2004. Sales to power-generation customers increased in the
period,
primarily due to a single large order. Sales to most other industrial markets
were modestly higher compared with the same period last year.
Operating
earnings from industrial product markets decreased in the first half of
2005
compared with the same period last year, due to the previously disclosed
plan to
discontinue manufacturing operations at the Company’s Carteret, NJ facility.
Asset impairment, severance and other charges related to this action totaled
$10.4 million (see Note 2, “Special Charges”). Earnings from the
power-generation market improved versus the prior year, commensurate with
the
above-mentioned increased sales. Earnings improved modestly from operations
serving the temperature-sensing market due to an acquisition completed
in 2004.
Process
Technologies
Results
of Operations (in
millions)
|
|
First
Half 2005
|
|
First
Half 2004
|
|
%
change
|
|
Sales
|
|
$
|
320.5
|
|
$
|
291.4
|
|
|
10.0%
|
|
Operating
earnings
|
|
|
42.4
|
|
|
39.4
|
|
|
7.6%
|
|
Discussion
Sales
to
the petroleum-refining market increased modestly in the first half of 2005
compared with the first half of 2004. Higher volumes of petroleum-refining
additives drove the improvement. Demand remains strong for catalyst based
on the
Company’s DMS technology platform. Operating earnings from products sold to
petroleum-refining markets increased in the first half of 2005 compared
with the
first half of 2004, primarily due to the aforementioned increase
in sales
of additives. These improvements were offset by higher natural gas costs
of
approximately $2 million and other raw material costs.
Sales
of
catalysts to the chemical-process markets increased significantly in the
first
half of 2005 compared with the same period last year. The increase in revenues
came from most served markets including the oleochemical, petrochemical
and
polyolefin markets. Price increases initiated in 2004 and 2005 accounted
for
approximately $3 million of higher revenues from the chemical-process markets.
Operating earnings from products sold to chemical-process markets increased
in
the first half of 2005 compared with the first half of 2004 primarily due
to
absence of Tarragona start-up costs of $2.3 million in the first quarter
last
year. Margins were negatively impacted due to the mix of products sold.
Results
for the half were also negatively impacted by higher SG&A spending of
approximately $2 million, and higher raw material costs compared with the
same
period last year.
Appearance
and Performance Technologies
Results
of Operations (in
millions)
|
|
First
Half 2005
|
|
First
Half 2004
|
|
%
change
|
|
Sales
|
|
$
|
360.5
|
|
$
|
351.5
|
|
|
2.6%
|
|
Operating
earnings
|
|
|
38.5
|
|
|
38.9
|
|
|
-1.0%
|
|
Discussion
Sales
from the Company’s mineral-based operations decreased 2% in the first half of
2005 compared with the first half of 2004. This decrease is due to lower
volumes
of kaolin-based products to the paper market, partially offset by an increase
in
sales of kaolin- and attapulgite-based products to specialty markets. Lower
sales to the paper market is partially attributable to industry strikes
in
Finland and Canada, somewhat offset by higher prices.
Operating
earnings from mineral-based products decreased significantly in the first
half
of 2005 compared with the same period of 2004. Despite increased sales
of
kaolin- and attapulgite-based products to specialty markets, earnings
decreased
as a result of higher manufacturing costs. Earnings from kaolin-based
products
to the paper market decreased as a result of the aforementioned strike-related
negative impact on volumes of approximately $2 million in the half, as
well as a
negative impact from natural gas prices of approximately $4 million.
Sales
of
effect materials, colors and personal care actives increased 7% in the
first
half of 2005 compared with the same period in 2004. The recent acquisitions
serving the personal care materials markets accounted for all of the increase
in
sales, partially offset by decreased sales to other served markets. Operating
earnings from effect materials, colors and personal care actives increased
in
the first half of 2005 compared with the first half of 2004, due entirely
to the
above-mentioned acquisitions, partially offset by decreased earnings from
effect
materials and colorants.
Materials
Services
Results
of Operations (in
millions)
|
|
First
Half 2005
|
|
First
Half 2004
|
|
%
change
|
|
Sales
|
|
$
|
930.7
|
|
$
|
1,016.3
|
|
|
-8.4%
|
|
Operating
earnings
|
|
|
10.3
|
|
|
6.1
|
|
|
68.9%
|
|
Discussion
Revenues
in the first half of 2005 decreased compared with the first half of 2004
due to
lower volumes of precious metal sales partially offset by higher prices
of
platinum group metals. Earnings from metal sourcing operations improved
in the
first half of 2005 compared with the first half of 2004. Refining and related
service operations were improved compared with the same period last year,
as the
Company’s domestic refinery experienced improved volumes and operating
efficiencies, partially offset by higher administrative costs.
Liquidity
and Capital Resources
Liquidity
Working
capital was $565.2 million at June 30, 2005, compared with $659.8 million
at
December 31, 2004. The current ratio was 1.5 and 1.7 at June 30, 2005 and
December 31, 2004, respectively. This primarily reflects reduced cash balances,
as the Company utilized existing cash balances to fund two acquisitions
(see
Note 3, “Acquisitions”). The working capital of the Company’s technology
segments (Environmental Technologies, Process Technologies and Appearance
and
Performance Technologies) is not subject to significant fluctuations from
period
to period. While these businesses experience some modest seasonality, it
is not
enough to have a significant impact on their overall working capital
requirements. The working capital of the Materials Services segment may
vary due
to the timing of metal contracts, but is monitored closely by senior management.
While long-term working capital requirements cannot be readily predicted,
it is
expected that they will grow proportionally with the revenues and earnings
of
the technology segments.
Cash
balances were $28.3 million and $126.2 million at June 30, 2005 and December
31,
2004, respectively. The majority of this cash is held by foreign subsidiaries.
Where economically feasible, the Company finances its foreign subsidiaries
locally. The Company maintains cash pooling systems among certain foreign
operations, most notably in Europe, that allow for effective inter-subsidiary
financing.
In
May
2005, the Company entered into a five-year committed credit facility for
approximately $33 million (270 million Chinese Renminbi) with three major
foreign banks. The facility is available for general corporate purposes
for
various subsidiaries within China. In addition, the Company has a $12 million,
seven-year committed credit facility with two major foreign banks that
expires
in October 2010 related to a plant expansion in China.
On
March 7, 2005, the Company replaced existing
committed credit facilities with a new $800 million, five-year committed
credit
facility. This facility is available for general corporate purposes, including,
without
limitation,
to provide liquidity support for the issuance of commercial paper and
acquisition financing. As of June 30, 2005, the Company had $10.0 million
of
commercial paper outstanding, all of which matured on July 1,
2005.
The
Company’s total debt increased to $534.5 million at June 30, 2005 from $525.7
million at December 31, 2004. The percentage of total debt to total
capitalization was 28% at June 30, 2005 compared with 27% at December 31,
2004.
In
2004,
the Company increased its existing $150 million shelf registration to $450
million in order to increase the Company’s ability to raise cash for general
corporate purposes. The Company maintains investment-grade credit ratings
that
it considers important for cost-effective and ready access to the capital
markets. Should the Company’s rating drop below investment grade, the Company
would experience higher capital costs and may incur difficulty in procuring
metals.
The
Company’s available cash and unused committed credit lines represent a measure
of the Company’s short-term liquidity position. The Company believes that its
short-term liquidity position is sufficient to meet the cash requirements
of the
Company. In addition to the short-term liquidity, the Company’s investment grade
rating, $450 million shelf registration and access to debt and equity markets
are sufficient to meet the long-term liquidity requirements of the
Company.
Capital
Resources
The
Company’s technology segments represent the most significant internal capital
resource of the Company. The Company’s technology segments contain businesses
that generate significant cash flow. Cash flows from the Materials Services
segment tend to fluctuate from period to period due to the timing of metal
contracts. The “All Other” category includes certain small manufacturing
operations, the Strategic Technologies group and other corporate functions,
which collectively use cash. The Strategic Technologies group develops
technologies to commercial levels to generate future sources of cash.
Net
cash
provided by operating activities was $139.9 million in the first half of
2005
compared with $169.6 million in the first half of 2004. The variance in
cash
flows from operating activities primarily occurred in the Materials Services
segment and reflects changes in metal positions used to facilitate requirements
of the Company, its metal customers and suppliers (see Note 15 “Supplemental
Information,” for Material Services variations). Current levels of hedged metal
obligations and committed metal positions are expected to prevail for the
remainder of the year. Materials Services routinely enters into a variety
of
arrangements for the sourcing of metals. Generally, transactions are hedged
on a
daily basis. Hedging is accomplished primarily through forward, future
and
option contracts. However, in closely monitored situations for which exposure
levels have been set by senior management, the Company, from time to time,
holds
large unhedged industrial commodity positions that are subject to future
market
price fluctuations. These positions are included in committed metal positions,
along with hedged metal holdings. The bulk of hedged metal obligations
represent
spot short positions. Other than in closely monitored situations, these
positions are hedged through forward purchases. Unless a forward counterparty
fails to perform, there is no price risk. In addition, the aggregate fair
value
of derivatives in a loss position is reported in hedged metal obligations
(derivatives in a gain position are included in committed metal positions).
Materials Services works to ensure that the Company and its customers have
an
uninterrupted source of metals, primarily platinum group metals, utilizing
supply contracts and commodities markets around the world. Committed metal
positions may include significant advances made for the purchase of precious
metals that have been delivered to the Company but for which the final
purchase
price has not yet been determined. As of June 30, 2005, the aggregate market
value of the metals purchased under a contract for which a provisional
price had
been paid was in excess of the amounts advanced by a total of $7.6 million.
As a
result, this amount was recorded in committed metal positions and accounts
payable at June 30, 2005.
The
Company’s joint ventures operate independently of additional Company financing.
These joint ventures returned $8.9 million of cash to the Company in the
first
half of 2005. The Company does not anticipate additional cash proceeds
from its
joint ventures in 2005.
The
Company also depends upon access to debt and equity
markets, as discussed in the liquidity section, as a source of cash.
The
Company continues to invest currently to develop future sources of cash
through
self-investment, alliances, licensing agreements and acquisition. Notably,
during the first half of 2005, the Company invested $53.6 million in capital
projects and $93.8 million in acquisitions and other investments. Capital
expenditures for 2005 are expected to be approximately $140 million to
$150
million. Acquisitions during the first half of 2005 included approximately
$70
million, net of cash acquired, for the acquisition of Coletica, S.A. and
related
holdings and approximately $14 million for the acquisition of the catalyst
business of Nanjing Chemical Industry Corporation (NCIC) (see Note 3 -
“Acquisitions”). The Company expects to pay the remaining $7 million due to the
former owners of NCIC in the third quarter of 2005. The Company actively
pursues
investment opportunities that meet risk and return criteria set by senior
management. The Company expects to find opportunities in the future and
will act
upon these opportunities accordingly.
If
sources of cash exceed opportunities for investment, the Company will return
value to the shareholders. This is done through share buy-back programs,
dividends and debt repayment. In the first half of 2005 the Company purchased
approximately 2.5 million outstanding shares of common stock, net of stock
options exercised. In May 2005, the Company’s Board of Directors authorized a
share repurchase program of 6 million shares. In addition, the Company’s Board
of Directors approved an increase in the quarterly dividend from $0.11
per share
to $0.12 per share in the first quarter of 2005. The Company expects to
find
future investment opportunities, and will be able to reduce the future
amount of
shares purchased when this occurs.
Forward-Looking
Statements
This
document contains forward-looking statements within the meaning of the
Private
Securities Litigation Reform Act of 1995. These statements relate to analyses
and other information that are based on forecasts of future results and
estimates of amounts not yet determinable. These statements also relate
to
future prospects, developments and business strategies. These forward-looking
statements are identified by their use of terms and phrases such as
“anticipate,”“believe,”“could,”“estimate,”“expect,”“intend,”“may,”“plan,”“predict,”“project,”“will”
and similar terms and phrases, including references to assumptions. These
forward-looking statements involve risks and uncertainties, internal and
external, that may cause the Company’s actual future activities and results of
operations to be materially different from those suggested or described
in this
document.
Internal
risks and uncertainties that could cause actual results to differ materially
and
negatively impact the Company include:
· |
The
Company’s ability to achieve and execute internal business
plans.
The Company is currently engaged in formal productivity improvement
plans
in its Appearance and Performance Technologies and Environmental
Technologies segments that are expected to have a positive impact
on
earnings. Failure to achieve certain milestones would negatively
impact
the Company. The Company is also engaged in growth initiatives
in all
technology segments, led by the Strategic Technologies group.
Failure to
commercialize proprietary and other technologies or to acquire
businesses
or licensing agreements to serve targeted markets would negatively
impact
the Company.
|
· |
Future
divestitures and restructurings.
The Company may experience changes in market conditions that
cause the
Company to consider divesting or restructuring operations, which
could
impact future earnings.
|
· |
The
success of research and development activities and the speed
with which
regulatory authorizations and product launches may be
achieved.
The Company’s future cash flows depend upon the creation, acquisition and
commercialization of new
technologies.
|
· |
Manufacturing
difficulties, property loss, or casualty loss.
Although the Company maintains business interruption insurance,
the
Company is dependent upon the operating success of its manufacturing
facilities, and does not maintain redundant capacity. Failure
of these
manufacturing facilities would cause short-term profitability
losses and
could damage customer relations in the
long-term.
|
· |
Capacity
constraints. Some
of the Company’s businesses operate near current capacity levels. Should
demand for certain products increase, the Company would experience
short-term difficulty meeting the increased demand, hindering
growth
opportunities.
|
· |
Product
quality deficiencies. The
Company’s products are generally sold based upon specifications agreed
upon with our customers. Failure to meet these specifications
could
negatively impact the Company.
|
· |
The
impact of physical inventory losses, particularly with regard
to precious
and base metals.
Although the Company maintains property and casualty insurance,
the
Company holds large physical quantities of precious and base
metals, often
for the account of third parties. These quantities are subject
to loss by
theft and manufacturing
inefficiency.
|
· |
Litigation
and legal claims. The
Company is currently engaged in various legal disputes. Unfavorable
resolution of these disputes would negatively impact the Company.
Still
unidentified future legal claims could also negatively impact
the
Company.
|
· |
Contingencies
related to actual or alleged environmental contamination to which
the
Company may be a party (see
Note 21, “Environmental Costs,” of the Company’s 2004 Form 10-K, as well
as the section above).
|
· |
Exposure
to product liability lawsuits.
|
External
risks, uncertainties and changes in market conditions that could cause
actual
results to differ materially and negatively impact the Company
include:
· |
Competitive
pricing or product development activities affecting demand for
our
products.
The Company operates in a number of markets where overcapacity,
low priced
foreign competitors, and other factors create a situation where
competitors compete for business by reducing their prices, notably
the
kaolin to paper market, some effect pigments markets, the colorant
market,
certain chemical process markets and certain components of the
mobile-source environmental markets.
|
· |
Overall
demand for the Company’s products, which is dependent on the demand for
our customers’ products.
As
a supplier of materials to other manufacturers, the Company is
dependent
upon the markets for its customers’ products. Notably, some North American
automobile producers have recently experienced financial difficulties
and
decreased product demand. Additionally, technological advances
by direct
and not-in-kind competitors could render the Company’s current products
obsolete.
|
· |
Changes
in the solvency and liquidity of our customers.
Although the Company believes it has adequate credit policies,
the
creditworthiness of customers could
change.
|
· |
Fluctuations
in the supply and prices of precious and base metals and fluctuations
in
the relationships between forward prices to spot prices.
The Company depends upon a reliable source of precious metals,
used in the
manufacture of its products, for itself and its customers. These
precious
metals are sourced from a limited number of suppliers. Decrease
in the
availability of these precious metals could impact the profitability
of
the Company.
|
· |
A
decrease in the availability or an increase in the cost of energy,
notably
natural gas. The
Company consumes more than 10 million MMBTUs of natural gas annually.
Compared with other sources of energy, natural gas is subject
to
volatility in availability and price, due to transportation,
processing
and storage requirements.
|
· |
The
availability and price of rare earth compounds.
The Company uses certain rare earth compounds, produced in limited
locations worldwide.
|
· |
The
availability and price of other raw materials.
The Company’s products contain a broad array of raw materials for which
increases in price or decreases in availability could negatively
impact
the Company.
|
· |
The
impact of increased employee benefit costs and/or the resultant
impact on
employee relations and human resources.
The Company employs approximately 7,000 employees worldwide and
is subject
to recent trends in benefit costs, notably pension and medical
benefits.
|
· |
Higher
interest rates.
Approximately half of the Company’s debt is exposed to short-term interest
rate fluctuations. An increase in long-term debt rates would
impact the
Company when the current long-term debt instruments mature, or
if the
Company requires additional long-term debt.
|
· |
Changes
in foreign currency exchange rates.
The Company regularly enters into transactions denominated in
foreign
currencies, and accordingly is exposed to changes in foreign
currency
exchange rates. The Company’s policy is to hedge the risks associated with
monetary assets and liabilities resulting from these transactions.
Additionally, the Company has significant foreign currency investments
and
earnings, which are subject to changes in foreign currency exchange
rates
upon translation into U.S. dollars.
|
· |
Geographic
expansions not developing as anticipated.
The Company expects markets in Asia to fuel growth for many served
markets. China’s expected growth exceeds that of most developed countries,
and failure of that growth to materialize would negatively impact
the
Company.
|
· |
Economic
downturns and inflation.
The diversity of the Company’s markets has substantially insulated the
Company’s profitability from economic downturns in recent years. The
Company is exposed to overall economic
conditions.
|
· |
Increased
levels of worldwide political instability, as the Company operates
primarily in the United States, the European community, Asia,
the Russian
Federation, South Africa and Brazil.
Much of the Company’s identified growth prospects are foreign markets. As
such, the Company expects continued foreign investment and, therefore,
increased exposure to foreign political instability. Additionally,
the
worldwide threat of terrorism can directly and indirectly impact
the
Company’s foreign and domestic
profitability.
|
· |
The
impact of the repeal of the U.S. export sales tax incentive and
the
enactment of the American
Jobs Creation Act of 2004.
The Company is in the process of assessing the impact of these
actions.
|
· |
Government
legislation and/or regulation particularly on environmental and
taxation
matters.
The Company maintains manufacturing facilities and, as a result,
is
subject to environmental laws. The Company will be impacted by
changes in
these laws. The Company operates in tax jurisdictions throughout
the
world, and, as a result, is subject to changes in tax laws, notably
in the
United States, the United Kingdom, Germany, the Netherlands,
Italy,
Switzerland, France, Spain, South Africa, Brazil, Mexico, China,
Korea,
Japan, India and Thailand.
|
· |
A
slowdown in the expected rate of environmental
requirements.
The Company’s Environmental Technologies segment’s customers, and to a
lesser extent, the Process Technologies segment’s customers, are generally
driven by increasingly stringent environmental regulations. A
slowdown or
repeal of regulations could negatively impact the
Company.
|
Investors
are cautioned not to place undue reliance upon these forward-looking statements,
which speak only as of their dates. The Company disclaims any obligation
to
update or revise any forward-looking statements, whether as a result of
new
information, future events or otherwise.
Item
3. Quantitative and
Qualitative Disclosures about Market Risk
Market
Risk Sensitive Transactions
The
Company is exposed to market risks arising from adverse changes in interest
rates, foreign currency exchange rates and commodity prices. In the normal
course of business, the Company uses a variety of techniques and instruments,
including derivatives, as part of its overall risk-management strategy.
The
Company enters into derivative agreements with a diverse group of major
financial and other institutions with individually determined credit limits
to
reduce exposure to the risk of nonperformance by counterparties.
A
discussion and analysis of the Company’s market risk is included in the
Company’s 2004 Form 10-K. There have been no significant changes to these market
risks as of June 30, 2005.
Item
4. Controls and
Procedures
The
Company carried out an evaluation, under the supervision and with the
participation of the Company’s management, including the Company’s Chief
Executive Officer and Chief Financial Officer, as of June 30, 2005, of
the
effectiveness of the design and operation of the Company’s disclosure controls
and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation,
the Chief Executive Officer and Chief Financial Officer concluded that
the
Company’s disclosure controls and procedures as of June 30, 2005 were effective
to provide reasonable assurance that material information related to the
Company
(including its consolidated subsidiaries) required to be included in the
Company’s periodic SEC filings would be communicated to them on a timely basis.
There was no change in the Company’s internal control over financial reporting
during the Company’s second fiscal quarter of 2005 that has materially affected,
or is reasonably likely to materially affect, the Company’s internal control
over financial reporting.
The
Company’s management, including the Chief Executive Officer and Chief Financial
Officer, do not expect that our disclosure controls or our internal control
over
financial reporting will prevent all errors and all fraud. A control system,
no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met.
Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to
their
costs. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and
instances
of fraud, if any, within the Company have been detected. These inherent
limitations include the reality that judgments and estimates can be faulty,
and
that breakdowns can occur because of simple error or mistake. Additionally,
controls can be circumvented by the individual acts of some persons or
by
collusion of two or more people. The design of any system of controls also
is
based, in part, upon certain assumptions about the likelihood of future
events,
and there can be no assurance that any design will succeed in achieving
its
stated goals under all potential future conditions. Because of the inherent
limitations in a cost-effective control system, misstatements due to error
or
fraud may occur and not be detected. Accordingly, the Company’s disclosure
controls and procedures are designed to provide reasonable, not absolute,
assurance that the objectives of the Company’s disclosure control system are met
and, as set forth above, the Company’s Chief Executive Officer and Chief
Financial Officer have concluded, based on their evaluation as of June
30, 2005,
that the Company’s disclosure controls and procedures were effective to provide
reasonable assurance that the objectives of the Company's disclosure control
system were met.