Form 10Q for quarterly period ended March 31, 2006
UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
(Mark
One)
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For
the
quarterly period ended March 31, 2006
OR
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For
the
transition period from ________ to _________
Commission
file number 1-8142
ENGELHARD
CORPORATION
(Exact
name of Registrant as specified in its charter)
|
DELAWARE
(State
or other jurisdiction of
incorporation
or organization)
|
22-1586002
(I.R.S.
Employer Identification No.)
|
101
WOOD AVENUE, ISELIN, NEW JERSEY, 08830
(Address
of principal executive offices)
|
(732)
205-5000
(Registrant’s
telephone number, including area
code)
|
Indicate
by check mark whether the Registrant (1) has filed all reports required to
be
filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days. Yes x No
o
Indicate
by check mark whether the registrant is a large filer, an accelerated filer
or
non-accelerated filer. See definition of “accelerated filer and large
accelerated filer” in Rule 12b-2 of the Act. (Check One):
Large
accelerated filer x Accelerated
filer o Non-accelerated
filer o
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No
x
Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date.
Class
of Common Stock
$1
par value
|
Outstanding
at April 28, 2006
124,011,840
|
PART
I - FINANCIAL INFORMATION
Item
1. |
Financial
Statements
|
ENGELHARD
CORPORATION
CONDENSED
CONSOLIDATED STATEMENTS OF EARNINGS
(Thousands,
except per-share data)
(Unaudited)
|
|
Three
Months Ended
March
31,
|
|
|
|
2006
|
|
2005
|
|
Net
sales
|
|
$
|
1,455,327
|
|
$
|
1,018,711
|
|
Cost
of sales
|
|
|
1,244,551
|
|
|
849,990
|
|
Gross
profit
|
|
|
210,776
|
|
|
168,721
|
|
Selling,
administrative and other expenses
|
|
|
117,159
|
|
|
98,482
|
|
Expenses
related to BASF offer
|
|
|
6,875
|
|
|
-
|
|
Operating
earnings
|
|
|
86,742
|
|
|
70,239
|
|
Equity
in earnings of affiliates
|
|
|
7,656
|
|
|
8,109
|
|
(Loss)
gain on investment
|
|
|
(32
|
)
|
|
119
|
|
Interest
income
|
|
|
3,678
|
|
|
1,232
|
|
Interest
expense
|
|
|
(10,093
|
)
|
|
(6,012
|
)
|
Earnings
before income taxes
|
|
|
87,951
|
|
|
73,687
|
|
Income
tax expense
|
|
|
18,823
|
|
|
15,231
|
|
Net
earnings from continuing operations
|
|
|
69,128
|
|
|
58,456
|
|
|
|
|
|
|
|
|
|
Loss
from discontinued operations, net of tax
|
|
|
(135
|
)
|
|
(504
|
)
|
Net
earnings
|
|
$
|
68,993
|
|
$
|
57,952
|
|
|
|
|
|
|
|
|
|
Earnings
per share from continuing operations:
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.56
|
|
$
|
0.48
|
|
Diluted
|
|
$
|
0.55
|
|
$
|
0.47
|
|
|
|
|
|
|
|
|
|
Earnings
per share from discontinued operations:
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.00
|
)
|
$
|
(0.00
|
)
|
Diluted
|
|
$
|
(0.00
|
)
|
$
|
(0.00
|
)
|
|
|
|
|
|
|
|
|
Earnings
per share:
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.56
|
|
$
|
0.48
|
|
Diluted
|
|
$
|
0.55
|
|
$
|
0.47
|
|
|
|
|
|
|
|
|
|
Cash
dividends per share
|
|
$
|
0.12
|
|
$
|
0.12
|
|
Average
number of shares outstanding - basic
|
|
|
122,582
|
|
|
121,702
|
|
Average
number of shares outstanding - diluted
|
|
|
125,712
|
|
|
123,905
|
|
See
the
Accompanying Notes to the Unaudited Condensed Consolidated Financial
Statements
ENGELHARD
CORPORATION
CONDENSED
CONSOLIDATED BALANCE SHEETS
(Thousands)
(Unaudited)
|
|
March
31,
2006
|
|
December
31,
2005
|
|
Cash
and cash equivalents
|
|
$
|
64,573
|
|
$
|
41,619
|
|
Cash
in trust
|
|
|
112,377
|
|
|
-
|
|
Receivables,
net
|
|
|
631,791
|
|
|
526,962
|
|
Committed
metal positions
|
|
|
1,004,646
|
|
|
904,953
|
|
Inventories
|
|
|
561,658
|
|
|
532,638
|
|
Other
current assets
|
|
|
137,941
|
|
|
145,392
|
|
Total
current assets
|
|
|
2,512,986
|
|
|
2,151,564
|
|
Investments
|
|
|
203,369
|
|
|
204,495
|
|
Property,
plant and equipment, net
|
|
|
909,612
|
|
|
936,193
|
|
Goodwill
|
|
|
406,252
|
|
|
400,719
|
|
Other
intangible assets, net and noncurrent assets
|
|
|
184,309
|
|
|
186,007
|
|
Total
assets
|
|
$
|
4,216,528
|
|
$
|
3,878,978
|
|
Short-term
borrowings
|
|
$
|
167,876
|
|
$
|
48,784
|
|
Current
maturities of long-term debt
|
|
|
106,737
|
|
|
120,852
|
|
Accounts
payable
|
|
|
799,773
|
|
|
561,955
|
|
Hedged
metal obligations
|
|
|
533,477
|
|
|
640,812
|
|
Other
current liabilities
|
|
|
246,928
|
|
|
265,359
|
|
Total
current liabilities
|
|
|
1,854,791
|
|
|
1,637,762
|
|
Long-term
debt
|
|
|
432,247
|
|
|
430,500
|
|
Other
noncurrent liabilities
|
|
|
321,545
|
|
|
321,554
|
|
Shareholders’
equity
|
|
|
1,607,945
|
|
|
1,489,162
|
|
Total
liabilities and shareholders’ equity
|
|
$
|
4,216,528
|
|
$
|
3,878,978
|
|
See
the
Accompanying Notes to the Unaudited Condensed Consolidated Financial
Statements
ENGELHARD
CORPORATION
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Thousands)
(Unaudited)
|
|
Three
Months Ended
March
31,
|
|
|
|
2006
|
|
2005
|
|
Cash
flows from operating activities
|
|
|
|
|
|
|
|
Net
earnings
|
|
$
|
68,993
|
|
$
|
57,952
|
|
Adjustments
to reconcile net earnings to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
Depreciation
and depletion
|
|
|
33,154
|
|
|
31,368
|
|
Amortization
of intangible assets
|
|
|
1,594
|
|
|
1,117
|
|
Loss
(gain) on investment
|
|
|
32
|
|
|
(119
|
)
|
Equity
results, net of dividends
|
|
|
(5,855
|
)
|
|
(5,050
|
)
|
Net
change in assets and liabilities:
|
|
|
|
|
|
|
|
Materials
Services related
|
|
|
(23,899
|
)
|
|
(14,662
|
)
|
Funding
of retirement trust
|
|
|
(112,377
|
)
|
|
-
|
|
Excess
tax benefits from share-based arrangements
|
|
|
(15,527
|
)
|
|
-
|
|
All
other
|
|
|
(65,948
|
)
|
|
(28,982
|
)
|
Net
cash (used in) provided by operating activities
|
|
|
(119,833
|
)
|
|
41,624
|
|
Cash
flows from investing activities
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
|
(32,918
|
)
|
|
(24,967
|
)
|
Acquisitions
and other investments, net of cash acquired
|
|
|
-
|
|
|
(55,084
|
)
|
Net
cash used in investing activities
|
|
|
(32,918
|
)
|
|
(80,051
|
)
|
Cash
flows from financing activities
|
|
|
|
|
|
|
|
Increase
in short-term borrowings
|
|
|
118,805
|
|
|
20,532
|
|
(Decrease)
increase in long-term debt
|
|
|
(8,993
|
)
|
|
69
|
|
Purchase
of treasury stock
|
|
|
-
|
|
|
(46,016
|
)
|
Cash
from exercise of stock options
|
|
|
66,732
|
|
|
2,709
|
|
Excess
tax benefits from share-based arrangements
|
|
|
15,527
|
|
|
-
|
|
Dividends
paid
|
|
|
(14,859
|
)
|
|
(14,636
|
)
|
Net
cash provided by (used in) financing activities
|
|
|
177,212
|
|
|
(37,342
|
)
|
Effect
of exchange rate changes on cash and cash equivalents
|
|
|
(1,507
|
)
|
|
2,202
|
|
Net
increase (decrease) in cash and cash equivalents
|
|
|
22,954
|
|
|
(73,567
|
)
|
Cash
and cash equivalents at beginning of year
|
|
|
41,619
|
|
|
126,229
|
|
Cash
and cash equivalents at end of period
|
|
$
|
64,573
|
|
$
|
52,662
|
|
See
the
Accompanying Notes to the Unaudited Condensed Consolidated Financial
Statements
ENGELHARD
CORPORATION
BUSINESS
SEGMENT INFORMATION
(Thousands)
(Unaudited)
|
|
Three
Months Ended
March
31,
|
|
|
|
2006
|
|
2005
|
|
Net
Sales
|
|
|
|
|
|
Environmental
Technologies
|
|
$
|
320,222
|
|
$
|
237,458
|
|
Process
Technologies
|
|
|
171,048
|
|
|
147,981
|
|
Appearance
and Performance Technologies
|
|
|
206,332
|
|
|
173,875
|
|
Technology
segments
|
|
|
697,602
|
|
|
559,314
|
|
Materials
Services
|
|
|
727,788
|
|
|
446,424
|
|
All
Other
|
|
|
29,937
|
|
|
12,973
|
|
Total
net sales
|
|
$
|
1,455,327
|
|
$
|
1,018,711
|
|
Operating
Earnings
|
|
|
|
|
|
|
|
Environmental
Technologies
|
|
$
|
41,530
|
|
$
|
36,981
|
|
Process
Technologies
|
|
|
26,263
|
|
|
19,057
|
|
Appearance
and Performance Technologies
|
|
|
21,512
|
|
|
18,063
|
|
Technology
segments
|
|
|
89,305
|
|
|
74,101
|
|
Materials
Services
|
|
|
17,205
|
|
|
4,725
|
|
All
Other
|
|
|
(19,768
|
)
|
|
(8,587
|
)
|
Total
operating earnings
|
|
|
86,742
|
|
|
70,239
|
|
Equity
in earnings of affiliates
|
|
|
7,656
|
|
|
8,109
|
|
(Loss)
gain on investments
|
|
|
(32
|
)
|
|
119
|
|
Interest
income
|
|
|
3,678
|
|
|
1,232
|
|
Interest
expense
|
|
|
(10,093
|
)
|
|
(6,012
|
)
|
Earnings
before income taxes
|
|
|
87,951
|
|
|
73,687
|
|
Income
tax expense
|
|
|
18,823
|
|
|
15,231
|
|
Net
earnings from continuing operations
|
|
|
69,128
|
|
|
58,456
|
|
Loss
from discontinued operations, net of taxes
|
|
|
(135
|
)
|
|
(504
|
)
|
Net
earnings
|
|
$
|
68,993
|
|
$
|
57,952
|
|
See
the
Accompanying Notes to the Unaudited Condensed Consolidated Financial
Statements
Notes
to the Unaudited Condensed Consolidated Financial
Statements
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 2005 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.
Note
2 - Acquisitions
In
January 2006, the Company increased its ownership percentage of Engelhard
Environmental Systems (India) Private Limited (EESIPL), an environmental
technologies joint venture in the State of Tamil Nadu, India, from 60% to 90%.
The Company purchased the additional 30% share, previously owned by UCAL Fuel
Systems Limited, for $6.5 million. This cash was held in escrow at December
31,
2005 and was reflected as a cash outflow in the 2005 Consolidated Statement
of
Cash Flows. EESIPL produces emission-control technologies for automotive and
motorcycle applications. The operations primarily serve the growing Indian
market. This transaction will enable the Company to fully integrate the
operations into its global growth strategy. EESIPL is a majority-owned
subsidiary that is consolidated in the financial statements of the Company
and
for which minority interest is recorded. In accordance with SFAS No. 141,
“Business Combinations” and APB No. 16, “Business Combinations,” the acquisition
of some or all of the stock held by minority stockholders of a subsidiary
whether acquired by the parent, the subsidiary itself, or another affiliate
should be accounted for by the purchase method. As such, the Company reduced
minority interest, representing UCAL’s share (30%), which had historically been
recorded in consolidation and recorded the excess of the purchase price over
the
minority interest acquired as goodwill.
Note
3 - 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):
|
|
March
31,
2006
|
|
March
31,
2005
|
|
Balance
at beginning of year
|
|
$
|
10.0
|
|
$
|
10.8
|
|
Accretion
expense
|
|
|
0.3
|
|
|
0.2
|
|
Payments
|
|
|
(0.3
|
)
|
|
(0.3
|
)
|
Asset
retirement obligation at end of period
|
|
$
|
10.0
|
|
$
|
10.7
|
|
Note
4 - Inventories
Inventories
consist of the following (in millions):
|
|
March
31,
2006
|
|
December
31, 2005
|
|
Raw
materials
|
|
$
|
171.3
|
|
$
|
174.4
|
|
Work
in process
|
|
|
60.3
|
|
|
54.6
|
|
Finished
goods
|
|
|
313.9
|
|
|
287.7
|
|
Precious
metals
|
|
|
16.2
|
|
|
15.9
|
|
Total
inventories
|
|
$
|
561.7
|
|
$
|
532.6
|
|
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 $164.3 million and $125.7 million at March 31, 2006 and
December 31, 2005, 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
5 - Comprehensive Income
Comprehensive
income is summarized as follows (in millions):
|
|
Three
Months Ended
March
31,
|
|
|
|
2006
|
|
2005
|
|
Net
earnings
|
|
$
|
69.0
|
|
$
|
58.0
|
|
Other
comprehensive income (loss):
|
|
|
|
|
|
|
|
Foreign
currency translation adjustment
|
|
|
9.6
|
|
|
(1.4
|
)
|
Cash
flow derivative adjustment, net of tax
|
|
|
(9.5
|
)
|
|
8.5
|
|
Minimum
pension liability adjustment, net of tax
|
|
|
(0.1
|
)
|
|
0.2
|
|
Other
|
|
|
—
|
|
|
1.7
|
|
Comprehensive
income
|
|
$
|
69.0
|
|
$
|
67.0
|
|
The
foreign currency translation adjustments are not currently adjusted for income
taxes as they relate to permanent investments in non-U.S. entities, however
the
balances as of March 31, 2006 and 2005 are shown net of income tax benefit
of
$1.6 million and $1.2 million, respectively, related to the mark-to-market
of
the Company’s net investment hedges.
The
cash
flow derivative adjustment is shown net of income tax (expense) benefit of
$6.6
million and $(5.9) million for the three-month periods ended March 31, 2006
and
2005, respectively.
The
minimum pension liability adjustment is shown net of income tax (expense)
benefit of less than $0.1 million and $(0.1) million for the three-month periods
ended March 31, 2006 and 2005, respectively.
Note
6 - 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
March
31,
|
|
(in
millions, except per-share data):
|
|
2006
|
|
2005
|
|
Basic
EPS Computation
|
|
|
|
|
|
|
|
Income
from continuing operations
|
|
$
|
69.1
|
|
$
|
58.5
|
|
Loss
from discontinued operations, net of tax
|
|
|
(0.1
|
)
|
|
(0.5
|
)
|
Net
earnings applicable to common shares
|
|
$
|
69.0
|
|
$
|
58.0
|
|
Average
number of shares outstanding - basic
|
|
|
122.6
|
|
|
121.7
|
|
Basic
earnings per share from continuing
operations
|
|
$
|
0.56
|
|
$
|
0.48
|
|
Basic
earnings per share from discontinued
operations
|
|
|
(0.00
|
)
|
|
(0.00
|
)
|
Basic
earnings per share
|
|
$
|
0.56
|
|
$
|
0.48
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
EPS Computation
|
|
|
|
|
|
|
|
Income
from continuing operations
|
|
$
|
69.1
|
|
$
|
58.5
|
|
Loss
from discontinued operations, net of tax
|
|
|
(0.1
|
)
|
|
(0.5
|
)
|
Net
earnings applicable to common shares
|
|
$
|
69.0
|
|
$
|
58.0
|
|
Average
number of shares outstanding - basic
|
|
|
122.6
|
|
|
121.7
|
|
Effect
of dilutive stock options and other incentives
|
|
|
3.1
|
|
|
2.2
|
|
Average
number of shares outstanding - diluted
|
|
|
125.7
|
|
|
123.9
|
|
Diluted
earnings per share from continuing
operations
|
|
$
|
0.55
|
|
$
|
0.47
|
|
Diluted
earnings per share from discontinued
operations
|
|
|
(0.00
|
)
|
|
(0.00
|
)
|
Diluted
earnings per share
|
|
$
|
0.55
|
|
$
|
0.47
|
|
Note
7 - 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 “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 either cash flow hedges
or
net investment 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 maintain an effective control environment 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-month periods
ended
March 31, 2006 and 2005, 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
three-month periods ended March 31, 2006 and 2005, the Company reported an
after-tax gain balance of $0.3 million and an after-tax loss balance of $0.5
million, respectively, in accumulated other comprehensive income relating to
the
change in the fair value of derivatives designated as foreign exchange cash
flow
hedges. The Company reported an after-tax gain balance of $1.4 million in
accumulated other comprehensive income for the year ended December 31, 2005.
It
is expected that cumulative losses of $1.1 million as of March 31, 2006 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. As of March 31, 2006, 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 foreign currency derivative 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 other
commodity cash flow hedges. The ultimate maturities of the contracts are timed
to coincide with the expected usage of these commodities.
For
the
three-month periods ended March 31, 2006 and 2005, the Company reported an
after-tax loss balance of $2.7 million and an after-tax gain balance of $6.1
million, respectively, in accumulated other comprehensive income relating to
the
change in the fair value of derivatives designated as cash flow commodity
hedges. The Company reported an after-tax gain balance of $6.5 million in
accumulated other comprehensive income for the year-ended December 31, 2005.
It
is expected that the cumulative loss of $9.2 million as of March 31, 2006 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 commodity hedges due to the
probability of the original forecasted transactions not occurring. As of March
31, 2006, the maximum length of time over which the Company has hedged its
exposure to movements in commodity prices for forecasted transactions is 12
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 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-month periods ended March 31,
2006
and 2005.
In
December 2005, the Company entered into an interest rate derivative contract,
referred to as a Forward Rate Agreement (FRA) contract. This derivative
economically hedged the Company’s interest rate exposure for the May 15, 2006
Euribor rate reset under two US dollar to euro cross-currency interest rate
derivative swap agreements.
In
September 2005, the Company terminated two interest rate swap agreements, with
a
total notional value of $100 million maturing in August 2006, that were
designated as fair value hedges. The accumulated gain of $0.4 million resulting
from the termination of these two interest rate swap agreements will be
amortized to earnings over the remaining term of the underlying debt
instrument.
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 an accumulated gain of $20.1 million that will be amortized to
earnings over the remaining term of the underlying debt instrument.
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. As of March 31, 2006, the
Company reported an after-tax gain balance of $2.0 million in accumulated other
comprehensive income. The Company reported an after-tax gain balance of $1.2
million in accumulated other comprehensive income for the year-ended December
31, 2005. There was no gain or loss recorded to 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 three tranches (the first tranche in April 2004, the second
tranche in August 2004 and the third tranche in August 2005) of 5.5 billion
Japanese yen notes (approximately $50 million for each tranche) with a blended
coupon rate of 1.0% and maturity dates of April 2009. 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. As of December 31, 2005, a gain of $5.7 million
represented the balance within accumulated other comprehensive income relating
to the mark-to-market of these notes. During the first quarter of 2006, the
Company recorded a net after-tax loss of $0.2 million in accumulated other
comprehensive income, resulting in an after-tax gain balance of $5.5 million
at
March 31, 2006 relating to the mark-to-market of these notes.
In
October 2005, the Company entered into two US dollar to Euro cross-currency
interest rate derivative contracts with a total notional value of 124 million
Euro (approximately $150 million). This transaction effectively swaps the
Company’s US dollar floating rate exposure for a Euro floating rate exposure.
The notional Euro liability of this cross-currency swap is designated as a
net
investment hedge of a portion of the Company’s Euro-denominated investments, and
as such it is marked-to-market with the gain/loss reflected in accumulated
other
comprehensive income. As of December 31, 2005, a gain of $2.0 million
represented the balance within accumulated other comprehensive income relating
to the mark-to-market of this cross-currency swap. During the first quarter
of
2006, the Company recorded an after-tax loss of $2.1 million, resulting in
an
after tax loss balance of $0.1 million at March 31, 2006 relating to the
mark-to-market of this cross-currency swap.
Note
8 - 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 March 31, 2006, the aggregate outstanding amount of
letters of credit supporting such obligations amounted to $119.3 million, of
which $112.9 million will expire in less than one year, $0.7 million will expire
in two to three years, $0.1 million will expire in four to five years and $5.6
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):
|
|
March
31, 2006
|
|
March
31, 2005
|
|
Balance
at beginning of year
|
|
$
|
4.2
|
|
$
|
8.7
|
|
Payments
|
|
|
(0.2
|
)
|
|
(0.1
|
)
|
Provision
|
|
|
0.1
|
|
|
0.1
|
|
Reversal
of reserve
|
|
|
—
|
|
|
(0.2
|
)
|
Balance
at end of period
|
|
$
|
4.1
|
|
$
|
8.5
|
|
Note
9 - 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, which range from 3
to 15
years. 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 March 31, 2006
|
|
As
of December 31, 2005
|
|
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Acquired
Amortizable Intangible Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Usage
rights
|
|
$
|
19.9
|
|
$
|
7.3
|
|
$
|
19.4
|
|
$
|
6.8
|
|
Supply
agreements
|
|
|
18.5
|
|
|
7.8
|
|
|
18.1
|
|
|
7.3
|
|
Technology
licenses
|
|
|
18.3
|
|
|
5.7
|
|
|
11.5
|
|
|
4.8
|
|
Other
|
|
|
25.4
|
|
|
4.1
|
|
|
23.6
|
|
|
4.0
|
|
Total
|
|
$
|
82.1
|
|
$
|
24.9
|
|
$
|
72.6
|
|
$
|
22.9
|
|
Intangible
assets, other than goodwill, with indefinite useful lives, and thus not subject
to amortization, are $2.1 million as of March 31, 2006 and December 31, 2005.
The increase in the gross carrying amount balance as of March 31, 2006 is
primarily due to approximately $8 million of additional intangibles related
to
acquisitions. These intangibles include customer relationships and technology
licenses.
As
of
March 31, 2006, the estimated aggregate amortization expense for each of the
five succeeding years is as follows (in millions):
Estimated
Annual Amortization Expense:
|
|
|
|
|
2006
|
|
$
|
6.5
|
|
2007
|
|
|
6.5
|
|
2008
|
|
|
6.4
|
|
2009
|
|
|
6.0
|
|
2010
|
|
|
5.5
|
|
|
|
|
|
|
The
following table represents the changes in the carrying amount of goodwill for
the three-month period ended March 31, 2006 (in millions):
|
|
Environmental
Technologies
|
|
Process
Technologies
|
|
Appearance
& Performance Technologies
|
|
All
Other
|
|
Total
|
|
Balance
as of January 1, 2006
|
|
$
|
17.4
|
|
$
|
109.6
|
|
$
|
243.5
|
|
$
|
30.2
|
|
$
|
400.7
|
|
Goodwill
additions (a)
|
|
|
4.5
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
4.5
|
|
Purchase
accounting adjustments (b)
|
|
|
-
|
|
|
-
|
|
|
(1.1
|
)
|
|
(0.1
|
)
|
|
(1.2
|
)
|
Foreign
currency translation adjustment
|
|
|
0.3
|
|
|
0.1
|
|
|
1.9
|
|
|
-
|
|
|
2.3
|
|
Balance
as of March 31, 2006
|
|
$
|
22.2
|
|
$
|
109.7
|
|
$
|
244.3
|
|
$
|
30.1
|
|
$
|
406.3
|
|
(a) |
Goodwill
additions amount of $4.5 million is related to the Company’s acquisition
of 30% minority interest of Engelhard Environmental (India) Private
Limited during the first quarter. This amount represents the excess
of the
purchase price paid over the minority interest acquired, in accordance
with SFAS No. 141, “Business
Combinations.”
|
(b) |
Purchase
accounting adjustments include $1.1 million and $0.1 million related
to a
revision of the allocation of the purchase price of Coletica, S.A.
and
Almatis AC, Inc., respectively. All adjustments were made in accordance
with SFAS No. 141, “Business
Combinations.”
|
Note
10 - Committed Metal Positions and Hedged Metal
Obligations
|
|
March
31, 2006
|
|
December
31, 2005
|
|
Committed
Metal Positions were comprised of the following (in
millions):
|
|
|
|
|
|
|
|
Metals
in a net spot long position economically hedged with
derivatives
(primarily forward sales)
|
|
$
|
892.7
|
|
$
|
572.2
|
|
Fair
value of hedging derivatives in a “gain” position
|
|
|
16.4
|
|
|
8.8
|
|
Unhedged
metal positions, net (see analysis below)
|
|
|
83.8
|
|
|
72.1
|
|
Fair
value of metals received with prices to be determined, net
of
|
|
|
|
|
|
|
|
hedged
spot sales.
|
|
|
11.7
|
|
|
251.9
|
|
Total committed metal positions
|
|
$
|
1,004.6
|
|
$
|
905.0
|
|
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):
|
|
March
31, 2006
|
|
December
31, 2005
|
|
|
|
Net
Position
|
|
Value
|
|
Net
Position
|
|
Value
|
|
Platinum
group metals
|
|
|
Long
|
|
$
|
70.1
|
|
|
Long
|
|
$
|
66.3
|
|
Gold
|
|
|
Long
|
|
|
0.8
|
|
|
Long
|
|
|
3.8
|
|
Silver
|
|
|
Long
|
|
|
0.4
|
|
|
Short
|
|
|
(1.8
|
)
|
Base
metals
|
|
|
Long
|
|
|
12.5
|
|
|
Long
|
|
|
3.8
|
|
Total
unhedged metal positions
|
|
|
|
|
$
|
83.8
|
|
|
|
|
$
|
72.1
|
|
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 March 31, 2006 and December
31, 2005, 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 $11.7 million and $138.9 million, respectively, and
is
included in accounts payable.
|
|
March
31, 2006
|
|
December
31, 2005
|
|
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
|
|
$
|
474.4
|
|
$
|
611.5
|
|
Fair
value of hedging derivatives in a “loss” position
|
|
|
59.1
|
|
|
29.3
|
|
Total
hedged metal obligations
|
|
$
|
533.5
|
|
$
|
640.8
|
|
At
March
31, 2006 and December 31, 2005, hedged metal obligations relating to 938,096
and
1,272,994 troy ounces of gold, respectively, were outstanding. These quantities
were sold short on a spot basis generating cash approximating $489 million
and
$619 million, respectively. These spot sales were hedged with forward purchases
for the same number of ounces at an average price of $521.33 at March 31, 2006
and $486.22 at December 31, 2005. 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 March 31, 2006, 96% of these instruments have settlement
terms of less than one year, with the remaining instruments having settlement
terms within 51 months. These derivative metal and foreign currency instruments
consist of the following:
Metal
Hedging Instruments (in millions):
|
|
March
31, 2006
|
|
December
31, 2005
|
|
|
|
Buy
|
|
Sell
|
|
Buy
|
|
Sell
|
|
Metal
forwards/futures
|
|
$
|
1,156.1
|
|
$
|
984.5
|
|
$
|
1,022.6
|
|
$
|
791.4
|
|
Eurodollar
futures
|
|
|
333.2
|
|
|
94.7
|
|
|
89.2
|
|
|
95.9
|
|
Swaps
|
|
|
55.6
|
|
|
25.1
|
|
|
37.5
|
|
|
18.8
|
|
Options
|
|
|
0.3
|
|
|
-
|
|
|
10.0
|
|
|
7.5
|
|
Foreign
exchange forwards/futures - Japanese yen
|
|
|
-
|
|
|
98.7
|
|
|
-
|
|
|
70.2
|
|
Foreign
exchange forwards/futures - Euro
|
|
|
-
|
|
|
49.5
|
|
|
-
|
|
|
39.0
|
|
Foreign
exchange forwards/futures - Other
|
|
|
6.5
|
|
|
-
|
|
|
4.5
|
|
|
-
|
|
Note
11 - New Accounting Pronouncements
Servicing
of Financial Assets
In
March
2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
Assets.” This Statement establishes, among other things, the accounting for all
separately recognized servicing assets and servicing liabilities. This
Statement
amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets
and Extinguishments
of Liabilities,” to require that all separately recognized servicing assets and
servicing liabilities be initially measured at fair value, if practicable.
This
Statement permits, but does not require, the subsequent measurement of
separately recognized servicing assets and servicing liabilities at fair
value.
By electing this option, an entity may simplify its accounting because
this
Statement permits income statement recognition of the potential offsetting
changes in fair value of those servicing assets and servicing liabilities
in the
same accounting period. An entity should adopt this Statement as of the
beginning of its fiscal year that begins after September 15, 2006. Earlier
adoption is permitted as of the beginning of an entity’s fiscal year, provided
the entity has not yet issued financial statements, for any period of that
fiscal year. The effective date of this Statement is the date an entity
adopts
the requirements of this Statement. The Company does not expect this Statement
to have a material impact on its financial statements.
Certain
Hybrid Financial Instruments
In
February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
Financial Instruments, an amendment of FASB Statements No. 133 and 140.” This
Statement simplifies the accounting for certain hybrid financial instruments
under SFAS No. 133, “Accounting for Derivative Instruments and Hedging
Activities,” by permitting fair value remeasurement for any hybrid financial
instrument that contains an embedded derivative that otherwise would require
bifurcation. This Statement also eliminates the interim guidance in Statement
133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial
Interests in Securitized Financial Assets,” which provides that beneficial
interests in securitized financial assets are not subject to the provisions
of
Statement 133. The primary objective of this Statement with respect to FASB
Statement No. 140, “Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities,” is to eliminate a restriction on the
passive derivative instruments that a qualifying special-purpose entity (SPE)
may hold. This Statement is effective for all financial instruments acquired
or
issued after the beginning of an entity’s first fiscal year that begins after
September 15, 2006. The Company does not expect this Statement to have a
material impact on its financial statements.
Stripping
Costs
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 is
effective for financial statements issued for fiscal years beginning after
December 15, 2005. The Company adopted EITF No. 04-06 on January 1, 2006. The
Company recorded a charge to equity of $29.8 million, net of tax, in the first
quarter of 2006 as a result of the adoption of EITF No. 04-06.
Stock
Option Expense
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 is no longer an acceptable
alternative to recognition of expenses in the financial statements. The Company
adopted SFAS 123(R) on January 1, 2006. Prior to this, the Company accounted
for
these plans under the recognition and measurement provisions of APB Opinion
No.
25, and related Interpretations, as permitted by SFAS No. 123. No stock-based
employee compensation costs related to the granting of stock options were
recognized in the Consolidated Statements of Earnings for the year ended
December 31, 2005, as all options granted under these
plans
had
an exercise price equal to the market value of the underlying common stock
on
the date of grant.
Note
12 - Stock Option and Bonus Plans
Effective
January 1, 2006, the Company adopted the fair value recognition provisions
of
SFAS No. 123(R) using the modified-prospective transition method. Under this
transition method, compensation costs recognized during the first quarter of
2006 include: (a) compensation costs for all share-based payments granted prior
to, but not yet vested as of January 1, 2006, based on the grant date fair
value
estimated in accordance with the original provisions of SFAS No. 123, and (b)
compensation costs for all share-based payments granted subsequent to January
1,
2006, based on the grant-date fair value estimated in accordance with the
provisions of Statement 123(R). Results of prior periods have not been
restated.
As
a
result of adopting SFAS 123(R), the Company’s earnings before income taxes and
net earnings for the three-month period ended March 31, 2006 are $1.1 million
and $0.6 million lower, respectively, than if the Company had continued to
account for share-based compensation under APB No. 25. Basic earnings per
share would have been $0.57 for the three-month period ended March 31, 2006
had the Company not adopted SFAS 123(R), compared to reported
basic earnings per share of $0.56. Diluted earnings per share would
have remained the same as the reported amount of $0.55 per share.
Prior
to
the adoption of SFAS 123(R), the Company presented all tax benefits of
deductions resulting from the exercise of stock options as operating cash flows
in the Consolidated Statement of Cash Flows. SFAS 123(R) requires the cash
flows
resulting from the tax benefits resulting from tax deductions in excess of
the
compensation cost recognized for these options (excess tax benefits) to be
classified as financing cash flows. The $15.5 million excess tax benefit
classified as a financing cash flow in the Consolidated Statement of Cash Flows
for the three-month period ended March 31, 2006 would have been classified
as an
operating cash inflow if the Company had not adopted SFAS 123(R).
The
following table represents a comparison of reported net earnings for the
three-month periods ended March 31, 2006 and 2005, and pro-forma net earnings
for the three-month period ended March 31, 2005, including effects of expensing
stock options:
(in
millions, except per-share data)
|
|
Three
Months Ended
March
31,
|
|
|
|
2006
|
|
2005
|
|
Net
earnings — as reported
|
|
$
|
69.0
|
|
$
|
58.0
|
|
|
|
|
|
|
|
|
|
Basic
earnings per share, as reported
|
|
|
0.56
|
|
|
0.48
|
|
Diluted
earnings per share, as reported
|
|
|
0.55
|
|
|
0.47
|
|
|
|
|
|
|
|
|
|
Stock
option expense included in net earnings
|
|
|
0.6
|
|
|
-
|
|
Total
stock option expense
|
|
|
0.6
|
|
|
2.3
|
|
Pro-forma
effects
|
|
|
|
|
|
|
|
Net
earnings — pro forma
|
|
|
|
|
|
55.7
|
|
|
|
|
|
|
|
|
|
Basic
earnings per share — pro forma
|
|
|
|
|
|
0.46
|
|
Diluted
earnings per share — pro forma
|
|
|
|
|
|
0.45
|
|
The
Company’s Stock Option Plans of 1999 and 1991, as amended (the Key Option
Plans), generally provide for the granting of options to key employees to
purchase an aggregate of 5,500,000 and 16,875,000 common shares, respectively,
at fair market value on the date of grant. No options under the Stock Option
Plans of 1999 and 1991 may be granted after December 16, 2009 and June 30,
2003,
respectively.
In
1995,
the Company established the Directors Stock Option Plan, which generally
provides for the annual granting to each non-employee director the option
to
purchase up to 3,000 common shares at the fair market value on the date of
grant.
On
May 2,
2002, shareholders approved the 2002 Long-Term Incentive Compensation Plan.
The
plan provides for the grant to eligible employees and directors of stock
options, share appreciation rights (SARs), restricted shares, restricted share
units, performance units and other share-based awards. An aggregate of 6,000,000
shares of common stock have been reserved for issuance under the plan, of which
no more than 500,000 shares may be issued in connection with awards other than
options and SARs. All terms and conditions of each grant have been set on the
date of grant, including the grant price of options which is based on the fair
market value on the day of grant. No grants may be made under the plan after
March 7, 2012.
Options
under all plans become exercisable in four installments beginning after one
year, and no options may be exercised after 10 years from the date of grant.
The
Company amortizes the expense using the graded expense attribution method over
four years. However, if an employee is eligible to retire, the expense is
recognized on the date of the grant.
There
were no options granted during the three-month period ended March 31, 2006.
The
weighted-average fair value at date of grant for options granted during the
three-month period ended March 31, 2005 was $10.41. Fair value of each option
grant is estimated on the date of grant using the Black-Scholes option-pricing
model. The following assumptions were used:
|
|
Three
Months Ended
March
31, 2005
|
|
Dividend
yield
|
|
|
1.46
|
%
|
Expected
volatility
|
|
|
32.30
|
%
|
Risk-free
interest rate
|
|
|
3.94
|
%
|
Expected
life (years)
|
|
|
6.75
|
|
A
summary
of stock option activity under all Plans as of March 31, 2006 is as
follows:
|
|
Number
of Shares
|
|
Weighted-Average
Exercise Price Per Share
|
|
Weighted-Average
Remaining Contractual Term
(in
Years)
|
|
Aggregate
Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at January 1, 2006
|
|
|
10,678,061
|
|
$
|
23.04
|
|
|
|
|
|
|
|
Granted
|
|
|
-
|
|
$
|
-
|
|
|
|
|
|
|
|
Exercised
|
|
|
(3,158,901
|
)
|
$
|
21.15
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(772
|
)
|
$
|
29.24
|
|
|
|
|
|
|
|
Expired
|
|
|
(1,376
|
)
|
$
|
23.88
|
|
|
|
|
|
|
|
Outstanding
at March 31, 2006
|
|
|
7,517,012
|
|
$
|
23.83
|
|
|
5.7
|
|
$
|
118,585,724
|
|
Exercisable
at March 31, 2006
|
|
|
5,267,269
|
|
$
|
21.89
|
|
|
4.6
|
|
$
|
93,339,464
|
|
The
total
intrinsic value of options exercised during the three months ended March 31,
was
$56.5 million. As of March 31, 2006, there was $5.0 million of total
unrecognized compensation cost related to non-vested options. That cost is
expected to be recognized over a weighted average period of 2 years and 6
months.
The
Company’s Key Employee Stock Bonus Plan, as amended (the Bonus Plan) provides
for the award of up to 15,187,500 common shares to key employees as compensation
for future services, not exceeding 1,518,750 shares in any year (plus any
canceled awards or shares available for award but not previously awarded).
The
Bonus Plan terminates on June 30, 2006. As previously mentioned, the 2002
Long-Term Incentive Plan provides for the granting of equity awards to employees
and directors for future services. Shares awarded vest in five annual
installments, provided the recipient is still employed by the Company on
the
vesting date. Compensation expense is measured on the date the award is granted
and is amortized on a straight-line basis over five years. Shares awarded
are
considered issued and outstanding at the date of grant and are included in
shares outstanding for purposes of computing diluted earnings per share.
Employees have both dividend and voting rights on all unvested shares. In
February 2006, the Company granted 173,500 shares at a price of
$40.69.
A
summary
of Restricted Stock Awards activity as of March 31, 2006 is as
follows:
|
|
Number
of Shares
|
|
Weighted-Average
Price Per Share
|
|
Weighted-Average
Remaining Contractual Term
(in
Years)
|
|
Aggregate
Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
Unvested
at January 1, 2006
|
|
|
415,255
|
|
$
|
26.42
|
|
|
|
|
|
|
|
Granted
|
|
|
173,500
|
|
$
|
40.69
|
|
|
|
|
|
|
|
Vested
|
|
|
(157,480
|
)
|
$
|
40.30
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(591
|
)
|
$
|
29.40
|
|
|
|
|
|
|
|
Unvested
at March 31, 2006
|
|
|
430,684
|
|
$
|
32.72
|
|
|
2.3
|
|
$
|
17,059,393
|
|
The
total
intrinsic value of the Restricted Stock Awards vested during the three months
ended March 31, 2006 was $6.3 million. As of March 31, 2006, there was $3.9
million of total unrecognized compensation cost related to unvested stock
awards. That cost is expected to be recognized over a weighted average period
of
2 years and 4 months.
Note
13 - 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 three-month periods ended March 31, 2006 and 2005 are shown in the following
table:
Net
Periodic Benefit Cost (in millions):
|
|
Pension
Benefits
|
|
Other
Benefits
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Service
cost
|
|
$
|
6.6
|
|
$
|
6.0
|
|
$
|
1.0
|
|
$
|
1.0
|
|
Interest
cost
|
|
|
10.5
|
|
|
10.2
|
|
|
1.9
|
|
|
2.0
|
|
Expected
return on plan assets
|
|
|
(13.0
|
)
|
|
(12.3
|
)
|
|
-
|
|
|
-
|
|
Amortization
of prior service cost
|
|
|
0.5
|
|
|
0.6
|
|
|
(0.2
|
)
|
|
(0.6
|
)
|
Recognized
actuarial loss
|
|
|
5.4
|
|
|
3.6
|
|
|
0.3
|
|
|
0.2
|
|
Net
periodic benefit cost
|
|
$
|
10.0
|
|
$
|
8.1
|
|
$
|
3.0
|
|
$
|
2.6
|
|
The
effects of the Medicare Prescription Drug, Improvement and Modernization Act
of
2003 will reduce the net periodic benefit cost by $3.3 million for the year
ended December 31, 2006.
The
Company does not anticipate any significant changes to the 2006 contributions
disclosed in the December 31, 2005 Form 10-K.
The
Company incurred benefit payments of $3.1 million for the three-month period
ended March 31, 2006. Expected future benefit payments, including prescription
drug benefits, are as follows (in millions):
Year
|
|
|
|
2006
(April 1 through December 31)
|
|
$
|
10.0
|
|
2007
|
|
|
13.4
|
|
2008
|
|
|
13.8
|
|
2009
|
|
|
14.0
|
|
2010
|
|
|
14.3
|
|
2011
through 2015
|
|
|
76.4
|
|
The
Company expects the following reimbursements under the subsidy portion of the
Medicare Prescription Drug, Improvement and Modernization Act of 2003 (in
millions):
Year
|
|
|
|
2006
(April 1 through December 31)
|
|
$
|
2.0
|
|
2007
|
|
|
2.2
|
|
2008
|
|
|
2.3
|
|
2009
|
|
|
2.4
|
|
2010
|
|
|
2.5
|
|
2011
through 2015
|
|
|
12.8
|
|
Note
14 - 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):
|
|
Three
Months Ended March 31,
|
|
|
|
2006
|
|
2005
|
|
Materials
Services related:
|
|
|
|
|
|
|
|
Change
in assets and liabilities - source (use):
|
|
|
|
|
|
|
|
Receivables
|
|
$
|
(28.2
|
)
|
$
|
(6.6
|
)
|
Committed
metal positions
|
|
|
(197.1
|
)
|
|
54.2
|
|
Inventories
|
|
|
(0.1
|
)
|
|
0.4
|
|
Other
current assets
|
|
|
1.1
|
|
|
(0.4
|
)
|
Accounts
payable
|
|
|
342.7
|
|
|
(63.6
|
)
|
Hedged
metal obligations
|
|
|
(137.1
|
)
|
|
3.7
|
|
Other
current liabilities
|
|
|
(5.2
|
)
|
|
(2.4
|
)
|
Net
cash flows from changes in assets and liabilities
|
|
$
|
(23.9
|
)
|
$
|
(14.7
|
)
|
|
|
Three
Months Ended March 31,
|
|
|
|
2006
|
|
2005
|
|
All
Other:
|
|
|
|
|
|
|
|
Change
in assets and liabilities - source (use):
|
|
|
|
|
|
|
|
Receivables
|
|
$
|
(69.4
|
)
|
$
|
(38.3
|
)
|
Inventories
|
|
|
(24.1
|
)
|
|
(13.5
|
)
|
Other
current assets
|
|
|
6.6
|
|
|
(6.7
|
)
|
Other
noncurrent assets
|
|
|
6.6
|
|
|
5.7
|
|
Accounts
payable
|
|
|
18.8
|
|
|
23.3
|
|
Other
current liabilities
|
|
|
13.0
|
|
|
19.4
|
|
Noncurrent
liabilities
|
|
|
(17.4
|
)
|
|
(18.9
|
)
|
Net
cash flows from changes in assets and liabilities
|
|
$
|
(65.9
|
)
|
$
|
(29.0
|
)
|
Note
15 - Legal and Environmental Matters
The
Company is one of a number of defendants in numerous proceedings that allege
that the plaintiffs were injured from exposure to hazardous substances
purportedly supplied by the Company and other defendants or that existed on
company premises. The Company is also subject to a number of environmental
contingencies and is a defendant in a number of lawsuits covering a wide range
of other matters. In some of these matters, the remedies sought or damages
claimed are substantial. While it is not possible to predict with certainty
the
ultimate outcome of these lawsuits or the resolution of the environmental
contingencies, management believes, after consultation with counsel, that
resolution of these matters is not expected to have a material adverse effect
on
financial condition. However, if these matters are resolved in a manner
different from management’s current expectations, they could have a material
adverse effect on the Company’s operating results or cash flows.
In
April
2006, an additional site has been identified, resulting in a total of 15 sites,
at which the Company believes liability as a potentially responsible party
is
probable under the Comprehensive Environmental Response, Compensation and
Liability Act of 1980, as amended, or similar state laws (collectively referred
to as Superfund) for the cleanup of contamination and natural resource damages
resulting from the historic disposal of hazardous substances allegedly generated
by the Company, among others. Superfund imposes strict, joint and several
liability under certain circumstances. In many cases, the dollar amount of
the
claim is unspecified and claims have been asserted against a number of other
entities for the same relief sought from the Company. At this time, management
cannot reasonably estimate a probable cost associated with this newly identified
site.
The
Company has been 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.,
(now
Engelhard Peru S.A.C. en liquidaciόn or “Engelhard Peru”), a wholly owned
subsidiary, was denied refund claims of approximately $28 million. The Peruvian
tax authority also determined that Engelhard Peru 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 was liable for these amounts,
overruling precedent to apply a “substance over form” theory without any
determination of fraudulent participation specific to Engelhard Peru. Engelhard
Peru filed a constitutional action against the Peruvian tax authority and Tax
Court but the government of Peru prevailed on final appeal to Peru’s
Constitutional Court. Although management believes, based on consultation with
counsel, that this is an extraordinary decision that is plainly inconsistent
with the law and the facts, no further appeal in Peru is likely to be
productive. Management believes based on consultation with counsel, that the
maximum economic exposure is limited to the aggregate value of all assets of
Engelhard Peru. That amount, which is approximately $30 million, including
unpaid refunds, has been fully provided for in the accounts of the
Company.
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. In September 2005, a Superior prosecutor concluded that there
was no basis for the criminal proceedings against several defendants, including
both officials of
Engelhard
Peru. Final dismissal of those criminal charges remains subject to judicial
review and determination of the Supreme Prosecutor. Although Engelhard Peru
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 is
assisting in the vigorous defense of this proceeding and will support appeal
of
any conviction not based on the evidence. Convictions involving violation
of
human rights may be appealed to international organizations which may also
afford an opportunity for further appeal of the value added tax loss discussed
above to a non-Peruvian tribunal. As noted above, management believes the
economic exposure is limited to the aggregate of all assets of Engelhard
Peru,
which amount has been fully provided for in the accounts of the
Company.
On
January 4, 2006, Scott Sebastian, who alleges that he is a stockholder of the
Company, commenced a purported class action on behalf of the stockholders of
the
Company against the Company and all of its directors in the Chancery Division
of
the New Jersey Superior Court for Middlesex County. The complaint alleges that
the defendants breached their fiduciary duties in connection with their response
to BASF’s proposal to acquire the Company and seeks declaratory and injunctive
relief and damages. On January 4, 2006, Hindy Silver, who alleges that she
is a
stockholder of the Company, commenced a purported class action on behalf of
the
stockholders of the Company against the Company and all of its directors in
the
Chancery Division of the New Jersey Superior Court for Mercer County. The
complaint alleges that the defendants breached their fiduciary duties in
connection with their response to BASF’s proposal to acquire the Company and
seeks injunctive relief and an accounting. On January 17, 2006, the plaintiffs
in the Sebastian and Silver actions moved to transfer the Sebastian action
to
the New Jersey Superior Court for Mercer County and to consolidate the two
actions in that Court. The defendants cross-moved to stay the New Jersey actions
until the Delaware actions, described below, have been resolved or, in the
alternative, to dismiss the New Jersey actions for failure to state a claim,
and
plaintiffs moved for expedited discovery. Plaintiffs opposed defendants’
cross-motions and requested leave to file an amended complaint if the Court
was
inclined to grant defendants’ motion to dismiss. The proposed amended complaint
adds, among other things, allegations that the Schedule 14D-9 filed by the
Company with the SEC fails to disclose material information that the proposed
amended complaint alleges is needed by Engelhard shareholders to be able to
make
an informed decision concerning whether to tender their shares to BASF. The
proposed amended complaint seeks declaratory and injunctive relief and damages.
Defendants opposed plaintiffs’ motion for expedited discovery and motion to
amend their complaint. Argument on all motions and cross-motions was held on
February 9, 2006 in the New Jersey Superior Court for Mercer County. The Court
stated that the motion to consolidate would be granted and took the other
matters under advisement. On
March
7, 2006 the Court issued an Order with a statement of reasons. The Order granted
plaintiffs' motion to transfer the Sebastian action to the Court and to
consolidate it with the Silver action, granted defendants' motion to stay the
consolidated actions pending disposition of the action in Delaware captioned,
In re: Engelhard Corporation Shareholders Litigation, and, in view of
the stay, denied both defendants' motion to dismiss and plaintiffs' motion
for
expedited discovery without prejudice.
On
January 5, 2006, Laura Benjamin and Sam Cohn, and on January 6, 2006, Stewart
Simon, all of whom purport to be stockholders of the Company, each commenced
a
purported class action on behalf of the stockholders of the Company against
the
Company and all of its directors in the Delaware Court of Chancery for New
Castle County. Each complaint alleged that the defendants breached their
fiduciary duties in connection with their response to BASF’s proposal to acquire
the Company and sought injunctive relief. The Benjamin and Cohn complaints
also
sought damages and the Simon complaint sought an accounting. On January 13,
2006
these three actions were consolidated under the caption In
re: Engelhard Corporation Shareholders Litigation,
Consolidated C.A. No. 1871-N, in the Delaware Court of Chancery for New Castle
County, and a Consolidated Amended Complaint was filed and served which names
the same defendants and contains allegations similar to those made in the
complaints initially filed in the underlying actions, and seeks injunctive
relief and damages. On the same day, plaintiffs served a request for production
of documents. On January 17, 2006, the court entered an order governing the
protection and exchange of confidential information. On January 24, 2006, the
Court entered a case management order. Defendants have begun to produce
documents to plaintiffs. On January 25, 2006, with defendants’ consent, the
Court granted plaintiffs leave to file a Second Consolidated Amended Complaint.
The Second Consolidated Amended Complaint adds, among other things, allegations
that the Schedule 14D-9 filed by the Company with the SEC fails to disclose
material information concerning what the Company and its Board of Directors
are
doing with respect to the exploration of strategic alternatives to BASF’s offer
and fails to disclose information that is material to evaluating the opinion
Merrill Lynch provided to the Company’s Board of Directors that BASF’s offer is
inadequate from a financial point of view.
The
Company and the individual defendants believe the claims made in each of
the
putative class action suits described above are without merit and intend
to
vigorously defend against these suits.
Note
16 - Income Taxes
The
Company’s effective tax rate (“ETR”) is dependent upon many factors including
(1) the impact of enacted tax laws in jurisdictions in which the Company
operates, (2) the amount of earnings by jurisdiction due to varying tax rates
by
country, (3) the amount of depletion deductions related to the Company's mining
activities, (4) the ability to utilize minimum tax credits, foreign tax credits
and research and development tax credits and (5) the amount of extraterritorial
income and domestic production related benefits.
The
ETR
on continuing operations for the three months ended March 31, 2006 was 21.4%.
Based upon the Company’s assessment of the above factors and the resolution of
certain tax issues in the quarter (see discussion below), the ETR on continuing
operations for the full year 2006 is expected to be 24%.
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
first quarter of 2006, the Company recorded a net $2.5 million reduction of
tax
expense resulting from an agreement with the IRS on certain tax issues relating
to the audit of the Company’s tax return for 2002 and 2003. The IRS examination
of 2002-2003 is expected to be completed in the second half of 2006 and the
examination of the Company’s 2004-2005 federal income tax returns will likely
commence before the end of the year.
Note
17 - Other Matters
In
January of 2006, BASF announced a tender offer for all of the outstanding shares
of the Company’s stock, for $37.00 per share, and subsequently increased this
offer to $38.00 per share. Since then, the Company’s stock has traded above
$38.00 per share. As a result, many employees and former employees exercised
vested stock options resulting in proceeds of $66.7 million and an increase
in
the shares outstanding of 3.2 million as of March 31, 2006. As a result of
the
BASF tender offer, the Company was required to fund a trust account for certain
previously unfunded retirement programs for current and former senior executives
and directors, resulting in a cash payment to this trust of approximately $111
million in January 2006. Should a change in control of the Company occur at
a
price of $38.00 per share, additional cash payments of approximately $87 million
will be due to certain employees.
In
response to the BASF tender offer, which the Company’s Board of Directors
believes is inadequate, the Company has proposed a recapitalization plan. The
recapitalization plan is comprised of a $45 per share self-tender offer for
up
to 26 million shares (approximately 20% of the Company’s outstanding shares
including shares underlying exercisable options), continued execution of the
Company’s business strategy and incremental cost savings the Company expects
will deliver $15 million annually beginning in 2007. The Company commenced
the
$45 per share self-tender offer on May 5, 2006, and the offer will expire on
June 5, 2006 unless earlier terminated or extended pursuant to its terms. The
Company anticipates that it will obtain long-term financing, but will initially
finance the transaction with a bridge loan. This recapitalization plan will
increase debt by approximately $1.2 billion and decrease equity by a similar
amount. Upon issuance of the long-term debt, this transaction will increase
interest expense by approximately $85 million ($53 million, net of tax) and
decrease dividend payments by approximately $12 million annually, resulting
in
reduced cash flows of approximately $41 million. The Company expects to
maintain an investment grade credit rating after consummation of the
recapitalization plan. Should the Company not meet its expected earnings and
cash flow goals, the recapitalization plan would have a negative impact on
the
Company’s liquidity. Additional information about the recapitalization plan is
contained in the Company’s Tender Offer Statement on Schedule TO filed with the
SEC on May 5, 2006. Investors may obtain a free copy of the Schedule TO at
the
SEC’s website at http://www.sec.gov.
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 20,
“BUSINESS SEGMENT AND GEOGRAPHIC AREA DATA” in the Company’s 2005 Form
10-K.
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 8
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 generally operating close to capacity generating demand for
the
extra yields provided by the Company's advanced fluid cracking catalysts and
performance additives; (4) markets for effect pigments, and colors 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) inflationary pressures for raw materials and energy, particularly
natural gas, are expected to have a negative impact across the Company's
technology segments compared to the recent low inflationary period, which the
Company will mitigate via price increases and energy surcharges; and (6) the
Company is expanding into previously unserved and growing markets such as energy
and personal care actives that are expected to grow at rates exceeding the
growth rates of most developed economies.
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 charges. 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 First Quarter of 2006 with the First Quarter of
2005
Net
earnings from continuing operations increased to $69.1 million in the first
quarter of 2006 compared to $58.5 million in the first quarter of 2005.
Operating earnings increased to $86.7 million in the first quarter compared
to
$70.2 million in the same period last year. Operating earnings for the first
quarter of 2006 included $6.9 million of expenses, primarily legal and other
professional fees, related to the BASF hostile tender offer. Improvements
in operating earnings came from all of the Company’s segments and the Ventures
group as the Company continues to leverage its technology platforms across
increasingly diverse markets. These improvements were modestly offset by higher
unallocated corporate expenses.
The
first
quarter of 2006 includes stock option expense of $0.6 million, net of tax,
compared to no expense in the prior period (see Note 12 “Stock Option and
Bonus Plans”). Full year stock option expense is expected to be approximately $4
million, net of tax, with the majority of this expense occurring in the fourth
quarter when the Company grants stock options to employees.
The
Company’s effective tax rate (“ETR”) is dependent upon many factors including
(1) the impact of enacted tax laws in jurisdictions in which the Company
operates, (2) the amount of earnings by jurisdiction due to
varying
tax rates by country, (3) the amount of depletion deductions related to the
Company's mining activities, (4) the ability to utilize minimum tax credits,
foreign tax credits and research and development tax credits and (5) the
amount
of extraterritorial income and domestic production related benefits.
The
ETR
on continuing operations for the three months ended March 31, 2006 was 21.4%.
Based upon the Company’s assessment of the above factors and the resolution of
certain tax issues in the quarter (see discussion below), the ETR on continuing
operations for the full year 2006 is expected to be 24%.
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
first quarter of 2006, the Company recorded a net $2.5 million reduction of
tax
expense resulting from an agreement with the IRS on certain tax issues relating
to the audit of the Company’s tax return for 2002 and 2003. The IRS examination
of 2002-2003 is expected to be completed in the second half of 2006 and the
examination of the Company’s 2004-2005 federal income tax returns will likely
commence before the end of the year.
The
Company’s share of equity earnings from affiliates was $7.7 million in the first
quarter of 2006 compared to $8.1 million in the same period last year. These
continued strong earnings reflect the strength of the Asian automotive markets.
The Company considers these joint ventures to be an integral component of the
Company’s operations, as they service the large Japanese and Korean automotive
markets.
Interest
expense increased to $10.1 million in the first quarter of 2006 compared to
$6.0
million in the first quarter of 2005 due to higher short-term borrowings and
higher short-term interest rates. Interest income increased to $3.7 million
compared to $1.2 million in the first quarter of 2005 primarily due to a
cash in trust balance from the funding of a trust account for certain
previously unfunded retirement programs for current and former senior executives
and directors. Higher debt levels were driven by the funding of this trust
in
addition to higher working capital requirements (please see Liquidity and
Capital Resources section).
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, temperature sensing 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)
|
|
Q1
2006
|
|
Q1
2005
|
|
%
change
|
|
Sales
|
|
$
|
320.2
|
|
$
|
237.5
|
|
|
34.8
|
%
|
Operating
earnings
|
|
|
41.5
|
|
|
37.0
|
|
|
12.2
|
%
|
Discussion
Results
from this segment were strong, as operating earnings increased 12% compared
to
the same quarter last year.
Revenues
from mobile-source markets increased approximately 40% in the first quarter
of
2006 compared with the same period in 2005. Increased substrate costs accounted
for approximately 75% of this increase. Substrate
costs were higher primarily due to increased demand for catalyzed soot filters
(CSF) for the European light-duty diesel market. Overall volumes of catalyst
solutions sold to the light-duty markets were higher, driven by European
light-duty diesel demand and strong growth from emerging markets such as India
and China. Also in the
quarter,
the Company increased its interest in its India operations from 60% to 90%.
While this operation is relatively modest, it represents a presence in
geographical areas that are expected to grow significantly in future years.
Volumes of light-duty gasoline solutions in North America decreased modestly.
Revenues from motorcycle applications increased compared to the year ago
quarter, as the Company experienced a step change in motorcycle business
which
commenced in the second quarter of 2005. Motorcycle revenues are expected
to
approximate 2005 full year levels in 2006. Diesel retrofit revenues were
modestly higher, and revenues from sales to heavy-duty diesel original equipment
manufacturers (OEMs) were flat compared to the same quarter last year. Sales
to
OEMs are expected to improve in the fourth quarter of 2006, and will continue
into 2007, as tougher environmental regulations are implemented.
Operating
earnings from mobile-source markets increased approximately 15% in the first
quarter of 2006 compared with the first quarter of 2005, driven by the
aforementioned improvements in revenues, with the exception of increased
revenues due to higher pass-through substrate costs. Increased revenues due
to
higher pass-through substrate costs do not improve profitability, as the
Company’s customers establish substrate prices directly with substrate
providers. This arrangement has the effect of reducing operating margin
percentages when substrate costs are increasing. It also insulates the Company’s
results from rising substrate costs, as the Company’s profitability is not
associated with substrate costs. The negative impact from the translation of
foreign currency denominated earnings was $1.8 million compared to the same
quarter last year, as the dollar strengthened compared to the Euro. These
businesses also experienced reduced royalty income of $1.5 million and higher
selling and research and development expenses in the current quarter
compared to the same quarter last year.
Sales
to
industrial product markets decreased in the first quarter of 2006 compared
to
the first quarter of 2005. Sales to power-generation customers in the first
quarter of last year were positively impacted by one large order in that period,
as previously mentioned. Sales to other industrial markets were mixed, as
decreased sales to the temperature-sensing market were more than offset by
increased sales to other served markets.
Earnings
from industrial product markets decreased in the first quarter of 2006 compared
with the first quarter of 2005 due to the aforementioned 2005 sale to a single
power-generation customer, and a decrease in revenues from the operations
serving the European temperature-sensing market.
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)
|
|
Q1
2006
|
|
Q1
2005
|
|
%
change
|
|
Sales
|
|
$
|
171.0
|
|
$
|
148.0
|
|
|
15.5
|
%
|
Operating
earnings
|
|
|
26.3
|
|
|
19.1
|
|
|
37.7
|
%
|
Discussion
This
segment experienced strong results in the first quarter of 2006 compared to
the
same period last year.
Sales
of
catalyst and additives to the petroleum-refining market increased approximately
20% in the first quarter of 2006 compared with the first quarter of 2005. The
increase was driven by continued strong demand for catalyst products derived
from the Company’s Distributed Matrix Structure (DMS) technology platform.
In
2005,
the Company successfully implemented additional price increases and energy
surcharges to this market, which accounted for approximately $3 million of
increased revenues compared to the same quarter last year. DMS
technology allows refiners to increase yields within their existing capacity.
Also in the current quarter, the Company experienced increased demand for an
older product offering due to a customer experiencing operating difficulties.
Sales of this older product offering tend to fluctuate due to a limited customer
base, and were significantly higher in the current quarter. Higher volumes
of
additives, particularly sulfur-reducing additives, also positively impacted
sales as gasoline-producing customers are required to meet increasingly
stringent sulfur content requirements.
Operating
earnings from products sold to petroleum-refining markets increased
significantly in 2006 compared with 2005. Earnings from increased demand for
DMS
technologies were driven by the aforementioned price increases, and improved
operating efficiencies. As previously mentioned, in
the
second quarter of 2005, the Company completed and implemented a project to
reduce costs and increase capacity at these facilities, resulting in lower
per-unit manufacturing costs. The Company continues to benefit from this project
compared to the same quarter last year, and has also focused on other more
modest productivity initiatives. Earnings
from increased sales of additives, while relatively high compared to the same
quarter last year, contributed modestly to the overall improvement in earnings.
Operating earnings increased $2.8 million due to the above mentioned increased
sales of older product offerings.
Sales
of
catalysts to the chemical-process markets increased approximately 10% in the
first quarter of 2006 compared with the first quarter of 2005.
The 2005
second-quarter acquisition of the catalyst business of Nanjing Chemical Industry
Corporation accounted for $3.3 million of increased revenues.
Higher precious metal costs on sales to certain European customers increased
revenues approximately $2.5 million compared to the first quarter of 2005.
Improved pricing and energy surcharges totaled approximately $1 million compared
to the same quarter last year. Increased volumes of Lynx
1000, the
Company’s leading technology offering to the polyolefins market, drove higher
revenues from this market. Sales of catalyst to the oleochemical (edible oils)
market were lower, reflecting continuing trends in this market.
Operating
earnings from products sold to chemical-process markets increased slightly
compared to the same period last year. The earnings impact of improved pricing
and increased volumes to petrochemical, gas economy and polyolefins markets
were
offset by decreased royalty income of $1.0 million. The decrease in royalty
income represents the end of a contractual agreement, and will impact comparable
quarterly results for the next two quarters.
Appearance
and Performance Technologies
The
Appearance and Performance Technologies segment provides coatings and pigment
extenders, 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, packaging,
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)
|
|
Q1
2006
|
|
Q1
2005
|
|
%
change
|
|
Sales
|
|
$
|
206.3
|
|
$
|
173.9
|
|
|
18.6
|
%
|
Operating
earnings
|
|
|
21.5
|
|
|
18.1
|
|
|
18.8
|
%
|
Discussion
Results
from this segment were solid, as sales from strong demand and price actions
increased earnings.
Sales
of
minerals-based products increased greater than 10% in the first quarter of
2006
compared with the first quarter of 2005, as the Company experienced increased
revenues to all served markets including higher prices to the paper market.
The
Company continues to focus on non-paper kaolin markets to maximize cash flows
from these assets, and accordingly, sales to non-paper kaolin markets increased
at a greater rate than sales to other markets. These markets include plastics,
construction, automotive, agriculture, coatings and the precursors for refining
catalysts. Additionally, the Company has implemented energy surcharges to paper
and non-paper kaolin customers, to offset rising energy costs. This resulted
in
increased revenues of approximately $3 million dollars. The Company will
continue to pass higher energy costs to customers, based upon contractually
agreed terms.
Operating
earnings from minerals-based products increased approximately 30% in the first
quarter of 2006 compared with the first quarter of 2005. Decreased earnings
from
kaolin-based products to the paper market were more than offset by higher
earnings from kaolin-based and attapulgite-based products to other markets
as
discussed above. Higher natural gas prices negatively impacted these operations
in the quarter, but were largely offset by
energy
surcharges. 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.” Currently, these assets
are not impaired.
Sales
of
effect materials, colors and personal care actives increased approximately
25%
in the first quarter of 2006 compared with the same period in 2005. In late
March of 2005, the Company strengthened its position in the personal care market
by acquiring Coletica, S.A., a European 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. The 2005 acquisition accounted for approximately $9
million in increased sales in the first quarter of 2006 compared to the first
quarter of 2005. Colorant volumes increased approximately 50%, as a major
customer built inventory in the current quarter in advance of a new and
innovative product packaging introduction, compared to the same quarter last
year when the same customer reduced inventory levels.
Operating
earnings from effect materials, colors and personal care actives increased
approximately 15% in the first quarter of 2006 compared with the first quarter
of 2005, due primarily to the above-mentioned 2005 acquisition, and earnings
from sales of colorants driven by the above-mentioned increased volumes. These
businesses also benefited from lower manufacturing and administrative
expenses.
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)
|
|
Q1
2006
|
|
Q1
2005
|
|
%
change
|
|
Sales
|
|
$
|
727.8
|
|
$
|
446.4
|
|
|
63.0
|
%
|
Operating
earnings
|
|
|
17.2
|
|
|
4.7
|
|
|
264.0
|
%
|
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 first quarter
of 2006 increased compared to the first quarter of 2005. Approximately one-third
of this increase is due to higher volumes, and approximately two-thirds of
this
increase is due to higher precious metal prices, primarily platinum group
metals.
Earnings
from metal sourcing operations and refining operations increased significantly
in the first quarter of 2006 compared with the first quarter of 2005, driven
by
overall industrial demand for platinum group metals and related services, and
favorable platinum-group-metal market conditions.
Ventures
The
Ventures group, which is not a reportable segment as defined in SFAS 131,
“Disclosures about Segments of an Enterprise and Related Information,” develops
opportunities that leverage attractive markets, new technologies and the
Company's core competencies in surface and materials science. Through its
existing Separation Systems business, this group also serves a broad array
of
end markets with adsorbents, agents and desiccants which purify liquids and
gases. In September 2005, the Company acquired U.S.-based Almatis AC, Inc.,
a
major developer and producer of alumina-based adsorbents and purification
catalysts for approximately $65 million. In addition, this group is currently
developing market positions that will serve the oil and gas field services,
fuel
cell and battery materials markets in the future. Current expectations for
the
oil and gas field services market include opening a plant in the second half
of
2006, while fuel cell and battery material remain in development stages. In
the
first quarter of 2006, this group recognized sales of $29.9 million and
operating earnings of $2.1 million. The Almatis acquisition accounted for $15
million of the sales and $1.9 million of the operating earnings.
Liquidity
and Capital Resources
Liquidity
Working
capital was $658.2 million at March 31, 2006, compared with $513.8 million
at
December 31, 2005. The current ratio was 1.4 and 1.3 at March 31, 2006 and
December 31, 2005, respectively. The overall working capital of the Company’s
technology segments (Environmental Technologies, Process Technologies and
Appearance and Performance Technologies) has not been subject to significant
fluctuations prior to 2005. However, in the current quarter and in 2005,
Environmental Technologies has experienced a fundamental increase in working
capital employed. This increase is primarily due to Environmental Technologies’
recent market penetration into catalyzed soot filter (CSF) technology for
light-duty diesel applications to the mobile-source environmental markets (see
Environmental Technologies section for further discussion). The increase in
working capital for the Environmental Technologies segment was approximately
$50
million in the first quarter of 2006. The working capital of the Materials
Services segment may vary due to the timing of metal contracts, but is monitored
closely by senior management. In the recent period, committed metal positions
have increased due to the effects of higher prices and usage and a shift in
the
mix of metals. While long-term working capital requirements cannot be readily
predicted, it is expected that they will grow proportionally with the revenues
of the technology segments.
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 March 31, 2006, the Company had $125.0 million of commercial
paper outstanding.
The
Company maintains committed credit facilities for approximately $33 million
(270
million Chinese Renminbi) with three major foreign banks. These facilities
are
available for general corporate purposes for various subsidiaries within China.
Additionally, in March 2006, the Company replaced an existing $12 million credit
facility with a new $17 million, five-year committed, dual currency revolving
credit facility for its Environmental Technologies business within
China.
In
the
fourth quarter of 2005, the Company entered into a cross-currency swap with
a
notional amount of $150 million. This transaction effectively swaps the
Company’s US dollar floating rate exposure for a Euro floating rate exposure.
The notional Euro amount has been designated as a net investment hedge of a
portion of the Company’s Euro-denominated investments.
The
Company’s total debt increased to $706.9 million at March 31, 2006 from $600.1
million at December 31, 2005 due primarily to the funding of a trust account
for
certain previously unfunded retirement programs for current and former senior
executives and directors totaling $111 million, and higher working capital
requirements within the Environmental Technologies segment. The percentage
of
total debt to total capitalization was 31% at March 31, 2006 compared with
29%
at December 31, 2005.
The
Company holds certain cash balances that are subject to withdrawal restrictions.
The trust held for current and former senior executives and directors mentioned
above totaled $112 million at March 31, 2006. These funds may become available
to the Company for general corporate purposes upon meeting certain trust
conditions, including the passage of six months following the occurrence
of a
potential change in control and a good faith determination by the Company’s
Board of Directors, evidenced by a resolution that a change in control
is
unlikely to occur. Engelhard maintains a fully consolidated subsidiary
in the
United Kingdom that engages in precious metal dealing on the London Metals
Exchange (LME), which is regulated by the Financial Services Authority
(FSA). In
accordance with applicable regulations within the United Kingdom, this
subsidiary may be required to maintain certain cash balances. These balances
totaled $45 million at March 31, 2006.
The
Company maintains a shelf registration of $450 million to facilitate 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.
In
January of 2006, BASF announced a tender offer for all of the outstanding shares
of the Company’s stock, for $37.00 per share, and subsequently increased this
offer to $38.00 per share. Since then, the Company’s stock has traded above
$38.00 per share. As a result, many employees and former employees exercised
vested stock options resulting in proceeds of $66.7 million and an increase
in
the shares outstanding of 3.2 million as of March 31, 2006. As a result of
the
BASF tender offer, the Company was required to fund a trust account for certain
previously unfunded retirement programs for current and former senior executives
and directors, resulting in a cash payment to this trust of approximately $111
million in January 2006. Should a change in control of the Company occur at
a
price of $38.00 per share, additional cash payments of approximately $87 million
will be due to certain employees.
In
response to the BASF tender offer, which the Company’s Board of Directors
believes is inadequate, the Company has proposed a recapitalization plan. The
recapitalization plan is comprised of a $45 per share cash self-tender offer
for
up to 26 million shares (approximately 20% of the Company’s outstanding shares
including shares underlying exercisable options), continued execution of the
Company’s business strategy and incremental cost savings the Company expects
will deliver $15 million annually beginning in 2007. The Company commenced
the
$45 per share self-tender offer on May 5, 2006, and the offer will expire on
June 5, 2006 unless earlier terminated or extended pursuant to its terms. The
Company anticipates that it will obtain long-term financing, but will initially
finance the transaction with a bridge loan. This recapitalization plan will
increase debt by approximately $1.2 billion and decrease equity by a similar
amount. Upon issuance of the long-term debt, this transaction will increase
interest expense by approximately $85 million ($53 million, net of tax) and
decrease dividend payments by approximately $12 million annually, resulting
in
reduced cash flows of approximately $41 million. The Company expects to maintain
an investment grade credit rating after consummation of the recapitalization
plan. Should the Company not meet its expected earnings and cash flow goals,
the
recapitalization plan would have a negative impact on the Company’s liquidity.
Additional information about the recapitalization plan is contained in the
Company’s Tender Offer Statement on Schedule TO filed with the SEC on May 5,
2005. Investors may obtain a free copy of the Schedule TO at the SEC’s website
at http://www.sec.gov.
The
Company’s available cash and unused committed credit lines represent a measure
of the Company’s short-term liquidity position. The Company’s Materials Services
segment provides sufficient cash to fund the Company’s committed metal
positions, as discussed in the Capital Resources section. The Company believes
that its short-term liquidity position is sufficient to meet the cash
requirements of the Company. 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 the Ventures group, 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
used in operating activities was $119.8 million in the first quarter of
2006
compared with $41.6 million provided by operating activities in the first
quarter of 2005. The largest single usage of cash in the period was the
aforementioned funding of a trust account for certain previously unfunded
retirement programs for current and former senior executives and directors.
The
Environmental Technologies segment experienced an increase in working capital
requirements primarily associated with the segment’s diesel catalyzed soot
filter business of approximately $50 million, resulting in lower operating
cash
flows. Other decreases in cash flows from operating activities occurred
in the
Materials Services segment and reflect timing of payments from customers.
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 for these transactions. 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. The fair value of precious
metal received but not priced exceeded provisional payments by $11.7 million
and
$138.9 million at March 31, 2006 and December 31, 2005,
respectively.
The
Company’s joint ventures operate independently of additional Company financing.
These joint ventures returned $1.8 million of cash to the Company in the first
quarter of 2006. The Company anticipates cash proceeds from its joint ventures
to approximate recent levels.
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 acquisitions. Notably,
during the current quarter the Company invested $32.9 million in capital
projects and $6.5 million in acquisitions and other investments. Capital
expenditures for 2006 are expected to be approximately $175 million. Current
projects include a new facility in Cheto, AZ that will
serve the oil and gas field services market, and an expansion of gas-to-liquids
catalyst capacity at the Company’s DeMeern, The Netherlands
facility.
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.
In
addition to investment opportunities, the Company will return value to the
shareholders through effective capital structure management. This is done
through share buy-back programs and dividends. In the first quarter of 2006,
the
Company did not purchase any outstanding shares of the Company’s common stock
due to the outstanding BASF hostile tender offer. In May 2005, the Company’s
Board of Directors authorized a share repurchase program of 6 million shares.
Should the Company’s shareholders accept the proposed recapitalization plan, the
Company expects to continue its share buy back program, albeit at lower levels
than recent years.
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, which may cause the Company’s actual
future activities and
results
of operations to be materially different from those suggested or described
in
this document. A discussion of these risk factors is included below under the
caption “Risk Factors”. Investors are cautioned not to place undue reliance upon
these forward-looking statements, which speak only as of their dates.
Risk
Factors
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 engaged in growth and productivity initiatives in all
technology segments. Specifically, the Company has major growth
initiatives in businesses
serving the personal care, energy materials, polyethylene, diesel
emissions and gas-to-liquids markets.
These initiatives are subject
to greater risk than the Company’s traditional markets. Additionally,
failure to commercialize proprietary
and other technologies or to acquire businesses or licensing agreements
to
serve targeted markets could
negatively impact the Company’s business, financial condition and results
of operations.
|
· |
The
success of
research
and development activities and the speed with which regulatory
authorizations and product
launches may be achieved.
The
Company’s business depends upon the creation, acquisition and commercialization
of new technologies to replace obsolete technologies. The Company
cannot
give any assurance that it will be able to replace obsolete technologies
successfully or at all and the failure to do so could negatively
impact
the Company’s business, financial condition and results of
operations.
|
· |
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 could cause profitability losses and could damage customer
relations in the long term. Any significant loss of customers associated
with such manufacturing difficulties could negatively impact the
Company’s
business, financial condition and results of
operations.
|
· |
Capacity
constraints. Some
of the Company’s businesses operate near current capacity levels, notably
operations serving the petroleum refining operations. Should demand
for
certain products increase, the Company could experience 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’s
business.
|
· |
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. Significant loss of physical inventories, particularly
the
loss of the Company’s precious and base metals,
could negatively impact the Company’s business, financial condition and
results of operations.
|
· |
Litigation
and legal claims. The
Company is currently engaged in various legal disputes, including
litigation related
to the BASF tender offer. Unfavorable resolution of these disputes
would
negatively impact the
Company’s business, financial condition and results of
operations.
Unidentified
future legal claims could have a similar negative
impact.
|
· |
Contingencies
related to actual or alleged environmental contamination to which
the
Company may be a party (see
Note 22, “Environmental Costs” to the Company’s financial statements
included with the Company’s Annual Report on Form 10-K for the fiscal year
ended December 31, 2005).
|
· |
Exposure
to product liability lawsuits. As
a manufacturer, the Company is subject to end-user product liability
litigation
associated with the Company’s products. Unfavorable resolution of these
disputes would negatively impact the Company’s business, financial
condition and results of operations. Unidentified future legal
claims
could have a similar negative
impact.
|
· |
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.
|
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
in 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 unattractive or
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. Certain customers
of the
Company who supply parts to
the North American automobile producers have recently experienced
financial difficulties,
including bankruptcy.
Bankruptcy of other customers remains a threat. These customers represent
a
substantial portion of the
Environmental Technologies segment’s
business.
|
· |
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. A decrease in the availability of these precious metals
could negatively impact
the Company.
In closely monitored situations, for which exposure levels and transaction
size
limits have been set by
senior management, the Company holds unhedged metal positions that
are
subject to future
market fluctuations.
Such positions may include varying levels of derivative instruments.
At
times, these positions can be
significant. Significant changes in market prices could negatively
impact
the
Company’s business, financial condition and results of
operations.
|
· |
The
availability and price of
rare earth compounds. The
Company uses certain rare earth compounds in manufacturing its products,
produced in
limited locations worldwide. Decreased availability of these compounds
or
an increase in the price of these materials could negatively impact
the
Company’s business, financial condition and results of
operations.
|
· |
The
availability of substrates.
In
the Company’s Environmental Technologies segment, the Company purchases
large quantities
of catalyst substrates from a limited number of suppliers. These
substrates
are specifically designed and manufactured to requirements established
by
the Company’s customers. An inability to
obtain substrates in sufficient
volumes to meet customer demand could negatively impact the
Company’s business, financial condition and results of
operations.
|
· |
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’s business, financial condition and results of
operations.
|
· |
A
decrease in
the availability
or an increase in
the
cost of
energy,
notably natural gas. The
Company consumes more than 11 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. A
prolonged
continuation of higher prices, absent the ability to recover these
costs
through price increases or energy
surcharges, could negatively impact the
Company’s business, financial condition and results of
operations.
Changes could include customer and
product rationalization,
plant closures and asset impairments, particularly in certain minerals
operations serving the paper
market.
|
· |
The
impact of
increased employee benefit costs
and/or
the
resultant impact on employee relations and human resources.
The
Company employs over 7,000 employees worldwide and has been experiencing
increases
in
benefit costs, notably pension and medical benefits. Continued increases
in such costs could negatively impact the
Company’s business, financial condition and results of
operations.
|
· |
Higher
interest
rates. A
portion 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.
|
· |
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 United States
dollars.
|
· |
Geographic
expansions
may not
develop 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 as expected could negatively impact the Company’s business,
financial condition and results of
operations.
|
· |
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. Recent inflationary pressures have resulted in higher
material
costs.
The inability of the Company
to pass these higher costs to customers through price increases and
surcharges would have
a negative impact
on the
Company’s business, financial condition and results of
operations.
|
· |
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.
|
· |
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
and regulations. The Company will be impacted by changes in these
laws and
regulations. The Company operates in
tax jurisdictions throughout
the world, and, as a result, is subject to changes in tax law in
various
countries.
|
· |
A
slowdown in the expected rate of environmental regulations.
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.
|
· |
The
impact of natural disasters. Natural
disasters causing damage to the Company and our customers and suppliers
could negatively impact the
Company.
|
· |
Uncertainty
regarding the outcome of the
BASF Offer may affect the Company’s stock price and future
business.
The
uncertainty as to the outcome of the BASF Offer may have an adverse
effect
on employee retention and recruitment, and may negatively impact
supplier
and customer relationships. A significant loss of employees or
the
inability to attract new employees could negatively impact the
Company’s business, financial condition and results of
operations.
|
Risks
and
uncertainties associated with the Company’s tender offer and the Company’s
related recapitalization plan that, upon consummation of the recapitalization
plan, could cause actual results to differ materially and negatively impact
the
Company include:
· |
Increased
indebtedness and a greater ratio of indebtedness to stockholders’ equity.
The
Company will enter into new financing arrangements to finance the
Company’s tender offer and, as a result, indebtedness and interest expense
will increase. Such increased levels of indebtedness and higher interest
expenses may make it difficult for the Company to incur future
indebtedness at attractive terms or at all. In addition, the Company’s
indebtedness will be more substantial in relation to stockholders’ equity.
|
· |
Changes
in the Company’s credit ratings.
The Company expects its credit ratings will be downgraded by each
of the
principal rating agencies as a result of the announcement of the
Company’s
tender offer, but that the Company will maintain an investment grade
rating. Should the Company’s rating drop below investment grade, the
Company would experience higher interest expenses and may incur difficulty
in procuring metals.
|
· |
Conditions
to the Offer.
The Company’s ability to repurchase shares in the Company’s tender offer
will be subject to a number of conditions, including obtaining financing.
The commitment letter received to provide a one year bridge facility
of
$1.5 billion to fund the repurchase and related costs and expenses
is
subject to a number of conditions, including there being no material
adverse change in the Company since December 31, 2005 and there being
no
material disruption of or material adverse change in financial, banking
or
capital markets since April 25, 2006. In addition, we have to amend
our
existing credit facilities to permit the increased level of
indebtedness.
|
· |
Ability
to refinance the bridge facility.
The expected benefits of the recapitalization plan rely in part on
our
ability to refinance our bridge facility and the terms of the financing
obtained. The expected terms used herein are based on current market
conditions. The terms of any permanent financing will depend on market
conditions at the time we incur the indebtedness, and are likely
to be
different. In addition, a portion of the permanent financing is expected
to have a floating rate of interest, which may increase over
time.
|
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 Item 7A.
‘Quantitative and Qualitative Disclosures About Market Risk,’ Note 2
‘Derivatives and Hedging’ and Note 12 ‘Committed Metal Positions and Hedged
Metal Obligations’ of the Company’s 2005 Form 10-K. There have been no
significant changes to these market risks as of March 31, 2006. For more
information on the Company’s market risk, please see Item 2. ‘Management’s
Discussion and Analysis of Financial Condition and Results of Operations,’ Note
7 ‘Derivatives and Hedging’ and Note 10 ‘Committed Metal Positions and Hedged
Metal Obligations.’
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 March 31, 2006, 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 March 31, 2006 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 first fiscal quarter of 2006 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 March 31,
2006, 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.
PART
II - OTHER INFORMATION
Item
1. |
Legal
Proceedings
|
|
Please
see Note 15, “Legal and Environmental Matters” for an update on legal
proceedings.
|
|
Additional
risk factors to those disclosed in the Company’s 2005 Form 10-K include
items relating to the BASF tender offer and the Company’s proposed
recapitalization plan. Please see p.30 for a discussion of the Company’s
risk factors.
|
Item
2. |
Unregistered
Sales of Equity Securities and Use of
Proceeds
|
(e)
|
The
Company has Board authorized programs for the repurchase of the Company’s
stock. The following table represents repurchases under these programs
for
each of the three months of the quarter ended March 31,
2006:
|
ISSUER
PURCHASES OF EQUITY SECURITIES:
Period
|
|
Total
Number of Shares Purchased
|
|
Average
Price Paid per Share
|
|
Total
Number of Shares Purchased as Part of Publicly Announced Plans or
Programs
|
|
Maximum
Number of Shares that May Yet Be Purchased Under the Plans or Programs
(a)
|
|
1/1/06
- 1/31/06
|
|
|
-
(b
|
)
|
$
|
-
|
|
|
-
|
|
|
5,741,532
|
|
2/1/06
- 2/28/06
|
|
|
-
(c
|
)
|
|
-
|
|
|
-
|
|
|
5,741,532
|
|
3/1/06
- 3/31/06
|
|
|
-
(c
|
)
|
|
-
|
|
|
-
|
|
|
5,741,532
|
|
Total
|
|
|
-
|
|
$
|
-
|
|
|
-
|
|
|
|
|
(a) |
Share
repurchase program of 6 million shares authorized in May
2005.
|
(b) |
Excludes
265 shares obtained through dividend reinvestment by the Rabbi Trust
under
the Deferred Compensation Plan for Key Employees of Engelhard
Corporation.
|
(c) |
Excludes
a total of 32,923 shares received into treasury stock under the Key
Employee Stock Bonus Plan of Engelhard Corporation, representing
the net
shares received by the Company from employees to cover supplemental
withholding taxes on the vesting of stock award
shares.
|
(31)(a) Rule
13a-14(a)/15d-14(a) Certification of Chief Executive Officer. 37
(31)(b) Rule
13a-14(a)/15d-14(a) Certification of Chief Financial Officer. 38
(32) Section
1350 Certifications of Chief Executive Officer and Chief Financial Officer.
* 39
*
This
certification accompanies this Report pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and
shall
not
be deemed filed by the Company for purposes of Section 18 or any other provision
of the Securities
Exchange
Act of 1934, as amended.
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
ENGELHARD
CORPORATION
(Registrant)
Date:
|
May
9, 2006
|
|
/s/
Barry W. Perry
Barry
W. Perry
Chairman
and Chief
Executive
Officer
|
|
|
|
|
Date:
|
May
9, 2006
|
|
/s/
Michael A. Sperduto
Michael
A. Sperduto
Vice
President and Chief
Financial
Officer
|
|
|
|
|
Date:
|
May
9, 2006
|
|
/s/
Alan J. Shaw
Alan
J. Shaw
Controller
|