Hercules Incorporated Form 10-Q for the period ended March 31, 2007
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM 10-Q
Quarterly
Report
Pursuant
to Section 13 or 15(d)
of
the Securities Exchange Act of 1934
For
the quarterly period ended March 31, 2007
Commission
file number 1-496
HERCULES
INCORPORATED
A
Delaware Corporation
I.R.S.
Employer Identification No. 51-0023450
Hercules
Plaza
1313
North Market Street
Wilmington,
Delaware 19894-0001
Telephone:
302-594-5000
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: ý No: o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange
Act.
Large
accelerated filer ý 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: ý
As
of
April 30, 2007 116,592,141 shares of registrant’s common stock were
outstanding.
HERCULES
INCORPORATED
FORM
10-Q
FOR
THE QUARTERLY PERIOD ENDED MARCH 31, 2007
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47
|
HERCULES
INCORPORATED
(Dollars
in millions, except per share)
|
|
(Unaudited)
|
|
|
|
|
|
Three
Months Ended
March
31,
|
|
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|
|
|
2007
|
|
2006
|
|
Net
sales
|
|
|
|
|
$
|
502.3
|
|
$
|
527.3
|
|
Cost
of sales
|
|
|
|
|
|
323.4
|
|
|
360.7
|
|
Selling,
general and administrative expenses
|
|
|
|
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|
93.7
|
|
|
91.3
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|
Research
and development
|
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|
10.4
|
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|
9.6
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|
Intangible
asset amortization (Note 3)
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|
1.8
|
|
|
1.6
|
|
Other
operating expense, net (Note 11)
|
|
|
|
|
|
13.1
|
|
|
7.2
|
|
Profit
from operations
|
|
|
|
|
|
59.9
|
|
|
56.9
|
|
Interest
and debt expense
|
|
|
|
|
|
17.2
|
|
|
20.7
|
|
Vertac
litigation charges (Note 7)
|
|
|
|
|
|
1.5
|
|
|
—
|
|
|
|
|
|
|
|
3.3
|
|
|
10.6
|
|
Income
before income taxes, minority interests and equity loss
|
|
|
|
|
|
37.9
|
|
|
25.6
|
|
(Benefit)
provision for income taxes (Note 13)
|
|
|
|
|
|
(36.6
|
)
|
|
10.7
|
|
Income
before minority interests and equity loss
|
|
|
|
|
|
74.5
|
|
|
14.9
|
|
Minority
interests in earnings of consolidated subsidiaries
|
|
|
|
|
|
(0.5
|
)
|
|
(0.1
|
)
|
Equity
loss of affiliated companies, net of tax
|
|
|
|
|
|
(0.5
|
)
|
|
(0.4
|
)
|
Net
income from continuing operations before discontinued operations
and
cumulative effect of change in accounting principle
|
|
|
|
|
|
73.5
|
|
|
14.4
|
|
Net
loss from discontinued operations, net of tax
|
|
|
|
|
|
—
|
|
|
(0.6
|
)
|
Net
income before cumulative effect of change in accounting
principle
|
|
|
|
|
|
73.5
|
|
|
13.8
|
|
Cumulative
effect of change in accounting principle, net of tax
|
|
|
|
|
|
—
|
|
|
0.9
|
|
Net
income
|
|
|
|
|
$
|
73.5
|
|
$
|
14.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
earnings per share
|
|
|
|
|
|
|
|
|
|
|
Continuing
operations
|
|
|
|
|
$
|
0.64
|
|
$
|
0.13
|
|
Discontinued
operations
|
|
|
|
|
|
—
|
|
|
(0.01
|
)
|
Cumulative
effect of change in accounting principle
|
|
|
|
|
|
—
|
|
|
0.01
|
|
Net
income
|
|
|
|
|
$
|
0.64
|
|
$
|
0.13
|
|
Weighted
average number of shares (millions)
|
|
|
|
|
|
114.1
|
|
|
110.2
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
earnings per share
|
|
|
|
|
|
|
|
|
|
|
Continuing
operations
|
|
|
|
|
$
|
0.64
|
|
$
|
0.13
|
|
Discontinued
operations
|
|
|
|
|
|
—
|
|
|
(0.01
|
)
|
Cumulative
effect of change in accounting principle
|
|
|
|
|
|
—
|
|
|
0.01
|
|
Net
income
|
|
|
|
|
$
|
0.64
|
|
$
|
0.13
|
|
Weighted
average number of shares (millions)
|
|
|
|
|
|
114.9
|
|
|
110.5
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
|
|
$
|
73.5
|
|
$
|
14.7
|
|
Foreign
currency translation
|
|
|
|
|
|
6.1
|
|
|
7.4
|
|
Pension
and postretirement benefit adjustments, net of tax
|
|
|
|
|
|
6.4
|
|
|
64.4 |
|
Revaluation
of hedges, net of tax
|
|
|
|
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|
(4.6
|
)
|
|
(5.2
|
)
|
Comprehensive
income
|
|
|
|
|
$
|
81.4
|
|
$
|
81.3
|
|
See
accompanying notes to consolidated financial statements
HERCULES
INCORPORATED
(Dollars
in millions)
|
|
(Unaudited)
|
|
|
|
|
|
March
31,
2007
|
|
December 31,
2006
|
|
ASSETS
|
|
|
|
|
|
Current
assets
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
159.8
|
|
$
|
171.8
|
|
Accounts
receivable, net (Note
9)
|
|
|
340.1
|
|
|
326.6
|
|
|
|
|
230.9
|
|
|
210.6
|
|
Deferred
income taxes
|
|
|
71.2
|
|
|
70.2
|
|
Current
assets of discontinued operations
|
|
|
—
|
|
|
0.4
|
|
Income
taxes receivable
|
|
|
216.2
|
|
|
170.8
|
|
Other
current assets
|
|
|
41.2
|
|
|
34.1
|
|
Total
current assets
|
|
|
1,059.4
|
|
|
984.5
|
|
Property,
plant, and equipment, net (Note
9)
|
|
|
602.8
|
|
|
600.4
|
|
Intangible
assets, net (Note
3)
|
|
|
142.0
|
|
|
143.1
|
|
|
|
|
483.4
|
|
|
481.5
|
|
Deferred
income taxes
|
|
|
385.4
|
|
|
374.6
|
|
Asbestos-related
assets (Note
7)
|
|
|
41.9
|
|
|
87.5
|
|
Deferred
charges and other assets
|
|
|
136.8
|
|
|
136.9
|
|
Total
assets
|
|
$
|
2,851.7
|
|
$
|
2,808.5
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
Current
liabilities
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
188.6
|
|
$
|
205.3
|
|
Asbestos-related
liabilities (Note
7)
|
|
|
36.4
|
|
|
36.4
|
|
Current
debt obligations (Note
4)
|
|
|
35.3
|
|
|
35.8
|
|
Vertac
litigation liability (Note
7)
|
|
|
124.9
|
|
|
123.5
|
|
Accrued
expenses
|
|
|
228.0
|
|
|
228.6
|
|
Total
current liabilities
|
|
|
613.2
|
|
|
629.6
|
|
|
|
|
941.8
|
|
|
959.7
|
|
Deferred
income taxes
|
|
|
72.1
|
|
|
69.7
|
|
Pension
obligations
|
|
|
242.4
|
|
|
262.5
|
|
Other
postretirement benefit obligations
|
|
|
140.5
|
|
|
142.2
|
|
Deferred
credits and other liabilities
|
|
|
257.4
|
|
|
255.6
|
|
Asbestos-related
liabilities (Note
7)
|
|
|
230.2
|
|
|
233.6
|
|
Total
liabilities
|
|
|
2,497.6
|
|
|
2,552.9
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies (Note
7)
|
|
|
—
|
|
|
—
|
|
Minority
interests
|
|
|
13.2
|
|
|
12.7
|
|
Stockholders’
equity
|
|
|
|
|
|
|
|
Series preferred
stock
|
|
|
—
|
|
|
—
|
|
Common
stock, $25/48 par value (shares issued: 2007 and 2006 - 160.0
million)
|
|
|
83.3
|
|
|
83.3
|
|
Additional
paid-in capital
|
|
|
438.7
|
|
|
454.9
|
|
Unearned
compensation
|
|
|
(34.5
|
)
|
|
(42.1
|
)
|
Accumulated
other comprehensive losses
|
|
|
(401.7
|
)
|
|
(409.6
|
)
|
Retained
earnings
|
|
|
1,809.5
|
|
|
1,734.1
|
|
|
|
|
1,895.3
|
|
|
1,820.6
|
|
Reacquired
stock, at cost (2007 - 43.4 million shares; 2006 - 44.0 million
shares)
|
|
|
(1,554.4
|
)
|
|
(1,577.7
|
)
|
Total
stockholders’ equity
|
|
|
340.9
|
|
|
242.9
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
2,851.7
|
|
$
|
2,808.5
|
|
See
accompanying
notes to consolidated financial statements
HERCULES
INCORPORATED
(Dollars
in millions)
|
|
(Unaudited)
|
|
|
|
Three
Months Ended
March
31,
|
|
|
|
2007
|
|
2006
|
|
Cash
Flows from Operating Activities:
|
|
|
|
|
|
Net
income
|
|
$
|
73.5
|
|
$
|
14.7
|
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
Depreciation
|
|
|
17.1
|
|
|
19.1
|
|
Amortization
|
|
|
9.5
|
|
|
5.8
|
|
Deferred
income tax provision
|
|
|
(12.7
|
)
|
|
2.2
|
|
Write-off
of debt issuance costs
|
|
|
—
|
|
|
0.2
|
|
Loss
on sale of 51% interest in FiberVisions
|
|
|
(0.2
|
)
|
|
5.1
|
|
Minority
interests in earnings of consolidated subsidiaries
|
|
|
0.5
|
|
|
0.1
|
|
Other
non-cash charges and credits, net
|
|
|
3.8
|
|
|
0.9
|
|
Accruals
and deferrals of cash receipts and payments (net of acquisitions
and
dispositions):
|
|
|
|
|
|
|
|
Accounts
receivable, net
|
|
|
(11.2
|
)
|
|
(5.6
|
)
|
Inventories
|
|
|
(18.9
|
)
|
|
(4.1
|
)
|
Asbestos-related
assets and liabilities, net
|
|
|
43.1
|
|
|
2.7
|
|
Other
current assets
|
|
|
(0.5
|
)
|
|
10.8
|
|
Accounts
payable
|
|
|
(18.2
|
)
|
|
(8.7
|
)
|
Vertac
litigation liability
|
|
|
1.5
|
|
|
—
|
|
Accrued
expenses
|
|
|
(6.2
|
)
|
|
(10.4
|
)
|
Income
taxes payable
|
|
|
(33.1
|
)
|
|
(0.8
|
)
|
Pension
and postretirement benefit obligations
|
|
|
(11.7
|
)
|
|
5.9
|
|
Non-current
assets and liabilities
|
|
|
(10.5
|
)
|
|
(2.3
|
)
|
FiberVisions
net assets held for sale
|
|
|
—
|
|
|
(7.9
|
)
|
Net
cash provided by operating activities
|
|
|
25.8
|
|
|
27.7
|
|
|
|
|
|
|
|
|
|
Cash
Flows from Investing Activities:
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
|
(24.2
|
)
|
|
(8.1
|
)
|
Acquisitions
and investments, net
|
|
|
(0.9
|
)
|
|
(26.4
|
)
|
Proceeds
from sale of 51% interest in FiberVisions, net of transaction
costs
|
|
|
—
|
|
|
27.0
|
|
Other,
net
|
|
|
—
|
|
|
(0.1
|
)
|
Net
cash used in investing activities
|
|
|
(25.1
|
)
|
|
(7.6
|
)
|
|
|
|
|
|
|
|
|
Cash
Flows from Financing Activities:
|
|
|
|
|
|
|
|
Long-term
debt issued by FiberVisions, net of issuance costs
|
|
|
—
|
|
|
83.7
|
|
Long-term
debt proceeds
|
|
|
2.8
|
|
|
—
|
|
Long-term
debt payments
|
|
|
(22.2
|
)
|
|
(18.8
|
)
|
Change
in short-term debt
|
|
|
0.6
|
|
|
(2.5
|
)
|
Proceeds
from the exercise of stock options
|
|
|
3.8
|
|
|
0.1
|
|
Other,
net including income tax benefits attributable to stock-based
compensation
|
|
|
2.0
|
|
|
0.1
|
|
Net
cash (used in) provided by financing activities
|
|
|
(13.0
|
)
|
|
62.6
|
|
Effect
of exchange rate changes on cash
|
|
|
0.3
|
|
|
0.5
|
|
Net
(decrease) increase in cash and cash equivalents
|
|
|
(12.0
|
)
|
|
83.2
|
|
Cash
and cash equivalents - beginning of period
|
|
|
171.8
|
|
|
77.3
|
|
Cash
and cash equivalents - end of period
|
|
$
|
159.8
|
|
$
|
160.5
|
|
See
accompanying notes to consolidated financial statements
HERCULES
INCORPORATED
(Dollars
and shares in millions, except per share amounts)
(Unaudited)
The
interim consolidated financial statements and the notes to the consolidated
financial statements of Hercules Incorporated (“Hercules” or the “Company”) are
unaudited as of and for the three months ended March 31, 2007 and 2006, but
in
the opinion of management include all adjustments (consisting only of normal
recurring adjustments) necessary for a fair statement of Hercules’ financial
position and results of operations for the interim periods. The consolidated
financial statements include the accounts of variable interest entities for
which Hercules is the primary beneficiary. These consolidated financial
statements should be read in conjunction with the accounting policies, financial
statements and notes included in Hercules’ Annual Reports on Form 10-K and
Form 10-K/A for the year ended December 31, 2006.
The
results of operations and cash flows of FiberVisions have been consolidated
into
the Company’s Statements of Operations and Cash Flows through March 31, 2006,
preceding the sale of the Company’s 51% interest. Effective April 1, 2006,
FiberVisions has been reported as an equity investment and the Company includes
its proportionate share of earnings and losses using the equity method of
accounting.
Certain
prior period amounts in the consolidated financial statements and notes have
been reclassified to conform to the current period presentation.
2. Recent
Accounting Pronouncements
In
September 2006, the FASB issued Statement of Financial Accounting Standards
No.
157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 establishes a framework
for measuring fair value under accounting principles generally accepted in
the
United States (“GAAP”) and will be applied to existing accounting and disclosure
requirements in GAAP that are based on fair value. SFAS 157 does not require
any
new fair value measurements. SFAS 157 emphasizes a “market-based” as opposed to
an “entity-specific” measurement perspective, establishes a hierarchy of fair
value measurement methods and expands disclosure requirements about fair value
measurements including methods and assumptions and the impact on earnings.
The
Company has identified its cross-currency interest rate swaps, certain foreign
exchange-related contracts, its “available for sale” investment securities and
its measurement processes for asset retirement obligations and the impairment
of
goodwill and intangible assets as being impacted by SFAS 157. The Company
continues to evaluate the overall impact of SFAS 157, which is to be adopted
effective January 1, 2008 and applied prospectively.
In
February 2007, the FASB issued Statement of Financial Accounting Standards
No.
159, “The Fair Value Option for Financial Assets and Financial Liabilities -
Including an amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159
provides an option to report certain financial assets and liabilities at fair
value primarily to reduce the complexity and level of volatility in the
accounting for financial instruments resulting from measuring related financial
assets and liabilities differently under existing GAAP. SFAS 159 is effective
January 1, 2008. At this time, the Company does not anticipate SFAS 159 having
a
material impact on its financial statements.
3. Intangible
Assets and Goodwill
The
following table provides information regarding the Company’s intangible assets
with finite lives:
|
|
March
31, 2007
|
|
December
31, 2006
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
Gross
|
|
Amortization
|
|
Net
|
|
Gross
|
|
Amortization
|
|
Net
|
|
Customer
relationships
|
|
$
|
90.6
|
|
$
|
19.2
|
|
$
|
71.4
|
|
$
|
90.0
|
|
$
|
18.6
|
|
$
|
71.4
|
|
Trademarks
and tradenames
|
|
|
73.9
|
|
|
16.1
|
|
|
57.8
|
|
|
73.9
|
|
|
15.6
|
|
|
58.3
|
|
Other
intangible assets
|
|
|
32.3
|
|
|
19.5
|
|
|
12.8
|
|
|
32.2
|
|
|
18.8
|
|
|
13.4
|
|
|
|
$
|
196.8
|
|
$
|
54.8
|
|
$
|
142.0
|
|
$
|
196.1
|
|
$
|
53.0
|
|
$
|
143.1
|
|
Total
amortization expense for Other intangible assets was $1.8 million and $1.6
million for the three months ended March 31, 2007 and 2006, respectively.
Estimated amortization expense is $7.2 million for the year ended December
31,
2007.
The
following table shows changes in the carrying amount of goodwill by operating
segment for the three months ended March 31, 2007:
|
|
Paper
Technology and Ventures
|
|
Aqualon
Group
|
|
Total
|
|
Balance
at December 31, 2006
|
|
$
|
429.5
|
|
$
|
52.0
|
|
$
|
481.5
|
|
Foreign
currency translation
|
|
|
1.7
|
|
|
0.2
|
|
|
1.9
|
|
Balance
at March 31, 2007
|
|
$
|
431.2
|
|
$
|
52.2
|
|
$
|
483.4
|
|
A
summary
of debt by instrument is provided as follows:
|
|
March
31,
2007
|
|
December 31,
2006
|
|
Term
B Loan due 2010
|
|
$
|
354.0
|
|
$
|
375.0
|
|
6.6%
notes due 2027
|
|
|
100.0
|
|
|
100.0
|
|
11.125%
senior notes due 2007
|
|
|
16.1
|
|
|
16.1
|
|
6.75%
senior subordinated notes due 2029
|
|
|
250.0
|
|
|
250.0
|
|
8%
convertible subordinated debentures due 2010
|
|
|
2.3
|
|
|
2.4
|
|
6.5%
junior subordinated deferrable interest debentures due
2029
|
|
|
214.3
|
|
|
214.1
|
|
Term
loans at rates ranging from 5.5575% to 5.814% due in varying amounts
thru
2011
|
|
|
31.7
|
|
|
28.1
|
|
Other
|
|
|
8.7
|
|
|
9.8
|
|
|
|
|
977.1
|
|
|
995.5
|
|
Less:
Current debt obligations
|
|
|
35.3
|
|
|
35.8
|
|
Long-term
debt
|
|
$
|
941.8
|
|
$
|
959.7
|
|
As
of
March 31, 2007 the weighted-average interest rate on the Term B Loan, which
bears interest at LIBOR + 1.50%, was 6.85%.
As
of
March 31, 2007, $44.3 million of the $150.0 million Revolving Facility under
the
Company’s Senior Credit Facility was available for use. The Company had $105.7
million of outstanding letters of credit associated with the Revolving Facility
at March 31, 2007. As of March 31, 2007, the Company had $30.4 million of
foreign lines of credit available and unused.
5. |
Pension
and Other Postretirement
Benefits
|
The
following table sets forth the consolidated net periodic pension and other
postretirement benefit costs that are attributable to the Company’s global
pension and postretirement benefit plans as recognized for the three months
ended March 31, 2007 and 2006:
|
|
Pension
Benefits
|
|
Other
Postretirement Benefits
|
|
|
|
Three
Months Ended
March
31,
|
|
Three
Months Ended
March
31,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Net
periodic benefit cost:
|
|
|
|
|
|
|
|
|
|
Service
cost
|
|
$
|
4.5
|
|
$
|
4.7
|
|
$
|
0.1
|
|
$
|
0.2
|
|
Interest
cost
|
|
|
25.9
|
|
|
24.9
|
|
|
2.2
|
|
|
2.1
|
|
Expected
return on plan assets
|
|
|
(30.3
|
)
|
|
(28.4
|
)
|
|
—
|
|
|
—
|
|
Amortization
and deferrals
|
|
|
(0.7
|
)
|
|
(0.5
|
)
|
|
(1.9
|
)
|
|
(2.1
|
)
|
Actuarial
losses recognized
|
|
|
10.9
|
|
|
12.0
|
|
|
2.2
|
|
|
1.7
|
|
|
|
$
|
10.3
|
|
$
|
12.7
|
|
$
|
2.6
|
|
$
|
1.9
|
|
Total
contributions expected to be made to the Company’s pension plans during 2007 are
approximately $61 million, including $40 million in voluntary contributions
attributable to the U.S. defined benefit pension plan and $21 million
attributable to the Company’s international pension plans. During the three
months ended March 31, 2007, the Company contributed a total of $17.1 million,
which was entirely attributable to its pension plan in the United
Kingdom.
6. |
Asset
Retirement Obligations
|
The
following table provides a reconciliation of the changes in the asset retirement
obligations (“AROs”) during the period:
|
|
Active
Sites
|
|
Inactive
Sites
|
|
Total
|
|
Balance
at December 31, 2006
|
|
$
|
10.1
|
|
$
|
66.2
|
|
$
|
76.3
|
|
Accretion
|
|
|
0.1
|
|
|
0.5
|
|
|
0.6
|
|
Settlement
payments
|
|
|
(0.3
|
)
|
|
(2.0
|
)
|
|
(2.3
|
)
|
Foreign
currency translation
|
|
|
—
|
|
|
0.1
|
|
|
0.1
|
|
Balance
at March 31, 2007
|
|
$
|
9.9
|
|
$
|
64.8
|
|
$
|
74.7
|
|
While
not
reflected in the table above, the Company has recognized $5.2 million for
environmental contingencies whereby it is probable that the Company has incurred
a liability for costs associated with environmental remediation or for the
settlement of related litigation. Liabilities included in this amount are
attributable to sites that the Company formerly owned as well as sites that
the
Company did not have an ownership interest in, but was associated with including
landfills, waste sites and other similar properties.
7. Commitments
and Contingencies
Guarantees
In
accordance with FASB Interpretation No. 45, “Guarantor’s Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others” (“FIN 45”), disclosure about each group of guarantees is
provided below:
Indemnifications
In
connection with the sale of Company assets and businesses, the Company has
indemnified respective buyers against certain liabilities that may arise in
connection with the sale transactions and business activities prior to the
ultimate closing of the sale. The terms of these indemnifications
typically pertain to environmental, tax, employee and/or product related
matters. If the indemnified party were to incur a liability or have a
liability increase as a result of a successful claim, pursuant to the terms
of
the indemnification, the Company would be required to protect, defend, and/or
indemnify the buyer. These indemnifications are generally subject to
threshold amounts, specified claim periods and/or other restrictions and
limitations. The carrying amount recorded for indemnifications as of March
31, 2007 was $41.2 million.
In
addition, in connection with these transactions, the Company has generally
provided indemnifications on general corporate matters such as ownership of
the
relevant assets, the power and corporate authority to enter into transactions
and the satisfaction of liabilities not assumed by the buyer. These
indemnifications generally have indefinite terms.
As
noted
in greater detail in the Litigation section of this note, the Company has
entered into comprehensive settlement agreements with substantially all of
its
insurance carriers that provided coverage for asbestos-related products
liabilities. Under the terms of those agreements and in exchange for
payments received and to be received from such insurance carriers, the Company
has released and agreed to indemnify such insurers from claims asserted under
their cancelled policies.
Although
it is reasonably possible that future payments may exceed amounts accrued,
due
to the nature of indemnified items, it is not possible to make a reasonable
estimate of the maximum potential loss or range of loss. Generally, there
are no specific recourse provisions.
In
addition, the Company provides certain indemnifications in the ordinary course
of business such as product, patent and performance warranties in connection
with the manufacture, distribution and sale of its products and services.
Due to the nature of these indemnities, it is not possible to make a reasonable
estimate of the maximum potential loss or range of loss.
Debt
Obligations
The
Company has directly guaranteed $42.8 million of various obligations under
agreements with third parties related to consolidated subsidiaries and
affiliates of which $30.3 million was outstanding at March 31, 2007. The
outstanding balance reflects guarantees of debt for terms of varying length
as
well as a guarantee related to a foreign-based pension plan with an indefinite
term. The Company has also provided $2.9 million in collateral in the form
of a
mortgage security for the aforementioned pension plan. Existing guarantees
for subsidiaries and affiliates arose from liquidity needs in normal
operations.
Intercompany
Guarantees
The
Company and its subsidiaries have authorized intercompany guarantees between
and
among themselves, which aggregate approximately $193.5 million, of which $181.6
million was outstanding at March 31, 2007. These guarantees relate to
intercompany loans used to facilitate normal business operations and have been
eliminated from the Company’s consolidated financial statements.
Environmental
In
the
ordinary course of its business, the Company is subject to numerous
environmental laws and regulations covering compliance matters or imposing
liability for the costs of, and damages resulting from, cleaning up sites,
past
spills, disposals and other releases of hazardous substances. Changes in
these laws and regulations may have a material adverse effect on the Company’s
financial position and results of operations. Any failure by the Company
to adequately comply with such laws and regulations could subject the Company
to
significant future liabilities.
The
Company has been identified as a potentially responsible party (“PRP”) by U.S.
federal and state authorities, or by private parties seeking contribution,
for
the cost of environmental investigation and/or cleanup at numerous sites.
The Company becomes aware of sites in which it may be named a PRP in
investigatory and/or remedial activities through correspondence from the U.S.
Environmental Protection Agency (“EPA”) or other government agencies or from
previously named PRPs, who either request information or notify the Company
of
its potential liability. The Company has established procedures for
identifying environmental issues at its plant sites. In addition to
environmental audit programs, the Company has environmental coordinators who
are
familiar with environmental laws and regulations and act as a resource for
identifying environmental issues.
While
the
Company is involved in numerous environmental matters, the following matters
are
described below because they are currently viewed by management as potentially
material to the Company’s consolidated financial position, results of operations
and cash flows.
United
States of America v. Vertac Chemical Corporation, et al.,
No.
4:80CV00109 (United States District Court, Eastern District of Arkansas, Western
Division)
As
described further below, on April 23, 2007, the United States Supreme Court
denied the Company’s Petition for a Writ of Certiorari. As a result, the Company
will now be required to pay to the United States the amount set forth in the
Final Judgment dated June 6, 2005, plus post-judgment interest, plus any
additional response costs incurred or to be incurred by the United States after
June 1, 1998. The Company has accrued its total net liability of $124.9 million,
including interest but not including amounts for which Uniroyal has been held
liable based on the Final Judgment, which is recorded as a current liability
at
March 31, 2007. The Company will continue to accrue interest on that amount
until such time as the Final Judgment is paid. The United States has not yet
informed the Company of the amount of the additional response costs which the
United States will claim that it has incurred since June 1, 1998, nor has the
Company been provided an opportunity to evaluate those costs. As a result,
no
amounts have been accrued with respect to such response costs.
This
case, a cost-recovery action based upon the Comprehensive Environmental
Response, Compensation and Liability Act (“CERCLA” or the “Superfund statute”),
as well as other statutes, has been in litigation since 1980, and involves
liability for costs in connection with the investigation and remediation of
the
Vertac Chemical Corporation (“Vertac”) site in Jacksonville, Arkansas. The
Company owned and operated the site from December 1961 until 1971. The site
was
used for the manufacture of certain herbicides and, at the order of the United
States, Agent Orange. In 1971, the site was leased to Vertac’s
predecessor. In 1976, the Company sold the site to Vertac. The site was
abandoned by Vertac in 1987, and Vertac was subsequently placed into
receivership. Both prior to and following the abandonment of the site, the
EPA and the Arkansas Department of Pollution Control and Ecology were involved
in the investigation and remediation of contamination at and around the site.
Pursuant to several orders issued under CERCLA, the Company actively
participated in many of those activities.
The cleanup is essentially complete, except for certain on-going maintenance
and
monitoring activities. This litigation primarily concerns the responsibility
and
allocation of liability for the costs incurred in connection with the activities
undertaken by the EPA.
The
procedural history of this litigation is discussed in greater detail in reports
previously filed by the Company with the United States Securities and Exchange
Commission (“SEC”). In summary, in 1999, the District Court finalized a ruling
holding the Company and Uniroyal jointly and severally liable for approximately
$100 million in costs incurred by the EPA, as well as costs to be incurred
in
the future. In 2000, the District Court allocated 2.6% of such amounts to
Uniroyal and 97.4% of such amounts to the Company. Both the Company and Uniroyal
appealed those rulings to the U.S. Court of Appeals for the Eighth Circuit
(the
“Court of Appeals”). In 2001, the Court of Appeals reversed the District Court’s
rulings as to joint and several liability and allocation, and remanded the
case
back to the District Court for several determinations, including a determination
of whether the harms at the site giving rise to the EPA’s claims were divisible.
The trial on remand occurred in late 2001.
By
Memorandum Opinion and Order dated March 30, 2005, the District Court
largely affirmed its prior findings and prior judgment against the Company
and
Uniroyal, and the prior allocation with respect to the Company and Uniroyal,
although the District Court did agree that the Company should not be liable
for
costs associated with a particular off-site landfill, and held that the judgment
should be reduced accordingly. By Order dated June 6, 2005, the District
Court entered a Final Judgment in favor of the United States and against the
Company for $119.3 million, of which amount Uniroyal has been held jointly
and
severally liable for $110.4 million, with the Company alone liable for the
difference. The Final Judgment also provided that both the Company and Uniroyal
are responsible for any additional response costs incurred or to be incurred
by
the United States after June 1, 1998, as well as post-judgment interest
running from the date of the Final Judgment. In addition, the District Court
re-affirmed its prior holding which allocated 2.6% of the $110.4 million in
response costs for which Uniroyal is jointly and severally liable, or $2.9
million, to Uniroyal. Finally, the Final Judgment found Uniroyal liable to
the
Company for 2.6% of the response costs incurred by the Company of approximately
$27.4 million, or $0.7 million. Both the Company and Uniroyal appealed the
Final
Judgment to the Court of Appeals, asserting that the District Court had
committed reversible error.
On
July
13, 2006, a panel of the Court of Appeals affirmed the Final Judgment of the
District Court. The Company requested that the panel’s determination be reviewed
en
banc,
but
that request was denied by Order dated September 19, 2006. On December 14,
2006,
the Company filed a Petition for a Writ of Certiorari with the United States
Supreme Court, requesting that the Supreme Court review this matter. On April
23, 2007, that petition was denied, marking the end of the appellate process.
As
noted above, the Company has accrued its total net liability of $124.9 million,
including interest but not including amounts for which Uniroyal has been held
liable based on the Final Judgment, which is recorded as a current liability
at
March 31, 2007. The Company will continue to accrue interest on this amount
until such time as the Final Judgment is paid. The United States has not yet
informed the Company of the amount of the additional response costs which the
United States will claim that it has incurred since June 1, 1998, nor has the
Company been provided an opportunity to evaluate those costs. As a result,
no
amounts have been accrued with respect to such response costs.
Alleghany
Ballistics Laboratory
The
Alleghany Ballistics Laboratory (“ABL”) is a government-owned facility which was
operated by the Company from 1945 to 1995 under contract with the United States
Department of the Navy. The Navy and the Company have commenced discussions
with
respect to certain environmental liabilities which the Navy alleges are
attributable to the Company’s past operations at ABL. During the course of
discussions, the Navy has stated that, pursuant to CERCLA, it has spent and
anticipates spending in the future a total of approximately $76 million. The
Company has conducted an investigation of the Navy’s allegations, including the
basis of the Navy’s claims, and believes the contracts with the government
pursuant to which the Company operated ABL may provide the Company with a
defense from some or all of the amounts sought. The Company has exchanged
information with the Navy and discussions with the Navy are continuing. At
this
time, however, the Company cannot reasonably estimate its liability, if any,
with respect to ABL and, accordingly, has not included this site in the range
of
its environmental liabilities reported below.
Kim
Stan Landfill
The
Company is one of a limited number of industrial companies that have been
identified by the EPA as a PRP at the Kim Stan Landfill, near Covington,
Virginia. The EPA is seeking to have the PRPs undertake the remediation of
the
site at a currently estimated cost of $12.0 million (including EPA oversight
charges). Based on the investigation conducted to date, the Company believes
that parties not named by the EPA as PRPs may be responsible for the majority
of
the costs that have been and will be incurred at the site and intends to seek
contribution from those parties to the extent it is required to pay any monies
in connection with the site. As a result of that investigation, the Company
believes that it has defenses that would substantially reduce its exposure.
The
Company and two other PRPs are in negotiations with the EPA in an attempt to
resolve this matter in an equitable manner. The Company believes it is probable
that this matter will ultimately be amicably resolved, and the amount the
Company reasonably estimates that it will pay is included in the accrued
liability for environmental matters reported below.
Clean
Air Act Notice of Violation
On
December 23, 2005, EPA Region III issued a Notice of Violation (“NOV”) to the
Company and to Eastman Company (“Eastman”) that alleges various violations of
the Clean Air Act, primarily focused on the Act’s requirements governing
emissions of volatile organic compounds, at a manufacturing facility located
in
West Elizabeth, Pennsylvania. (In
the
Matter of Eastman Company and Hercules Incorporated,
EPA
Region III, Docket No. CAA-III-06-011.) That facility was sold to Eastman as
part of the Company's divestiture of its Resins business in May 2001. The EPA
has not specifically made a demand for monetary penalties upon the Company
and
Eastman. The Company is continuing to investigate the allegations set forth
in
the NOV, as well as any indemnification obligations that it may owe to Eastman
pursuant to the terms of the purchase and sale agreement. At this time, however,
the Company cannot reasonably estimate its liability, if any, with respect
to
this matter and, accordingly, has not included this site in the accrued
liability for environmental matters reported below.
Range
of Exposure
The
reasonably possible share of costs for environmental matters involving current
and former operating sites, including those with identified asset retirement
obligations (see Note 6), the Vertac site and other locations
where the Company may have a liability, is approximately $205 million as of
March 31, 2007. This accrued liability is evaluated at least quarterly based
on
currently available information, including the progress of remedial
investigations at each site and the current status of negotiations with
regulatory authorities regarding the method and extent of apportionment of
costs
among other PRPs. The actual costs for these matters will depend upon numerous
factors, including the number of parties found responsible at each environmental
site and their ability to pay; the actual methods of remediation required or
agreed to; outcomes of negotiations with regulatory authorities; outcomes of
litigation; changes in environmental laws and regulations; technological
developments; and the years of remedial activity required, which could range
from 0 to 30 or more years. While it is not feasible to predict the
outcome of all pending environmental matters, the ultimate resolution of one
or
more of these environmental matters could have a material adverse effect upon
the Company’s financial position, results of operations and/or cash flows for
any annual, quarterly or other period.
Litigation
The
Company is involved in litigation arising out of or incidental to the conduct
of
its business. Such litigation typically falls within the following broad
categories: environmental (discussed above); antitrust; commercial;
intellectual property; labor and employment; personal injury; property damage;
product liability; and toxic tort. These matters typically seek unspecified
or
large monetary damages or other relief, and may also seek punitive damages.
While it is not feasible to predict the outcome of all pending matters, the
ultimate resolution of one or more of these matters could have a material
adverse effect upon the Company’s financial position, results of operations
and/or cash flows for any annual, quarterly or other period. While the Company
is involved in numerous matters, certain matters are described below because
they are currently viewed by management as potentially material. From time
to
time, management may determine (based on further analysis or additional
information that becomes available through discovery or otherwise) that other
matters are or have become potentially material to the Company. As appropriate,
descriptions of such matters will be included in the periodic report following
such determination. Occasionally, management may not determine that a matter
is
material until it has been settled or otherwise resolved. In such a situation,
that matter may not have been described in the Company’s periodic reports prior
to such settlement or resolution, but the impact of such settlement or
resolution would be reflected in the financial statements included in the
periodic report following such settlement or resolution.
Asbestos
The
Company is a defendant in numerous asbestos-related personal injury lawsuits
and
claims which typically arise from alleged exposure to asbestos fibers from
resin
encapsulated pipe and tank products which were sold by one of the Company’s
former subsidiaries to a limited industrial market (“products claims”).
The Company is also a defendant in lawsuits alleging exposure to asbestos at
facilities formerly or presently owned or operated by the Company (“premises
claims”). Claims are received and settled or otherwise resolved on an
on-going basis.
As
of
March 31, 2007, there were approximately 26,034 unresolved claims, of which
approximately 980 were premises claims and the rest were products claims.
There were also approximately 1,900 unpaid claims which have been settled or
are
subject to the terms of a settlement agreement. In addition, as of March
31, 2007, there were approximately 528 claims which have either been dismissed
without payment or are in the process of being dismissed without payment, but
with plaintiffs retaining the right to re-file should they be able to establish
exposure to an asbestos-containing product for which the Company bears
liability.
Between
January 1, 2007 and March 31, 2007, the Company received approximately 323
new
claims. During that same period, the Company spent approximately $5.6 million
to
resolve and defend asbestos matters, including $3.4 million in settlement
payments and approximately $2.2 million for defense costs.
The
Company’s primary and first level excess insurance policies that provided
coverage for these asbestos-related matters exhausted their products limits
at
or before the end of July 2003. On November 27, 2002, the
Company initiated litigation against the solvent excess insurance carriers
that
provided insurance coverage for asbestos-related liabilities in a matter
captioned Hercules
Incorporated v. OneBeacon, et al.,
Civil
Action No. 02C-11-237 (SCD), Superior Court of Delaware, New Castle
County. Beginning in August 2004 and continuing through
October 2004, the Company entered into settlements with all of the insurers
named in that lawsuit. As a result, the lawsuit was dismissed in early
November 2004.
As
discussed in greater detail in reports previously filed by the Company with
the
SEC, the Company entered into several settlements with its insurers in 2004.
The
first such settlement involved insurance policies issued by certain underwriters
at Lloyd’s, London, and reinsured by Equitas Limited and related entities
(“Equitas”) (the “First Settlement Agreement”). As part of that
settlement, Equitas placed $67.0 million into a trust (the “Equitas Trust”)
set up to reimburse the Company for a portion of the costs it incurred to defend
and resolve certain asbestos claims. In exchange, the Company released the
underwriters from past, present and future claims under those policies, agreed
to the cancellation of those policies, and agreed to indemnify the underwriters
from any claims asserted under those policies. In addition, the settlement
provided that if federal asbestos reform legislation was not enacted into law
on
or prior to January 3, 2007, any funds remaining in the Equitas Trust would
be available to the Company to pay asbestos-related liabilities or to use for
other corporate purposes. Federal asbestos reform legislation was not enacted
on
or prior to January 3, 2007. As a result, on January 4, 2007, the Company
received as a lump sum distribution approximately $41.3 million, an amount
representing a complete liquidation of the remaining balance of the Equitas
Trust, including accrued interest, and the Equitas Trust has been terminated.
In
addition, effective October 8, 2004, the Company entered into a
comprehensive confidential settlement agreement with respect to certain
insurance policies issued by various insurance companies operating in the London
insurance market, and by one insurance company located in the United States
(the
“Second Settlement Agreement”). Under the terms of the Second Settlement
Agreement, the participating insurers agreed to place a total of approximately
$102.2 million into a trust (the “Second Trust”), with such amount to be paid
over a four-year period commencing in January 2005 and ending in 2008. In
exchange, the Company released the insurers from past, present and future claims
under those policies, agreed to the cancellation of those policies, and agreed
to indemnify the insurers from any claims asserted under those policies. The
trust funds have been and are continuing to be used to reimburse the Company
for
costs it incurs to defend and resolve asbestos-related claims. Any funds
remaining in the Second Trust subsequent to December 31, 2008 may be used
by the Company to defend and resolve both asbestos-related claims and
non-asbestos related claims. As of March 31, 2007, approximately $85.1
million of the $102.2 million had been placed into the Second Trust, and the
Second Trust had a balance of approximately $25.4 million.
The
Company also reached settlement agreements with additional insurers whose level
of participation in the Company’s insurance program is substantially lower than
the aggregate participation of the insurers referred to above (the “Other
Settlement Agreements”). Pursuant to the Other Settlement Agreements, the
Company has released or partially released its rights to coverage under
insurance policies issued by such insurers. The Company has received all
amounts due under the Other Settlement Agreements.
In
addition, effective October 13, 2004, the Company reached a confidential
settlement agreement with the balance of its solvent excess insurers whereby
a
significant portion of the costs incurred by the Company with respect to future
asbestos product liability claims will be reimbursed, subject to those claims
meeting certain qualifying criteria (the “Future Coverage Agreement”).
That agreement is not expected to result in reimbursement to the Company,
however, unless and until defense costs and settlement payments for qualifying
asbestos products claims paid by the Company subsequent to the effective date
of
the agreement aggregate to approximately $330 million to $370 million, with
the
foregoing approximation based on various assumptions, including that there
are
sufficient qualifying claims to require such payments, that for such qualifying
claims the time periods of each claimant’s alleged exposure to asbestos products
falls within the time periods covered by the participating insurers’ policies,
and that
each
of
the participating insurers remain solvent and honor their commitments under
the
terms of the Future Coverage Agreement. The Company expects that such
amounts, if required to be paid, would be paid by the Company using monies
from
the above settlements and from other sources. If and when such amounts are
paid by the Company, the insurers’ obligations pursuant to the terms of the
Future Coverage Agreement would be triggered, and the participating insurers
would thereafter be required to pay their allocated share of defense costs
and
settlement payments for asbestos product liability claims that qualify for
reimbursement subject to the limits of their insurance policies, which limits
are believed to be sufficient to cover the insurers’ allocated shares of an
amount that exceeds the high end of the reasonably possible range of financial
exposure described below. The Company will be responsible for the share of
such costs and payments that are not reimbursed by the participating insurers
pursuant to the terms of the Future Coverage Agreement, as well as for such
costs and payments for those claims that do not qualify for reimbursement under
the terms of the Future Coverage Agreement. Should asbestos reform
legislation be passed, some or all of the obligations under the Future Coverage
Agreement will be suspended for so long as such legislation remains in effect.
As of March 31, 2007, defense costs and settlement payments for qualifying
asbestos products claims of approximately $87 million have been credited towards
the range of $330 million to $370 million noted above.
As
a
result of the above settlements, the Company is expected to have available
to it
a combination of cash and trust fund monies which can be used to pay or
reimburse the Company for a significant portion of the defense costs and
settlement payments that may be incurred by the Company with respect to its
asbestos-related liabilities. Upon exhaustion of the trust fund monies, the
Company will be required to fund such liabilities itself until such time as
the
insurers’ obligations under the Future Coverage Agreement are triggered. If and
when those obligations are triggered, the Company and the insurers who are
participants in the Future Coverage Agreement will share qualifying asbestos
product liability claims, defense costs and settlement payments at varying
levels over time, with the Company typically bearing a slightly larger share
than such participating insurers. Of note, as a result of the First Settlement
Agreement, Second Settlement Agreement and Other Settlement Agreements,
substantially all of the Company’s insurance coverage applicable to asbestos
products claims has been cancelled (except for obligations under the Future
Coverage Agreement), and such insurance coverage will no longer be available
to
cover any such claims. In addition and as described above, as a result of the
First Settlement Agreement, Second Settlement Agreement and Other Settlement
Agreements, substantial amounts of insurance coverage that would have been
available to cover insured claims other than asbestos products claims have
been
cancelled and will no longer be available to cover such claims.
Based
on
the current number of claims pending, the amounts the Company anticipates paying
to resolve those claims which are not dismissed or otherwise resolved without
payment, and anticipated future claims, the Company believes that the total
monetary recovery under the settlements noted above will provide coverage for
a
significant portion, but less than a majority, of the Company’s monetary
exposure going forward for its estimated asbestos-related liabilities. Since
the
settlements noted above were entered into, the Company’s insurers have paid over
$207 million to the Company and to the Trusts referred to above. Some of those
payments have been used to pay or reimburse the Company for asbestos-related
liabilities, and some of those payments have been used by the Company for other
corporate purposes. Based on the Company’s current claims experience, it is
possible that before the end of 2007, the Company will be responsible for
payment of a portion of its asbestos-related liabilities without the ability
to
seek reimbursement from the Second Trust, and that by mid-2008, or earlier,
it
is likely that the Company will be responsible for payment of all such
liabilities until such time as the obligations under the Future Coverage
Agreement are triggered, at which point in time the Company is expected to
share
the cost of defending and settling qualifying asbestos product liability claims
with the participating insurers, with it being anticipated that the Company
will
typically bear a slightly larger share than the participating insurers. In
any
period of time, however, including after obligations under the Future Coverage
Agreement are triggered, the amounts paid by the Company in connection with
the
defense and settlement of asbestos claims versus the amounts funded and to
be
funded by settlement monies and amounts anticipated to be reimbursed by the
Future Coverage Agreement are expected to vary significantly.
In
early
2003, the Company commissioned a study of its asbestos-related liabilities
by a
recognized expert at a major national university, who is a member of the
American Academy of Actuaries with broad experience in estimating such
liabilities. Since that time, such study has been updated several times to
take into account the then most current data concerning, among other factors,
the Company’s claims and payment experience. In January 2007, the study was
updated again and, as a result, the reasonably possible exposure for these
matters as of December 31, 2006 was revised to a range of $270 million to
$770 million, which is the same as the previously established range at the
lower
end, and slightly lower than the previously established range at the high
end. Due to inherent uncertainties in estimating the timing and amounts of
future payments, the foregoing range does not include the effects of inflation
and has not been discounted for the time value of money. In addition, the
range of financial exposures set forth above does not include estimates for
future legal costs. It is the Company’s policy to expense these legal costs as
incurred. Cash payments related to this exposure are expected to be made
over an extended number of years and actual payments, when made, could be for
amounts in excess of the range due to potential future changes in estimates
as
well as the effects of inflation.
The
foregoing is based on the Company’s assumption that the number of future claims
filed per year and claim resolution payments will vary considerably from
year-to-year and by plaintiff, disease, venue and other circumstances, but
will,
when taken as a whole, remain relatively consistent with the Company’s
experience to date and will decline as the population of potential future
claimants expires due to non-asbestos-related causes. It is also based on
the results of the updated study and the status of the Company’s settlements
with its insurers, as described above. However, the Company recognizes
that the number of future claims filed per year and claim resolution payments
could greatly exceed those reflected by its past experience and contemplated
by
the study referenced above, that the Company’s belief of the range of its
reasonably possible financial exposure could change as the study referenced
above is periodically updated, and that its evaluation of the total payments
to
be received from its insurers may change depending upon numerous variables
including potential legislation and the risk that one or more insurance carriers
may refuse or be unable to meet their obligations to the Company. Moreover,
while
the
expert noted above has applied his methodology in determining the Company’s
reasonably possible range of exposures for these liabilities on a consistent
basis, other methods in practice exist which place a differing degree of
emphasis on the underlying variables used to measure asbestos-related
contingencies. Such other methods could yield significantly different ranges
of
reasonably possible exposures.
Due
to
the dynamic nature of asbestos litigation, the Company’s estimates are
inherently uncertain, and these matters may present significantly greater
financial exposures than presently anticipated. In addition, the Company
intends to periodically update the asbestos study referenced above, and further
analysis combined with new data received in the future could result in a
material modification of the range of reasonably possible financial exposure
set
forth above. As a result of all of the foregoing, the Company’s liability
with respect to asbestos-related matters could vary significantly from present
estimates and may require a material change in the accrued liability for these
matters within the next 12 months. If the Company’s liability does exceed
amounts recorded in the balance sheet sufficient to trigger the obligations
under the Future Coverage Agreement, the Company presently believes that a
significant portion of the liability it may reasonably anticipate will be
reimbursed by monies to be received pursuant to the Future Coverage Agreement.
However, there can be no assurance that such liabilities will be
reimbursed.
The
findings of the updated study referenced above identified a range of the
Company’s reasonably possible financial exposure for these asbestos-related
matters. The Company adjusted its accrual for present and future potential
asbestos claims before anticipated insurance recoveries at December 31,
2006 to $270.0 million, reflecting the low end of the range noted above in
accordance with generally accepted accounting principles (since no amount within
the range is a better estimate than any other amount).
The
following table presents the beginning and ending balances and balance sheet
activity for the Company’s asbestos-related accounts for the three months ended
March 31, 2007.
|
|
Balance
December 31, 2006
|
|
Interest
Income/
Additional
Accruals
|
|
Insurance
Recovered/
Liabilities
Settled
|
|
Accretion/
Reclassifi-
cation
|
|
Balance
March 31, 2007
|
|
Asbestos-related
assets:
|
|
|
|
|
|
|
|
|
|
|
|
Insurance
receivable
|
|
$
|
32.8
|
|
$
|
—
|
|
$
|
(16.5
|
)
|
$
|
0.2
|
|
$
|
16.5
|
|
Restricted
cash in trust
|
|
|
54.7
|
|
|
0.7
|
|
|
(30.0
|
)
|
|
—
|
|
|
25.4
|
|
Asbestos-related
assets
|
|
$
|
87.5
|
|
$
|
0.7
|
|
$
|
(46.5
|
)
|
$
|
0.2
|
|
$
|
41.9
|
|
Asbestos-related
liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asbestos-related
liabilities, current
|
|
$
|
36.4
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
36.4
|
|
Asbestos-related
liabilities, non-
current
|
|
|
233.6
|
|
|
—
|
|
|
(3.4
|
)
|
|
—
|
|
|
230.2
|
|
Total
asbestos-related liabilities
|
|
$
|
270.0
|
|
$
|
—
|
|
$
|
(3.4
|
)
|
$
|
—
|
|
$
|
266.6
|
|
The
Company, in conjunction with outside advisors, will continue to study its
asbestos-related matters, insurance recovery expectations and reserves on an
ongoing basis, and make adjustments as appropriate.
Composite
Products Antitrust and Qui Tam Matters
Commencing
in 1999, the Company was one of several companies sued in a series of civil
antitrust and related lawsuits concerning the pricing and sale of carbon
fiber
and carbon prepreg products (together referred to as “carbon fiber products”).
These products were manufactured and sold by the Company’s former Composite
Products division, which division was sold to Hexcel Corporation in 1996.
These
lawsuits encompassed the following: (a) a federal class action brought on
behalf
of direct
purchasers of carbon fiber products captioned Thomas &
Thomas Rodmakers v. Newport Adhesives and Composites,
Case
No. CV-99-07796-GHK (CTx) (U.S. District Court, Central District of
California; (b) a total of nine California state purported class actions
brought
on behalf of indirect purchasers of carbon fiber products, all consolidated
under the caption Carbon
Fiber Cases I, II, and III,
Judicial Council Coordination Proceeding Nos. 4212, 4216 and 4222, Superior
Court of California, County of San Francisco; (c) a Massachusetts state
purported class action brought on behalf of indirect purchasers of carbon
fiber
products captioned Saul
M. Ostroff, et al. v. Newport Adhesives, et al.,
Civil
Action No. 02-2385, Superior Court of Middlesex County; and (d) a lawsuit
brought by Horizon Sports Technologies, a company that had “opted out” of the
federal class action lawsuit referred to above and captioned Horizon
Sports Technologies, Inc. v. Newport Adhesives and Composites, Inc.,
et al.,
Case
No. CV02-8126 FMC (RNEX), U.S. District Court, Central District of
California, Western Division. In addition, the Company and the other
defendants in the foregoing lawsuits were sued in a related “Qui Tam” action
captioned Randall
M. Beck, et al. v. Boeing Defense and Space Group, Inc., et
al.,
(Civil
Action No. 99 CV 1557 JM JAH), which lawsuit was originally filed under
seal in 1999 pursuant to the False Claims Act, 31 U.S.C. Section 729 et
seq. Throughout 2005, the Company entered into agreements to resolve each
of the
foregoing lawsuits, and the results of such settlements have been reflected
in
the Company’s financial statements. At this time, all of the forgoing lawsuits
have been resolved, and all payments have been made, without any admission
of
liability. Each of the settlements was entered into by the Company in order
to
avoid the risks, uncertainties and costs inherent in litigation. In addition
to
the foregoing, two of the Company’s former customers have “opted-out” of the
Federal and California state class actions referred to above. In April 2007,
the
Company reached a confidential settlement agreement in principle with these
two
former customers. The amount of that settlement is included in the accrued
liability for non-asbestos litigation reported below. Furthermore, by letter
dated January 30, 2007, one of the defendants in the foregoing lawsuits asserted
a claim against the Company for damages as a result of the alleged
anticompetitive activities alleged in the lawsuits described above, and
requested that the Company enter into settlement discussions. The Company
intends to investigate this claim, but currently believes it is without merit
and legally defensible.
In
December 2004, the Company filed a lawsuit against Hexcel Corporation
(Hercules
Incorporated v. Hexcel Corporation,
Supreme
Court of the State of New York, County of New York, Index No.04/604098) seeking
indemnification for the settlements described above. The lawsuit against
Hexcel is based on the terms of the purchase and sale agreement by which the
Company sold its Composite Products division to Hexcel in 1996. In
response, Hexcel Corporation has denied liability and has filed a counter-claim
also seeking indemnification. Both parties have filed motions for summary
judgment, but no ruling has yet been issued by the Court. No date for trial
has
been set.
Agent
Orange Litigation
Agent
Orange is a defoliant that was manufactured by several companies, including
the
Company, at the direction of the U.S. Government, and used by the U.S.
Government in military operations in both Korea and Vietnam from 1965 to
1970. In 1984, as part of a class action settlement, the Company and other
defendants settled the claims of persons who were in the U.S., New Zealand
and
Australian Armed Forces who alleged injury due to exposure to Agent
Orange. In
Re
“Agent Orange” Prod. Liab. Litig.,
597 F.
Supp. 740 (E.D.N.Y. 1984). Following that settlement, all claims for
alleged injuries due to exposure to Agent Orange by persons who had served
in
the Armed Forces of those countries were treated as covered by that class action
settlement.
On
June
9, 2003, the United States Supreme Court affirmed the decision of the United
States Court of Appeals for the Second Circuit in a case captioned Dow
Chemical Company, et al. v. Daniel Raymond Stephenson, et al.,
123 S.
Ct. 2161 (2003), where plaintiffs Stephenson and Isaacson (in a separate but
consolidated case) alleged that they were injured from exposure to Agent Orange
and that such injury did not manifest until after exhaustion of the settlement
fund created through the 1984 class action settlement. As a result of that
decision, the claims of persons who allege injuries due to exposure to Agent
Orange and whose injuries first manifest themselves after exhaustion of the
settlement fund created through the 1984 class action settlement may no longer
be barred by the 1984 class action settlement and such persons may now be able
to pursue claims against the Company and the other former manufacturers of
Agent
Orange.
Currently,
the Company is a defendant in approximately twenty-eight lawsuits (including
two
purported class actions) where plaintiffs allege that exposure to Agent Orange
caused them to sustain various personal injuries. On February 9,
2004, the U.S. District Court for the Eastern District of New York issued a
series of rulings granting several motions filed by defendants in the two cases
that had been remanded to the U.S. District Court by the U.S. Court of Appeals
for the Second Circuit on remand from the U.S. Supreme Court (In
re:
“Agent Orange” Product Liability Litigation: Joe Isaacson, et al v. Dow Chemical
Company, et al. and Daniel Raymond Stephenson, et al. v. Dow Chemical Company,
et al.
(MDL 381, CV 98-6383 (JBW), CV 99-3056 (JBW))). In relevant part, those
rulings held that plaintiffs’ claims against the defendant manufacturers of
Agent Orange that were brought in the state courts are properly removable to
federal court under the “federal officer removal statute” and that such claims
are subject to
dismissal
by application of the “government contractor defense.” The Court then
dismissed plaintiffs’ claims, but stayed its decision to allow plaintiffs to
obtain additional discovery and to move for reconsideration of the Court’s
decision. A hearing on the motion for reconsideration was held on
February 28, 2005. By Orders dated March 2, 2005, the Court
denied reconsideration, lifted the stay of the earlier decision, and dismissed
plaintiffs’ claims in all of the lawsuits that were before the Court at that
time. Plaintiffs have appealed those dismissals to the United States Court
of Appeals for the Second Circuit. Oral argument before the Court of Appeals
is
currently scheduled on June 18, 2007.
In
addition, in January 2004, the Company was sued in a purported class action
filed in the United States District Court for the Eastern District of New York
by The Vietnam Association for Victims of Agent Orange/Dioxin and several
individuals who claim to represent between two and four million Vietnamese
who
allege that Agent Orange used by the United States during the Vietnam War caused
them or their families to sustain personal injuries. (The
Vietnam Association for Victims of Agent Orange/Dioxin, et al. v. The Dow
Chemical Company, et al.,
Civil
Action No. 04 CV 0400 (JBW)). That complaint alleges violations of
international law and war crimes, as well as violations of the common law for
products liability, negligence and international torts. The defendants
moved to dismiss this case on several grounds, including failure to state a
claim under the Alien Tort Claims Statute, lack of jurisdiction and
justiciability, the bar of the statute of limitations, failure to state claims
for violations of international law, and the “government contractor
defense.” A hearing on these motions was held on February 28,
2005. By order dated March 10, 2005, the Court dismissed this
lawsuit. Plaintiffs have appealed that dismissal to the United States
Court of Appeals for the Second Circuit. Oral argument before the Court of
Appeals is currently scheduled on June 18, 2007.
In
addition, in 1999, approximately 17,200 Korean veterans of the Vietnam War
filed
suit in the 13th
Civil
Department of the District Court in Seoul, Korea, against The Dow Chemical
Company (“Dow”) and Monsanto Company (“Monsanto”) for their alleged injuries
from exposure to Agent Orange. These lawsuits were filed under various captions,
including Dong
Jin Kim and 9 others,
99
Gahap 84123, Il
Joo
La and 9 others,
99
Gahap 84147, and Dae
Jin Jang,
99
Gahap 84130. Following the commencement of those lawsuits, Dow and Monsanto
petitioned the court to issue Notices of Pendency to each of the non-defendant
manufacturers of Agent Orange, including the Company, in an attempt to bind
those companies to factual and legal findings which may be made in the Korean
courts if Dow and Monsanto are held liable to plaintiffs and sue those companies
for contribution. Thereafter, the Company was served with such notices through
diplomatic channels. In 2002, the District Court dismissed the plaintiffs'
claims, and the plaintiffs appealed. It has been reported that on January 26,
2006, the intermediate appellate court in Seoul reversed the District Court
and
awarded damages of $65.2 million plus pre- and post-judgment interest to
approximately 6,800 of the approximately 17,200 plaintiffs that filed these
lawsuits. The Company has been informed that Dow and Monsanto have appealed.
If
Dow and Monsanto are not successful on appeal, it is possible that they might
initiate an action seeking contribution from the non-defendant manufacturers
of
Agent Orange, including the Company. Further, if the intermediate appellate
court’s decision is ultimately upheld, it is possible that new lawsuits could be
brought in Korea against the Agent Orange manufacturers, including the Company,
by other Korean veterans of the Vietnam War.
The
Company believes that it has substantial meritorious defenses to all of the
Agent Orange-related claims described above and those that may yet be
brought. To that end, the Company denies any liability to plaintiffs, and
will vigorously defend all actions now pending or that may be brought in the
future.
Other
Litigation
The
Company is one of several defendants that had been sued by over 2,000
individuals in a series of lawsuits, including a purported class action lawsuit,
captioned Jerry
Oldham, et al. v. The State of Louisiana, et al.,
Civil
Action No. 55,160, John
Capone, et al. v. The State of Louisiana, et al.,
Civil
Action No. 56,048C, and Georgenner
Batton, et al. v. The State of Louisiana, et al.,
Civil
Action No. 55,285, all brought in the 18th
Judicial
District Court, Parish of Iberville, Louisiana. The purported class members
and
plaintiffs, who claimed to have worked or lived at or around the Georgia Gulf
facility in Iberville Parish, Louisiana, alleged injury and fear of future
illness from the consumption of contaminated water and, specifically, elevated
levels of arsenic in that water. As to the Company, plaintiffs alleged
that the Company itself and as part of a joint venture operated a nearby plant
and, as part of those operations, used a groundwater injection well to dispose
of various wastes, and that those wastes contaminated the potable water supply
at Georgia Gulf. In August 2005, the Company and several other
defendants entered into an agreement to settle these matters with the Company
agreeing to pay $1.4 million, an amount which has since been paid. On May 4,
2006, the Court granted settlement class certification. This settlement, which
was agreed to by the Company without any admission of liability, is pending
final approval by the Court.
In
June
2004, a purported class action captioned Charles
Stepnowski v. Hercules Inc.; The Pension Plan of Hercules Inc.; The Hercules
Inc. Finance Committee; and Edward V. Carrington, Hercules’ Vice President Human
Resources,
Civil
Action No. 04-cv-2296, was filed in the United States District Court,
Eastern District of Pennsylvania. The Stepnowski
lawsuit
sought the payment of benefits under the Pension Plan of Hercules Incorporated
(the “Plan”), and alleged violations of the Employee Retirement Income Security
Act, 29 U.S.C. §1001 et seq. (“ERISA”). Under the Plan, eligible retirees
of the Company may opt to receive a single cash payment of 51% of the present
value of their accrued benefit (with the remaining 49% payable as a monthly
annuity). In the Stepnowski
lawsuit,
it was alleged that the Company’s adoption in 2002 of a new interest rate
assumption used to determine the 51% cash payment constituted a breach of
fiduciary duty and a violation of the anti-cutback requirements of ERISA, the
Internal Revenue Code and the terms of the Plan, and that its communications
to
employees concerning the new interest rate assumption constituted a breach
of
fiduciary duty. The Stepnowski
lawsuit
sought, among other things, the payment of additional benefits under ERISA
(as
well as costs and attorneys fees), and to compel the Company to use an interest
rate assumption that is more favorable to eligible retirees. In December
2005, a virtually identical purported class action lawsuit was filed in the
same
Court in a matter captioned Samuel
J. Webster, et al. v. Hercules, Inc.; The Pension Plan of Hercules Inc.; The
Hercules Inc. Finance Committee; and Edward V. Carrington, Hercules’ Vice
President Human Resources,
Civil
Action No. 05-6404. In January 2006, the Court consolidated the Stepnowski
and
Webster
lawsuits
for discovery and trial. In March 2006, the Court certified the Webster
action
as a class action. By Order dated April 20, 2006, the Court entered partial
summary judgment in favor of plaintiffs, holding that while the interest rate
change did not violate the anti-cutback provisions of ERISA, such change did
violate provisions of the Plan, and ordered the Company to recalculate the
lump
sum pension benefit owed to class members by using the prior interest rate
assumption (the “PBGC” rate, which was the rate used prior to the change to the
new interest rate, as referenced above) to calculate benefits accrued through
December 31, 2001, and the new interest rate (the “30-Year Treasury Bond” rate)
for all benefits accrued after December 31, 2001. That Order also required
the
Company to make certain payments to Mr. Stepnowski and Mr. Webster, with such
payments representing the additional lump sum benefit payable as a result of
the
adjusted lump sum calculation described in the preceding sentence, plus
interest. On October 4, 2006, the parties entered into a settlement in principle
to resolve both the Stepnowski
lawsuit
and Webster
class
action lawsuit. Preliminary approval of the settlement was granted by the Court
on December 4, 2006. A hearing for final approval of the settlement was set
for
April 16, 2007, but has been adjourned until May 7, 2007. The main points of
the
settlement are: (1) each Class member’s lump sum will be computed using the
30-Year Treasury Bond rate applied to all eligible service through December
31,
2004 as the “floor,” plus 75% of the additional value gained, if any, by using
the PBGC rate for that portion of eligible service accrued through December
31,
2001 (the Plan’s actuaries have estimated that the “present value” of the total
settlement award is approximately $18 million, without consideration of
additional interest payments); (2) each Class member who has already received
a
lump sum will also receive 3% interest, compounded annually, on his or her
settlement award, from the date the original lump sum amount was paid until
the
settlement award has been paid; and (3) Defendants will pay $0.3 million toward
the fees and litigation costs of plaintiffs’ counsel. In addition, plaintiffs
and plaintiffs’ counsel have agreed to petition the Court for an additional
award which, if approved, will be credited against the present value of the
aggregate settlement award and will reduce each Class member’s settlement award
by the same percentage. Of note, except for $0.3 million, the payments to be
made as a result of this lawsuit will be made by the Company’s pension plan.
Acevedo,
et al. v. Union Pacific Railroad Company, et al.,
Case
No. C-4885-99-F. 332nd
Judicial
District Court, Hidalgo County, Texas (2001), and related lawsuits, are mass
toxic tort lawsuits alleging pesticide exposure relating to operations at a
former pesticide formulation facility in Mission, Texas. There are
currently approximately 1,700 plaintiffs and approximately 30 defendants,
including the Company. Plaintiffs include former workers at the pesticide
formulation facility, and persons who currently reside, or in the past resided,
near the facility. All plaintiffs allege personal injuries and some
plaintiffs also allege property damage. The vast majority of the
plaintiffs allege residential exposure to a variety of pesticide and chemical
products as a result of leaks, spills, flooding, and airborne emissions from
the
pesticide formulation facility. It is alleged that certain of the
Company’s products were sold to or used by the pesticide formulation facility
prior to its ceasing operations in 1967. In November 2004, Defendants
filed a Petition for a Writ of Mandamus in the Texas Supreme Court seeking
to
set aside an order consolidating the claims of certain plaintiffs for trial,
and
seeking to require the plaintiffs to provide certain evidence of exposure and
injury before being permitted to proceed in court. In response, the Texas
Supreme Court issued a partial stay of the underlying litigation. In November
2005, oral argument with respect to Defendants’ Petition for Writ of Mandamus
was held before the Texas Supreme Court. No decision has yet been rendered
with
respect to that petition. The Company denies any liability to plaintiffs and
intends to vigorously defend these matters.
The
Company and others have been sued by approximately 520 former employees and
employees of third-party contractors who allege hearing loss as a result
of
their having worked at plants located in or about Lake Charles, Louisiana.
The Company formerly owned and operated a plant in Lake Charles. In
July 2005, the Company and other defendants reached a settlement in
principle with plaintiffs’ lawyers which provides for the resolution of these
claims over a period of approximately two years, and since that time, a portion
of these claims have been resolved. The Company has accrued its
remaining
probable and reasonably estimable liability as a portion of the amount described
in the paragraph below entitled “Amounts Accrued for Non-Asbestos
Litigation.” The lawsuits at issue are all pending in the 14th
Judicial
District Court of Calcasieu Parish, Louisiana, and are captioned as
follows: James
Allee, et al. v. Canadianoxy Offshore Production Co., et al.,
Case
No. 2001-4085, James
Hollingsworth, et al. v. Hercules Inc.,
Civil
Action No. 2001-4064, Joseph
Kelley, et al. v. Canadianoxy Offshore Production Co., et al.,
Civil
Action No. 98-2802, Robert
Corbin, et al. v. Canadianoxy Offshore Production Co., et al.,
Civil
Action No. 98-1097, Carl
Belaire, et al. v. Bridgestone Firestone Inc., et al.,
Civil
Action No. 2005-004369, Darrell
Comeaux, et al. v Bridgestone/Firestone, Inc.,
et
al.,
Civil
Action No. 2006-2242, and Howard
Dejean, et al. v. Bridgestone/Firestone, Inc., et al., Civil Action No.
2006-6276.
Amounts
Accrued for Non-Asbestos Litigation
During
the period January 1, 2007 through March 31, 2007 no new accruals for
non-asbestos and non-environmental litigation were established. During that
same
time period, settlement payments for non-asbestos and non-environmental
litigation were $2.0 million. The March 31, 2007 Consolidated Balance Sheet
reflects a current liability of $6.6 million for non-asbestos and
non-environmental related litigation matters, representing management’s best
estimate of the probable and reasonably estimable losses for such matters.
A
separate liability is provided for the Vertac litigation. While it is not
feasible to predict the outcome of all pending legal proceedings, it is
reasonably possible that an exposure to loss exists in excess of the amounts
accrued for these and other matters, and the ultimate resolution of one or
more
of these matters could have a material adverse effect upon the Company’s
financial position, results of operations and/or cash flows for any annual,
quarterly or other period.
8. Stock-Based
Compensation
In
addition to cash compensation, the Company provides for the grant of stock
options and the award of restricted common stock and other market-based units
to
key employees and non-employee directors under the following plans: (1) Hercules
Incorporated Long Term Incentive Compensation Plan (“LTICP”), (2) Management
Incentive Compensation Plan (“MICP”), and (3) Hercules Incorporated Omnibus
Equity Compensation Plan for Non-Employee Directors (“Omnibus Plan”)
(collectively, the “Plans”). A summary of the valuation for share-based awards
granted under the plans as well as a summary of award activity is described
in
further detail below.
Stock
Options
The
fair
value of option awards granted is estimated on the date of grant using the
Black-Scholes option pricing model and the weighted-average assumptions in
the
following table:
|
|
Three
Months Ended
March
31,
|
|
|
|
2007
|
|
2006
|
|
Expected
volatility
|
|
|
30.00
|
%
|
|
30.11
|
%
|
Expected
dividend yield
|
|
|
0.00
|
%
|
|
0.00
|
%
|
Expected
life (in years)
|
|
|
6.0
|
|
|
6.0
|
|
Risk-free
interest rate
|
|
|
4.68
|
%
|
|
4.59
|
%
|
A
summary
of option activity under the Plans as of March 31, 2007 and changes during
the
three months then ended is presented as follows:
|
|
Regular
|
|
Performance
Accelerated
|
|
|
|
Number
of
Shares
|
|
Weighted-
Average
Price
|
|
Number
of
Shares
|
|
Weighted-Average
Price
|
|
Outstanding
at December 31, 2006
|
|
|
4,677,295
|
|
$
|
23.22
|
|
|
720,990
|
|
$
|
40.75
|
|
Granted
|
|
|
230,133
|
|
|
21.04
|
|
|
—
|
|
|
—
|
|
Exercised
|
|
|
(260,075
|
)
|
|
14.64
|
|
|
—
|
|
|
—
|
|
Forfeited
|
|
|
(65,175
|
)
|
|
37.88
|
|
|
(46,925
|
)
|
|
42.56
|
|
Outstanding
at March 31, 2007
|
|
|
4,582,178
|
|
$
|
23.39
|
|
|
674,065
|
|
$
|
40.62
|
|
Exercisable
at March 31, 2007
|
|
|
4,002,846
|
|
$
|
24.44
|
|
|
151,565
|
|
$
|
39.58
|
|
The
following supplemental disclosures are provided with respect to the Company’s
stock option plans:
|
|
Three
Months Ended
March
31,
|
|
|
|
2007
|
|
2006
|
|
Compensation
cost recognized
|
|
$
|
0.5
|
|
$
|
0.3
|
|
Unrecognized
compensation cost included in Additional paid-in capital
|
|
$
|
3.1
|
|
$
|
2.5
|
|
Weighted-average
remaining periods for recognition (years)
|
|
|
2.1
|
|
|
2.6
|
|
Fair
value of options granted (per share)
|
|
$
|
8.26
|
|
$
|
4.74
|
|
Intrinsic
value of options exercised
|
|
$
|
1.4
|
|
$
|
—
|
|
Tax
benefits recognized in Additional paid-in capital
|
|
$
|
0.5
|
|
$
|
—
|
|
Restricted
Stock Awards
A
summary
of restricted stock award activity under the Plans as of March 31, 2007 and
changes during the three months then ended is presented as follows:
|
|
Number
of
Shares
|
|
Weighted-Average
Grant Date Fair
Value
|
|
Outstanding
at December 31, 2006
|
|
|
2,057,408
|
|
$
|
12.05
|
|
Granted
|
|
|
364,786
|
|
|
20.91
|
|
Vested(1)
|
|
|
(575,093
|
)
|
|
11.89
|
|
Outstanding
at March 31, 2007
|
|
|
1,847,101
|
|
$
|
13.85
|
|
(1)Includes
approximately 547,113 shares attributable to the accelerated vesting of certain
2004 restricted stock awards due to the achievement of specific share price
performance benchmarks upon the February 2007 anniversary date.
The
following supplemental disclosures are provided with respect to the Company’s
restricted stock awards:
|
|
Three
Months Ended
March
31,
|
|
|
|
2007
|
|
2006
|
|
Compensation
cost recognized (1)
|
|
$
|
3.8
|
|
$
|
0.9
|
|
Unrecognized
compensation cost included in Additional paid-in capital
|
|
$
|
15.9
|
|
$
|
16.2
|
|
Weighted-average
remaining periods for recognition (years)
|
|
|
4.2
|
|
|
4.0
|
|
Tax
benefits recognized in Additional paid-in capital
|
|
$
|
1.7
|
|
$
|
0.2
|
|
(1)Includes
approximately $3 million attributable to the accelerated vesting of certain
2004
restricted stock awards due to the achievement of specific share-price
performance benchmarks upon the February 2007 anniversary date.
9. Supplemental
Financial Statement Disclosures
|
|
March
31,
2007
|
|
December 31,
2006
|
|
Accounts
receivable, gross
|
|
$
|
345.4
|
|
$
|
332.2
|
|
Allowance
for doubtful accounts
|
|
|
(5.3
|
)
|
|
(5.6
|
)
|
Accounts
receivable, net
|
|
$
|
340.1
|
|
$
|
326.6
|
|
|
|
|
|
|
|
|
|
Inventories:
|
|
|
|
|
|
|
|
Finished
goods
|
|
$
|
129.8
|
|
$
|
115.4
|
|
Raw
materials and work-in-process
|
|
|
78.6
|
|
|
73.3
|
|
Supplies
|
|
|
22.5
|
|
|
21.9
|
|
|
|
$
|
230.9
|
|
$
|
210.6
|
|
|
|
|
|
|
|
|
|
Property,
plant and equipment:
|
|
|
|
|
|
|
|
Land
|
|
$
|
16.4
|
|
$
|
16.4
|
|
Buildings
and equipment
|
|
|
1,641.0
|
|
|
1,643.0
|
|
Construction
in progress
|
|
|
98.7
|
|
|
85.0
|
|
|
|
|
1,756.1
|
|
|
1,744.4
|
|
Accumulated
depreciation and amortization
|
|
|
(1,153.3
|
)
|
|
(1,144.0
|
)
|
Property,
plant and equipment, net
|
|
$
|
602.8
|
|
$
|
600.4
|
|
|
|
Three
Months Ended
March
31,
|
|
|
|
2007
|
|
2006
|
|
Depreciation:
|
|
|
|
|
|
Included
in Cost of sales and Selling, general and administrative
(“SG&A”)
expenses
|
|
$
|
16.8
|
|
$
|
16.1
|
|
Accelerated
depreciation included in Other operating expense, net
|
|
|
0.3
|
|
|
3.0
|
|
|
|
$
|
17.1
|
|
$
|
19.1
|
|
|
|
|
|
|
|
|
|
Amortization:
|
|
|
|
|
|
|
|
Intangible
assets
|
|
$
|
1.8
|
|
$
|
1.6
|
|
Capitalized
software (normal basis) included in SG&A expenses
|
|
|
3.8
|
|
|
3.7
|
|
Accelerated
amortization of capitalized software included in Other operating
expense,
net
|
|
|
3.5
|
|
|
—
|
|
Deferred
financing costs included in Interest and debt expense
|
|
|
0.4
|
|
|
0.5
|
|
|
|
$
|
9.5
|
|
$
|
5.8
|
|
Cash
paid during the period for:
|
|
|
|
|
|
|
|
Interest
|
|
$
|
13.4
|
|
$
|
15.0
|
|
Income
taxes, net of refunds received
|
|
|
7.3
|
|
|
8.3
|
|
Non-cash
investing and financing activities:
|
|
|
|
|
|
|
|
De-consolidation
of debt issued by FiberVisions
|
|
|
—
|
|
|
90.0
|
|
De-consolidation
of FiberVisions capitalized debt issuance costs
|
|
|
—
|
|
|
(6.3
|
)
|
Incentive
and other share-based compensation plan issuances
|
|
|
7.6
|
|
|
11.4
|
|
10. Restructuring
Programs
A
summary
of the charges included in Other operating expense, net incurred during 2007
in
connection with restructuring programs as well as an allocation to the reporting
segments is provided as follows:
|
|
Severance
|
|
Other
Exit
Costs
|
|
Asset
Charges
|
|
Total
|
|
Research
and development consolidation
|
|
$
|
—
|
|
$
|
0.1
|
|
$
|
0.1
|
|
$
|
0.2
|
|
Manufacturing
and Alliance-related rationalization
|
|
|
0.2
|
|
|
0.1
|
|
|
0.1
|
|
|
0.4
|
|
Business
segment realignment
|
|
|
0.5
|
|
|
—
|
|
|
—
|
|
|
0.5
|
|
Business
Infrastructure Projects
|
|
|
6.0
|
|
|
1.7
|
|
|
3.5
|
|
|
11.2
|
|
Total
restructuring and asset charges
|
|
$
|
6.7
|
|
$
|
1.9
|
|
$
|
3.7
|
|
$
|
12.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Paper
Technologies and Ventures
|
|
|
0.2
|
|
|
0.2
|
|
|
0.1
|
|
|
0.5
|
|
Aqualon
Group
|
|
|
0.5
|
|
|
—
|
|
|
—
|
|
|
0.5
|
|
Corporate
|
|
|
6.0
|
|
|
1.7
|
|
|
3.6
|
|
|
11.3
|
|
Total
by reporting segment
|
|
$
|
6.7
|
|
$
|
1.9
|
|
$
|
3.7
|
|
$
|
12.3
|
|
The
restructuring programs listed in the table above were all initiated in 2006
or
prior years. The charges recorded during the three months ended March 31, 2007
primarily reflect severance and termination benefits which are being accrued
over periods during which affected employees are required to provide continuing
services in connection with the related program. In addition, other exit costs,
including transition services, employee relocation and site closure expenses,
among others are charged as incurred. Less than ten employees were added to
the
severance plans associated with these programs during the three months ended
March 31, 2007. Of this additional headcount, the majority were managerial
employees terminated in connection with certain aspects of the Manufacturing
and
Alliance-related rationalization program. Approximately $11 million of
additional charges are expected to be accrued through 2009 resulting in
approximately $26 million of future cash payments primarily in 2007 and 2008
with certain amounts continuing into 2010.
Asset
charges recorded during the three months ended March 31, 2007 include
accelerated depreciation for certain assets at the Company’s Wilmington,
Delaware research facility in connection with construction programs attributable
to the Research and development consolidation program and certain production
assets at various domestic PTV manufacturing facilities in connection with
the
planned transfer of production activities in accordance with the rosin-based
sizing product alliance with MeadWestvaco. Also included is $3.5 million of
accelerated amortization charges attributable to capitalized software
development costs associated with the Company’s information technology platform
which is in the process of undergoing a substantial technical upgrade that
is
expected to continue through the second quarter of 2008. Accordingly, charges
resulting in additional accelerated amortization of approximately $15 million
will continue to be recorded through the second quarter of 2008.
A
reconciliation of activity with respect to the accrued liabilities for the
plans
described above is as follows:
|
|
Three
Months Ended March 31,
|
|
|
|
2007
|
|
2006
|
|
Balance
at beginning of period
|
|
$
|
10.5
|
|
$
|
16.6
|
|
Accrued
charges for severance and related benefits
|
|
|
6.7
|
|
|
5.8
|
|
Accrued
charges for other exit and restructuring costs
|
|
|
1.7
|
|
|
1.5
|
|
Cash
payments
|
|
|
(4.1
|
)
|
|
(7.7
|
)
|
Other,
including foreign currency translation
|
|
|
0.1
|
|
|
—
|
|
Balance
at end of period
|
|
$
|
14.9
|
|
$
|
16.2
|
|
In
addition, the Company made cash payments of $0.2 million and $0.1 million during
the three months ended March 31, 2007 and 2006, respectively, for certain exit
costs that have been paid as incurred and are not included in the reconciliation
of accrued restructuring liabilities above.
Restructuring
charges recorded during the three months ended March 31, 2006 included $6.8
million of severance charges, $0.5 million of other exit costs and $3.0 million
of accelerated depreciation associated with the aforementioned restructuring
programs.
In
connection with the substantial completion of the Research and development
consolidation program, the Company is in the process of marketing its former
facility in Jacksonville, Florida. This facility, with a carrying value of
$7.7
million, is reflected as an asset held for sale and is included in the caption
“Other current assets” on the Consolidated Balance Sheet as of March 31,
2007.
11. Other
Operating Expense, Net
Other
operating expense, net consists of the following:
|
|
Three
Months Ended
March
31,
|
|
|
|
2007
|
|
2006
|
|
Severance,
restructuring and other exit costs, net
|
|
$
|
8.6
|
|
$
|
7.3
|
|
Accelerated
depreciation and amortization
|
|
|
3.7
|
|
|
3.0
|
|
Legal
settlements
|
|
|
(0.2
|
)
|
|
(3.6
|
)
|
Environmental
charges
|
|
|
0.1
|
|
|
0.1
|
|
Loss
(gains) on asset dispositions, net
|
|
|
0.1
|
|
|
(0.1
|
)
|
Dismantlement
costs
|
|
|
0.7
|
|
|
0.2
|
|
Other
miscellaneous charges, net
|
|
|
0.1
|
|
|
0.3
|
|
|
|
$
|
13.1
|
|
$
|
7.2
|
|
Other
expense, net consists of the following:
|
|
Three
Months Ended
March
31,
|
|
|
|
2007
|
|
2006
|
|
Asbestos-related
costs, net
|
|
$
|
2.1
|
|
$
|
2.2
|
|
Loss
on sale of 51% interest in FiberVisions
|
|
|
(0.2
|
)
|
|
5.1
|
|
Loss
on repurchase of debt
|
|
|
—
|
|
|
1.4
|
|
Environmental
charges
|
|
|
1.5
|
|
|
1.3
|
|
Litigation
settlements and accruals
|
|
|
0.7
|
|
|
0.7
|
|
Other,
net
|
|
|
(0.8
|
)
|
|
(0.1
|
)
|
|
|
$
|
3.3
|
|
$
|
10.6
|
|
Benefit/Provision
for Income Taxes
For
the
three months ended March 31, 2007, the Company recognized pretax income of
$37.9
million and a tax benefit of $36.6 million. The tax benefit included the
following discrete items: a $47.3 million benefit related to the final
resolution of IRS audits for the years 1993 through 2003; and a $0.2 million
charge related to income tax law changes enacted in China. The full year
effective tax rate for 2007 is estimated to be 2%. The Company recognized pretax
income of $25.6 million and a tax provision of $10.7 million for the three
months ended March 31, 2006. The 2006 effective tax rate of 42% reflects charges
attributable to the valuation allowance for the loss on the sale of FiberVisions
as well as a provision related to undistributed foreign earnings triggered
by
the sale.
Adoption
of FIN 48
The
Company adopted the provisions of FASB Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN
48”) effective January 1, 2007. In accordance with the transition provisions of
FIN 48, the Company recorded an increase to its beginning balance of retained
earnings in the amount of $1.9 million with a corresponding decrease to certain
state income tax reserves included in the caption Deferred credits and other
liabilities.
The
Company has identified $40.4 million of unrecognized tax benefits (“UTB”) as of
January 1, 2007. Of this amount, $14.6 million would affect the effective tax
rate if recognized in future periods. The total amount of UTB could increase
or
decrease within the next twelve months for a number of reasons including the
expiration of statute of limitations, audit settlements, tax examination
activities and the recognition and measurement considerations under FIN 48.
The
Company does not believe that the total amount of UTB will significantly
increase or decrease over the next twelve months.
The
Company has a long audit history with the Internal Revenue Service (“IRS”), and
recently settled all issues for the years 1993 through 2003. The tax years
2004
and 2005 are currently under audit by the IRS. The Company also files tax
returns in every state which imposes corporate income tax and those
jurisdictions remain subject to examination in accordance with relevant state
statutes. In addition, the Company has significant international operations
and
approximately 45 legal entities have income tax filing requirements in
accordance with local country tax regulations. These returns remain subject
to
examination in accordance with the local country statutes. The Company is
currently under audit in Germany for tax years 1999 through 2004.
In
addition to the impact on the Company’s balance sheet, the Company has elected
to retain its existing accounting policy with respect to the treatment of
interest and penalties attributable to income taxes in accordance with FIN
48,
and continues to reflect interest and penalties attributable to income taxes,
to
they extent they arise, as a component of its income tax provision or benefit
as
well as its outstanding income tax assets and liabilities. The total amount
of
interest and penalties recognized in the Consolidated Balance Sheet as of
January 1, 2007 was $15.2 million.
The
following table provides the weighted-average number of common shares (in
millions) used in computing basic and diluted earnings per share:
|
|
Three
Months Ended March 31,
|
|
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Weighted-average
number of common shares outstanding - Basic
|
|
|
114.1
|
|
|
110.2
|
|
Dilutive
effect of:
|
|
|
|
|
|
|
|
Convertible
debentures
|
|
|
0.2
|
|
|
0.2
|
|
Share-based
compensation plans
|
|
|
0.6
|
|
|
0.1
|
|
Weighted-average
number of common shares outstanding - Diluted
|
|
|
114.9
|
|
|
110.5
|
|
Weighted-average
common shares outstanding on a diluted basis for the three months ended March
31, 2007 and 2006 exclude 2.7 million and 5.8 million of options and 6.6 million
and 6.7 million of warrants to purchase shares of common stock, respectively,
as
their exercise prices exceed their current market value.
15. Reporting
Segment Information
A
summary
of reporting segment data is provided below:
|
|
Three
Months Ended
March
31,
|
|
|
|
2007
|
|
2006
|
|
Net
sales:
|
|
|
|
|
|
Paper
Technology and Ventures
|
|
$
|
283.2
|
|
$
|
254.2
|
|
Aqualon
Group
|
|
|
219.1
|
|
|
203.9
|
|
FiberVisions
|
|
|
—
|
|
|
69.2
|
|
|
|
$
|
502.3
|
|
$
|
527.3
|
|
|
|
|
|
|
|
|
|
Profit
from operations(1):
|
|
|
|
|
|
|
|
Paper
Technology and Ventures
|
|
$
|
28.0
|
|
$
|
14.6
|
|
Aqualon
Group
|
|
|
47.6
|
|
|
39.5
|
|
FiberVisions
|
|
|
—
|
|
|
0.5
|
|
Corporate
items (2)
|
|
|
(15.7
|
)
|
|
2.3
|
|
|
|
$
|
59.9
|
|
$
|
56.9
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization:
|
|
|
|
|
|
|
|
Paper
Technology and Ventures
|
|
$
|
10.1
|
|
$
|
12.7
|
|
Aqualon
Group
|
|
|
11.2
|
|
|
10.0
|
|
Corporate
items
|
|
|
5.3
|
|
|
2.2
|
|
|
|
$
|
26.6
|
|
$
|
24.9
|
|
|
|
|
|
|
|
|
|
Capital
expenditures:
|
|
|
|
|
|
|
|
Paper
Technology and Ventures
|
|
$
|
5.0
|
|
$
|
2.8
|
|
Aqualon
Group
|
|
|
18.4
|
|
|
4.2
|
|
Corporate
items
|
|
|
0.8
|
|
|
1.1
|
|
|
|
$
|
24.2
|
|
$
|
8.1
|
|
(1)Normal
depreciation incurred by Corporate is allocated to the business segments in
the
determination of Profit from operations.
(2)Corporate
items include severance, restructuring and other exit costs, accelerated
depreciation and amortization and certain other items that are not allocated
to
the business segments.
16.
Financial
Instruments and Risk Management, Including Derivatives
The
Company selectively uses foreign currency forward contracts and currency swaps
to offset the effects of foreign currency exchange rate changes on reported
earnings, cash flow and net asset positions. During the three months ended
March
31, 2007 and 2006, the Company recorded $0.4 million and $0.5 million,
respectively, as a component of Other expense, net representing the net loss
due
to underlying foreign currency exposures net of the impact of foreign currency
contracts. The Company also uses cross-currency interest rate swaps to hedge
the
Company’s foreign currency exposure associated with its net investment in
certain foreign operations that utilize the Euro as their functional currency.
The notional amount of the swaps is $500/€420.2 million and requires payment of
EURIBOR + 1.59% and receipt of LIBOR + 1.50%. During the three months ended
March 31, 2007 and 2006, the Company recorded $1.2 million and $0.8 million,
respectively, as a reduction to Interest and debt expense representing the
net
amount received from the swaps in excess of amounts paid.
The
following table presents the net carrying amounts and fair values of the
Company’s financial instruments and derivatives as well as the balance sheet
caption in which they are included:
|
|
March
31, 2007
|
|
December
31, 2006
|
|
|
|
Carrying
|
|
Fair
|
|
Carrying
|
|
Fair
|
|
|
|
Value
|
|
Value
|
|
Value
|
|
Value
|
|
Deferred
charges and other assets:
|
|
|
|
|
|
|
|
|
|
Investment
securities available for sale
|
|
$
|
2.6
|
|
$
|
2.6
|
|
$
|
2.6
|
|
$
|
2.6
|
|
Foreign
exchange contracts, net
|
|
|
—
|
|
|
—
|
|
|
(0.1
|
)
|
|
(0.1
|
)
|
Current
and long-term debt obligations
|
|
|
977.1
|
|
|
937.6
|
|
|
995.5
|
|
|
964.2
|
|
Deferred
credits and other liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cross
currency interest rate swaps
|
|
|
60.3
|
|
|
60.3
|
|
|
53.2
|
|
|
53.2
|
|
17. Financial
Information of Guarantor Subsidiaries
The
following condensed consolidating financial information for the Company presents
the financial information of Hercules, the guarantor subsidiaries and the
non-guarantor subsidiaries based on the Company’s understanding of the
Securities and Exchange Commission’s interpretation and application of
Rule 3-10 under the Securities and Exchange Commission’s Regulation S-X.
The financial information may not necessarily be indicative of results of
operations or financial position had the guarantor subsidiaries or non-guarantor
subsidiaries operated as independent entities.
In
this
presentation, Hercules consists of the parent company’s operations. Guarantor
subsidiaries and non-guarantor subsidiaries of Hercules are reported on an
equity basis. Additionally, prior year information has been restated to conform
to the current period presentation.
Condensed
Consolidating Statement of Operations
|
|
Three
Months Ended March 31, 2007
|
|
|
|
Unconsolidated
|
|
|
|
|
|
|
|
Parent
|
|
Guarantor
Subsidiaries
|
|
Non-
Guarantor
Subsidiaries
|
|
Eliminations
and
Adjustments
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$
|
154.6
|
|
$
|
108.9
|
|
$
|
285.2
|
|
$
|
(46.4
|
)
|
$
|
502.3
|
|
Cost
of sales
|
|
|
108.2
|
|
|
75.8
|
|
|
185.7
|
|
|
(46.3
|
)
|
|
323.4
|
|
Selling,
general and administrative expenses
|
|
|
26.3
|
|
|
32.2
|
|
|
35.2
|
|
|
—
|
|
|
93.7
|
|
Research
and development
|
|
|
4.6
|
|
|
4.5
|
|
|
1.3
|
|
|
—
|
|
|
10.4
|
|
Intangible
asset amortization
|
|
|
1.5
|
|
|
0.2
|
|
|
0.1
|
|
|
—
|
|
|
1.8
|
|
Other
operating expense, net
|
|
|
11.9
|
|
|
0.1
|
|
|
1.1
|
|
|
—
|
|
|
13.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Profit
(loss) from operations
|
|
|
2.1
|
|
|
(3.9
|
)
|
|
61.8
|
|
|
(0.1
|
)
|
|
59.9
|
|
Interest
and debt expense (income), net
|
|
|
45.2
|
|
|
(29.0
|
)
|
|
1.0
|
|
|
—
|
|
|
17.2
|
|
Vertac
litigation charges
|
|
|
1.5
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1.5
|
|
Other
expense, net
|
|
|
2.0
|
|
|
1.0
|
|
|
0.5
|
|
|
(0.2
|
)
|
|
3.3
|
|
Income
(loss) before income taxes, minority interests and equity (loss)
income
|
|
|
(46.6
|
)
|
|
24.1
|
|
|
60.3
|
|
|
0.1
|
|
|
37.9
|
|
(Benefit)
provision for income taxes
|
|
|
(58.9
|
)
|
|
8.8
|
|
|
13.4
|
|
|
0.1
|
|
|
(36.6
|
)
|
Income
before minority interests and equity (loss) income
|
|
|
12.3
|
|
|
15.3
|
|
|
46.9
|
|
|
—
|
|
|
74.5
|
|
Minority
interests in earnings of consolidated subsidiaries
|
|
|
—
|
|
|
—
|
|
|
(0.5
|
)
|
|
—
|
|
|
(0.5
|
)
|
Equity
(loss) income of affiliated companies
|
|
|
—
|
|
|
(0.3
|
)
|
|
0.2
|
|
|
(0.4
|
)
|
|
(0.5
|
)
|
Equity
income (loss) from consolidated subsidiaries
|
|
|
61.2
|
|
|
—
|
|
|
—
|
|
|
(61.2
|
)
|
|
—
|
|
Net
income
|
|
$
|
73.5
|
|
$
|
15.0
|
|
$
|
46.6
|
|
$
|
(61.6
|
)
|
$
|
73.5
|
|
Condensed
Consolidating Statement of Operations
|
|
Three
Months Ended March 31, 2006
|
|
|
|
Unconsolidated
|
|
|
|
|
|
|
|
Parent
|
|
Guarantor
Subsidiaries
|
|
Non-
Guarantor
Subsidiaries
|
|
Eliminations
and
Adjustments
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$
|
140.4
|
|
$
|
139.8
|
|
$
|
286.1
|
|
$
|
(39.0
|
)
|
$
|
527.3
|
|
Cost
of sales
|
|
|
97.6
|
|
|
105.3
|
|
|
196.9
|
|
|
(39.1
|
)
|
|
360.7
|
|
Selling,
general and administrative expenses
|
|
|
23.4
|
|
|
32.3
|
|
|
35.6
|
|
|
—
|
|
|
91.3
|
|
Research
and development
|
|
|
4.6
|
|
|
4.5
|
|
|
0.5
|
|
|
—
|
|
|
9.6
|
|
Intangible
asset amortization
|
|
|
1.5
|
|
|
—
|
|
|
0.1
|
|
|
—
|
|
|
1.6
|
|
Other
operating expense (income), net
|
|
|
(1.3
|
)
|
|
2.7
|
|
|
5.8
|
|
|
—
|
|
|
7.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Profit
(loss) from operations
|
|
|
14.6
|
|
|
(5.0
|
)
|
|
47.2
|
|
|
0.1
|
|
|
56.9
|
|
Interest
and debt expense (income), net
|
|
|
43.4
|
|
|
(23.0
|
)
|
|
0.3
|
|
|
—
|
|
|
20.7
|
|
Other
expense, net
|
|
|
8.9
|
|
|
1.5
|
|
|
0.2
|
|
|
—
|
|
|
10.6
|
|
Income
(loss) before income taxes, minority interests and equity (loss)
income
|
|
|
(37.7
|
)
|
|
16.5
|
|
|
46.7
|
|
|
0.1
|
|
|
25.6
|
|
Provision
(benefit) for income taxes
|
|
|
(1.7
|
)
|
|
6.0
|
|
|
6.4
|
|
|
—
|
|
|
10.7
|
|
Income
(loss) before minority interests and equity (loss) income
|
|
|
(36.0
|
)
|
|
10.5
|
|
|
40.3
|
|
|
0.1
|
|
|
14.9
|
|
Minority
interests in earnings of consolidated subsidiaries
|
|
|
—
|
|
|
—
|
|
|
(0.1
|
)
|
|
—
|
|
|
(0.1
|
)
|
Equity
(loss) income of affiliated companies
|
|
|
—
|
|
|
(0.1
|
)
|
|
(0.3
|
)
|
|
—
|
|
|
(0.4
|
)
|
Equity
income (loss) from consolidated subsidiaries
|
|
|
50.4
|
|
|
3.0
|
|
|
(3.3
|
)
|
|
(50.1
|
)
|
|
—
|
|
Net
income from continuing operations before discontinued operations
and
cumulative effect of change in accounting principle
|
|
|
14.4
|
|
|
13.4
|
|
|
36.6
|
|
|
(50.0
|
)
|
|
14.4
|
|
Net
loss from discontinued operations, net of tax
|
|
|
(0.6
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(0.6
|
)
|
Net
income before cumulative effect of change in accounting principle
|
|
|
13.8
|
|
|
13.4
|
|
|
36.6
|
|
|
(50.0
|
)
|
|
13.8
|
|
Cumulative
effect of change in accounting principle, net of tax
|
|
|
0.9
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
0.9
|
|
Net
income
|
|
$
|
14.7
|
|
$
|
13.4
|
|
$
|
36.6
|
|
$
|
(50.0
|
)
|
$
|
14.7
|
|
Condensed
Consolidating Balance Sheet
|
|
As
of March 31, 2007
|
|
|
|
|
|
Unconsolidated
|
|
|
|
|
|
|
|
|
|
Guarantor
|
|
Non-Guarantor
|
|
Eliminations
and
|
|
|
|
Assets
|
|
Parent
|
|
Subsidiaries
|
|
Subsidiaries
|
|
Adjustments
|
|
Consolidated
|
|
Current
assets
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
95.3
|
|
$
|
0.5
|
|
$
|
64.0
|
|
$
|
—
|
|
$
|
159.8
|
|
Accounts
receivable, net
|
|
|
64.7
|
|
|
45.8
|
|
|
229.3
|
|
|
0.3
|
|
|
340.1
|
|
Intercompany
receivables
|
|
|
63.1
|
|
|
(1.2
|
)
|
|
(5.2
|
)
|
|
(56.7
|
)
|
|
—
|
|
Inventories
|
|
|
63.0
|
|
|
72.7
|
|
|
95.7
|
|
|
(0.5
|
)
|
|
230.9
|
|
Deferred
income taxes
|
|
|
58.7
|
|
|
3.3
|
|
|
9.2
|
|
|
—
|
|
|
71.2
|
|
Income
taxes receivable
|
|
|
216.2
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
216.2
|
|
Other
current assets
|
|
|
21.0
|
|
|
2.0
|
|
|
18.2
|
|
|
—
|
|
|
41.2
|
|
Total
current assets
|
|
|
582.0
|
|
|
123.1
|
|
|
411.2
|
|
|
(56.9
|
)
|
|
1,059.4
|
|
Property,
plant and equipment, net
|
|
|
129.4
|
|
|
136.1
|
|
|
337.3
|
|
|
—
|
|
|
602.8
|
|
Investments
in subsidiaries and advances, net
|
|
|
2,610.2
|
|
|
84.8
|
|
|
—
|
|
|
(2,695.0
|
)
|
|
—
|
|
Intangible
assets, net
|
|
|
130.9
|
|
|
2.7
|
|
|
8.4
|
|
|
—
|
|
|
142.0
|
|
Goodwill
|
|
|
58.7
|
|
|
37.6
|
|
|
387.1
|
|
|
—
|
|
|
483.4
|
|
Deferred
income taxes
|
|
|
368.9
|
|
|
—
|
|
|
18.6
|
|
|
(2.1
|
)
|
|
385.4
|
|
Asbestos-related
assets
|
|
|
41.9
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
41.9
|
|
Deferred
charges and other assets
|
|
|
82.7
|
|
|
28.1
|
|
|
26.0
|
|
|
—
|
|
|
136.8
|
|
Total
assets
|
|
$
|
4,004.7
|
|
$
|
412.4
|
|
$
|
1,188.6
|
|
$
|
(2,754.0
|
)
|
$
|
2,851.7
|
|
Liabilities
and Stockholders' Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
54.8
|
|
$
|
31.1
|
|
$
|
102.7
|
|
$
|
—
|
|
$
|
188.6
|
|
Intercompany
payables
|
|
|
1.4
|
|
|
45.3
|
|
|
9.9
|
|
|
(56.6
|
)
|
|
—
|
|
Asbestos-related
liabilities
|
|
|
36.4
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
36.4
|
|
Current
debt obligations
|
|
|
20.1
|
|
|
—
|
|
|
15.2
|
|
|
—
|
|
|
35.3
|
|
Vertac
litigation liability
|
|
|
124.9
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
124.9
|
|
Accrued
expenses
|
|
|
69.7
|
|
|
87.5
|
|
|
70.8
|
|
|
—
|
|
|
228.0
|
|
Total
current liabilities
|
|
|
307.3
|
|
|
163.9
|
|
|
198.6
|
|
|
(56.6
|
)
|
|
613.2
|
|
Long-term
debt
|
|
|
916.6
|
|
|
—
|
|
|
25.2
|
|
|
—
|
|
|
941.8
|
|
Deferred
income taxes
|
|
|
—
|
|
|
2.2
|
|
|
72.0
|
|
|
(2.1
|
)
|
|
72.1
|
|
Pension
obligations
|
|
|
187.2
|
|
|
—
|
|
|
55.2
|
|
|
—
|
|
|
242.4
|
|
Other
postretirement benefit obligations
|
|
|
137.5
|
|
|
—
|
|
|
3.0
|
|
|
—
|
|
|
140.5
|
|
Deferred
credits and other liabilities
|
|
|
223.5
|
|
|
15.9
|
|
|
18.0
|
|
|
—
|
|
|
257.4
|
|
Asbestos-related
liabilities
|
|
|
230.2
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
230.2
|
|
Intercompany
notes payable (receivable)
|
|
|
1,661.5
|
|
|
(1,455.0
|
)
|
|
(206.5
|
)
|
|
—
|
|
|
—
|
|
Minority
interests
|
|
|
—
|
|
|
—
|
|
|
13.2
|
|
|
—
|
|
|
13.2
|
|
Total
stockholders' equity
|
|
|
340.9
|
|
|
1,685.4
|
|
|
1,009.9
|
|
|
(2,695.3
|
)
|
|
340.9
|
|
Total
liabilities and stockholders' equity
|
|
$
|
4,004.7
|
|
$
|
412.4
|
|
$
|
1,188.6
|
|
$
|
(2,754.0
|
)
|
$
|
2,851.7
|
|
Condensed
Consolidating Statement of Cash Flows
|
|
Three
Months Ended March 31, 2007
|
|
|
|
|
|
Unconsolidated
|
|
|
|
|
|
|
|
Parent
|
|
Guarantor
Subsidiaries
|
|
Non-
Guarantor
Subsidiaries
|
|
Eliminations
and
Adjustments
|
|
Consolidated
|
|
Net
Cash Provided By Operating Activities
|
|
$
|
57.7
|
|
$
|
50.2
|
|
$
|
5.9
|
|
$
|
(88.0
|
)
|
$
|
25.8
|
|
Cash
Flow From Investing Activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
|
(2.9
|
)
|
|
(6.9
|
)
|
|
(14.4
|
)
|
|
—
|
|
|
(24.2
|
)
|
Acquisitions
and investments, net
|
|
|
—
|
|
|
(0.9
|
)
|
|
—
|
|
|
—
|
|
|
(0.9
|
)
|
Net
cash used in investing activities
|
|
|
(2.9
|
)
|
|
(7.8
|
)
|
|
(14.4
|
)
|
|
—
|
|
|
(25.1
|
)
|
Cash
Flow From Financing Activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
debt proceeds
|
|
|
—
|
|
|
—
|
|
|
2.8
|
|
|
—
|
|
|
2.8
|
|
Long-term
debt payments
|
|
|
(21.0
|
)
|
|
—
|
|
|
(1.2
|
)
|
|
—
|
|
|
(22.2
|
)
|
Change
in short-term debt
|
|
|
—
|
|
|
—
|
|
|
0.6
|
|
|
—
|
|
|
0.6
|
|
Change
in intercompany advances
|
|
|
(34.0
|
)
|
|
(42.4
|
)
|
|
(10.5
|
)
|
|
86.9
|
|
|
—
|
|
Proceeds
from the exercise of stock options
|
|
|
3.8
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
3.8
|
|
Dividends
paid
|
|
|
—
|
|
|
—
|
|
|
(1.1
|
)
|
|
1.1
|
|
|
—
|
|
Other,
net
|
|
|
2.0
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
2.0
|
|
Net
cash used in financing activities
|
|
|
(49.2
|
)
|
|
(42.4
|
)
|
|
(9.4
|
)
|
|
88.0
|
|
|
(13.0
|
)
|
Effect
of exchange rate changes on cash
|
|
|
—
|
|
|
—
|
|
|
0.3
|
|
|
—
|
|
|
0.3
|
|
Net
(decrease) increase in cash and cash
equivalents
|
|
|
5.6
|
|
|
—
|
|
|
(17.6
|
)
|
|
—
|
|
|
(12.0
|
)
|
Cash
and cash equivalents at beginning of period
|
|
|
89.7
|
|
|
0.5
|
|
|
81.6
|
|
|
—
|
|
|
171.8
|
|
Cash
and cash equivalents at end of period
|
|
$
|
95.3
|
|
$
|
0.5
|
|
$
|
64.0
|
|
$
|
—
|
|
$
|
159.8
|
|
Condensed
Consolidating Statement of Cash Flows
|
|
Three
Months Ended March 31, 2006
|
|
|
|
|
|
Unconsolidated
|
|
|
|
|
|
|
|
Parent
|
|
Guarantor
Subsidiaries
|
|
Non-
Guarantor
Subsidiaries
|
|
Eliminations
and
Adjustments
|
|
Consolidated
|
|
Net
Cash Provided By (Used In)
Operating Activities
|
|
$
|
21.5
|
|
$
|
(15.5
|
)
|
$
|
100.7
|
|
$
|
(79.0
|
)
|
$
|
27.7
|
|
Cash
Flow From Investing Activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
|
(2.0
|
)
|
|
(3.5
|
)
|
|
(2.6
|
)
|
|
—
|
|
|
(8.1
|
)
|
Acquisitions
and investments, net
|
|
|
—
|
|
|
(21.4
|
)
|
|
(5.0
|
)
|
|
—
|
|
|
(26.4
|
)
|
Proceeds
from sale of 51%
interest
in FiberVisions, net
|
|
|
27.0
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
27.0
|
|
Other,
net
|
|
|
(0.2
|
)
|
|
—
|
|
|
0.1
|
|
|
—
|
|
|
(0.1
|
)
|
Net
cash (used in) provided by investing activities
|
|
|
24.8
|
|
|
(24.9
|
)
|
|
(7.5
|
)
|
|
—
|
|
|
(7.6
|
)
|
Cash
Flow From Financing Activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
debt issued by FiberVisions,
net
of issuance costs
|
|
|
83.7
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
83.7
|
|
Long-term
debt payments
|
|
|
(12.0
|
)
|
|
—
|
|
|
(6.8
|
)
|
|
—
|
|
|
(18.8
|
)
|
Change
in short-term debt
|
|
|
—
|
|
|
—
|
|
|
(2.5
|
)
|
|
—
|
|
|
(2.5
|
)
|
Change
in intercompany advances
|
|
|
(13.5
|
)
|
|
41.8
|
|
|
(18.7
|
)
|
|
(9.6
|
)
|
|
—
|
|
Proceeds
from the exercise of stock options
|
|
|
0.1
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
0.1
|
|
Dividends
paid
|
|
|
—
|
|
|
—
|
|
|
(88.6
|
)
|
|
88.6
|
|
|
—
|
|
Other,
net
|
|
|
0.1
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
0.1
|
|
Net
cash provided by (used in) financing
activities
|
|
|
58.4
|
|
|
41.8
|
|
|
(116.6
|
)
|
|
79.0
|
|
|
62.6
|
|
Effect
of exchange rate changes on cash
|
|
|
—
|
|
|
—
|
|
|
0.5
|
|
|
—
|
|
|
0.5
|
|
Net
increase (decrease) in cash and cash
equivalents
|
|
|
104.7
|
|
|
1.4
|
|
|
(22.9
|
)
|
|
—
|
|
|
83.2
|
|
Cash
and cash equivalents at beginning of period
|
|
|
6.5
|
|
|
1.0
|
|
|
69.8
|
|
|
—
|
|
|
77.3
|
|
Cash
and cash equivalents at end of period
|
|
$
|
111.2
|
|
$
|
2.4
|
|
$
|
46.9
|
|
$
|
—
|
|
$
|
160.5
|
|
This
Quarterly Report on Form 10-Q includes forward-looking statements, as
defined in the Private Securities Litigation Reform Act of 1995, reflecting
management’s current analysis and expectations, based on what management
believes to be reasonable assumptions. Forward-looking statements may involve
known and unknown risks, uncertainties and other factors, which may cause the
actual results to differ materially from those projected, stated or implied,
depending on such factors as: ability to generate cash, changes in tax laws,
regulations and/or rates or changes resulting from ongoing reviews of tax
liabilities, ability to raise capital, ability to refinance, ability to execute
productivity improvements and reduce costs, ability to execute and integrate
acquisitions, ability to raise product prices, ability to execute divestitures,
ability to realign business portfolio and segments, ability to achieve growth
in
earnings and cash flows, business climate, business performance, economic and
competitive uncertainties, higher manufacturing costs, reduced level of customer
orders, changes in strategies, risk in developing new products and technologies,
risk in developing new market opportunities, environmental and safety
regulations and clean-up costs, foreign exchange rates and exchange control
regulations, foreign investment laws, the impact of changes in the value of
pension fund assets and liabilities, changes in generally accepted accounting
principles, legislative changes, adverse legal and regulatory developments,
including increases in the number or financial exposures of claims, lawsuits,
settlements or judgments, the financial capacity of settling insurers, the
impact of increased accruals and reserves for such exposures, the outcome of
litigation and appeals, including the ability to obtain judicial review of
adverse litigation results, and adverse changes in economic and political
climates around the world, including terrorist activities, international
hostilities, governmental instabilities and potential natural disasters.
Accordingly, there can be no assurance that the Company will meet future
results, performance or achievements expressed or implied by such
forward-looking statements. As appropriate, additional factors are contained
in
other reports filed by the Company with the Securities and Exchange Commission.
The words or phrases “will likely result,” “are expected to,” “will continue,”
“is anticipated,” “estimate,” “project” or similar expressions are among those
which identify forward-looking statements. This paragraph is included to provide
safe harbor for forward-looking statements, which are not generally required
to
be publicly revised as circumstances change, and which the Company does not
intend to update, except as may be required by law.
ITEM
2. Management’s Discussion and Analysis of
Financial Condition and Results of Operations
The
following discussion should be read in connection with the information contained
in the Consolidated Financial Statements and Notes thereto. All references
to
individual Notes refer to Notes to the Consolidated Financial Statements. Within
the following discussion, unless otherwise stated “quarter” and “three-month
period” refer to the first quarter of 2007 and the three months ended March 31,
2007. All comparisons are with the corresponding period in the previous year,
unless otherwise stated.
Business
Profile - Market and Geographic Concentration
Hercules
is a leading global manufacturer and marketer of specialty chemicals and related
services for a broad range of business, consumer and industrial applications.
The Company’s principal products are chemicals used by the paper industry to
improve performance and enhance the manufacturing process; water-soluble
polymers; and specialty resins. The primary markets the Company serves include
pulp and paper; paints and adhesives; construction materials; food,
pharmaceutical and personal care; and industrial specialties, including oilfield
and general industrial.
More
than
50% of the Company’s revenues are generated outside of North America. Net sales
by region expressed as a percentage of total net sales for the three months
ended March 31, 2007 and 2006 were:
|
|
2007
|
|
2006
|
|
North
America
|
|
|
49
|
%
|
|
47
|
%
|
Europe
|
|
|
35
|
%
|
|
37
|
%
|
Asia
Pacific
|
|
|
11
|
%
|
|
11
|
%
|
Latin
America
|
|
|
5
|
%
|
|
5
|
%
|
Consolidated
|
|
|
100
|
%
|
|
100
|
%
|
Business
Segments
The
Company operates through two active reportable segments: Paper Technologies
and
Ventures (“PTV”) and the Aqualon Group (“Aqualon”). PTV includes the following
business units: Paper Technologies and the Venture businesses-Pulping chemicals,
Water Treatment chemicals, Lubricants and Building and Converted products.
Aqualon includes the following business units: Coatings and Construction,
Regulated Industries, and Energy and Specialty Solutions. A reporting segment
is
also maintained for FiberVisions for historical reporting purposes reflecting
the Company’s consolidation of this business through March 31, 2006. The Company
currently holds a 49% ownership interest in the FiberVisions business. The
results of operations for the three months ended March 31, 2006 reflect the
Company’s 100% ownership of this business.
Net
sales
for the three months ended March 31, 2007 and 2006 as a percent of total net
sales, by segment, were:
|
|
2007
|
|
2006
|
|
Paper
Technologies and Ventures
|
|
|
56
|
%
|
|
48
|
%
|
Aqualon
Group
|
|
|
44
|
%
|
|
39
|
%
|
FiberVisions
|
|
|
—
|
|
|
13
|
%
|
Consolidated
|
|
|
100
|
%
|
|
100
|
%
|
Key
Developments
The
following strategic business and corporate actions and financial reporting
developments had an impact on the Company’s results of operations and financial
position as well as the overall presentation of financial information: (1)
formal signing of outsourcing agreements and initiation of significant aspects
of the Business Infrastructure Projects, (2) formal agreement with the Internal
Revenue Service (“IRS”) regarding the resolution of certain income tax matters
and the initial receipt of estimated tax refunds and (3) the adoption of FASB
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an
interpretation of FASB Statement No. 109” (“FIN 48”). A discussion of these
developments follows.
Business
Infrastructure Projects
On
January 16, 2007, the Company signed outsourcing agreements with Genpact
International, HCL America Inc. and HCL Technologies Limited and proceeded
with
plans to transition certain corporate and business support activities and
services in connection with the Company’s previously disclosed Business
Infrastructure Projects.
Resolution
of Income Tax Matters and Receipt of Estimated Refunds
During
the first quarter of 2007, the Company reached formal agreement with the IRS
on
all remaining income tax matters for the years 1993 through 2003. As a result,
an additional benefit of $47.3 million, including interest, was recorded over
and above those amounts recorded during the fourth quarter of 2006. In addition,
the Company received $12.4 million of an estimated $230 million in income tax
refunds, including interest, during the first quarter of 2007. These matters
are
discussed in greater detail in Note 13 to the Consolidated
Financial Statements and within the discussion of Liquidity and Capital
Resources that follows.
Adoption
of FIN 48
The
Company adopted FIN 48 effective January 1, 2007 and recorded $1.9 million
as an
adjustment to its beginning balance of retained earnings and a corresponding
decrease to its income tax reserves recorded in the balance sheet caption
Deferred credits and other liabilities in accordance with the required
transition provisions. The Company has recorded $40.4 million of unrecognized
tax benefits as of January 1, 2007. Additional information regarding the
adoption of FIN 48 is provided in Note 13 to the
Consolidated Financial Statements.
Reference
is made to the Company’s Annual Report on Form 10-K for the year ended December
31, 2006 for a complete description of the Company’s critical accounting
estimates. However, the following developments are discussed below with respect
to their applicability during the three months ended March 31, 2007 and future
periods.
Pension
and Other Postretirement Benefits
In
accordance with Statement of Financial Accounting Standards No. 158, “Employers
Accounting for Defined Benefit Pension and Other Postretirement Benefit Plans”
(“SFAS 158”), prior service costs and credits, actuarial gains and losses and
transition obligations attributable to the Company’s pension and other
postretirement benefit plans have been recorded in Accumulated other
comprehensive losses (“AOCL”) within Stockholders’ equity effective with the
adoption of SFAS 158. These amounts are to be amortized out of AOCL as a
component of net periodic benefit expense. In addition, any gains and losses
and
prior service costs or credits that arise subsequent to the adoption of SFAS
158
are required to be recognized as a component of Other comprehensive income
and
ultimately reflected in AOCL similar to amounts recognized upon the adoption
of
SFAS 158. These amounts are also subject to subsequent amortization as a
component of net periodic benefit expense. With respect to the amortization
of
those amounts from AOCL denominated in currencies other than the U.S. dollar,
the Company has applied a “current rate” approach whereby the amounts are
translated at the current exchange rate in effect for the period in which the
reclassification from AOCL to net income occurs.
Stock-Based
Compensation
In
accordance with Statement of Financial Accounting Standards No. 123 (revised
2004), “Share-Based Payment”, the Company records share-based compensation cost
based on the number of awards expected to vest. This accounting methodology
implicitly requires a process to estimate forfeitures of awards. The Company
has
a policy to review its estimate of award forfeitures on an annual basis or
when
specific facts and circumstances warrant additional review. The review is
primarily based on historical experience and provides for estimated rates for
Company officers and all other employees, respectively. Prior to 2007, the
Company had estimated different rates for these two employee groups. Based
on
its most recent annual review, actual experience rates and other factors have
resulted in the convergence of the estimated forfeiture rates for the two
employee groups. However, future reviews will continue to assess the groups
independently. The change in estimated forfeiture rates for 2007 will result
in
total share-based compensation cost that is lower by less than $1 million than
that which would have been recorded had the change in estimate not
occurred.
Income
Taxes
As
discussed in greater detail in Note 13 to the Consolidated
Financial Statements, the Company adopted the provisions of FIN 48 effective
January 1, 2007. In connection with the adoption of FIN 48, the Company retained
its prior practice of accounting for interest and penalties related to tax
positions as a component of income tax expense and related income tax assets
and
liabilities.
Results
of Operations - Consolidated Review
Net
sales
for the three months ended March 31, 2007 and 2006 were as follows:
|
|
2007
|
|
2006
|
|
Change
|
|
Net
sales
|
|
$
|
502.3
|
|
$
|
527.3
|
|
$
|
(25.0
|
)
|
Net
sales
for the three months ended March 31, 2007 decreased 5% from the prior year
period primarily as a result of the Company’s disposition of a majority interest
in FiberVisions on March 31, 2006. FiberVisions sales during the prior year
period were $69.2 million. Excluding the impact of FiberVisions, Net sales
increased approximately 10%, or $44.2 million, as compared to the prior year
period. The increase is attributable to higher volume of $28.1 million, or
6%,
higher pricing of $8.6 million, or 2%, and $14.4 million, or 3% related to
higher rates of exchange. These increases were partially offset by an
unfavorable product mix of $6.9 million, or 1%. The Company increased sales
in
all of its business units reflecting overall volume growth, particularly in
emerging markets and pricing growth to continue efforts to recover higher raw
material, transportation and energy costs, respectively. The rate of exchange
impact is primarily attributable to continued strengthening of the Euro versus
the U.S. Dollar (“USD”). Accordingly, the average Euro/USD exchange rate was
approximately 10% higher during the 2007 period.
The
table
below reflects Net sales per region and the percentage change from the prior
year period as well as the percentage change excluding the impact of rates
of
exchange (“ROE”):
|
|
|
|
|
|
%
Change
Excluding
|
|
Regions
|
|
2007
|
|
2006
|
|
%Change
|
|
ROE
|
|
North
America
|
|
$
|
247.7
|
|
$
|
262.6
|
|
|
(6
|
)%
|
|
(6
|
)%
|
Europe
|
|
|
174.9
|
|
|
177.1
|
|
|
(1
|
)%
|
|
(9
|
)%
|
Asia
Pacific
|
|
|
52.9
|
|
|
57.5
|
|
|
(8
|
)%
|
|
(9
|
)%
|
Latin
America
|
|
|
26.8
|
|
|
30.1
|
|
|
(11
|
)%
|
|
(12
|
)%
|
All
regions
|
|
$
|
502.3
|
|
$
|
527.3
|
|
|
(5
|
)%
|
|
(7
|
)%
|
Excluding
the impact of FiberVisions as well as the impact of ROE, Net sales increased
in
all regions of the world. On this basis, Net sales increased 8% in North
America, 5% in Europe, 8% in Asia Pacific and 5% in Latin America. North and
Latin American markets were particularly strong for PTV, which more than offset
slight declines attributable to Aqualon. Higher European sales reflected
continued growth by Aqualon, which was particularly strong in the developing
Eastern European markets. In addition, PTV experienced a favorable recovery
in
its European markets as customer and competitor dynamics have stabilized
somewhat from the prior year period. PTV sales to the emerging markets increased
by 39% in Eastern Europe, including Russia, 78% in the Middle East, 52% in
Chile
and 20% in Brazil. Strong growth was achieved by Aqualon in China reflecting
the
segment’s expanding presence in the country and the Asia Pacific region as a
whole. PTV sales were relatively flat in the Asia Pacific region except for
a
decline in China resulting from an ongoing effort to improve pricing and product
mix in that country.
|
|
2007
|
|
2006
|
|
Change
|
|
Cost
of sales
|
|
$
|
323.4
|
|
$
|
360.7
|
|
$
|
(37.3
|
)
|
As
a % of sales
|
|
|
64
|
%
|
|
68
|
%
|
|
|
|
Cost
of
sales decreased $37.3 million, or 10%, during the quarter ended March 31, 2007
as compared to the comparable period during 2006 primarily reflecting the
absence of FiberVisions’ costs during the prior year period. The most
significant of FiberVisions’ costs were attributable to polypropylene raw
materials. Excluding the impact of FiberVisions, higher raw materials of $6.6
million and other fixed costs were substantially offset by overall lower
transportation, pension and energy costs as well as higher fixed cost absorption
attributable to Aqualon as production remained at or near capacity for a number
of high demand products. Raw material cost increases over the prior year level
are expected to be approximately $30 million. Pricing increases implemented
during 2006 and the first quarter of 2007 are anticipated to provide for the
full recovery of these cost increases.
|
|
2007
|
|
2006
|
|
Change
|
|
Selling,
general and administrative
expenses
|
|
$
|
93.7
|
|
$
|
91.3
|
|
$
|
2.4
|
|
As
a % of sales
|
|
|
19
|
%
|
|
17
|
%
|
|
|
|
Selling,
general and administrative expenses (“SG&A”) increased approximately 3%
during the three months ended March 31, 2007 as compared to the prior year
period reflecting higher rates of exchange, higher incentive compensation
charges reflecting the accelerated vesting of certain 2004 restricted stock
awards based on the achievement of specific share price performance benchmarks
as well as other compensation-related charges. These increases were partially
offset by the absence of FiberVisions during the current year period as well
as
lower legal expenses attributable to the completion and settlement of PTV’s
patent infringement litigation during the latter part of 2006.
|
|
2007
|
|
2006
|
|
Change
|
|
Research
and development
|
|
$
|
10.4
|
|
$
|
9.6
|
|
$
|
0.8
|
|
As
a % of sales
|
|
|
2
|
%
|
|
2
|
%
|
|
|
|
Research
and
development charges for the three months ended March 31, 2007 increased $0.8
million, reflecting slightly higher spending primarily related to the Aqualon
Group partially offset by the absence of FiberVisions charges during the current
year period. In addition, the current level of spending reflects a general
level
of stabilization now that the Company has completed its global research and
development consolidation program.
|
|
2007
|
|
2006
|
|
Change
|
|
Intangible
asset amortization
|
|
$
|
1.8
|
|
$
|
1.6
|
|
$
|
0.2
|
|
Intangible
asset amortization increased $0.2 million during the three months ended March
31, 2007 as compared to the prior year period. The increase is attributable
to
intangible assets recognized in connection with the consolidation of Hercules
Tianpu, which was not completed until the beginning of the second quarter of
2006. Amortization is expected to be $7.2 million for 2007.
|
|
2007
|
|
2006
|
|
Change
|
|
Other
operating expense, net
|
|
$
|
13.1
|
|
$
|
7.2
|
|
$
|
5.9
|
|
Other
operating expense, net for the three months ended March 31, 2007 reflects $8.6
million in severance benefits and other exit costs as well as $3.7 million
of
accelerated depreciation and amortization charges attributable to the Company’s
continued execution on several restructuring and rationalization programs that
began during 2006 and prior periods (see Note 10 to the
Consolidated Financial Statements). The most significant restructuring program
is the Business Infrastructure Project, which results in severance and
termination benefits being accrued over periods during which the affected
employees are required to provide continuing services. The most significant
asset charge is attributable to accelerated amortization of certain capitalized
software development costs in connection with a planned information technology
upgrade. In addition, the Company incurred $1.0 million in dismantlement,
environmental, asset disposition and other costs partially offset by $0.2
million of legal recoveries related to a domestic product anti-dumping suit
against certain competitors.
Other
operating expense, net recorded during the three months ended March 31, 2006
included $7.3 million of severance benefits and other exit costs and $3.0
million of accelerated depreciation charges primarily attributable to the
Research and development consolidation plans as well as the Business segment
realignment program, partially offset by $3.6 million attributable to a
favorable judgment in the Company’s price fixing suit against certain raw
material suppliers.
|
|
2007
|
|
2006
|
|
Change
|
|
Interest
and debt expense
|
|
$
|
17.2
|
|
$
|
20.7
|
|
$
|
(3.5
|
)
|
Interest
and debt expense for the quarter ended March 31, 2007 decreased $3.5 million,
or
17%, from 2006 primarily as a result of lower outstanding debt balances
resulting from the Company’s repurchase of its 11.125% notes during prior
periods. The resulting impact of the repurchases was a combined reduction of
$3.1 million in interest expense and amortization of issuance costs. Also
contributing to the reduction was an offset to interest expense of $0.5 million
attributable to the cross-currency interest rate swaps initiated during the
first quarter of 2006 and $0.2 million of lower interest expense attributable
to
the absence of FiberVisions debt. These decreases were partially offset by
increasing LIBOR-based interest rates on the Company’s Term B loan resulting in
approximately $0.3 million higher interest expense and $0.1 million related
to
borrowings utilized to finance Hercules Tianpu’s MC capacity expansion project
in China.
|
|
2007
|
|
2006
|
|
Change
|
|
Vertac
litigation charge
|
|
$
|
1.5
|
|
$
|
—
|
|
$
|
1.5
|
|
During
the three months ended March 31, 2007, the accrual of interest continued on
the
judgment related to the lawsuit captioned United
States of America v. Vertac Chemical Corporation, et al.
(the
“Vertac litigation”) while the Company sought review by the United States
Supreme Court (see Note 7 to the Consolidated Financial
Statements). Interest charges on the judgment from the Vertac litigation were
not material during the prior year period.
|
|
2007
|
|
2006
|
|
Change
|
|
Other
expense, net
|
|
$
|
3.3
|
|
$
|
10.6
|
|
$
|
(7.3
|
)
|
Other
expense, net
for the three months ended March 31, 2007 reflects $2.1 million in legal fees
for asbestos-related litigation costs, net of interest accretion from the
asbestos insurance trusts, $0.7 million for legal expenses attributable to
previously divested businesses, $0.5 million in accretion expense attributable
to asset retirement obligations and $1.0 million for other environmental-related
charges. Partially offsetting these charges is interest and other miscellaneous
income of $0.8 million and a benefit of $0.2 million attributable to the
expiration of an option for the majority owner of FiberVisions to acquire an
additional 14% equity interest from the Company.
Other
expense, net for the three months ended March 31, 2006 reflects a loss of $5.1
million on the sale of the Company’s majority interest in FiberVisions. The
Company incurred a total of $1.4 million including premiums and debt issuance
cost write-offs in connection with the repurchase of $11.0 million of its
11.125% senior notes. Also included are $2.2 million in legal fees for
asbestos-related litigation costs, net of interest accretion from the asbestos
insurance trusts, $0.7 million for legal expenses attributable to previously
divested businesses and $1.3 million for environmental-related charges including
accretion expense of $0.4 million attributable to asset retirement obligations.
Partially offsetting these charges is interest and other miscellaneous income
of
$0.1 million.
|
|
2007
|
|
2006
|
|
Change
|
|
(Benefit)
provision for income taxes
|
|
$
|
(36.6
|
)
|
$
|
10.7
|
|
$
|
(47.3
|
)
|
Effective
(benefit) tax rate
|
|
|
(97
|
%)
|
|
42
|
%
|
|
|
|
For
the
three months ended March 31, 2007, the Company recognized pretax income of
$37.9
million and a tax benefit of $36.6 million. The current period benefit reflects
$47.3 million related to the final resolution of IRS audits for the years 1993
through 2003, partially offset by a $0.2 million charge related to income tax
law changes enacted in China. The full year effective tax rate for 2007 is
estimated to be 2%. The effective rate for the 2006 period reflects charges
attributable to the sale of the Company’s majority interest in FiberVisions.
Additional detail is provided in Note 13 to the Consolidated
Financial Statements.
|
|
2007
|
|
2006
|
|
Change
|
|
Minority
interests in earnings of consolidated
subsidiaries
|
|
$
|
(0.5
|
)
|
$
|
(0.1
|
)
|
$
|
(0.4
|
)
|
Minority
interests in earnings of consolidated subsidiaries reflects earnings
attributable to the Company’s joint venture partners’ interests in Hercules
Tianpu during the three months ended March 31, 2007 and FiberVisions bicomponent
fibers marketing entities during the three months ended March 31, 2006,
respectively.
|
|
2007
|
|
2006
|
|
Change
|
|
Equity
(loss) income of affiliated companies, net of tax
|
|
$
|
(0.5
|
)
|
$
|
(0.4
|
)
|
$
|
(0.1
|
)
|
The
loss
during the three months ended March 31, 2007 is primarily attributable to losses
incurred by FiberVisions for which the Company maintains a 49% ownership
interest, while the prior year period reflects losses attributable to the
Company’s other smaller equity-method investments.
|
|
2007
|
|
2006
|
|
Change
|
|
Net
loss from discontinued operations, net of tax
|
|
$
|
—
|
|
$
|
(0.6
|
)
|
$
|
0.6
|
|
Net
loss
from discontinued operations during the three months ended March 31, 2006
reflects the results of operations from the Company’s terpenes specialties
business. Net sales were $1.7 million during this period and the loss from
discontinued operations includes $0.1 million of restructuring and other exit
costs.
|
|
2007
|
|
2006
|
|
Change
|
|
Cumulative
effect of change in accounting principle, net of
tax
|
|
$
|
—
|
|
$
|
0.9
|
|
$
|
(0.9
|
)
|
As
a
result of the adoption of SFAS 123R effective January 1, 2006, the Company
recorded a $0.9 million benefit, net of income taxes, as a cumulative effect
of
a change in accounting principle attributable to the required change in
accounting policy for the recognition of forfeitures for awards that were
outstanding upon the date of adoption.
Results
of Operations - Segment Review
The
table
below reflects Net sales and Profit from operations for the three months ended
March 31, 2007 and 2006. Substantially all reconciling items have been allocated
to the segments.
|
|
|
|
|
|
|
|
|
|
2007
|
|
2006
|
|
Change
|
|
%
Change
|
|
Net
sales:
|
|
|
|
|
|
|
|
|
|
Paper
Technologies and Ventures
|
|
$
|
283.2
|
|
$
|
254.2
|
|
$
|
29.0
|
|
|
11
|
%
|
Aqualon
Group
|
|
|
219.1
|
|
|
203.9
|
|
|
15.2
|
|
|
7
|
%
|
FiberVisions
|
|
|
—
|
|
|
69.2
|
|
|
(69.2
|
)
|
|
(100
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated
|
|
$
|
502.3
|
|
$
|
527.3
|
|
$
|
(25.0
|
)
|
|
(5
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Profit
from operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Paper
Technologies and Ventures
|
|
$
|
28.0
|
|
$
|
14.6
|
|
$
|
13.4
|
|
|
92
|
%
|
Aqualon
Group
|
|
|
47.6
|
|
|
39.5
|
|
|
8.1
|
|
|
21
|
%
|
FiberVisions
|
|
|
—
|
|
|
0.5
|
|
|
(0.5
|
)
|
|
(100
|
)%
|
Corporate
Items
|
|
|
(15.7
|
)
|
|
2.3
|
|
|
(18.0
|
)
|
|
NM
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated
|
|
$
|
59.9
|
|
$
|
56.9
|
|
$
|
3.0
|
|
|
5
|
%
|
NM
= not
meaningful
The
table
below reflects Net sales percentage changes for the three months ended March
31,
2007 as compared to the same period in 2006.
|
|
Net
Sales Percentage Increase (Decrease) from Prior Year Due
To:
|
|
|
|
Volume
|
|
Product
Mix
|
|
Price
|
|
Rates
of
Exchange
|
|
Total
|
|
Paper
Technologies and Ventures
|
|
|
7
|
%
|
|
(1)
|
%
|
|
2
|
%
|
|
3
|
%
|
|
11
|
%
|
Aqualon
Group
|
|
|
5
|
%
|
|
(3)
|
%
|
|
2
|
%
|
|
3
|
%
|
|
7
|
%
|
FiberVisions
|
|
|
(100
|
)%
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(100
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated
|
|
|
(9
|
)%
|
|
(1
|
)%
|
|
2
|
%
|
|
3
|
%
|
|
(5
|
)%
|
Paper
Technologies and Ventures
The
following table reflects PTV’s sales revenues by business unit for the three
months ended March 31, 2007 and 2006, respectively:
|
|
2007
|
|
2006
|
|
Paper
Technologies
|
|
$
|
221.5
|
|
$
|
198.1
|
|
Ventures
|
|
|
61.7
|
|
|
56.1
|
|
|
|
$
|
283.2
|
|
$
|
254.2
|
|
PTV’s
sales increased 11% during the three months ended March 31, 2007 primarily
due
to 7% higher volume, 2% higher average prices and 3% higher rates of exchange
partially offset by 1% unfavorable product mix. PTV experienced increased volume
in the North American and European regions which were partially offset by
decreases in Asia Pacific, primarily China. Overall sales into emerging markets,
including Brazil, Chile, non-Western Europe, China and Indonesia were higher
by
approximately 14% as compared to the prior year period. Pricing was favorable
in
both of PTV’s business units with the most significant increases achieved in
North America with modestly lower pricing in both Europe and Asia. PTV’s
strategy of improving product mix through innovation and increased selling
prices to reflect value continues to show progress.
Paper
Technologies Sales
Paper
Technologies’ sales increased 12% during the 2007 period primarily due to 8%
higher volume, 1% higher average pricing and 4% due to higher rates of exchange,
primarily the Euro, partially offset by 1% unfavorable product mix. Volume
increases in North America and Europe more than offset declines in Asia Pacific,
primarily China. Ongoing efforts to improve pricing and product mix were the
primary cause for volume declines in China. The increase in North America is
primarily due to the Company’s recently formed marketing and manufacturing
alliance with MeadWestvaco for rosin-based size products. Excluding the impact
of the alliance, volume increased approximately 3% over the prior year period.
Price increases were achieved primarily in North America with slightly lower
pricing in both the European and Asia Pacific regions.
Ventures
Sales
Ventures’
sales increased 10% during the 2007 period primarily due to 2% higher volume,
4%
higher average prices, 2% improved product mix and 2% favorable rates of
exchange. Sales increased in all ventures except pulp mill products. Significant
growth was achieved in both building products and lubricants. Pricing was
favorable across all venture businesses.
PTV
Profitability
Profit
from operations increased $13.4 million, or 92%, to $28.0 million for the three
months ended March 31, 2007 as compared to $14.6 million for the 2006 period.
The increase reflects higher volume, improved selling prices, favorable rates
of
exchange and lower SG&A costs, partially offset by higher raw material and
tolling costs. SG&A costs were lower during the 2007 period primarily due to
lower patent defense costs, partially offset by the accelerated vesting of
2004
restricted stock awards. Severance, restructuring and other exit costs and
accelerated depreciation taken during the 2007 period resulted in a combined
charge of $0.5 million as compared to $6.4 million during the 2006 period.
The
decrease is primarily attributable to significant actions during the 2006 period
with respect to restructuring programs for research and development
consolidation, the rationalization of manufacturing capacity resulting in the
closure of PTV’s Pendlebury facility in the United Kingdom and the realignment
of the Company’s business segments.
Aqualon
Group
The
following table reflects Aqualon’s sales revenues by business unit for the three
months ended March 31, 2007 and 2006, respectively:
|
|
2007
|
|
2006
|
|
Coatings
and Construction
|
|
$
|
100.7
|
|
$
|
92.1
|
|
Regulated
|
|
|
60.1
|
|
|
56.6
|
|
Energy
and Specialties
|
|
|
58.3
|
|
|
55.2
|
|
|
|
$
|
219.1
|
|
$
|
203.9
|
|
Aqualon’s
sales increased 7% during the three months ended March 31, 2007 primarily due
to
5% higher volume, 2% higher average prices and 3% favorable rates of exchange,
partially offset by 3% unfavorable product mix. Sales attributable to Hercules
Tianpu, Aqualon’s methylcellulose (“MC”) joint venture in China, which was
consolidated beginning with the second quarter of 2006, accounted for 1% of
the
sales increase over 2006 levels.
Coatings
and Construction Sales
Coatings
and constructions sales increased 9% during the 2007 period as compared to
the
2006 period due to 4% higher volume, 1% higher average prices and 4% favorable
rates of exchange. Sales into the Coatings markets were higher by 8% during
the
2007 period. Strong volume growth in China and 5% growth in Europe offset a
4%
decline in North America. Aqualon expects modest improvement in the North
American paint markets throughout the remainder of the year. Price increases
were achieved in most of the coating product families and regions of the world.
Construction market sales increased 10% as compared to the 2006 period. Strong
growth was achieved in Europe, Latin America and China as well as emerging
markets including Eastern Europe which were especially strong. Pricing
improvements were also achieved in construction markets. Improved pricing has
now reversed the declining trends that were experienced during the majority
of
2006. Aqualon’s expanded production capacity in MC through Hercules Tianpu is in
the process of finalization and is expected to be available to meet the growing
demands in the construction markets.
Regulated
Sales
Regulated
industry sales increased 6% during the 2007 period as compared to the 2006
period due to 6% improved product mix, 2% higher average prices and 2% favorable
rates of exchange, partially offset by 4% lower volume. Sales increased in
the
pharmaceutical, personal care and food markets by 17%, 6% and 2%, respectively.
Middle Eastern and Asian markets were especially strong during the 2007 period
offsetting slower revenue growth in the North American markets.
Energy
and Specialties Sales
Energy
and specialties’ sales increased 6% during the 2007 period as compared to the
2006 period due to 14% higher volume, 2% higher average prices and 2% favorable
rates of exchange, partially offset by 12% unfavorable product mix. Energy
market sales increased 11% with strong growth in both North and Latin America
offset by declines in the Middle East and Western Europe. Aqualon continues
to
expand its presence in markets overseas, particularly the Middle East, to
capture anticipated growth in these regions. Specialty sales increased 2%,
with
growth obtained in Europe, the Middle East and Latin America offsetting declines
in North American markets. Pricing increases were achieved across both the
energy and specialty markets.
Aqualon
Profitability
Profit
from operations increased $8.1 million, or 21%, to $47.6 million during the
three months ended March 31, 2007 as compared to $39.5 million for the 2006
period. The increase reflects higher volume and the associated contribution
margin, increased selling prices and favorable rates of exchange, partially
offset by higher raw material and transportation costs. SG&A costs were
slightly higher during the 2007 period reflecting increased sales, marketing,
business management, technology and other spending to support growth as well
as
higher incentive compensation costs attributable to the accelerated vesting
of
2004 restricted stock awards. Severance, restructuring and other exit costs
were
$0.5 million during the 2007 period as compared to $2.6 million during the
2006
period. The decrease is primarily attributable to significant actions during
the
2006 period impacting a larger group of employees with respect to restructuring
programs for the realignment of the Company’s business segments. The 2007 period
had minimal activity in Europe associated with this program.
FiberVisions
FiberVisions’
results of operations for the three months ended March 31, 2006 are included
in
the Company’s consolidated results of operations. During that period,
FiberVisions had sales of $69.2 million and Profit from operations of $0.5
million. Effective April 1, 2006, the Company’s proportionate 49% share of
FiberVisions’ results of operations are reported within the caption Equity
(loss) income of affiliated companies, net of tax. During the three months
ended
March 31, 2007, the Company recognized $0.3 million of equity losses
attributable to its interest in FiberVisions.
Corporate
Items
Corporate
items include certain charges and credits that have not been allocated to the
business segments. The most significant of these items typically appear in
Other
operating expense, net, although portions are also reflected in Cost of sales
and SG&A, respectively, depending upon the specific nature of the items. The
following table reflects the components of those unallocated Corporate
items.
|
|
Three
Months Ended
March
31,
|
|
|
|
2007
|
|
2006
|
|
Severance,
restructuring and other exit costs
|
|
$
|
7.7
|
|
$
|
0.9
|
|
Accelerated
depreciation and amortization
|
|
|
3.6
|
|
|
0.3
|
|
Legal
settlements, net
|
|
|
—
|
|
|
(3.6
|
)
|
Dismantlement
costs
|
|
|
0.6
|
|
|
0.2
|
|
Unallocated
corporate costs
|
|
|
3.5
|
|
|
—
|
|
Other
miscellaneous expense (income), net
|
|
|
0.3
|
|
|
(0.1
|
)
|
Total
Corporate items - expense (income)
|
|
$
|
15.7
|
|
$
|
(2.3
|
)
|
Severance,
restructuring and other exit costs of $7.7 million for the three months ended
March 31, 2007 primarily reflect amounts attributable to the Business
Infrastructure Projects which encompass outsourcing and offshoring service
arrangements for various functions. As these functions are transferred to the
individual service providers, the Company is incurring severance costs for
employees required to provide services during the transition periods as well
as
related exit costs and other implementation charges. Ancillary to the Business
Infrastructure Projects is a planned upgrade of the Company’s information
technology platform which has resulted in $3.5 million of accelerated
amortization of capitalized software development costs during the transition
period which is expected to continue into 2008. Corporate items also includes
$3.5 million of corporate costs previously allocated to the FiberVisions
segment, $0.6 million of costs associated with the dismantlement of inactive
portions of certain manufacturing facilities and $0.2 of miscellaneous other
operating expenses including costs to prepare certain properties for
disposition.
Corporate
items for the three months ended March 31, 2006 included a $3.6 million legal
settlement, net of related costs attributable to a favorable judgment in the
Company’s price fixing suit against certain raw materials suppliers partially
offset by severance, restructuring and other exit costs of $0.9 million
primarily attributable to the Business Infrastructure Projects, $0.3 million
of
accelerated depreciation attributable to certain assets at the Company’s
Wilmington, Delaware research facility and $0.2 million of dismantlement costs
at various manufacturing facilities partially offset by $0.1 million of
miscellaneous income.
Liquidity
and Capital Resources
Analysis
of Cash Flows
Operating
Activities
|
|
2007
|
|
2006
|
|
Net
income, depreciation, amortization and all other non-cash
items
|
|
$
|
91.5
|
|
$
|
48.1
|
|
Changes
in working capital, net
|
|
|
(48.3
|
)
|
|
(18.4
|
)
|
All
other sources and uses of cash
|
|
|
(17.4
|
)
|
|
(2.0
|
)
|
Net
cash provided by operating activities
|
|
$
|
25.8
|
|
$
|
27.7
|
|
Net
cash
provided by operating activities decreased slightly by $1.9 million to $25.8
million for the three months ended March 31, 2007 as compared to $27.7 million
for the comparable period in 2006. The change primarily reflects improved
operating performance offset by a $29.9 million higher use of working capital
during the 2007 period. The 2007 working capital use reflects higher inventories
including those attributable to the impact of Aqualon’s strategic purchases of
certain key raw materials including guar and China-sourced gum rosins during
the
2007 period as well as increased production levels to meet expected demand
in
the seasonally stronger second and third quarters. In addition, there was
substantial growth in accounts receivable attributable to increased
sales.
Aside
from working capital, there were a number of discrete cash flow changes that
impacted the variance between periods. The most significant among these is
an
increase of $40.3 million attributable to amounts received from the asbestos
settlement trusts in excess of settlement payments. This change includes the
receipt of $41.3 million related to the liquidation of one of the settlement
trusts on January 4, 2007. Payments for severance and termination benefits
were
$3.4 million lower during the 2007 period as the prior year period included
payments to a larger group of employees impacted by actions that were initiated
during 2005 and early in 2006. While there are currently a number of employees
impacted by ongoing restructuring programs including the Business Infrastructure
Projects, the actual payment of severance and termination benefits will not
occur until later in 2007 and into future periods based on the longer transition
periods unique to this program. Interest payments were lower by $1.6 million
during the 2007 period reflecting lower outstanding debt balances and the impact
of the cross-currency interest rate swaps. Income taxes, net of refunds received
were lower by $1.2 million reflecting the initial receipt of $12.4 million
for
one of the series of refunds anticipated from the settlement of issues with
the
IRS for the years 1993 through 2003. Partially offsetting these cash flow
increases during the 2007 period was a voluntary contribution to the Company’s
pension plan in the United Kingdom for $17.1 million while the prior year period
did not reflect significant contributions to any of the Company’s domestic or
international pension plans.
Investing
Activities
|
|
2007
|
|
2006
|
|
Capital
expenditures
|
|
$
|
24.2
|
|
$
|
8.1
|
|
Acquisitions
and investments, net
|
|
|
0.9
|
|
|
26.4
|
|
Proceeds
from asset and investment dispositions and all other sources,
net
|
|
|
—
|
|
|
(26.9
|
)
|
Net
cash used in investing activities
|
|
$
|
25.1
|
|
$
|
7.6
|
|
Net
cash
used in investing activities increased $17.5 million to $25.1 million during
the
three months ended March 31, 2007 as compared to $7.6 million for the comparable
period in 2006. Included in these totals are capital expenditures of $24.2
million and $8.1 million, respectively, for the 2007 and 2006 periods. The
increase in capital expenditures is primarily related to Aqualon’s planned
expansion at both its MC and CMC manufacturing facilities in China. Additional
investing outflows during the 2007 period include $1.4 million for an earn-out
payment to Benchmark Performance Group, Inc. (“BPG”) based on the 2006
performance of the guar and guar derivatives business (“Benchmark Acquisition”)
that was acquired by the Company from BPG at the beginning of 2006. This payment
was partially offset by a $0.5 million payment received from BPG in connection
with the Company’s $2.5 million loan to BPG during 2006 as well. The prior year
period reflects the Benchmark Acquisition as well as a capital contribution
made
in connection with the formation of the Hercules Tianpu joint venture. In
connection with the sale of the Company’s 51% interest in FiberVisions in the
first quarter of 2006, a portion of the cash realized was provided by $27.0
million in proceeds received directly from SPG, less transaction costs.
Financing
Activities
|
|
2007
|
|
2006
|
|
Long-term
debt payments
|
|
$
|
(22.2
|
)
|
$
|
(18.8
|
)
|
Long-term
debt proceeds and changes in short-term debt
|
|
|
3.4
|
|
|
(2.5
|
)
|
Long-term
debt issued by FiberVisions, net of issuance costs
|
|
|
—
|
|
|
83.7
|
|
Proceeds
from the exercise of stock options and all other sources,
net
|
|
|
5.8
|
|
|
0.2
|
|
Net
cash (used in) provided by financing activities
|
|
$
|
(13.0
|
)
|
$
|
62.6
|
|
Net
cash
used in financing activities was $13.0 million for the three months ended March
31, 2007 as compared to $62.6 million of net cash provided for the comparable
period in 2006. During the 2007 period, the Company paid $21 million on its
Term
B loan due 2010 in addition to other payments on its various international
borrowings. The 2006 period includes the issuance of $90.0 million of debt,
net
of $6.3 million of issuance costs, by FiberVisions prior to the sale
transaction. The FiberVisions’ debt is non-recourse to Hercules. Higher average
stock prices during the 2007 period, as compared to the prior year period,
resulted in an increase in proceeds from the exercise of stock options during
the 2007 period.
Sources
of Liquidity
The
Company projects that cash flow from operations and other available financial
resources discussed below will be sufficient to meet its investing and financing
requirements and enable the Company to comply with the covenants and other
terms
of the Senior Credit Facility and the indenture governing its senior
notes.
As
of
March 31, 2007, the Company had a $550 million Senior Credit Facility with
a
syndicate of banks. Under the Senior Credit Facility, the Company has a $150
million revolving credit agreement, which permits certain additional borrowings.
As of March 31, 2007, $44.3 million of the $150.0 million Revolving Facility
was
available for use as the Company had $105.7 million of outstanding letters
of
credit associated with the Revolving Facility. In addition, the Company had
$30.4 million of foreign lines of credit available and unused.
In
connection with the comprehensive settlement of tax years 1993 through 2003,
the
Company anticipates the receipt of refunds and interest of approximately $230
million in total during 2007. During the three months ended March 31, 2007,
the
Company received $12 million. Of the remainder, approximately $145 million
is
expected to be received in the second quarter and $73 million is expected to
be
received during the second half of 2007.
The
Company maintains ownership over a number of properties, including land and
buildings, associated with businesses that have been exited, divested or
otherwise curtailed. In addition, during the normal course of business, assets
associated with current operations, including such items as surplus land and
excess or fully depreciated equipment and buildings among others, become
available for disposition. In order to maximize their value, the Company is
actively engaged in an ongoing process of identifying alternative utilization
strategies including leasing and outright sales of the underlying assets and
properties. When specific actions progress to the point that “plan of sale”
criteria have been met, impairments, to the extent they exist, are recognized
and the underlying properties are reclassified as assets held for sale. Assets
held for sale are included in the caption “Other current assets” on the
Consolidated Balance Sheets. The carrying value of total assets held for sale
was $7.7 million as of March 31, 2007, primarily reflecting the Company’s former
research facility in Jacksonville, Florida. This property is currently under
contract for sale and the transaction is expected to close during the second
quarter of 2007 for a net sales price in excess of its carrying
amount.
Total
debt at March 31, 2007 was $977.1 million, which decreased $18.4 million from
$995.5 million at December 31, 2006 primarily as a result of the debt payments
discussed above. Cash balances decreased to $159.8 million at March 31, 2007
from $171.8 million at December 31, 2006.
During
the three months ended March 31, 2007, the Company’s cash cycle time increased
by a total of 3 days to 66 days from year-end 2006 levels. Days Sales
Outstanding (“DSO”) remained at 60 days similar to the year-end 2006 levels.
Days Sales in Inventories (“DSI”) increased by 2 days to 58 days primarily
reflecting increases in Aqualon’s inventory partially offset by improved metrics
in PTV. Days Payable Outstanding (“DPO”) decreased by 1 day to 52 days. The
Company expects to improve its cash cycle time during the remainder of the
year
as efforts continue with respect to working capital initiatives, primarily
with
respect to inventories.
Commitments
and Contractual Obligations
Capital
Expenditures and Other Investing Commitments
Capital
expenditures are projected to total approximately $117 million during 2007.
Of
this total, approximately 32% will be attributable to PTV, 57% to Aqualon and
11% for Corporate purposes. Approximately $70 million is targeted for global
expansion and new product capability projects at various manufacturing
facilities.
In
connection with the Benchmark transaction, Aqualon made an earn-out payment
of
$1.4 million during the first quarter of 2007 based on 2006 performance. Similar
performance-based commitments are in place through 2010. In April 2007 the
Company completed its requirement to provide an additional $1.2 million
contribution to FiberVisions based on its performance through the three months
ended March 31, 2007. There are no further commitments or requirements to
provide funding to FiberVisions in the future.
Pension
Plan Funding
The
Company is projecting total pension plan contributions to approximate $61
million during 2007 including $40 million attributable to the U.S.-based plan
and $21 million to its international plans. A total of $17.1 million was
contributed for the United Kingdom pension plan during the quarter ended March
31, 2007 which resulted in the plan being fully funded. A forthcoming change
in
the pension asset investment model is expected to mitigate long-term plan
performance risk. During April 2007, the Company made a $10 million contribution
to its U.S. qualified plan. Further contributions of approximately $4 million
to
the Company’s other international plans are expected to be made ratably through
the remainder of the year.
Funding
for Litigation, Environmental and Asset Retirement Obligations
On
April
23, 2007, the United States Supreme Court denied the Company’s Petition for a
Writ of Certiorari. As a result, the Company will now be required to pay to
the
United States the amount set forth in the Final Judgment dated June 6, 2005,
plus post-judgment interest, plus any additional response costs incurred or
to
be incurred by the United States after June 1, 1998. The Company has accrued
its
total net liability of $124.9 million, including interest but not including
amounts for which Uniroyal has been held liable based on the Final Judgment,
which is recorded as a current liability at March 31, 2007. The Company will
continue to accrue interest on that amount until such time as the Final Judgment
is paid. The United States has not yet informed the Company of the amount of
the
additional response costs which the United States will claim that it has
incurred since June 1, 1998, nor has the Company been provided an opportunity
to
evaluate those costs. As a result, no amounts have been accrued with respect
to
such response costs.
As
of
March 31, 2007, the Company has recorded $79.9 million for environmental and
other asset retirement matters involving current and former operating sites,
including those with identified asset retirement obligations as well as other
locations where the Company may have a known liability, excluding the Vertac
site. The annual costs required for remediation and similar asset retirement
activities are generally funded from operations as well as proceeds from the
disposition of assets. While such obligations are bound by legal, statutory
or
contractual provisions, the Company has a certain degree of discretion with
respect to the timing and magnitude of cash
expenditures
within a given range of periods. However, unfavorable developments
regarding legal, regulatory or operating matters with respect to any existing
sites as well as unknown exposures could have a material adverse effect on
cash
requirements for any annual, quarterly or other period. In addition, the
Company’s future commitment to certain actions, including modifications to its
existing facilities or preparing sites for sale involving demolition and other
related activities among others, could trigger the recognition of additional
obligations. The Company has paid $2.3 million towards these obligations during
the three months ended March 31, 2007 and anticipates a total of approximately
$20 million in payments for the full year. The most significant of the total
projected payments are attributable to the Company’s operating facility and
related property in Parlin, New Jersey. Obligations at this site include those
attributable to existing Aqualon Natrosol manufacturing operations as well
as
demolition and environmental remediation activities attributable to that portion
of the facility that previously housed the Company’s nitrocellulose
manufacturing operations. With regard to this portion of the site, the Company
is proceeding with plans to dispose of 400 acres for a brownfield redevelopment
project.
Asbestos-Related
Litigation
In
January 2007, the Company received $41.3 million of funds from the reversion
of
one of the trusts established in 2004 related to the settlement with asbestos
claim insurers. During 2007, the Company projects reimbursements from the
remaining trust to approximate $31 million, which will be used to fund a
substantial portion of the related estimated asbestos claims for the year.
The
Company also projects approximately $9 million in defense costs and legal fees
to be paid and incurred during the year. The combined cash impact of the trust
liquidation and projected reimbursements from the remaining trust should result
in a positive net cash inflow related to asbestos litigation matters during
2007. However, subsequent to 2007 and upon liquidation of the remaining trust,
the Company will be required to fund its asbestos settlements and related
defense costs and legal fees from its cash from operations and other available
financial resources until its excess insurance policies are triggered based
on
cumulative asbestos-related expenditures. Depending upon the magnitude of future
settlement and defense costs, substantial coverage under such policies is not
anticipated to be triggered for several years.
Debt
Retirement
In
December 2006, the Board of Directors authorized the Company, from time to
time,
subject to market conditions and provisions of the Company’s credit agreements
and indentures, to repurchase up to $200 million of its outstanding
indebtedness. As discussed above, the Company repurchased $20 million over
and
above its required payments due on its Term B loan.
The
Company’s 6.6% notes due 2027 may be put to the Company at the option of the
bond holders at a redemption price equal to 100% of the principal amount, or
$100.0 million, requiring a cash payment on August 1, 2007 if the bond holders
exercise this option. Beginning June 2, 2007, the bond holders will have a
period of 29 days during which to exercise their option. Assuming that the
option is exercised, the Company intends to fund such requirement from available
cash on hand.
Recent
Accounting Pronouncements
Reference
is made to Note 2 to the Consolidated Financial Statements
for a discussion and analysis of recently issued accounting pronouncements
and
their impact on the Company.
Fluctuations
in interest and foreign currency exchange rates affect the Company's financial
position and results of operations. The Company has used several strategies
to
actively hedge interest rate and foreign currency exposure and minimize the
effect of such fluctuations on reported earnings and cash flow. Sensitivity
of
the Company's financial instruments to selected changes in market rates and
prices, which are reasonably possible over a one-year period, are described
below. The market values for interest rate risk are calculated by the Company
utilizing a third-party software package that employs standard pricing models
to
determine the present value of the instruments based on the market conditions
as
of the valuation date.
Foreign
Exchange Rate Risk
The
Company’s financial instruments subject to foreign currency exchange risk
consist of foreign currency forwards and options and represent a net asset
position of less than $0.1 million at March 31, 2007. The following sensitivity
analysis assumes an instantaneous 10% change in foreign currency exchange rates
from period-end levels, with all other variables held constant. A 10%
strengthening of the U.S. Dollar versus other currencies at March 31, 2007
would
result in a $1.1 million increase in the net position, while a 10% weakening
of
the dollar versus all currencies would result in a $1.5 million decrease in
the
net position.
The
Company also utilizes cross currency interest rate swaps to hedge the foreign
currency exposure associated with its net investment in certain foreign
operations. At March 31, 2007, the net market value of the swaps was a liability
of $60.2 million. A 10% strengthening of the Euro versus the U.S. dollar at
March 31, 2007 would result in a $56.0 million increase in the liability, while
a 10% weakening of the Euro versus the U.S. dollar would result in a $56.0
million decrease in the liability. Changes in the underlying interest rates
would have an insignificant impact.
Interest
Rate Risk
The
Company's derivative and other financial instruments subject to interest rate
risk consist substantially of debt instruments. At March 31, 2007, the net
market value of these combined instruments was a liability of $937.6 million.
The sensitivity analysis assumes an instantaneous 100-basis point move in
interest rates from their period end levels, with all other variables held
constant. A 100-basis point increase in interest rates at March 31, 2007 would
result in a $70.5 million decrease in the net market value of the liability.
A
100-basis point decrease in interest rates at March 31, 2007 would result in
a
$59.7 million increase in the net market value of the liability.
Equity
Price Risk
The
Company’s financial instruments subject to equity price risk consist of the
warrants component of the CRESTS units issued in 1999 and the Company’s 8%
convertible subordinated debentures due 2010 and represent a net liability
position of $67.5 million. The sensitivity analysis assumes an instantaneous
10%
change in valuation with all other variables held constant. A 10% increase
in
market value at March 31, 2007 would increase the net liability by $10.9 million
while a 10% decrease would reduce the net liability by $10.5
million.
Commodity
Price Risk
As
of and
for the three month period ended March 31, 2007, the Company did not transact
in
any hedging activities with respect to commodities or any related raw materials
requirements.
Derivative
Financial Instruments
As
noted
above, the Company utilizes foreign exchange forward and option contracts to
hedge the Company’s firm and anticipated foreign currency cash flows. Thus,
there is either an asset or cash flow exposure related to all the financial
instruments in the above sensitivity analysis for which the impact of a movement
in exchange rates would be in the opposite direction and substantially equal
to
the impact on the instruments in the analysis.
Other
than cross-currency interest rate swaps to hedge the foreign currency exposure,
the Company has not designated any derivative as a hedge instrument under
Statement of Financial Accounting Standards No. 133, “Accounting for Derivative
Instruments and Hedging Activities” and, accordingly, changes in the fair value
of derivatives are recorded each period in earnings.
The
Company carried out an evaluation, under the supervision and with the
participation of the Company’s management, including the Company’s President and
Chief Executive Officer and the Company’s Vice President and Chief Financial
Officer of the effectiveness of the Company’s disclosure controls and procedures
pursuant to Exchange Act Rule 13a-15 as of March 31, 2007. Based upon that
evaluation, the Company’s President and Chief Executive Officer and the
Company’s Vice President and Chief Financial Officer concluded that the
Company’s disclosure controls and procedures are effective. Disclosure controls
and procedures are controls and procedures that are designed to ensure that
information required to be disclosed in Company reports filed or submitted
under
the Exchange Act is recorded, processed, summarized and reported within the
time
periods specified in the Securities and Exchange Commission’s rules and
forms.
There
have been no significant changes in the Company’s internal controls over
financial reporting that occurred during the Company’s first fiscal quarter that
have materially affected, or are reasonably likely to materially affect, the
Company’s internal control over financial reporting.
PART II
- OTHER INFORMATION
The
information disclosed by the Company under the headings “Environmental” and
“Litigation” in Note 7 to the Consolidated Financial
Statements is incorporated herein by this reference.
(a) Exhibits
Please
see the exhibits listed on the Exhibits Index.
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.
|
HERCULES
INCORPORATED
|
|
|
|
|
|
By:
|
/s/
Allen A. Spizzo
|
|
|
Allen
A. Spizzo
|
|
Vice
President and Chief Financial Officer
|
|
(Principal
Financial Officer and Duly
|
|
Authorized
Signatory)
|
|
May
1, 2007
|
Number
|
|
Description
|
|
|
|
|
|
Certification
of President and Chief Executive Officer Pursuant to Exchange Act
Rule 13a-14(a)/15d-14(a)
|
|
|
|
|
|
Certification
of Vice President and Chief Financial Officer Pursuant to Exchange
Act
Rule 13a-14(a)/15d-14(a)
|
|
|
|
|
|
Section 1350
Certification of President and Chief Executive Officer
|
|
|
|
|
|
Section 1350
Certification of Vice President and Chief Financial
Officer
|
*
Filed
herewith
-47-