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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, 2003
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: |X| No: | |
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act).
Yes: |X| No: | |
As of April 30, 2003, 109,914,973 shares of registrant's common stock were
outstanding.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HERCULES INCORPORATED
CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)
(Dollars in millions, except per share) Three Months Ended
March 31,
-------------------
2003 2002
------- -------
Net sales $ 441 $ 402
Cost of sales (Note 7) 281 243
Selling, general and administrative expenses 90 88
Research and development 10 10
Intangible asset amortization (Note 5) 2 2
Other operating (income) expense, net (Note 8) (1) 5
------- -------
Profit from operations 59 54
Interest and debt expense 19 36
Preferred security distributions of subsidiary trusts 15 15
Other expense, net (Note 9) 4 4
------- -------
Income (loss) before income taxes and equity income (loss) 21 (1)
Provision for income taxes 8 2
------- -------
Income (loss) before equity income (loss) 13 (3)
Equity income (loss) of affiliated companies, net of tax -- --
------- -------
Net income (loss) from continuing operations before discontinued
operations and cumulative effect of changes in accounting principle 13 (3)
Net loss on discontinued operations, net of tax (Note 4) -- (209)
------- -------
Net income (loss) before cumulative effect of changes in accounting principle 13 (212)
Cumulative effect of changes in accounting principle, net of tax (Notes 5 and 13) (28) (368)
------- -------
Net loss $ (15) $ (580)
======= =======
Basic and diluted earnings (loss) per share (Note 6)
Continuing operations $ 0.12 $ (0.03)
Discontinued operations $ -- $ (1.92)
Cumulative effect of changes in accounting principle $ (0.26) $ (3.37)
Net loss $ (0.14) $ (5.32)
Weighted-average number of shares - basic (millions) 109.5 109.0
Weighted-average number of shares - diluted (millions) 109.7 109.0
See accompanying notes to consolidated financial statements.
2
HERCULES INCORPORATED
CONSOLIDATED BALANCE SHEET
(Dollars in millions) (Unaudited)
March 31, December 31,
2003 2002
----------- ------------
ASSETS
Current assets
Cash and cash equivalents $ 218 $ 209
Restricted cash (Note 11) 125 125
Accounts and notes receivable (net of allowance for doubtful
accounts of $12 million) 368 360
Inventories
Finished products 91 88
Materials, supplies, and work in process 86 79
Deferred income taxes 39 46
--------- ---------
Total current assets 927 907
Property, plant, and equipment 1,949 1,925
Accumulated depreciation and amortization (1,286) (1,262)
--------- ---------
Net property, plant, and equipment 663 663
Intangible assets, net (Note 5) 196 198
Goodwill, net (Note 5) 477 468
Deferred income taxes 20 15
Other assets 414 442
--------- ---------
Total assets $ 2,697 $ 2,693
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities
Accounts payable $ 167 $ 176
Accrued expenses 273 295
Short-term debt (Note 11) 145 145
--------- ---------
Total current liabilities 585 616
Long-term debt (Note 11) 733 738
Deferred income taxes 71 80
Postretirement benefits and other liabilities 792 758
Commitments and contingencies (Note 14) -- --
Company-obligated preferred securities of subsidiary trusts (Note 12) 625 624
Stockholders' deficit
Series preferred stock -- --
Common stock (shares issued: 2003 - 159,984,444;
2002 - 159,984,444) 83 83
Additional paid-in capital 667 682
Unearned compensation (89) (93)
Accumulated other comprehensive losses (434) (454)
Retained earnings 1,468 1,483
--------- ---------
1,695 1,701
Reacquired stock, at cost (shares: 2003 - 50,061,718;
2002 - 50,615,487) (1,804) (1,824)
--------- ---------
Total stockholders' deficit (109) (123)
--------- ---------
Total liabilities and stockholders' deficit $ 2,697 $ 2,693
========= =========
See accompanying notes to consolidated financial statements.
3
HERCULES INCORPORATED
CONSOLIDATED STATEMENT OF CASH FLOW
(Dollars in millions) (Unaudited)
Three Months Ended March 31,
----------------------------
2003 2002
-------- --------
Net cash provided by (used in) operating activities of continuing operations $ 12 $ (15)
-------- --------
CASH FLOW FROM INVESTING ACTIVITIES:
Capital expenditures (8) (5)
Proceeds of investment and fixed asset disposals 3 11
Other, net 1 --
-------- --------
Net cash (used in) provided by investing activities of continuing operations (4) 6
CASH FLOW FROM FINANCING ACTIVITIES:
Long-term debt proceeds -- 155
Long-term debt repayments (5) (178)
Change in short-term debt (1) 2
Common stock issued 5 2
-------- --------
Net cash used in financing activities of continuing operations (1) (19)
Net cash provided by discontinued operations -- 7
Effect of exchange rate changes on cash 2 (3)
-------- --------
Net increase (decrease) in cash and cash equivalents 9 (24)
Cash and cash equivalents - beginning of period 209 76
-------- --------
Cash and cash equivalents - end of period $ 218 $ 52
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 6 $ 22
Preferred security distributions of subsidiary trusts 14 14
Income taxes 5 71
Non-cash investing and financing activities:
Incentive and other employee benefit stock plan 4 --
See accompanying notes to consolidated financial statements.
4
HERCULES INCORPORATED
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
(Dollars in millions) (Unaudited)
Three Months Ended
March 31,
-------------------
2003 2002
------ ------
Net loss $ (15) $ (580)
Foreign currency translation 20 (55)
------ ------
Comprehensive income (loss) $ 5 $ (635)
====== ======
See accompanying notes to consolidated financial statements.
5
HERCULES INCORPORATED
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. These condensed 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, 2003 and
2002, but in the opinion of management include all adjustments necessary to
present fairly in all material respects Hercules' financial position and results
of operations for the interim periods. These condensed consolidated financial
statements should be read in conjunction with the accounting policies, financial
statements and notes included in Hercules' Annual Report on Form 10-K for the
year ended December 31, 2002. Certain prior period amounts have been
reclassified to conform to the current period presentation.
2. Stock-based Compensation
Compensation costs attributable to stock option and similar plans are
recognized based on any excess of the quoted market price of the stock on the
date of grant over the amount the employee is required to pay to acquire the
stock (the intrinsic-value method under Accounting Principles Board Opinion 25
("APB 25")). Such amount, if any, is accrued over the related vesting period, as
appropriate. Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" ("SFAS 123") and the related amendments in
Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" ("SFAS 148") require companies
electing to continue to use the intrinsic-value method to make pro forma
disclosures of net income and earnings per share as if the fair value based
method of accounting had been applied.
Pursuant to the disclosure requirements of SFAS 123, as amended by SFAS
148, the following table presents the pro forma effect on net loss and loss per
share assuming the Company had applied the fair value recognition provisions of
SFAS 123 to stock-based employee compensation.
(Dollars in millions, except per share) Three Months Ended March 31,
----------------------------
2003 2002
-------- --------
Net loss, as reported $ (15) $ (580)
Deduct: Total stock-based employee compensation
expense determined under fair value based method for
all awards, net of tax 2 3
-------- --------
Pro forma net loss $ (17) $ (583)
======== ========
Loss per share:
Basic - as reported $ (0.14) $ (5.32)
======== ========
Basic - pro forma $ (0.16) $ (5.35)
======== ========
Diluted - as reported $ (0.14) $ (5.32)
======== ========
Diluted - pro forma $ (0.16) $ (5.35)
======== ========
3. Recent Accounting Pronouncements
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Certain Variable Interest Entities" ("FIN 46") ("VIEs"), which
is an interpretation of Accounting Research Bulletin No. 51, "Consolidated
Financial Statements" ("ARB 51"). FIN 46 addresses the application of ARB 51 to
VIEs, and generally would require that assets, liabilities and results of the
activity of a VIE be consolidated into the financial statements of the
enterprise that is considered the primary beneficiary. The provisions of FIN 46
apply on a prospective basis to VIEs created after January 31, 2003 and become
effective after June 30, 2003 for VIEs the Company had prior to January 31,
2003. The Company currently has two joint-venture VIEs that are presently
accounted for using the equity method of accounting. These entities serve as
strategic global marketers of the Company's bicomponent fibers. The assets and
liabilities of these entities are not consolidated within the Company's
financial statements. There are no assets of the Company that serve as
collateral for the VIEs and the creditors of the VIEs have no recourse to the
general credit of the Company.
In April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities" ("SFAS 149"). SFAS 149 incorporates provisions
6
that were clarified by the Derivatives Implementation Group. The provisions of
SFAS 149 should be applied prospectively to contracts entered into after June
30, 2003. The Company does not believe this statement will have a material
effect on its financial statements.
4. Discontinued Operations
On April 29, 2002, the Company completed the sale of the BetzDearborn
Water Treatment Business (the "Water Treatment Business") to GE Specialty
Materials, a unit of General Electric Company. The sale price was $1.8 billion
in cash, resulting in net after-tax proceeds of approximately $1.7 billion. The
Company used the net proceeds to prepay debt under its senior credit facility
and ESOP credit facility (see Note 11). Pursuant to Statement of Financial
Accounting Standards No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("SFAS 144") as adopted on January 1, 2002, the Water
Treatment Business has been treated as a discontinued operation as of February
12, 2002 and accordingly, all financial information has been restated. The loss
from discontinued operations for the three months ended March 31, 2002 includes
an after-tax loss on the disposal of the business of $230 million.
The Paper Process Chemicals Business, representing approximately one-third
of the business of BetzDearborn Inc. when it was originally acquired in 1998,
was fully integrated into and continues to be reported within Pulp and Paper.
Summarized below are the results of operations of the Water Treatment
Business for the three months ended March 31, 2002.
(Dollars in millions) Three Months Ended
March 31, 2002
------------------
Net sales $ 192
Profit from operations 33
Income before income taxes 35
Tax provision 14
-------
Income from operations 21
Loss from disposal of business, including a provision
for income taxes of $51 million (230)
-------
Loss from discontinued operations $ (209)
=======
Summarized below is the net cash flow provided by discontinued
operations for the three months ended March 31, 2002.
(Dollars in millions) Three Months Ended
March 31, 2002
------------------
Net cash provided by operations $ 9
Capital expenditures (2)
-------
Net cash flow from discontinued operations $ 7
=======
The major classes of assets and liabilities included in the consolidated
balance sheet at the time of disposal were as follows:
(Dollars in millions)
ASSETS LIABILITIES
Accounts receivable, net $ 160 Accounts payable $ 57
Inventory 76 Accrued expenses 46
Fixed assets 216 Deferred income taxes 171
Goodwill and other intangible assets 1,419 Other liabilities 6
-----
Other assets 43 $ 280
------- =====
$ 1,914
=======
7
5. Goodwill and Other Intangible Assets
Effective January 1, 2002, Hercules adopted the provisions of Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142"). Hercules identified the following reporting units: BetzDearborn,
Pulp and Paper, Aqualon, FiberVisions and Pinova. In connection with Hercules'
transitional review, recorded goodwill was determined to be impaired in the
BetzDearborn and FiberVisions reporting units. In the first quarter of 2002,
Hercules completed its transitional impairment review of the identified
reporting units and recognized after-tax impairment losses of $262 million in
the BetzDearborn reporting unit and $87 million in the FiberVisions reporting
unit as a cumulative effect of a change in accounting principle. In addition, an
after-tax impairment loss of $19 million was recognized in the first quarter of
2002 relating to the Company's equity investment in CP Kelco, which had an
impairment under SFAS 142. Pursuant to SFAS 142, the Company is required to
perform an annual assessment of its reporting units for impairment. The annual
assessment was performed as of November 30, 2002 and indicated no additional
impairment to the Company's goodwill was warranted.
Accumulated amortization for goodwill upon adoption of SFAS 142 was $185
million. The following table shows changes in the carrying amount of goodwill by
operating segment for the three months ended March 31, 2003.
(Dollars in millions) Engineered
Performance Materials
Products and Additives Total
----------- ------------- -------
Balance at December 31, 2002 $ 383 $ 85 $ 468
Foreign currency translation 9 -- 9
------- ------- -------
Balance at March 31, 2003 $ 392 $ 85 $ 477
======= ======= =======
The following table provides information regarding the Company's other
intangible assets with finite lives:
(Dollars in millions) Customer Trademarks Other
Relationships & Tradenames Intangibles Total
------------- ------------ ----------- -----------
Gross Carrying Amount
Balance, December 31, 2002 $ 89 $ 70 $ 95 $ 254
Balance, March 31, 2003 89 70 95 254
Accumulated Amortization
Balance, December 31, 2002 $ 11 $ 7 $ 38 $ 56
Balance, March 31, 2003 11 8 39 58
Total amortization expense for each of the three month periods ended March
31, 2003 and 2002 for other intangible assets was $2 million and $4 million,
respectively, of which $2 million was included in income from continuing
operations for each of the three months ended March 31, 2003 and 2002. Estimated
amortization expense for 2003 and the five succeeding fiscal years is $9 million
per year for 2003 and 2004 and $8 million per year from 2005 through 2008.
8
6. Earnings (Loss) Per Share
The following table shows the amounts used in computing earnings (loss) per
share and the effect on net income (loss) and the weighted-average number of
shares of dilutive potential common stock:
(Dollars in millions, except per share) Three Months Ended March 31,
2003 2002
-------------------- -------------------
Earnings
Income (loss) (Loss)
(loss) per share (Loss) per share
------- --------- ------- ---------
BASIC AND DILUTED:
Continuing operations $ 13 $ 0.12 $ (3) $ (0.03)
Discontinued operations -- -- (209) (1.92)
Cumulative effect of changes in accounting principle (28) (0.26) (368) (3.37)
------- ------- ------- -------
Net loss $ (15) $ (0.14) $ (580) $ (5.32)
Weighted-average number of shares - basic (millions) 109.5 109.0
Weighted-average number of shares - diluted (millions) 109.7 109.0
For the three months ended March 31, 2003 and 2002, the Company had convertible
subordinated debentures which are convertible into approximately 0.2 million
shares of common stock. However, the common stock shares into which these
debentures are convertible have not been included in the dilutive share
calculation for the three months ended March 31, 2002 because the impact of
their inclusion would be anti-dilutive. The dilutive effect of the convertible
debentures was included in the calculation for the three months ended March 31,
2003.
7. Depreciation Expense
Cost of sales and selling, general and administrative expenses include
depreciation expense related to continuing operations of $17 million and $18
million for the three months ended March 31, 2003 and 2002, respectively.
8. Other Operating (Income) Expense, Net
Other operating (income) expense, net, for the three months ended March
31, 2003 and 2002 includes additional charges for severance benefits of $2
million and $4 million, respectively, associated with the comprehensive cost
reduction and work process redesign program announced in September 2001 (see
Note 10). The Company also recognized a $3 million gain in the three months
ended March 31, 2003 related to a favorable legal settlement. The Company
recognized approximately $1 million in environmental charges in the three months
ended March 31, 2002.
9. Other Expense, Net
Other expense, net, for the three months ended March 31, 2003 and 2002
includes $1 million and $2 million, respectively, in net charges for
asbestos-related costs (see Note 14), $1 million and $2 million, respectively,
in bank charges and other charges of approximately $3 million and $1 million,
respectively. Interest income of $1 million was recognized in both periods. In
addition, the three months ended March 31, 2002 included approximately $1
million for litigation costs, a $1 million foreign currency loss and a gain from
the sale of assets of $2 million. Litigation costs and asset sales primarily
relate to former operations of the Company.
10. Restructuring
The consolidated balance sheet reflects liabilities for employee severance
benefits and other exit costs of $14 million and $36 million at March 31, 2003
and 2002, respectively. During 2001, management authorized and committed to a
plan to reduce the workforce as part of the comprehensive cost reduction and
work process redesign program. Through December 31, 2002, the Company incurred
charges related to this restructuring of $76 million, which includes charges of
$68 million for employee termination benefits and $8 million for exit costs
related to facility closures. During the three months ended March 31, 2003, the
accrual for severance benefits recognized in accordance with Statement of
Financial Accounting Standards No. 112, "Employers' Accounting for
Postemployment Benefits," increased by approximately $2 million. Under this
plan, approximately 1,364 employees have left or will leave the Company, of
which approximately 1,260 employees were terminated through March 31, 2003.
Approximately 46 employees were terminated during the three months ended March
31, 2003. The employees under the plan that have not been terminated will be
terminated by December 31, 2003. The plan includes reductions throughout the
Company with the majority of them from support functions.
Cash payments during the three months ended March 31, 2003 were $10
million for severance benefits and other exit costs. Severance benefits paid
during the quarter include the continuing benefit streams of previously
9
terminated employees as well as those terminated in the current period.
Severance benefits were paid in accordance with the Company's standard severance
pay plans, or in accordance with local practices outside the United States.
A reconciliation of activity with respect to the liabilities established
for these plans is as follows:
(Dollars in millions) March 31, December 31,
2003 2002
--------- ------------
Balance at beginning of year $ 22 $ 43
Additional termination benefits and other exit costs 2 25
Cash payments (10) (39)
Reversals against goodwill -- (3)
Reversals against earnings -- (2)
Transferred with discontinued operations -- (2)
------- -------
Balance at end of period $ 14 $ 22
======= =======
The balance at the end of the period represents severance benefits and
other exit costs of which $12 million pertains to the 2001 restructuring plan
and $2 million pertains to a prior year plan. The Company expects cash payments
relating to these plans to be made over the next two years.
Effective January 1, 2003, the Company adopted Statement of Financial
Accounting Standards No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities" ("SFAS 146"). SFAS 146 addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs in a Restructuring)." SFAS 146 defines the timing of the
recognition of costs associated with exit or disposal activities, the types of
costs that may be recognized and the methodology for calculating the fair value
of such costs. In the first quarter of 2003, the Company did not recognize any
costs associated with exit or disposal activities pursuant to SFAS 146.
11. Debt
A summary of short-term and long-term debt follows:
(Dollars in millions) March 31, December 31,
2003 2002
--------- ------------
SHORT-TERM:
Banks $ -- $ 1
Current maturities of long-term debt 145 144
------- -------
$ 145 $ 145
======= =======
Bank borrowings represent primarily foreign overdraft facilities and
short-term lines of credit, which are generally payable on demand with interest
at various rates. At March 31, 2003, the Company had $15 million of unused
short-term lines of credit that may be drawn as needed. There were no short-term
lines of credit in use at March 31, 2003.
10
(Dollars in millions) March 31, December 31,
2003 2002
--------- ------------
LONG-TERM:
6.60% notes due 2027 $ 100 $ 100
6.625% notes due 2003 125 125
11.125% senior notes due 2007 400 400
8% convertible subordinated debentures due 2010 3 3
Term notes at various rates from 4.07% to 8.56% due in
varying amounts through 2006 47 50
Term B loan due 2007 199 200
Other 4 4
------- -------
878 882
Current maturities of long-term debt (145) (144)
------- -------
Net long-term debt $ 733 $ 738
======= =======
On December 20, 2002, the Company completed the refinancing of its
existing senior credit facility with a new senior credit facility. The new
senior credit facility consists of a four year $125 million revolving credit
agreement and a $200 million term B loan due May 2007. In addition, the Company
has the option of borrowing an additional $50 million to $150 million on terms
identical to the term B loan. The incremental term loan will remain available
until the earlier of December 20, 2005 or the repayment of the $200 million term
B loan. In conjunction with the execution of the credit agreement, $125 million
of the proceeds of the term B loan was placed into an escrow account to pay the
principal amount of the 6.625% notes in June 2003. The escrow funds have been
recognized as restricted cash on the Consolidated Balance Sheet. The term B loan
bears interest at LIBOR + 3.25%. The revolving credit agreement bears interest
at LIBOR plus an applicable margin, currently 2.75%, which is determinable based
on the Company's leverage ratio. Interest rates are reset for one, two, three or
six month periods at the Company's option.
The new senior credit facility is secured by liens on the Company's assets
(including real, personal and intellectual properties) and is guaranteed by
substantially all of the Company's current and future wholly-owned domestic
subsidiaries.
As of March 31, 2003, $58 million of the $125 million revolver was
available for use. The Company had outstanding letters of credit associated with
the credit facility of $67 million at March 31, 2003.
The Company's new senior credit facility requires quarterly compliance
with certain financial covenants, including a debt/EBITDA ratio ("leverage
ratio") and an interest coverage ratio and establishes limitations on the
permitted amount of annual capital expenditures.
12. Company-obligated Preferred Securities of Subsidiary Trusts
Company-obligated Preferred Securities of Subsidiary Trusts consists of:
(Dollars in millions) March 31, December 31,
2003 2002
--------- ------------
9.42% Trust Originated Preferred Securities $ 363 $ 363
6 1/2% CRESTS Units 262 261
--------- ---------
$ 625 $ 624
========= =========
13. Asset Retirement Obligations
Effective January 1, 2003, the Company adopted Statement of Financial
Accounting Standards No. 143, "Accounting for Asset Retirement Obligations"
("SFAS 143"). SFAS 143, which was issued in June 2001, establishes accounting
and reporting standards for the recognition and measurement of legal obligations
associated with the retirement of tangible long-lived assets. SFAS 143 requires
that the fair value of an asset retirement obligation be recorded when incurred.
Included within the scope of SFAS 143 are environmental remediation liabilities
that resulted from the normal operation of a long-lived asset. The Company has a
number of environmental remediation liabilities associated with current and
former operations that were incurred during the course of normal operations.
The most significant differences in the measurement of these obligations under
SFAS 143 are outlined below:
11
RECORDING OF FULL OBLIGATION: SFAS 143 requires that the fair value of an
asset retirement obligation be recorded when it is incurred if a
reasonable estimate of fair value can be made. Under SFAS 143,
uncertainties (probability) in the amount and timing of settlement are
incorporated into the fair value measure of the recognized liability,
whereas under Statement of Financial Accounting Standards No. 5,
"Accounting for Contingencies," and FASB Interpretation 14, "Reasonable
Estimation of the Amount of a Loss," uncertainties are considered in
determining recognition of a liability.
PRESENT VALUE OF OBLIGATION: SFAS 143 requires that the fair value of the
asset retirement obligation be discounted using a credit adjusted
risk-free rate.
CAPITALIZATION OF COSTS RELATED TO ENVIRONMENTAL CONTAMINATION: SFAS 143
requires capitalization of costs as a component of fixed assets to the
extent there is a corresponding operating asset. EITF 90-8,
"Capitalization of Costs to Treat Environmental Contamination," permitted
capitalization of environmental remediation costs incurred in preparing a
property for sale.
With the adoption of SFAS 143, the Company recorded an increase to its
environmental remediation liabilities of $28 million with a corresponding
increase to property, plant, and equipment of $2 million and a decrease in
capitalized environmental remediation costs of $18 million, resulting in an
after-tax charge of $28 million ($44 million on a pre-tax basis), or $0.26 per
share, as a cumulative effect of a change in accounting principle.
The following table provides a reconciliation of the changes in the asset
retirement obligations during the period.
SFAS 143 Adoption
---------------------------
Balance Cumulative Capitalized Liabilities Balance
January 1, Effect Retirement (Incurred) March 31,
2003 Adjustment Obligations Settled Accretion 2003
---------- ---------- ----------- ----------- --------- ---------
Capitalized remediation costs $ 18 $ (18) $ -- $ -- $ -- $ --
Environmental Remediation
Liabilities:
SFAS 143 ARO sites (85) (26) (2) 2 -- (111)
Non-SFAS 143 sites (3) -- -- (1) -- (4)
------- ------- ------- ------- ------- -------
$ (70) $ (44) $ (2) $ 1 $ -- $ (115)
======= ======= ======= ======= ======= =======
The accretion the Company recognized during the quarter was rounded to
zero.
14. Commitments and Contingencies
GUARANTEES
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). The initial recognition and
measurement provisions of FIN 45 were applicable on a prospective basis to
guarantees issued or modified after December 31, 2002. The Company applied the
initial recognition and measurement provisions on a prospective basis effective
January 1, 2003. FIN 45 modifies existing disclosure requirements for most
guarantees and requires that at the time a company issues a guarantee, the
company must recognize an initial liability for the fair value of the obligation
it assumes under that guarantee. The Company adopted the disclosure requirements
of FIN 45 as of December 31, 2002. Disclosure about each group of similar
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. The carrying amount recorded for all
indemnifications as of March 31, 2003 was $110 million.
In addition, in connection with these transactions, the Company has
generally provided indemnifications on
12
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.
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. Approximately $1 million in cash is
held in escrow or collateral to cover certain indemnifications related to the
sale of a business in 2001.
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 various debt obligations under
agreements with third parties related to subsidiaries and affiliates, and/or
other unaffiliated companies. At March 31, 2003, the Company had directly
guaranteed $23 million of such obligations. This represents the maximum
principal amount of potential future payments that the Company could be required
to make under the guarantees. Any applicable interest and expenses would
generally be added to the amount of the obligations.
Directly guaranteed obligations include approximately $8 million of
outstanding obligations which are recorded as debt in the Company's Consolidated
Financial Statements. Existing guarantees for subsidiaries and affiliates arose
from liquidity needs in normal operations. The Company will be required to
perform on these guarantees in the event of default by the guaranteed party.
INTERCOMPANY GUARANTEES
The Company and its subsidiaries have intercompany guarantees between and
among themselves which aggregate approximately $165 million as of March 31,
2003. These guarantees relate to intercompany loans used to facilitate normal
business operations. All of the $165 million has 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.
Hercules 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 range of the reasonably possible share of costs for the investigation and
cleanup of current and former operating sites, and other locations where the
Company may have a known liability is between $115 million and $225 million. The
actual costs 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 and timing of
remedial activity required, which could range from 0 to 30.
Hercules 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.
United States, et al. v. Vertac Corporation, et al., USDC No. LR-C-80-109
and LR-C-80-110 (E.D. Ark.)
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 pending since 1980, and
involves liability for costs expended and to be expended in connection with the
investigation and remediation of the Vertac Chemical Company ("Vertac") site in
Jacksonville, Arkansas. Hercules 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
13
States, Agent Orange. In 1971, the site was leased to Vertac's predecessor. In
1976, Hercules 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 ("ADPC&E") were involved in the investigation and
remediation of contamination at and around the site. Pursuant to several orders
issued pursuant to CERCLA, Hercules actively participated in many of these
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 these activities.
Although the case initially involved many parties, as a result of various
United States District Court rulings and decisions, as well as a trial, Hercules
and Uniroyal were held jointly and severally liable for the approximately $100
million in costs allegedly incurred by the EPA, as well as costs to be incurred
in the future. That decision was made final by the District Court on September
13, 1999. Both Hercules and Uniroyal timely appealed that judgment to the United
States Court of Appeals for the Eighth Circuit.
On February 8, 2000, the District Court issued a final judgment on the
allocation between Hercules and Uniroyal finding Uniroyal liable for 2.6 percent
and Hercules liable for 97.4 percent of the costs at issue. Hercules timely
appealed that judgment. Oral argument on both appeals was held before the Eighth
Circuit on June 12, 2000. On April 10, 2001, the United States Court of Appeals
for the Eighth Circuit issued an opinion in the consolidated appeals described
above. In that opinion, the Appeals Court reversed the District Court's decision
which had held Hercules jointly and severally liable for costs incurred and to
be incurred at the Jacksonville site, 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 government's claims were divisible. The Appeals
Court also vacated the District Court's allocation decision holding Hercules
liable for 97.4 percent of the costs at issue, ordering that these issues be
revisited following further proceedings with respect to divisibility. Finally,
the Appeals Court affirmed the judgment of liability against Uniroyal.
The trial on remand commenced on October 8, 2001, continued through
October 19, 2001, resumed on December 11, 2001 and concluded on December 14,
2001. At the trial, the Company presented both facts and law to the District
Court in support of its belief that the Company should not be liable under
CERCLA for some or all of the costs incurred by the government in connection
with the site because those harms are divisible. The District Court has not yet
rendered its decision. Should the Company prevail on remand, any liability to
the government will be either eliminated or reduced from the prior judgment.
Hercules Incorporated v. Aetna Casualty & Surety Company, et al., Del.
Super., C.A. No. 92C-10-105 and 90C-FE-195-1-CV (consolidated).
In 1992, Hercules brought suit against its insurance carriers for past and
future costs for cleanup of certain environmental sites. In April 1998, the
trial regarding insurance recovery for the Jacksonville, Arkansas, site (see
discussion above) was completed. The jury returned a "Special Verdict Form" with
findings that, in conjunction with the Court's other opinions, were used by the
Court to enter a judgment in August 1999. The judgment determined the amount of
Hercules' recovery for past cleanup expenditures and stated that Hercules is
entitled to similar coverage for costs incurred since September 30, 1997 and in
the future. Hercules has not included any insurance recovery in the estimated
range of costs above. Since entry of the Court's August 1999 order, Hercules has
entered into settlement agreements with several of its insurance carriers and
has recovered certain settlement monies. The terms of those settlements and the
amounts recovered are confidential. On August 15, 2001, the Delaware Supreme
Court issued a decision in Hercules Incorporated v. Aetna Casualty & Surety
Company, et al., Del. Super., C.A. No. 92C-10-105 and 90C-FE-195-1-CV
(consolidated). In its decision, the Delaware Supreme Court affirmed the trial
court in part, reversed the trial court in part and remanded the case for
further proceedings. The specific basis upon which the Delaware Supreme Court
reversed the trial court was the trial court's application of pro rata
allocation to determine the extent of the insurers' liability. Following
settlements with two additional insurers, the terms of which are confidential,
Hercules decided not to pursue this litigation against the remaining defendants.
This matter was dismissed with prejudice on or about February 3, 2003.
The Allegany Ballistics Laboratory ("ABL") is a government-owned facility
which was operated by Hercules from 1945 to 1995 under contract with the United
States Department of the Navy. The Navy has notified Hercules that they would
like to negotiate with Hercules with respect to certain environmental
liabilities which, the Navy alleges, are attributable to Hercules' past
operations at ABL. The Navy alleges that, pursuant to CERCLA, it has spent a
total of $24.8 million and expects to spend an additional $60 million over the
next 10 years. The Company is currently investigating the Navy's allegations,
including the basis of the Navy's claims, and whether the contracts with the
government pursuant to which the Company operated ABL may insulate the Company
from some or all of the amounts
14
sought. 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 above.
At March 31, 2003, the accrued liability for environmental remediation was
$115 million. The extent of liability is evaluated 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.
While it is not feasible to predict the outcome of all pending suits and claims,
the ultimate resolution of these environmental matters could have a material
effect upon the results of operations and the financial position of Hercules,
and the resolution of any of these matters during a specific period could have a
material effect on the quarterly or annual results of that period.
LITIGATION
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. In late December 1999, the Company entered into a settlement
agreement to resolve the majority of the claims then pending. In connection with
that settlement, the Company also entered into an agreement with several of the
insurance carriers which sold that former subsidiary primary and first level
excess insurance policies. Under the terms of that agreement, the majority of
the amounts paid to resolve those products claims were insured, subject to the
limits of the insurance coverage provided by those policies. The terms of both
settlement agreements are confidential.
Since entering into those agreements, the Company has continued to receive
and settle or otherwise resolve claims on an on-going basis. Between January 1,
2002 and December 31, 2002, the Company received approximately 11,000 new
claims, approximately half of which were included in "consolidated" complaints
naming anywhere from one hundred to thousands of plaintiffs and a large number
of defendants, but providing little information connecting any specific
plaintiff's alleged injuries to any specific defendant's products or premises.
It is the Company's belief that a significant majority of these "consolidated"
claims will be dismissed for no payment. During that same time period, the
Company also received approximately 13,000 other new claims, most of which were
included in "consolidated" complaints, 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, 2003 and March 31, 2003, the Company received
approximately 6,380 new claims, of which approximately 4,040 claims were
included in "consolidated" complaints. The Company is continuing to evaluate
whether the claims experience of 2002 and the first quarter of 2003, which
represents a significant increase over prior years, is an anomaly or a new
trend.
With respect to total claims pending, as of March 31, 2003, there were
approximately 21,180 unresolved claims, of which approximately 1,055 were
premises claims. There were also approximately 2,220 unpaid claims which have
been settled or are subject to the terms of a settlement agreement. In addition,
as of March 31, 2003, there were approximately 13,340 claims (including the
13,000 claims noted in the above paragraph) which have been dismissed without
payment or are in the process of being dismissed without payment.
The Company anticipates that the primary and first level excess insurance
policies referenced above will likely exhaust over the next 1 to 2 months,
assuming that the rate of settlements and payments remains relatively consistent
with the Company's past experience. Nonetheless, 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 it and its former
subsidiary together have sufficient additional insurance to cover the majority
of its current and estimated future asbestos-related liabilities, as discussed
in the paragraph below.
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 preliminary results of the study discussed below, the
Company's evaluation of potentially available insurance coverage and its review
of the relevant case law. 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
below, that the Company's belief of the range of its reasonably possible
financial exposure could
15
change as the study referenced below continues, that its evaluation of
potentially available insurance coverage may change depending upon numerous
variables including risks inherent in litigation and the risk that one or more
insurance carriers may refuse or be unable to meet its obligations to the
Company, and that conclusions resulting from its review of relevant case law may
be impacted by future court decisions or changes in the law.
The Company is seeking defense and indemnity payments or an agreement to
pay from those carriers responsible for excess coverage whose levels of coverage
have been or will soon be reached. Although those excess carriers have not yet
agreed to defend or indemnify it, the Company believes that it is likely that
they will ultimately agree to do so, and that the majority of its estimated
future asbestos-related costs will ultimately be paid or reimbursed by those
carriers. However, if the Company is not able to reach satisfactory agreements
with those carriers prior to exhaustion of the primary and first level excess
insurance policies now covering the majority of its current asbestos-related
claims, then, beginning as early as the second quarter of 2003, the Company
might be required to completely fund these matters while it seeks reimbursement
from its carriers. In order to maximize the likelihood of obtaining insurance
payments for these liabilities, on November 27, 2002, the Company initiated
litigation against its excess insurance carriers in a matter captioned Hercules
Incorporated v. OneBeacon, et al., Civil Action No. 02C-11-237 (SCD), Superior
Court of Delaware, New Castle County. Notwithstanding the filing of this
litigation, the Company is continuing settlement discussions with several of its
key insurers.
The Company has commissioned a study of its asbestos-related liabilities.
That study, which is in progress and will continue over the next several
quarters, is being conducted by Professor Eric Stallard, who is a Research
Professor of Demographic Studies at a major national university and a Member of
the American Academy of Actuaries. Professor Stallard is a consultant with broad
experience in estimating such liabilities. Based on the initial findings of that
study, the Company estimates that its reasonably possible financial exposure for
these matters ranges from $200 million to $500 million. Due to inherent
uncertainties in estimating the timing and amounts of future payments, this
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 costs as incurred. As stated above, the Company
presently believes that the majority of this range of financial exposures will
ultimately be funded by insurance proceeds. 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.
Due to the dynamic nature of asbestos litigation and the present
uncertainty concerning the participation of its excess insurance carriers, the
Company's estimates are inherently uncertain, and these matters may present
significantly greater financial exposures than presently anticipated. In
addition, the asbestos study referenced in the above paragraph is continuing,
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 exceed present
estimates and may require a material change in the accrued liability for these
matters within the next twelve months. If the Company's liability does exceed
amounts recorded in the balance sheet, the Company presently believes that the
majority of any additional liability it may reasonably anticipate will be paid
or reimbursed by its insurance carriers.
The initial findings of the study referenced above identify a range of the
Company's reasonably possible financial exposure for these matters. The Company
is not presently able to specify its best estimate of its liability within that
range. The Company recorded a gross accrual of $225 million for present and
future potential asbestos claims before anticipated insurance recoveries
resulting in a net charge of $65 million related to these matters in the period
ended September 30, 2002. At March 31, 2003, the Company has a remaining accrual
of $205 million for the gross liability. The Company believes that it is
probable that $126 million of the $205 million accrual will be funded by or
recovered from insurance carriers. At March 31, 2003, the consolidated balance
sheet reflects a current insurance receivable of $7 million and a long-term
insurance receivable of $119 million. The Company, in conjunction with outside
advisors, will continue to study its asbestos-related exposures, insurance
recovery expectations, and reserves on an on-going basis, and make adjustments
as appropriate.
In June 1998, Hercules and David T. Smith Jr., a former Hercules employee
and plant manager at the Brunswick plant, along with Georgia-Pacific Corporation
and AlliedSignal Inc., were sued in Georgia State Court by 423 plaintiffs for
alleged personal injuries and property damage. This litigation is captioned
Coley, et al. v. Hercules Incorporated, et al., No. 98 VSO 140933 B (Fulton
County, Georgia). Plaintiffs allege they were damaged by the discharge of
hazardous waste from the companies' plants. On February 11, 2000, the Georgia
State Court dismissed Georgia-Pacific Corporation and AlliedSignal Inc., without
prejudice. In September 2000, David T. Smith Jr., was dismissed by the Georgia
State Court with prejudice. On July 18, 2000, the Company was served with a
complaint in a
16
case captioned Erica Nicole Sullivan, et al. v. Hercules Incorporated and David
T. Smith, Jr., Civil Action File No. 00-1-05463-99 (Cobb County, Georgia). Based
on the allegations contained in the complaint, this matter is very similar to
the Coley litigation, and is brought on behalf of approximately 700 plaintiffs
for alleged personal injury and property damage arising from the discharge of
hazardous waste from Hercules' plant. The Company has reached an agreement in
principle to settle the claims of all but six of these plaintiffs for an amount
which is confidential, but which is not material to the financial condition of
the Company.
In August 1999, the Company was sued in an action styled as Cape
Composites, Inc. v. Mitsubishi Rayon Co., Ltd., Case No. 99-08260 (U.S. District
Court, Central District of California), one of a series of similar purported
class action lawsuits brought on behalf of purchasers (excluding government
purchasers) of carbon fiber and carbon prepreg in the United States from the
named defendants from January 1, 1993 through January 31, 1999. The lawsuits
were brought following published reports of a Los Angeles federal grand jury
investigation of the carbon fiber and carbon prepreg industries. In these
lawsuits, plaintiffs allege violations of Section 1 of the Sherman Antitrust Act
for alleged price fixing. In September 1999, these lawsuits were consolidated by
the Court into a case captioned Thomas & Thomas Rodmakers v. Newport Adhesives
and Composites, Case No. CV-99-07796-GHK (CTx) (U.S. District Court, Central
District of California), with all related cases ordered dismissed. This lawsuit
is proceeding through discovery and motion practice. On May 2, 2002, the Court
granted plaintiffs' Motion to Certify Class. The Company is named in connection
with its former Composites Products Division, which was sold to Hexcel
Corporation in 1996, and has denied liability and will vigorously defend this
action.
Since September 2001, Hercules, along with the other defendants in the
Thomas & Thomas Rodmakers action referred to above, has been sued in nine
California state court purported class actions brought on behalf of indirect
purchasers of carbon fiber. In January 2002, these were consolidated into a case
captioned Carbon Fiber Cases I, II, and III, Judicial Council Coordination
Proceeding Nos. 4212, 4216 and 4222, Superior Court of California, County of San
Francisco. These actions all allege violations of the California Business and
Professions Code relating to alleged price fixing of carbon fiber and unfair
competition. The Company denies liability and will vigorously defend each of
these actions.
In June 2002, a purported class action was filed in Massachusetts under
the caption Saul M. Ostroff, et al. v. Newport Adhesives, et al., Civil Action
No. 02-2385, Superior Court of Middlesex County. This matter is a purported
class action brought on behalf of consumers who purchased merchandise
manufactured with carbon fiber, and alleges the same types of price fixing
activities alleged in the actions described in the above two paragraphs. In
October 2002, the Company was notified that Horizon Sports Technologies had
"opted out" of the federal antitrust class action described above (Thomas &
Thomas Rodmakers) and filed its own suit against Hercules and the other
defendants in that action (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).
Further, in April 2002, a related "Qui Tam" action was unsealed by the
U.S. District Court for the Southern District of California. That action is
captioned Randall M. Beck, et al. v. Boeing Defense and Space Group, Inc., et
al., (Civil Action No. 99 CV 1557 JM JAH), was filed under seal in 1999, and is
a "False Claims" action brought pursuant to the False Claims Act (31 U.S.C.
Section 729 et seq.). In that action, the relators, in the name of the United
States Government, allege the same price fixing activities which are the subject
of the above-described actions. The relators then allege that those alleged
price fixing activities resulted in inflated prices being charged by the
defendant carbon fiber manufacturers to the defendant defense contractors, who,
in turn, submitted claims for payment to the United States Government under
various government contracts. It is alleged that those claims for payment were
"false claims" because the prices charged for the carbon fiber and carbon
prepreg were "fixed" contrary to the laws of the United States. The Company
denies liability and will vigorously defend each of these actions.
In connection with the grand jury investigation noted above in the
paragraph describing the Cape Composites litigation, in January 2000, the United
States Department of Justice ("DOJ"), Antitrust Division, served a grand jury
subpoena duces tecum upon Hercules. The Company has been advised that it is one
of several manufacturers of carbon fiber and carbon prepreg that have been
served with such a subpoena.
On September 28, 2000, the Company sold its Food Gums Division to CP Kelco
ApS, a joint venture that the Company entered into with Lehman Brothers Merchant
Banking Partners II, L.P. CP Kelco also acquired the biogums business of
Pharmacia Corporation (formerly Monsanto Company). In April 2001, CP Kelco U.S.,
Inc., a wholly-owned subsidiary of CP Kelco ApS sued Pharmacia (CP Kelco U.S.,
Inc. v. Pharmacia Corporation U.S. District Court for the District of Delaware,
Case No. 01-240-RRM), alleging federal securities fraud, common law fraud,
breach of warranties and representations, and equitable fraud. In essence, the
lawsuit alleges that Pharmacia misrepresented the value of the biogums business,
resulting in damages to CP Kelco U.S., including the devaluation of CP Kelco
U.S.'s
17
senior debt by the securities markets. In June 2001, Pharmacia filed a
third-party complaint against the Company and Lehman. That complaint seeks
contribution and indemnification from the Company and Lehman, jointly and
severally, for any damages that may be awarded to CP Kelco U.S. in its action
against Pharmacia. The Company filed a Motion for Judgement on the Pleadings,
which was granted by the Magistrate Judge on September 19, 2002. In March 2003,
the Magistrate Judge's ruling was adopted by the District Court judge. Prior to
a trial on the case-in-chief, the District Court dismissed the Company from the
case, subject to Pharmacia's right to appeal. On April 28, 2003, a jury trial
began on the case-in-chief among CP Kelco, Lehman and Pharmacia. After the
commencement of jury deliberations, the parties reached a settlement. The terms
of the settlement are confidential. Given the settlement of the case-in-chief,
the Company believes that the District Court's earlier dismissal of the Company
would be upheld, if appealed.
In November 2002, an action for declaratory judgment was filed in the U.S.
District Court for the District of Delaware under the caption of Atofina
Chemicals, Inc. and Atofina v. Hercules Incorporated (Civil Action No. 02-1613).
In this action, Atofina seeks a declaration from the court regarding its
liability for certain damages sought by the Company as compensation for injuries
arising from the actions of Atofina, Akzo Nobel Chemicals and Clariant
(including its successor in interest, Hoechst Celanese) in fixing the prices of
monochloracetic acid and sodium monochloractetate from 1995 to 2000. The Company
in response has counter-claimed against the entities identified above and
affiliated companies for damages and injunctive relief. The matter is still in
the pleadings stage with discovery to follow. The Company has settled with one
of the parties. The terms of the settlement are confidential.
By Order dated May 6, 2003, the U.S. District Court for the Middle
District of Louisiana remanded to the 18th Judicial District Court for the
Parish of Iberville, Louisiana, a total of nine (9) consolidated lawsuits,
including two (2) lawsuits in which the Company is a defendant. These two
lawsuits are Jerry Oldham, et al. v. The State of Louisiana, et al., Civil
Action No. 55,160, 18th Judicial District Court, Parish of Iberville, Louisiana
and John Capone, et al. v. The State of Louisiana, et al., Civil Action No.
56,048C, 18th Judicial District Court, Parish of Iberville, Louisiana, were
served on the Company in September 2002 and October 2002, respectively. The
Oldham case is a purported class action comprised of approximately 2,000
plaintiffs, and the Capone case is a consolidated action by approximately 44
plaintiffs. Both actions assert claims against the State of Louisiana, the
Company, American PetroFina, Hercofina, Ashland Oil, International Minerals and
Chemicals, Allemania Chemical, Ashland Chemical and the Parish of Iberville. The
purported class members and plaintiffs, who claim to have worked or lived at or
around the Georgia Gulf plant in Iberville Parish, allege 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 allege
that the Company, itself, and then 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. On October 17, 2002, the Company removed these matters
to federal court. In January 2003, the U.S. District Court for the Middle
District of Louisiana consolidated the Capone and Oldham matters with other
lawsuits in which the Company is not a party. Plaintiffs sought remand which, as
noted above, was granted by Order dated May 6, 2003. Discovery is now beginning.
The Company denies any liability and intends to vigorously defend these matters.
On January 31, 2003, the Court granted a Motion for Class Certification in
a lawsuit captioned Douglas C. Smith, Individually and on Behalf of All Others
Similarly Situated v. Hercules Incorporated and Thomas Gossage, CA No.
01C-08-291 WCC, Superior Court of Delaware, New Castle County. This lawsuit,
which was filed on August 31, 2001, on behalf of Mr. Smith and a class of
approximately 130 present and former Hercules employees, seeks payments under
the "Integration Synergies Incentive Compensation Plan" (the "Plan"), a program
put into place by the Company following its acquisition of BetzDearborn Inc. in
October 1998. The goal of the Plan was to provide certain financial incentives
to specific employees who were deemed to have significant impact on the
integration of BetzDearborn Inc. into Hercules Incorporated. The amount to be
paid under the Plan was tied to the successful achievement of "synergies," which
were defined as the annualized reduction of expenses or improvement of profits
realized as a result of the integration of BetzDearborn Inc. into Hercules. The
lawsuit essentially alleges that the payments made under the Plan were not
adequate and that the Company breached the terms of the Plan. The lawsuit seeks
payments of between $25 million and $30 million, although the Company does not
believe that any payments are owed to the class members. In February 2003,
plaintiffs agreed to dismiss Thomas Gossage from the lawsuit. Discovery is
ongoing. The Company denies any liability to the plaintiffs and is vigorously
defending this action.
At March 31, 2003, the consolidated balance sheet reflects a current
liability of approximately $27 million and a long-term liability of
approximately $184 million for litigation and claims. These amounts represent
management's best estimate of the probable and reasonably estimable losses
related to litigation or claims. The extent of the liability and recovery is
evaluated quarterly. While it is not feasible to predict the outcome of all
pending suits and claims, the ultimate resolution of these matters could have a
material effect upon the financial position of Hercules, and the
18
resolution of any of the matters during a specific period could have a material
effect on the quarterly or annual operating results for that period.
15. Segment Information
The table below reflects Net sales and Profit from operations for the
three months ended March 31, 2003 and 2002.
(Dollars in millions) Three Months Ended
March 31,
--------------------
2003 2002
------ ------
Net sales:
Performance Products $ 356 $ 327
Engineered Materials and Additives 85 75
------ ------
Consolidated $ 441 $ 402
====== ======
Profit from operations:
Performance Products $ 56 $ 58
Engineered Materials and Additives 2 3
Reconciling Items (a) 1 (7)
------ ------
Consolidated $ 59 $ 54
====== ======
(a) Reconciling Items for the three months ended March 31, 2003 include
severance charges and income recognized as a result of a favorable
legal settlement. Reconciling items for the three months ended March
31, 2002 include restructuring charges, environmental costs and
other corporate costs not allocated to the businesses.
16. 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.
19
Condensed Consolidating Statement of Operations
Three Months Ended March 31, 2003
(Unaudited)
(Dollars in millions)
Unconsolidated
-------------------------------------- Eliminations
Guarantor Non-Guarantor &
Parent Subsidiaries Subsidiaries Adjustments Consolidated
-------- ------------ ------------- ----------- --------------
Net sales $ 129 $ 107 $ 234 $ (29) $ 441
Cost of sales 83 76 149 (27) 281
Selling, general, and administrative expenses 28 15 47 -- 90
Research and development 5 4 1 -- 10
Intangible asset amortization 2 -- -- -- 2
Other operating (income) expense, net (2) -- 1 -- (1)
-------- -------- -------- -------- --------
Profit (loss) from operations 13 12 36 (2) 59
Interest and debt expense (income), net 45 (15) (11) -- 19
Preferred security distributions of subsidiary trusts -- -- 15 -- 15
Other expense, net 1 2 1 -- 4
-------- -------- -------- -------- --------
(Loss) income before income taxes and equity income (loss) (33) 25 31 (2) 21
(Benefit) provision for income taxes (11) 9 10 -- 8
Equity loss of affiliated companies -- -- -- -- --
Equity income (loss) from consolidated subsidiaries 35 2 1 (38) --
-------- -------- -------- -------- --------
Net income (loss) from continuing operations before
discontinued operations and cumulative effect of
changes in accounting principle 13 18 22 (40) 13
Net (loss) income from discontinued operations, net of tax -- -- -- -- --
Net income (loss) before cumulative effect of changes in
accounting principle 13 18 22 (40) 13
Cumulative effect of changes in accounting principle,
net of tax (28) -- -- -- (28)
-------- -------- -------- -------- --------
Net (loss) income $ (15) $ 18 $ 22 $ (40) $ (15)
======== ======== ======== ======== ========
20
Condensed Consolidating Statement of Operations
Three Months Ended March 31, 2002
(Unaudited)
(Dollars in millions)
Unconsolidated
-------------------------------------- Eliminations
Guarantor Non-Guarantor &
Parent Subsidiaries Subsidiaries Adjustments Consolidated
-------- ------------ ------------- ----------- --------------
Net sales $ 133 $ 115 $ 200 $ (46) $ 402
Cost of sales 84 81 124 (46) 243
Selling, general, and administrative expenses 20 26 42 -- 88
Research and development 5 4 1 -- 10
Intangible asset amortization 1 1 -- -- 2
Other operating (income) expense, net (1) 4 2 -- 5
-------- -------- -------- -------- --------
Profit (loss) from operations 24 (1) 31 -- 54
Interest and debt expense (income), net 68 (23) (9) -- 36
Preferred security distributions of subsidiary trusts -- -- 15 -- 15
Other expense, net 1 1 2 -- 4
-------- -------- -------- -------- --------
Loss (income) before income taxes and equity income (loss) (45) 21 23 -- (1)
(Benefit) provision for income taxes (11) 8 5 -- 2
Equity loss of affiliated companies -- -- -- -- --
Equity income (loss) from consolidated subsidiaries 31 15 1 (47) --
-------- -------- -------- -------- --------
Net (loss) income from continuing operations before
discontinued operations and cumulative effect of changes
in accounting principle (3) 28 19 (47) (3)
Net (loss) income from discontinued operations, net of tax (209) 12 10 (22) (209)
Net (loss) income before cumulative effect of changes in
accounting principle (212) 40 29 (69) (212)
Cumulative effect of changes in accounting principle,
net of tax (368) -- -- -- (368)
-------- -------- -------- -------- --------
Net (loss) income $ (580) $ 40 $ 29 $ (69) $ (580)
======== ======== ======== ======== ========
21
Condensed Consolidating Balance Sheet
March 31, 2003
(Unaudited)
(Dollars in millions)
Unconsolidated
-------------------------------------- Eliminations
Guarantor Non-Guarantor &
Parent Subsidiaries Subsidiaries Adjustments Consolidated
-------- ------------ ------------- ----------- --------------
ASSETS
Current assets
Cash and cash equivalents $ 106 $ 6 $ 106 $ -- $ 218
Restricted cash 125 -- -- -- 125
Accounts and notes receivable, net 90 66 212 -- 368
Intercompany receivables 80 25 19 (124) --
Inventories 49 55 85 (12) 177
Deferred income taxes 20 17 2 -- 39
-------- -------- -------- -------- --------
Total current assets 470 169 424 (136) 927
Property, plant, and equipment, net 173 162 328 -- 663
Investments in subsidiaries 2,351 69 50 (2,470) --
Goodwill and other intangible assets, net 232 90 351 -- 673
Deferred income taxes 122 -- 15 (117) 20
Other assets 344 13 57 -- 414
-------- -------- -------- -------- --------
Total assets $ 3,692 $ 503 $ 1,225 $ (2,723) $ 2,697
======== ======== ======== ======== ========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities
Accounts payable $ 49 $ 17 $ 101 $ -- $ 167
Accrued expenses 91 125 57 -- 273
Intercompany payables 8 71 45 (124) --
Short-term debt 127 -- 18 -- 145
-------- -------- -------- -------- --------
Total current liabilities 275 213 221 (124) 585
Long-term debt 700 -- 33 -- 733
Deferred income taxes -- 117 71 (117) 71
Postretirement benefits and other liabilities 655 71 66 -- 792
Company-obligated preferred securities of subsidiary trusts -- -- 625 -- 625
Intercompany notes payable/(receivable) 2,171 (1,050) (1,121) -- --
Stockholders' deficit (109) 1,152 1,330 (2,482) (109)
-------- -------- -------- -------- --------
Total liabilities and stockholders' deficit $ 3,692 $ 503 $ 1,225 $ (2,723) $ 2,697
======== ======== ======== ======== ========
22
Condensed Consolidating Statement of Cash Flows
Three Months Ended March 31, 2003
(Unaudited)
(Dollars in millions)
Unconsolidated
--------------------------------------
Guarantor Non-Guarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
-------- ------------ ------------- ----------- --------------
NET CASH (USED IN) PROVIDED BY OPERATIONS $ (36) $ 15 $ 33 $ -- $ 12
CASH FLOW FROM INVESTING ACTIVITIES:
Capital expenditures (2) (2) (4) -- (8)
Proceeds of investment and fixed asset disposals -- -- 3 -- 3
Other, net -- -- 1 -- 1
-------- -------- -------- -------- --------
Net cash used in investing activities (2) (2) -- -- (4)
-------- -------- -------- -------- --------
CASH FLOW FROM FINANCING ACTIVITIES:
Long-term debt repayments (1) -- (4) -- (5)
Change in short-term debt -- -- (1) -- (1)
Change in intercompany, noncurrent 9 (14) 5 -- --
Common stock issued 5 -- -- -- 5
-------- -------- -------- -------- --------
Net cash provided by (used in) financing activities 13 (14) -- -- (1)
Effect of exchange rate changes on cash -- -- 2 -- 2
-------- -------- -------- -------- --------
Net (decrease) increase in cash and cash equivalents (25) (1) 35 -- 9
Cash and cash equivalents at beginning of period 131 7 71 -- 209
-------- -------- -------- -------- --------
Cash and cash equivalents at end of period $ 106 $ 6 $ 106 $ -- $ 218
======== ======== ======== ======== ========
23
Condensed Consolidating Statement of Cash Flows
Three Months Ended March 31, 2002
(Unaudited)
(Dollars in millions)
Unconsolidated
--------------------------------------
Guarantor Non-Guarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
-------- ------------ ------------- ----------- --------------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES OF
CONTINUING OPERATIONS $ (17) $ 32 $ (10) $ (20) $ (15)
CASH FLOW FROM INVESTING ACTIVITIES:
Capital expenditures (2) (1) (2) -- (5)
Proceeds of investment and fixed asset disposals 8 2 1 -- 11
Other, net -- (3) -- 3 --
-------- -------- -------- -------- --------
Net cash provided by (used in) investing activities of
continuing operations 6 (2) (1) 3 6
-------- -------- -------- -------- --------
CASH FLOW FROM FINANCING ACTIVITIES:
Long-term debt proceeds 155 -- -- -- 155
Long-term debt repayments (105) -- (73) -- (178)
Change in short-term debt -- -- 2 -- 2
Change in intercompany, noncurrent (46) 29 -- 17 --
Common stock issued 2 -- -- -- 2
-------- -------- -------- -------- --------
Net cash provided by (used in) financing activities of
continuing operations 6 29 (71) 17 (19)
Net cash flow (used in) provided by discontinued operations -- (67) 74 -- 7
Effect of exchange rate changes on cash -- -- (3) -- (3)
-------- -------- -------- -------- --------
Net decrease in cash and cash equivalents (5) (8) (11) -- (24)
Cash and cash equivalents at beginning of period 8 12 56 -- 76
-------- -------- -------- -------- --------
Cash and cash equivalents at end of period $ 3 $ 4 $ 45 $ -- $ 52
======== ======== ======== ======== ========
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Within the following discussion, unless otherwise stated, "quarter" and
"three-month period" refer to the first quarter of 2003 and the three months
ended March 31, 2003. All comparisons are with the corresponding period in the
previous year, unless otherwise stated.
The Company operates through two reportable segments and four divisions:
Performance Products (Pulp and Paper, Aqualon) and Engineered Materials and
Additives (FiberVisions, Pinova).
The table below reflects Net sales and Profit from operations for the
quarters ended March 31, 2003 and 2002. Substantially all reconciling items have
been allocated to the segments. The reconciling items primarily include
corporate expenses.
(Dollars in millions) Three Months Ended
March 31,
--------------------
2003 2002
------ ------
Net sales:
Performance Products $ 356 $ 327
Engineered Materials and Additives 85 75
------ ------
Consolidated $ 441 $ 402
====== ======
Profit from operations:
Performance Products $ 56 $ 58
Engineered Materials and Additives 2 3
Reconciling Items (a) 1 (7)
------ ------
Consolidated $ 59 $ 54
====== ======
(a) Reconciling Items for the three months ended March 31, 2003 include
severance charges and income recognized as a result of a favorable legal
settlement. Reconciling items for the three months ended March 31, 2002
include restructuring charges, environmental costs and other corporate
costs not allocated to the businesses.
Consolidated net sales were $441 million for the quarter, an increase of
$39 million, or 10%. Compared to the first quarter 2002, prices were flat while
volume/mix had a 3% positive impact and rate of exchange had a 7% positive
impact. Volumes improved 7% versus the prior year. Regionally, net sales
improved 2% in North America, 24% in Europe and 15% in Asia Pacific and declined
12% in Latin America. European sales were higher primarily due to the positive
impact of the weaker dollar versus the euro. Profit from operations improved $5
million, or 9%. The improvement in profit from operations was driven by higher
volumes, the positive impact of the weaker dollar versus the euro and reductions
in the Company's fixed cost structure pursuant to the comprehensive cost
reduction and work process redesign program (see Note 10) commenced in 2001;
offsetting these amounts were higher raw material and energy costs, higher
insurance expenses and higher pension and postretirement costs. Profit from
operations benefited from income recognized as a result of a favorable legal
settlement as well as lower environmental and severance charges versus the prior
year.
In the Performance Products segment, net sales grew $29 million, or 9%,
and profit from operations declined $2 million, or 3%. In the Pulp and Paper
Division, net sales growth resulted from 7% higher volumes as a result of the
supply agreement with G.E. Betz. These volumes were recorded as intercompany
sales prior to the divestiture of the Water Treatment Business. Profit from
operations in the three-month period was negatively impacted by higher energy
and raw material costs and higher pension expenses offset by lower selling,
general and administrative expenses. Demand in the North American and European
markets was weaker than expected with extended shutdowns at a number of paper
mills. In addition, weather conditions in the southeastern United States
affected wood chip supply and slowed production with a number of the Company's
customers. Aqualon experienced 12% net sales growth and a 6% improvement in
profit from operations in the quarter versus the prior year quarter. These
improvements were largely driven by 4% higher volumes and the positive effect of
rate of exchange. Volume improvements were driven largely by improved oilfield
demand as rig counts were up worldwide versus the prior year. Profit from
operations was negatively impacted by higher pension expenses.
25
In the Engineered Materials and Additives segment, net sales increased $10
million, or 13%, and profit from operations declined $1 million, or 33%.
FiberVisions net sales increased 26% as a result of the positive rate of
exchange effect, 14% higher volumes and the contractual customer pass through of
higher polymer costs. Profit from operations was flat for the quarter. Higher
volumes, resulting from increased demand for fibers in wipes and baby diapers,
were offset by higher polymer costs. FiberVisions can recover approximately 75%
of the higher polymer costs with a four to eight week lag depending on the terms
of the customer contract. Conversely, when polymer prices begin to decline, the
lag results in margin recovery. Net sales in Pinova experienced a 12% decline as
a result of 5% lower volumes and changes in product/mix. Pinova's decreased
volumes were due to lost sales from competitive pricing in the chewing gum
market. Profit from operations decreased $1 million as a result of the lower
volumes and higher pension expenses.
Interest and debt expense, and preferred security distributions of
subsidiary trusts decreased $17 million for the quarter, primarily due to lower
outstanding debt balances, reflecting the application of proceeds from the sale
of the Water Treatment Business on April 29, 2002.
The effective tax rate for the quarter for continuing operations was 38%
versus 200% for the same period 2002. The rate for the 2002 quarter was
unfavorably impacted by the mix of earnings and losses by geographic region. The
anticipated full year 2003 tax rate is approximately 38%.
DISCONTINUED OPERATIONS
On April 29, 2002, Hercules completed the sale of the Water Treatment
Business to GE Specialty Materials, a unit of General Electric Company (see Note
4). The sale price was $1.8 billion in cash, resulting in net after-tax proceeds
of approximately $1.7 billion. The Company used the net proceeds to prepay debt
under its senior credit facility and ESOP credit facility. Pursuant to SFAS 144,
the Water Treatment Business has been treated as a discontinued operation as of
February 12, 2002, and accordingly, all financial information has been restated.
The loss from discontinued operations for the three months ended March 31, 2002
includes an after-tax loss on the disposal of the business of $230 million.
The Paper Process Chemicals Business, representing approximately one-third
of the business of BetzDearborn Inc. when it was originally acquired in 1998,
was fully integrated into and continues to be reported within Pulp and Paper.
FINANCIAL CONDITION
Liquidity and Financial Resources: Net cash provided by continuing
operations was $12 million for the three-month period compared to cash used by
continuing operations of $15 million in the first quarter 2002. The current
ratio has increased to 1.60 at March 31, 2003, compared with 1.47 at December
31, 2002. The quick ratio has increased to 1.30 at March 31, 2003 from 1.20 at
December 31, 2002.
As of March 31, 2003, the Company had $58 million available under its $125
million revolving credit agreement and $15 million of unused short-term lines of
credit. The Company had outstanding letters of credit associated with the credit
facility of $67 million at March 31, 2003. The Company expects to meet
short-term cash requirements from current available cash, operating cash flow
and availability under lines of credit.
Capital expenditures are expected to be between $45 million and $58
million during 2003. On April 28, 2003, the Company announced capacity expansion
plans for the Natrosol(R) HEC (Hydroxyethylcellulose) and Natrosol(R) Plus
product lines. The expansion, which will be staged at Aqualon's production
facilities in New Jersey, Virginia and The Netherlands, is expected to begin in
the fourth quarter 2003 and to be completed by the end of 2004. The expansion
and upgrades are designed to increase annual capacity by 10,000 tons and have
the added capability to produce new products now under development.
Capital Structure and Commitments: Total capitalization (stockholders'
(deficit) equity, company-obligated preferred securities of subsidiary trusts
and debt) remained flat at $1.4 billion at March 31, 2003 from year-end 2002.
The ratio of debt-to-total capitalization decreased to 63% at March 31, 2003
from 64% at December 31, 2002. In June 2003, the $125 million 6.625% notes will
mature. The Company has placed $125 million in proceeds from the term B loan
into an escrow account to pay the 6.625% notes. The escrow funds have been
recognized as restricted cash on the Consolidated Balance Sheet.
2003 OUTLOOK
The Company has experienced higher pension, health care, insurance, energy
and raw material costs than anticipated. Energy and natural gas price spikes
caused a number of raw material prices to increase as suppliers used the
opportunity to improve
26
margins. It also caused some structural changes and reductions in capacity. The
Company expects raw material prices to remain up for some period of time.
More specifically, producers of materials derived from the chlor-alkalai,
ethylene and natural gas chains are passing through increases in commodity
prices. A combination of market tightness due to capacity consolidation,
Venezuelan production interruptions and the war in Iraq affected many downstream
products. Solvents, surfactants and a number of other raw materials came under
pressure in the first quarter as all suppliers announced price increases. In
general, realized increases were well below announced price increases.
The Company raised prices across all four divisions, the effects of which
are expected to be realized beginning in the second quarter. The U.S. dollar
continues to weaken versus the euro.
In Pulp and Paper, production is expected to remain sluggish in the
near-term. In April, Pulp and Paper announced price increases across several
product lines to offset rising raw material and energy costs. However, the
environment continues to be very difficult and requires delivery of total cost
savings to customers through new product and application technology. Over the
long-term, Pulp and Paper is forecasting production growth for the global paper
industry to be consistent with historical trends.
In Aqualon, market conditions continue to be weak, but slightly ahead of
last year. However, Aqualon has seen increases in the oilfield-related
businesses.
FiberVisions anticipates no benefit from any economic upturn in 2003.
First quarter 2003 volume increases are due to new product introduction,
pipeline fill, some gain in market share and strong customer market share.
In Pinova, market conditions remain unchanged.
CRITICAL ACCOUNTING POLICIES
Effective January 1, 2003, the Company adopted SFAS 143 (see Note 13).
Adoption of SFAS 143 resulted in the Company increasing the recorded liabilities
for environmental remediation obligations. The actual costs for environmental
remediation obligations will depend on numerous factors, including 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 and timing of
remedial activity required. SFAS 143 introduced additional variables into the
measurement of these obligations, including probability weighting of expected
cash flows, present value and assumptions regarding interest rates. Revisions to
either the timing or amount of estimated cash flows, as well as the passage of
time, will result in changes to the recorded liability.
RECENT EVENTS
On March 20, 2003, the Hercules Shareholders' Committee for New Management
filed a preliminary proxy statement with the SEC announcing that it will solicit
proxies to elect four candidates to the Board of Directors of Hercules
Incorporated at the upcoming 2003 Annual Meeting. The Committee is comprised of
International Specialty Products Inc., a privately-held international specialty
chemicals company, four current members of the Hercules Board and the
Committee's four nominees for election to the Board of Directors at this year's
annual meeting. Since the initial filing, the Committee has filed several
amendments to the preliminary proxy statement, as well as definitive additional
soliciting materials.
RISK FACTORS
Market Risk - Fluctuations in interest and foreign currency exchange rates
affect the Company's financial position and results of operations. The Company
uses several strategies from time to time to actively hedge interest rate and
foreign currency exchange rate 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 are described below. Market values are the present value of
projected future cash flows based on the market rates and prices chosen. The
market values for interest rate risk are calculated by utilizing a third-party
software model that utilizes standard pricing models to determine the present
value of the instruments based on the market conditions as of the valuation
date.
The Company's derivative and other financial instruments subject to
interest rate risk at March 31, 2003 consist of debt instruments, pension
benefit obligations and pension plan assets invested in fixed rate securities.
The debt instruments had a net market value at March 31, 2003 of $1.46 billion.
The sensitivity analysis assumes an
27
instantaneous 100-basis point move in interest rates from their current levels,
with all other variables held constant. A 100-basis point increase in interest
rates at March 31, 2003 would result in a $61 million decrease in the net market
value of the liability. A 100-basis point decrease in interest rates at March
31, 2003 would result in a $78 million increase in the net market value of the
liability.
The Company's financial instruments subject to foreign currency exchange
risk consist of foreign currency forward contracts and represent a net liability
position of $0.6 million at March 31, 2003. The following sensitivity analysis
assumes an instantaneous 10% change in foreign currency exchange rates, with all
other variables held constant. A 10% strengthening of the U.S. dollar versus
other currencies at March 31, 2003 would result in a $1.1 million increase in
the net liability position, while a 10% weakening of the dollar versus other
currencies would result in a $1.1 million decrease in the net liability position
resulting in a net asset position.
Foreign exchange forward and option contracts have been used 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 foreign
exchange rates would be in the opposite direction and substantially equal to the
impact on the instruments in the analysis. There are presently no significant
restrictions on the remittance of funds generated by the Company's operations
outside the United States.
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," as amended, and accordingly, changes in the
fair value of derivatives are recorded each period in earnings.
The assets and liabilities associated with the Company's defined benefit
pension plans are subject to interest rate and market risk. At March 31, 2003,
the accumulated pension benefit obligation ("ABO") of the U.S. defined benefit
plan was $1,227 million based on a discount rate of 6.75%. The fair value of the
U.S. defined benefit plan assets at March 31, 2003 was $923 million. The assets
of the U.S. defined benefit plan are invested as follows: $427 million in
domestic corporate equity securities, $166 million in international corporate
equity securities, $317 million in fixed income securities and $13 million in
other investments. The Company has used an 8.75% assumed rate of return on plan
assets for the U.S. plans effective January 1, 2003. A 100-basis point decrease
or increase in the discount rate has approximately a plus or minus $130 million
impact on the ABO. A 100-basis point decrease or increase in the assumed rate of
return has approximately a plus or minus $12 million impact on the U.S. pension
expense estimated for 2003.
Environmental Litigation - Hercules has been identified by U.S. federal
and state authorities as a "potentially responsible party" for environmental
cleanup at numerous sites. The estimated range of reasonably possible costs for
remediation is between $115 million and $225 million. The Company does not
anticipate that its financial condition will be materially affected by
environmental remediation costs in excess of amounts accrued, although quarterly
or annual operating results could be materially affected (see Note 14).
Environmental remediation expenses are funded from internal sources of
cash. Such expenses are not expected to have a significant effect on the
Company's ongoing liquidity. Environmental cleanup costs, including capital
expenditures for ongoing operations, are a normal, recurring part of operations
and are not significant in relation to total operating costs or cash flows.
Other Litigation - Hercules is a defendant in numerous lawsuits that arise
out of, and are incidental to, the conduct of its business. These suits concern
issues such as product liability, contract disputes, employee-related matters,
patent infringement, environmental proceedings, property damage and personal
injury matters. 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"). The Company's estimated liability and insurance
recoveries are based on numerous assumptions regarding the number of future
claims, the cost of settlements, potential insurance recoveries and other
variables. While the Company believes its estimates are reasonable, there can be
no assurance that these assumptions will prove to be correct and the Company's
actual experience may differ materially over time. Since it is not feasible to
predict the outcome of all pending suits and claims, the ultimate resolution of
these matters could have a material effect upon the financial position of
Hercules, and the resolution of any of the matters during a specific period
could have a material effect on the quarterly or annual operating results for
that period (see Note 14). The Company anticipates that its primary and first
level excess insurance policies will likely exhaust over the next 1 to 2 months,
assuming that the rate of settlements and payments remains relatively consistent
with the Company's past experience. Nonetheless, based on the current number of
claims pending, the amounts the Company anticipates paying to resolve those
claims which are not dismissed or
28
otherwise resolved without payment, and anticipated future claims, the Company
believes that it and its former subsidiary together have sufficient additional
insurance to cover the majority of its current and estimated future
asbestos-related liabilities.
FORWARD-LOOKING STATEMENTS
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, ability to raise
capital, ability to refinance, the result of the pursuit of strategic
alternatives, ability to execute work process redesign and reduce costs,
business climate, business performance, economic and competitive uncertainties,
higher manufacturing costs, reduced level of customer orders, changes in
strategies, risks in developing new products and technologies, environmental and
safety regulations and clean-up costs, foreign exchange rates, 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, or the inability to
eliminate or reduce such financial exposures by collecting indemnity payments
from insurers, the impact of increased accruals and reserves for such exposures,
and adverse changes in economic and political climates around the world,
including terrorist activities and international hostilities. 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. 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For discussion of quantitative and qualitative disclosure about market
risk, see "Risk Factors" under Item 2, Management's Discussion and Analysis of
Financial Condition and Results of Operations.
ITEM 4. CONTROLS AND PROCEDURES
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and Vice President and Controller, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures
pursuant to Exchange Act Rule 13a-15 as of March 31, 2003. Based upon that
evaluation, the Company's Chief Executive Officer and Vice President and
Controller 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
or in other factors that could significantly affect internal controls subsequent
to the date the Company carried out this evaluation.
29
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
For information related to Legal Proceedings, see Notes to Financial
Statements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Please see the exhibits listed on the Exhibit Index.
(b) Reports on Form 8-K
Date of Report Item No. Financial Statements Included
-------------- -------- -----------------------------
February 13, 2003 5, 12 Yes
30
HERCULES INCORPORATED
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HERCULES INCORPORATED
By: /s/ Stuart C. Shears
--------------------------------------
Stuart C. Shears
Vice President and Treasurer
(Principal Financial Officer and duly
authorized signatory)
May 15, 2003
By: /s/ Fred G. Aanonsen
--------------------------------------
Fred G. Aanonsen
Vice President and Controller
(Principal Accounting Officer and duly
authorized signatory)
May 15, 2003
31
HERCULES INCORPORATED
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, William H. Joyce, Chairman and Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Hercules
Incorporated;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report.
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
/s/ William H. Joyce
- ------------------------------------
William H. Joyce
Chairman and Chief Executive Officer
May 15, 2003
32
HERCULES INCORPORATED
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Fred G. Aanonsen, Vice President and Controller, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Hercules
Incorporated;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report.
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
/s/ Fred G. Aanonsen
- -----------------------------
Fred G. Aanonsen
Vice President and Controller
May 15, 2003
33
HERCULES INCORPORATED
EXHIBIT INDEX
NUMBER DESCRIPTION
10-A* Amended and Restated Hercules Incorporated Management
Incentive Compensation Plan, dated February 21, 2003
10-B* Hercules Deferred Compensation Plan, restated December 1995
10-C* Employment Offer Letter - Fred G. Aanonsen, dated June 27,
2001
10-D* Employment Offer Letter - Robert C. Flexon, dated May 12, 2000
10-E* Hercules Executive Survivor Benefit Plan II dated January 1,
1987- Benefit structure is only applicable to one executive
officer
99.1* Certification of Chairman and Chief Executive Officer Pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
99.2* Certification of Vice President and Controller Pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
* Filed herewith
34